Contractual interpretation: where do we stand after Arnold v Brittan and Rainy Sky?

Summary

In Arnold v Britton, the Supreme Court upheld (by a 4:1 majority) a literal interpretation of a contractual service charge adjustment mechanism, despite the fact that it had disastrous commercial implications for one of the parties. Lord Neuberger, giving the leading judgment, emphasised the importance of the contractual wording used by the parties and its natural meaning. Lord Hodge, also in the majority, relied upon Lord Clarke’s frequently-cited formulation of the “unitary process of construction” in the Rainy Sky case, and emphasised that it was not the court’s function to re-write the parties’ contract so as to improve their contractual bargain.

The Arnold case has been interpreted by some practitioners as signalling a slight shift by the English courts, from the use of business common sense as an aid to interpretation to a more literal approach towards contractual wording. In our view, this is consistent with Lord Neuberger’s judgment in Arnold and in various speeches he has made, in which he has suggested that judges should be wary of placing too much emphasis on business common sense.

Lord Neuberger has, however, emphasised in a recent speech that his judgment in Arnold was not intended to change the law. This may help to explain the Supreme Court’s judgment in the recent case of Wood v Capita, in which Lord Hodge (giving the only judgment) emphasised that Arnold and Rainy Sky are consistent with each other and that the correct approach to contractual interpretation is the “unitary process” explained by Lord Clarke in Rainy Sky. In an attempt to reconcile the two cases, and emphasise that both language and commercial circumstances are still relevant, Lord Hodge said:

“Interpretation is, as Lord Clarke stated… a unitary exercise; where there are rival meanings, the court can give weight to the implications of rival constructions by reaching a view as to which construction is more consistent with business common sense. But, in striking a balance between the indications given by the language and the implications of the competing constructions the court must consider the quality of the drafting of the clause… and it must also be alive to the possibility that one side may have agreed to something which with hindsight did not serve his interest” (paragraph 11).

What does this mean?

Given Lord Neuberger’s comments about his judgment in Arnold, and Lord Hodge’s judgment in Wood, it can safely be said that the law on contractual interpretation has not fundamentally changed. Accordingly:

• Lord Clarke’s formulation, as developed by Lord Hodge (above), still represents the Courts’ approach to contractual interpretation, and
• business common sense is still a relevant consideration in the contractual interpretation process.

However, Lord Neuberger’s emphasis in Arnold on the natural meaning of contractual wording, and his comments about business common sense, should not be ignored. We still expect that English courts will be wary of the extent to which they will allow business common sense to assist in their interpretation of parties’ contracts. Accordingly, contracting parties should ensure that:

• They continue to consider carefully the precise wording they include in their contracts. In the Wood case (as explained below), the relevant provision appeared to be cogent and comprehensive, but in fact contained a subtle ambiguity which, ultimately, deprived Capita of a significant sum of money.
• They consider all of the possible commercial scenarios in which their contractual provisions could become relevant. The Courts will not rescue the parties if their contract leads to a bad bargain. Any possibility of this should be cured at the drafting stage.

The Supreme Court’s decision in Wood may be relied upon by the Courts in any future decisions concerning contractual interpretation. However, it is likely to be Lord Hodge’s comments, rather than the facts of the case, which are relevant.

For the interested reader, a summary of the facts and decision in Wood are set out below.

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Wood v Capital

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Background

• In 2010, Mr Wood sold to Capita his shares in a company called Sureterm, which was concerned with selling various motor insurance policies to consumers. After the share sale, Capita discovered that Sureterm had potentially mis-sold various insurance policies between 2009 and 2011.
• Capita informed the FSA of the issue and, in 2012, it was agreed that compensation would be paid to the affected customers. Capita subsequently brought a claim against Mr Wood pursuant to an indemnity provision in the SPA. (The SPA also contained wide-ranging warranties under which Capita could have brought a claim, however, the parties had agreed in the SPA a two-year time limit for a warranty claim).

The specific issue to be decided in this case was whether, under the wording of the indemnity provision, Mr Wood was liable to indemnify Capita even if there had been no claim or complaint made by a customer.

The High Court held that Mr Wood was so liable, but this was overturned by the Court of Appeal.

Supreme Court decision and comments on contractual interpretation

The Supreme Court agreed with the Court of Appeal and held that Mr Wood was not liable to indemnify Capita for any losses where a customer had not made a claim or complaint. Lord Hodge appears to have arrived at this decision on the basis of: 

• principally, the wording of the indemnity provision, which he analysed in considerable detail (paragraphs 29-38), ultimately preferring Mr Wood’s contended interpretation, and
• the commercial context - the wide-ranging warranties could have provided Capita with a claim, if it had brought this within the two-year time limit. The existence of these warranties supported a narrower interpretation of the indemnity provision, as contended by Mr Wood (paragraph 40).

Lord Hodge concluded that: “From Capita’s standpoint the SPA may have become a poor bargain… But it is not the function of the court to improve their bargain” (paragraph 41).

The significance of this case stems more from the Supreme Court’s comments in relation to contractual interpretation. As well as the comment cited above, Lord Hodge also said the following:

• “It is not appropriate in this case to reformulate the guidance given in Rainy Sky and _Arnold_…but…I do not accept the proposition that Arnold involved a recalibration of the approach summarised in _Rainy Sky_… Rainy Sky and Arnold were saying the same thing” (paragraphs 9 and 14).
• “The court’s task is to ascertain the objective meaning of the language which the parties have chosen to express their agreement… The court must consider the contract as a whole and, depending on the nature, formality and quality of drafting of the contract, give more or less weight to elements of the wider context in reaching its view as to that objective meaning” (paragraph 10). 
• “Textualism and contextualism are not conflicting paradigms in a battle for exclusive occupation of the field of contractual interpretation… Some agreements may be successfully interpreted principally by textual analysis, for example because of their sophistication and complexity and because they have been negotiated and prepared with the assistance of skilled professionals. The correct interpretation of other contracts may be achieved by a greater emphasis on the factual matrix, for example because of their informality, brevity or the absence of skilled professional assistance” (paragraph 13).