Case law: Court clarifies how it will interpret ambiguous contract clauses
Businesses negotiating contracts should check carefully that they contain no ambiguities - or risk the courts applying a complex combination of factors to decide what the contract means, following a recent ruling.
This update was published in Legal Alert - May 2017
Legal Alert is a monthly checklist from Atom Content Marketing highlighting new and pending laws, regulations, codes of practice and rulings that could have an impact on your business.
A dispute arose as to the meaning of an indemnity clause in a contract for the sale of shares in a motor insurance business. The contract was drafted by a law firm and both parties were legally represented during negotiations. However, the court described it as 'not precisely drafted' and 'avoidably opaque'.
The law says that language in contracts should be interpreted according to 'what a reasonable person having all the background knowledge which would have been available to the parties would have understood them to be using the language in the contract to mean'. Relevant factors include:
- The natural and ordinary meaning of the words used
- Other clauses in the contract (the contractual context)
- The overall purpose of the clause and the contract
- The 'factual matrix' or background context – the facts/circumstances known to the parties when the contract was signed
- Business common sense
The court will not take any account of subjective factors, ie either party's intentions.
In this case, the Court of Appeal ruled that the natural and ordinary meanings of the words used in the indemnity meant it did not apply in the circumstances. The other side appealed on grounds that the Court's construction did not make business sense and it had not sufficiently taken into account the background to the making of the contract (the factual matrix).
The Supreme Court (SC) rejected the appeal, carrying out an analysis of the indemnity in the context of the rest of the contract. The SC agreed with the Court of Appeal that it did not cover the circumstances in this case. It considered that more weight should be given to the contractual context in this instance than the factual context or business common sense.
The SC said interpreting a clause is "not a literalist exercise, focused solely on a parsing of the wording of the particular clause… [it] 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".
It gave the following guidance:
- If a clause is capable of two (or more) interpretations the court should carry out an iterative process whereby each interpretation is checked against the rest of the contract, the factual background and the commercial consequences. It does not matter in which order the court does this, as long as it strikes the right balance between each
- When considering each interpretation, the quality of the drafting can be taken into account, eg. where drafting is by a professional it may be appropriate to pay more attention to the rest of the contract than the factual matrix – although business common sense can never be ignored entirely
- The court should remember that a party to an agreement may have agreed to a clause that is not in its interests
- Businesses negotiating contracts should check very carefully that they contain no ambiguities, or the courts will apply a complex combination of factors to help them interpret the contract
Case ref: Wood v Capita Insurance Services Limited  UKSC 24
Disclaimer: This article from Atom Content Marketing is for general guidance only, for businesses in the United Kingdom governed by the laws of England. Atom Content Marketing, expert contributors and ICAEW (as distributor) disclaim all liability for any errors or omissions.