Update: commercial contracts

Correction of mistakes by construction

In Chartbrook v Persimmon Homes [2009] UKHL 38 (see solicitorsjournal.com, 3 July 2009) Lord Hoffmann qualified the conditions by which courts can deal sympathetically with unfortunate drafting in commercial contracts; or, as he expressed it, the 'correction of mistakes by construction'.

Following East v Pantiles (Plant Hire) Ltd [1982] 263 EG 61, he made it clear that 'there must be a clear mistake on the face of the instrument' and that 'it must be clear what correction ought to be made in order to cure the mistake' by establishing that 'the background and context must always be taken into consideration' not merely 'the face of the instrument'.

The effect of this has been to broaden the scope for a court to correct errors by interpretation.

However, the following two recent cases illustrate not only how difficult it is to discern whether there has been a mistake or not but also that one cannot infer that there has been a mistake merely because there is an uncommercial or surprising outcome. Indeed, it is not easy to rationalise the arguably different approaches of these two cases.

Uncommercial terms

In Kookmin Bank v (1) Rainy Sky SA & 6 Ors [2010] EWCA Civ 582, the question was whether 'all such sums' in the sentence 'we undertake to pay to you'¦ all such sums due to you under the contract' referred to all sums under the contract or just those sums mentioned in the previous paragraph. The leading judgment of Patten LJ favoured the latter. It contains a useful summary of the current law on construction of commercial contracts. It also squarely answered the concerns of the first-instance judge and the dissenting judgment of his fellow lord justice, Sir Simon Tuckey, that a court should not allow a result which 'defies commercial common sense'.

Patten LJ warned: 'Unless the most natural meaning of the words produces a result which is so extreme as to suggest that it was unintended, the court has no alternative but to give effect [to] its terms. To do otherwise would be to risk imposing obligations on one or other party which they were never willing to assume and in circumstances which amount to no more than guesswork on the part of the court.'

Nevetheless, the existence of the dissenting judgment and the following case indicate that some judges would prefer to dismiss or reinterpret, rather than to enforce, some uncommercial terms resulting from unfortunate drafting.

In Rooney & Anor v CSE Bournemouth Ltd (trading as CSE Citation Centre) [2010] CA (Civ Div), three judges felt they could reinterpret seriously uncommercial terms. The court confirmed that the statement 'terms and conditions available on request' on a work order incorporated those terms and conditions into the contract. It found that the first instance judge had erred in finding that the words used could not be said to have incorporated the standard conditions of trading because:

• the work order form was a contractual document that took its place in a contractual maintenance scheme whereby the work order form activated the work,and nature of work, to be done;
• while the judge's literal interpretation of the words used ('you can see and incorporate our terms if you want') might have been correct grammatically, in a business context it would be odd; and
• it was at least arguable that a reasonable person would have understood the words used as referring to contractual terms upon which the supplier had agreed to work.

Putting the Kookmin and Rooney judgments side by side, it is difficult to draw final conclusions as to, or advise clients, how the courts will interpret terms which, as a result of their poor drafting, are uncommercial.

While the principle seems to be that 'the reasonable person with knowledge' test will be applied until the effect of the mistake becomes irrational, absurd or unintentional '“ whereupon the courts will reinterpret or ignore the term '“ it is not at all clear where that line will be drawn. There also seems an inherent conflict with both:

• the conclusion from Chartbrook that an agreement might be a bad bargain was not a sufficient reason for supposing that it did not mean what it said; and
• the general rules exemplified recently by Cedric Aymard v Sisu Capital Limited [2009] EWHC 3214 (QBD).

Rectification

In Cedric, following Liverpool City Council v Irwin [1977] AC 239 HL, a term would not be implied just because it would be reasonable to do so, or just because it would improve the contract or make its carrying out more convenient. Furthermore, the judge confirmed that a court would only imply a term into a contract on the basis that it was 'necessary for the business efficacy' of the contract where without that term the contract would not work. The touchstone for implying a term remained, said the judge, necessity rather than reasonableness (following Mediterranean Salvage & Towage Ltd v Seamar Trading & Commerce Inc (The Reborn) [2009] EWCA Civ 531).

In those instances, therefore, where the outcome of the court's view of the offending clause is uncertain, it may be wise (if the facts suit such an application) to apply in the alternative for the remedy of rectification, even if such applications are more expensive, if the remedy is equitable and if the evidence must be 'strong irrefragable evidence' (Lake v Lake [1989] STC 865).

The following two contrasting recent cases illustrate how such applications can stand and fall.

In Traditional Structures Ltd v HW Construction Ltd [2010] EWHC 1530 (TCC), a sub-contractor's tender did not, by its own error, include the price for cladding works. The court found that the facts contained the four necessary elements identified in Thomas Bates & Son Limited v Wyndham's (Lingerie) Limited [1981] 1 WLR 505 CA (Civ Div) for a claim for rectification on the grounds of unilateral mistake to succeed:

(i) the claimant believed that the document contained the relevant term (in this case, the price for some cladding);

(ii) the defendant knew the claimant has made a mistake (in this case, the mistake was obvious to the defendant who 'wilfully and recklessly''¦ 'shut [its] eyes to the obvious, the obvious being that the price quoted was demonstrably or self evidently a price that related only to structural steelwork');

(iii) the defendant failed to notify the claimant of the mistake (in this case, it failed to ask whether the quoted price related to both the steelwork and cladding); and

(iv) the defendant unconscionably benefited from that mistake (in this case, 'in a manner which went beyond the boundaries of fair dealing, even bearing in mind that the parties were involved in an arm's length commercial transaction').

While the courts take a purely objective view of a contract in determining the meaning of a contractual term or whether it is necessary to imply a term, the court looks at the matter subjectively when considering whether one party has unconscionably benefited from the other's unilateral mistake.

In Daventry District Council v Daventry & District Housing Limited [2010] EWHC 1935 (Ch), the local authority failed to obtain rectification of a contract for the transfer to a social landlord of its stock of housing. The contract provided for the local authority to meet the cost of the local authority's pension scheme deficit of £2.4m. It argued that the contract should have, but for the parties' common mistake, required the social landlord to pay it.

Furthermore, it asserted that the relationship and the circumstances had created a mutual duty of care that 'neither would seek to benefit from the other's misunderstanding of any aspect of the transaction or mistake, but would draw such misunderstandings or mistake to the other's attention'. On the facts, the court held that there was no such mistake. By reference to the correspondence between the parties' solicitors, the court established that they had intended an unambiguous clause to the effect that the local authority would pay the pension deficit.

More interesting was the claim that there was a mutual duty to announce the other's mistakes. The parties had agreed in a memorandum of understanding to 'work within partnership principles' and to avoid 'causing any detriment to the other'. The court held that this did not give rise to any such duty of care. Mr Justice Vos said: 'If it did, it would make the negotiation of commercial transactions unworkable, uncertain and risky. Parties negotiating transactions must know where they stand.

'Whatever they may say to one another about behaving well, they must know that they will only owe duties of care to each other if their relationship goes some way beyond that of arm's length counterparties. I cannot speculate as to where that line might in other cases be crossed, but, in my judgment, it is far from being crossed here.

'Moreover, such duties were not necessary. If the requirements of common mistake or unilateral mistake were satisfied, the contract would be rectified'¦ To extend the law of negligence in the way suggested'¦ would be a retrograde step in the development of the English law of commercial contracts.'

Entire agreement clauses

Finally, the High Court has this summer confirmed, as has long been thought likely, the principle in JJ Huber Ltd v The Private DIY Co Ltd [1995] (unreported) that an entire agreement clause does not prevent the court from rectifying the agreement where the parties had made a unilateral mistake extends to include instances of common mistake (Surgicraft Limited v Paradigm Biodevices Inc [2010] EWHC 1291 (Ch)).

The judge held that an entire agreement clause in a distribution agreement which should have provided compensation for the distributor if the supplier terminated on a change of control did not prevent rectification, as its purpose was only 'to limit possible contractual claims arising from dealings outside the contract' not to oust the court's jurisdiction to rectify the contract where there had been a common mistake.

The overriding lesson is obvious: contracts must say what they mean. The courts will not lightly reinterpret contracts or, without necessity, imply terms. Care must be taken not to include extraneous words '“ the Kookmin case would never have occurred but for the carefree addition of the word 'such'. As for obvious mistakes, the discretion to point out a mistake may well be cheaper than hoping the mistake will be honoured in the fullness of time.