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Case law: Court clarifies limits on ability to refer to pre-contract negotiations in dispute over what contract means

Parties negotiating a contract cannot always rely on what was said in pre-contract negotiations as evidence of what they intended a particular clause to mean, so they must ensure every clause in the final contract is clear and unambiguous, a recent ruling makes clear.

May 2019

This update was published in Legal Alert - May 2019

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 local authority granted planning permission to a mining company on the condition it paid for the restoration of the site when it had finished mining it. The company agreed to make quarterly payments into a fund during mining, to help pay for the eventual restoration costs. A contract was signed to that effect.

The contract included clauses stating that if a payment was missed, the amount due on the next quarterly payment date would increase by the amount outstanding. There was a backstop provision to the effect that if the final payment was missed, the company had to pay the outstanding balance by an end date in 2022.

The company made no payments at all and the local authority asked the court for an order that it make the payments.

The company argued that the meaning of the backstop clause was that it did not need to make quarterly payments, provided it paid the full sum due on the end date. In support of its case it referred to statements in a proposal it had drafted in anticipation of signing the contract, and the local authority’s response to it, which said that if the company could not make a quarterly payment it could roll it forward, provided full payment was received by the end date. The company said this meant it could roll payment forward as it wished, with no consequences.

The principles that apply when interpreting commercial contracts have been clarified by the courts in a number of rulings. In summary, a clause should be interpreted by reference to:

  • the natural, ordinary meaning of the clause;
  • any other relevant provisions of the contract;
  • the overall purpose of the clause and the contract;
  • the facts and circumstances known or assumed by the parties at the time the document was executed (sometimes called the ‘factual matrix’); and
  • commercial common sense; but
  • disregarding subjective evidence of any party's intentions.

The court therefore looks for the ‘objective meaning’ of the contract by considering it as a whole, taking into account both the language used and the context surrounding it, and checking possible interpretations until it finds the one that makes sense.

The courts have construed this to mean that pre-contract negotiations and information are admissible as evidence of the factual background known to the parties at the time the contract is made – they are part of the factual matrix. This includes evidence of the genesis and objective aim of the contract as a whole, but otherwise evidence of pre-contract negotiations is not admissible.

The company argued that pre-contract negotiations should be admissible not just in respect of the genesis and aim of the contract as a whole, but in respect of the genesis and aim of the individual clause in dispute.

The Court of Appeal rejected the company’s argument. It said that a court could look at pre-contract negotiations and documents to determine what the surrounding circumstances were at the time the contract was made, in order to understand the commercial aim of entering into it - but not in order to understand what the contract (or a particular clause) was supposed to mean.

This meant that the court would not look at them to find out if the parties were of the same mind on a particular issue, or if they had used words in the contract in a particular, agreed sense.

If an understanding of the meaning and purpose of a clause in a contract is dependent on an underlying assumption or knowledge of certain background information, the parties should include those assumptions and information in the contract itself.

Operative date

  • Now

Recommendation

  • Parties negotiating a contract will not be able to rely on what was said in pre-contract negotiations as evidence of what they both intended a particular clause to mean, and must ensure every clause is clearly and unambiguously stated.

Case ref: Merthyr (South Wales) Ltd v Merthyr Tydfil County Borough Council [2019] EWCA Civ 526

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.

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