An almost plane-ful mistake - rectification vs interpretation

In dealing with a series of intertwined contracts, the English High Court found that the correct interpretation of a contract meant that an airline had had its obligations to make overdue payments terminated but then rectified the same contract  so that the airline's payment obligations were reinstated. In doing so, it provided helpful guidance on the requirements for rectification of multilateral contracts. 

The transactions

SATA is a regional air carrier in the Azores. It leased an Airbus A300 for 5 years. The plane was sold to Hi Fly and the lease novated. 

SATA got into financial difficulties and fell behind on its lease payments. Its financial situation worsened due to the COVID-19 pandemic. AELF entered into the picture and was interested in buying the plane from Hi Fly and having the SATA lease novated to it. 

A deal was agreed, and three agreements were signed at the same time. First, a sales agreement between Hi Fly and AELF; second, a novation agreement between all three making AELF the lessor; and lastly, a termination agreement between AELF and SATA, ending the lease for a lump sum payment. 

The dispute 

SATA owed roughly USD3 million in arrears on the lease by the time of the transactions. The disagreement arose over the terms of the novation agreement. AELF and Hi Fly had agreed in the sales agreement that, regardless of the actual execution date of the contract, 1 September 2019 would be treated as the economic closing date, known as the ECD. 

The key mechanism giving effect to this was that: any lease payments received by Hi Fly, for periods after the ECD, would be transferred to AELF; and any lease payments received by Hi Fly would be offset against the purchase price. 

The problem that AELF and Hi Fly then faced was that the termination agreement had a clause that relieved SATA of all the obligations it owed to AELF under the lease. This technically included the obligation to make lease payments after the ECD, as the effect of the novation agreement was to make the payments due to AELF, not Hi Fly. This meant that following the execution of the three agreements, SATA had unintentionally been relieved of its obligations to make the lease payments after the ECD. 

The legal arguments 

When brought before the court, AELF and Hi Fly raised two arguments: when properly interpreted, the novation agreement did not transfer the indebtedness from Hi Fly to AELF; and in the alternative, that the contract should be rectified to say that it did not. 

Interpretation

Despite various arguments about the economic purpose of the novation agreement in the wider context of the transaction as well as what was “usual” in a novation, the court was unpersuaded by AELF and Hi Fly’s interpretation. The court noted that “the language and structure of the novation agreement are clear, and admit only one possible interpretation”: namely that the indebtedness had transferred to AELF. 

Rectification

The court then turned to consider rectification, applying the law as set out in FSHC noting that this was a case of either a common mistake or unilateral mistake. 

Therefore, AELF and Hi Fly had to prove either that:

• there was a common assumption as to what rights the contract was going to confer; or 
• that there was a unilateral mistaken belief as to what rights the contract was going to confer and one party knew of the mistake of the other party. 

In finding that the novation agreement should be rectified, the court emphasised that this was an “unusual finding to make in a commercial context”, especially given the “expert care” that went into preparing the contract and was not one to be made “lightly”. However, based on contemporaneous documents and oral evidence given at trial, it was overwhelmingly clear that there had been a common mistake and the contract was rectified such that the indebtedness remained with Hi Fly. 

Multiparty contracts 

The court also made some interesting comments on the requirements for rectification when there are multiple parties to a contract. 

For common mistake, it was stated that the mistake had to be made by “all the parties”. This meant that potentially, if there were tens of parties, as could occur in complicated financial contracts, the party arguing rectification would have to prove that each and every of those parties shared that mistake. 

The court suggested that this requirement might not apply in contracts where the “rights to be altered are” not “those of all parties”. However, it is unclear how this would work in practice. 

In contrast, for unilateral mistake, the court suggested that it is sufficient that in a contract between A, B and C, if only A knows that B is mistaken but is unsure as to C’s belief. The court’s reasoning was that “it plainly would be inequitable for A to take advantage of B’s mistake, and A’s ignorance of C’s error provides no positive counter-equity in A’s favour. Nor is there any reason not to rectify the agreement against C, since as between C and B there is an equity that arises from the shared mistake.” 

At the same time, the court was quick to assert that it was still essential that both B and C were mistaken as if not, “the rights of an entirely innocent contracting party would be altered”, ultimately meaning that the difference between common mistake and unilateral mistake rectification is limited. 

Judgment: SATA v Hi Fly