Contractual interpretation post-Arnold v Britton

The decision of the English Supreme Court in Arnold v Britton [2015] UKSC 36 was widely viewed as marking a shift to a more literal interpretation of contracts and away from the purposive or commercial approach adopted in Re Sigma Finance [2009] UKSC 2 and Rainy Sky v Kookmin Bank [2011] UKSC 50. Lord Neuberger stated in Arnold v Britton that “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.” In other words, Lord Neuberger sought to give greater weight to the words used in the contract (“the parties have control over the language they use in a contract”) and to deter the courts from re-writing agreements to reflect the courts view of commercial common sense.

This article examines some of the cases that have considered contractual interpretation since Arnold v Britton, to identify to what degree it has been followed.

In summary, it seems that the courts have attached more weight to the language chosen by the parties and generally settled on more literal interpretations of contracts. However, subsequent cases have, at least in theory, also heeded sections of the judgment stating that words should be read in their “documentary, factual and commercial context” and have noted that these other factors could be of significant importance in an appropriate case. Moreover, the most recent decision of the Supreme Court, Wood v Sureterm Direct Ltd [2017] UKSC 24, sought to bridge the divide between literal and purposive approaches and cautioning against the suggestion that Arnold v Britton marked a departure from earlier practice.

Exsus, which concerned the interpretation of a standstill agreement, is a clear application of the more literal approach to contractual interpretation. The issue arose in the context of a claim for professional negligence against auditors. Recital (B) of the standstill agreement provided that: “The purpose of the Agreement is to suspend the running of the applicable limitation period both in contract and tort in respect of the [relevant claims] for a period of 12 months from the date of this Agreement or any later date agreed in writing by the Parties or until this Agreement is terminated in accordance with its terms (the “Standstill Period”).”

The agreement did not contain any provisions permitting termination of the “Agreement”, but clause 3 did allow the parties to terminate the “Standstill Period” “at any time” on at least 28 days’ written notice.

The judge decided that the recital divided “clearly” into two parts: “(a) a period of 12 months from the date of this Agreement or any later date agreed in writing by the Parties” and “(b) until this Agreement is terminated in accordance with its terms”. The judge further held that the second part of Recital (B) must refer to the Standstill Period termination right, as although the drafting was “imprecise” this intention was “clear”.  On the facts, the Standstill Period had not been extended or terminated early, so it expired 12 months after the agreement was made applicable to the claims.

The claimants had argued that the construction of Recital (B) was untenable when considered in its commercial and factual context, particularly because it was unrealistic for the claimant to commence proceedings within one year, due to other pending litigation. The judge stated that the claimant’s construction was “not saved by reference to the factual matrix, partly because there is no need to depart from the natural meaning of the words”.

The judgment of Hamblen LJ in this case is another faithful application of Arnold v Britton, focusing primarily on the language selected then cross checking against the wider context and commerciality. The case concerned the final redemption amount payable by the issuer (JP Morgan) to a noteholder (MetLife). This amount was to be calculated based on a published Argentine inflation index (the CER) unless a so called CER Event occurred, in which case JP Morgan would calculate the amount payable in good faith and in a commercially reasonable manner.

One CER Event was that the “Republic of Argentina… takes any action which… prevents or has the effect of restricting or limiting (a) the calculation or (b) announcement of the CER or any of the values used to determine the CER”. MetLife asserted that this CER Event had arisen because the Argentine government had manipulated the CER figures and the CER should be a genuine measure of inflation.

Hamblen LJ rejected MetLife’s argument. His reasons included: (a) inserting a genuineness requirement involved re-writing the contractual terms; (b) the wider contract supported the plain reading of the words - it suggested that use of the CER should be mechanical, not a process that required difficult judgments; and (c) the plain reading made commercial sense – investments such as these were often CER linked whereas linking investments to a “genuine measurement of inflation” was unknown in the market.

Lewison LJ reached the same conclusion as Hamblen LJ, although he viewed Re Sigma Finance as the relevant authority on the interpretation of financial instruments and considered that it had “not been overtaken” by Arnold v Britton. Lewison LJ highlighted passages from Re Sigma Finance supporting a contextualised approach and stated that the “documentary context” is of “critical importance”. This may represent a slight shift in the weight to attribute to the various factors applied when interpreting provisions, at least in the context of complex financial instruments, and has been echoed by the Supreme Court in the BNY Mellon case (discussed below). It is also, however, potentially significant for its endorsement of Re Sigma Finance, which may re-open the door to purposive interpretation arguments in the future.

In BNY Mellon, the Supreme Court confirmed that LBG could redeem certain contingent convertible notes issued in 2009 as part of a capital raising programme. The redemption trigger included in the documentation had been anchored to a concept (capital tierings) which was later superseded, so that the clause could no longer be triggered. The Supreme Court held that a dynamic definition should be substituted, as this was an obvious mistake by the parties and it was clear how it could be corrected.

The judgment emphasised the wider documentary context as a factor when interpreting complex financial instruments. It also acknowledged the need to understand the commercial purpose of the instruments and the “general thrust” of background market conditions in order to interpret them. Although this case can be distinguished from Arnold v Britton as here it was held that there was a clear drafting mistake, it can also be viewed as a triumph of commercial common sense. It will be interesting to see if this could perhaps be used to reposition the balance of the relevant factors in a suitable future case on contractual interpretation.  

In this recent case, the Supreme Court appears to have confirmed that the cases applying Arnold v Britton in the lower courts discussed above have taken the correct approach. However, in a unanimous decision the Supreme Court stated that Arnold v Britton did not in fact mark a departure from the approach in Rainy Sky. Rather, the two cases were essentially saying the same thing.

The case concerned whether liability for past mis-selling was recoverable under an imprecise and “opaque” indemnity in an SPA. The indemnity required the Seller to indemnify the Buyer against a comprehensive list of events arising out of “claims or complaints registered with the [company’s regulator]… against the company”. The Seller argued that it did not have to indemnify the Buyer because the company had reported itself to the regulator, so there was no complaint against it. 

Although the Supreme Court considered the indemnity in its contractual and commercial context, it concluded that the interpretative tool of “principal” importance was still a “careful examination of the language”. The Supreme Court adopted the literal interpretation of the indemnity advanced by the Seller and disregarded what many would have understood to be the parties’ commercial intention in agreeing such an indemnity.

Lord Hodge noted that it has long been accepted that interpretation is not a purely “literalist exercise focused solely on... the wording” but requires consideration of the contract as a whole, the wider context, business common sense and the commercial purpose. According to Lord Hodge, the amount of weight attributed to each of these factors depends on the context. The Supreme Court expressly acknowledged that some contracts may need to be interpreted with “greater emphasis” on their factual matrix and commercial purpose for reasons such as informality, brevity, differing drafting practises, deadline pressures and failures of communication.

It now seems clear that although Arnold v Britton positioned language as a crucial factor when interpreting contracts, other factors, such as the documentary and commercial context, should also still be taken into account and in an appropriate case may be of significant importance. Understood in this light, subsequent cases have followed the judgment in both their statements of the relevant test and in their application, largely settling on language driven, or literal, interpretations.

However, the Supreme Court is due for a significant changing of the guard over the next two years. Half of all the Supreme Court justices will have changed between mid-2016 and the end of 2018, including Lords Neuberger and Sumption, who are widely regarded as the strongest supporters of freedom of contract and a more literal interpretation of contracts. It will be interesting to see if their successors, perhaps drawing on the spirit of decisions such as the BNY Mellon case, move away from the present trend for literalism and adopt a greater willingness to use contractual interpretation as a tool to rewrite parties’ bargains in appropriate cases.