Developments in contract: contractual interpretation and commercial common sense

The principles

The process of interpreting a contract requires a court to identify the intention of the parties by reference to what a reasonable person, having all the background knowledge the parties had at the time of contracting, would have understood them to mean by the wording of the contract.

The meaning of a contractual provision is most obviously gleaned from the language that the parties chose to use. The starting point is therefore the natural meaning of the words.

A court should not reject the natural meaning of a provision simply because it appears commercially imprudent or even disastrous for one of the parties. The purpose of interpretation is to identify what the parties have agreed, not what the court thinks they should have agreed.

The less clear a provision (or the worse the drafting):

• the more ready a court will be to depart from its natural meaning, and
• the more that commercial common sense can be invoked (where, for example, a provision is capable of bearing two clear alternative meanings or there has been an “obvious mistake”, commercial common sense is likely to be very important).

Recent developments

The Supreme Court’s decision in Arnold v Britton may be referred to in years to come as marking the English courts’ shift back towards a more literal interpretation of contracts. In this case, the Supreme Court upheld clear contractual wording despite the fact that it appeared to result in a commercially disastrous bargain for one of the parties.

However, in Europa Plus v Anthracite Investments, the High Court said that a term did not have to be “absurd” before the court will fail to give effect to it. If a literal interpretation of it would mean that the agreement lacked practical and commercial coherence, the court could depart from the natural meaning of the words.

In LBG Capital v BNY Mellon, the Court of Appeal emphasised that the reasonable person interpreting the parties’ contract should be taken as having an informed understanding of the matters to which the contract relates, even if it is sufficiently technical to require advice from a specialist third party advisor.

What this means

• The tide seems to be shifting under English law towards a more literal approach to contractual wording. Parties will need to focus less on commercial common sense and more on the literal meaning of their contractual language.
• At the drafting stage, care needs to be taken to ensure that the meaning intended by the parties would be objectively clear to a third party. If there is the potential for any ambiguity, then irrespective of the commercial context in which the language operates, this should be cured at the drafting stage.
• Parties should be wary of bringing or defending any claims on the basis of a bad commercial bargain; if the relevant wording of the contract is clear, then the court is unlikely to be sympathetic to the party’s claim.