Contractual Interpretation: The Limits of Commerciality

In the recent decision of the English Supreme Court in Arnold v Britton [2015] UK SC 36 Lord Carnwath said “As Tolstoy said of unhappy families, every ill-drafted contract is ill-drafted ‘in its own way’”. So what of the contract whose natural meaning is clear but which has absurd or draconian consequences for one of the parties? Will the court try to give an interpretation which better reflects the commerciality of the situation, whatever the natural meaning, or will it only do so if the natural meaning is ambiguous? Arnold v Britton firmly reiterates that the latter approach is the correct one.

The Rainy Sky Approach

As is well known, over the last 45 years there has been a fundamental change in the way that the common law courts have construed commercial contracts, which has involved a move away from literal interpretation to one where contracts are construed against their background in a way intended to give effect to their commercial purpose. So in what is now the oft cited Rainy Sky SA v Kookmin Bank [2011] UKSC 50 (considered, for example, in Hong Kong in Sinoearn International Ltd v Hyundai-CCECC Joint Venture [2013] HKEC 1558, para. 76 per Mr Justice Tang PJ) it was held by the English Supreme Court that “where a term of a contract is open to more than one interpretation, it is generally appropriate to adopt the interpretation which is most consistent with business common sense” (per Lord Clarke at para. 30). Previously some courts, such as the majority of the Court of Appeal in Rainy Sky SA, had taken the more restrictive view that a purposive construction was only permissible where a literal interpretation flouted business common sense.

The consequence of the decision is that if the wording of the contract, construed against its factual background, gives rise to an ambiguity with competing potential interpretations, then the courts can and will adopt a purposive approach.

Arnold v Britton

The decision in Arnold v Britton has, however, signalled a very clear reminder that there is a limit to the extent to which a court can be creative in its interpretative role. There it was decided that where the natural meaning of the wording is not ambiguous it is not open to the court to re-interpret the contract to give it a purposive meaning even if the interpretation might be regarded by some (as it was by Lord Carnwath, the dissenting Supreme Court Justice) to be absurd or draconian in its effect.

The construction which was adopted had the harshest consequences. It meant that individuals who had bought 99 year leases of small, modest holiday units were subject to service charges which would not bear any relationship to the services which the landlord had provided; and would be subject to an automatic escalation every year on a base figure of £90 (equivalent to roughly HK$1,060) at a compound rate of 10 percent so that by the year 2072 a lessee of a lease granted in 1980 would be paying an annual service charge of over £550,000 (or roughly HK$6,516,000), a sum wholly disproportionate to the cost of the services provided.

The Principles

In this decision, Lord Neuberger made these important observations.

First, the reliance placed in some cases on commercial common sense and surrounding circumstances should not be invoked to undervalue the importance of the language of the provision which is to be construed.

Second, when it comes to considering the centrally relevant words to be interpreted, the less clear they are (ie, the worse their drafting, the more ready the court can properly be to depart from their natural meaning).

Third, commercial common sense is not to be invoked retrospectively: the mere fact that a contractual arrangement, if interpreted according to its natural language, has worked out badly, or even disastrously, for one of the parties, is not a reason for departing from the natural language.

Fourth, while commercial common sense is a very important factor to take into account when interpreting a contract, a court should be very slow to reject the natural meaning of a provision as correct simply because it appears to be a very imprudent term for one of the parties to have agreed: the purpose of interpretation is to identify what the parties have agreed, not what the court thinks they should have agreed.

Fifth, when interpreting a contractual provision, one can only take into account facts or circumstances which existed at the time the contract was made and were known or reasonably available to both parties.

Sixth, in cases where an event subsequently occurred which was plainly not intended or contemplated by the parties judging from the language of their contract, but where it is clear what the parties would have intended, the court will give effect to that intention. (See, for example, Aberdeen City Council v Stewart Milne Group Ltd [2011] UKSC 114.)

The Position Post-Arnold v Britton
If the strict approach in Arnold v Britton is adopted in Hong Kong then what are the likely consequences?

First, if there is unambiguous language then the court must apply it however harsh the consequences may be for a party (a point in fact made by Lord Clarke in Rainy Sky itself).

Second, it will, however, still be possible to point to an ambiguity by reference not only to the wording of the contract itself but by reference to that wording viewed against the admissible factual background. So if there is any ambiguity then the court may approach interpretation purposively in accordance with Rainy Sky principles. In Arnold v Britton there was little background material deployed, and what was produced did not create an ambiguity.

Third, parties will not be allowed to establish that an ambiguity exists (and that a purposive approach be taken) by merely pointing to the absurd consequences of a possible interpretation. If the natural meaning is clear, and there is nothing in the background to displace it, then the clear meaning must be applied.

As it was said by Lord Hope in Melanesian Mission Trust Board v Australian Mutual Provident Society (1997) 74 P&CR 297 at para. 301 (which was a Privy Council appeal from New Zealand and involved the interpretation of the provisions of a commercial lease in Auckland) in a passage which did not feature in the judgments in Arnold v Britton, but which clearly and succinctly states the position:

[W]here ordinary words have been used, they must be taken to have been used according to the ordinary meaning of these words. If the meaning is clear and unambiguous, effect must be given to them because that is what the parties have taken to have agreed to by their contract. Various rules may be invoked to assist interpretation in the event that there is an ambiguity. But it is not the function of the court, when construing a document, to search for an ambiguity. Nor should the rules which exist to resolve ambiguities be invoked in order to create an ambiguity which, according to the ordinary meaning of the words, is not there… unless the context shows that the ordinary meaning cannot be given to them or that there is an ambiguity, the ordinary meaning of the words which have been used in the document must prevail”.

Conclusion

Come what may, given the protean nature of words, there will inevitably still be argument as to what the natural meaning of the relevant wording is. Indeed there was such a debate in Arnold v Britton, albeit the majority thought that the meaning of the contractual terms was clear. Moreover, where there is an ambiguity (and so Rainy Sky can be invoked), there will still be argument as to the commercial purpose of the contract and what competing interpretation is more consistent with that purpose.

Barrister, Gilt Chambers