Court of Appeal lays down new test for rectification of contracts based on common mistake

The Court of Appeal has held that when considering whether or not a contract should be rectified because it does not reflect the parties’ common intention, that intention is to be judged subjectively rather than objectively, unless the intended terms are specified in an earlier binding contract. In doing so, the court departed from a significant obiter statement to the contrary in an earlier case.

Legal background

Rectification allows a court to amend a legal document if, because of a common mistake, it does not reflect the intention of the parties. In an influential, but controversial judgment in Chartbrook Ltd v Persimmon Homes Ltd [2009] UKHL 38, Lord Hoffmann expressed the obiter view that the intention of the parties was not to be established subjectively by evidence as to the parties’ actual state of mind, but objectively, by deciding what an impartial observer would have concluded with knowledge of the background facts and communications between the parties.

Facts

In FSHC Group Holdings Ltd v GLAS Trust Corporation Ltd [2019] EWCA Civ 1361, FSHC entered into a complex corporate acquisition. Due to an oversight, part of the intended security was omitted from the documentation. When this was spotted, FSHC agreed to correct the omission by acceding to two pre-existing security agreements. These agreements contained onerous additional obligations. At first instance, Carr J found that no-one involved in the transaction at the time had reviewed the security agreements, and therefore no-one had realised that the accession agreements would have the effect of binding FSHC to the additional obligations. He held that this result was both objectively and subjectively unintended, so that it did not matter whether the objective or subjective test was correct. He therefore granted rectification of the accession agreements so as to exclude the additional obligations. GLAS appealed on the basis that

• The correct test was objective; and

• An impartial observer would have concluded that the parties intended the additional obligations to be binding on FSHC.

Decision

After a detailed review of previous case law, the Court of Appeal concluded that Lord Hoffman’s remarks in Chartbrook did not correctly state the law. The court distinguished two scenarios:

1. Contract to execute: If the parties make a binding contract which requires them to execute a document containing particular terms, but the document they eventually execute mistakenly contains different terms, then the court can rectify the executed document. This should be understood as a type of order for specific performance of the agreement to execute the document. As such, the usual contractual test should be applied, which is an objective test.

1. No prior contract: If a document is executed without a prior contract, but by mistake the parties’ common intention at the time of executing the document is not reflected in its actual terms, then the court can rectify the document based on the equitable principle of good faith. The test in this case is subjective, since good faith is ultimately concerned with a party’s conscience. However, the parties must not merely have had the same subjective intention, but must have communicated that intention to each other. Only if the parties understood that they had a shared intention would it subsequently be unconscionable to take advantage of the common mistake.

The court acknowledged that the need to prove the parties’ state of mind creates a significant obstacle to rectification. However, the court saw this as a positive feature, since the written words of a contract should have primacy except in rare circumstances.

On the facts of FSHC, the Court of Appeal held that there was no prior contract, so the applicable test was subjective. Based on the findings at first instance, there had been a shared subjective intention as to the legal effect of the supplemental deeds that had been communicated by FSHC to the lender. As a result, the judge’s order to rectify the contract would stand and the appeal would be dismissed.

Comment

This is an important judgment which clearly sets out the tests to be applied in claims for rectification and when each one should be used. With its focus on the parties’ actual intention in any case where there was no formal prior contract, it is likely to lead to a more commercial approach by the courts than that suggested in Chartbrook. However, the court’s insistence that rectification should be rare and not easily achieved is a reminder that parties should closely scrutinise the wording, not just of the contract they intend to sign, but of any other document to which the contract refers.

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