Disputes 101- Contractual interpretation: through the looking-glass

The blog (or its ethos) is on tour in webinar form with "Disputes 101- Clause and effect: common contractual conundrums". You can register for the remaining talks here and find recordings of past talks here.  Each talk will be followed by blog post.  This is the first, “Contractual interpretation: through the looking-glass”.

Interpretation

If you draft contracts, you want to ensure, if there's ever a dispute, that the court agrees with your meaning. As a litigator, you will want the words to mean whatever your client wants them to mean. Either way, you need to understand how the court will interpret your contract.

There are countless recitations of the test for interpreting contracts. A neat rule of thumb is that if the meaning of the words is clear, you will be held to them; however, if there are two rival interpretations (and it may not take much creativity to establish this), then the court is entitled to prefer the one that makes most “business common sense”. What you can't do, if the meaning is clear, is complain that the terms are unfair or don't mean what they say.

Let's imagine loan some notes. They are initially AAA rated, they then drop to AA and revert to AAA. The question is whether they have been downgraded? The literal view would say they have, albeit temporarily, and that is all that matters. However, if you think about windows (instead of loan notes) and ask, “Have they been cleaned?”, you can see that you don't mean, “Ever in their existence as windows”. You mean, “In the recent past”. By analogy, it's possible to say that the loan notes have not been downgraded. Business common sense, which is highly contextual, can then (and only then) be deployed to pick which is the “right” answer.  

Implied terms

In carefully drafted contracts, an argument that there should be an implied term is likely to be hard to win (with some notable exceptions). The essence of the test is onerous: you have to be able to say that without the term you are proposing, the contract would lack commercial or practical coherence. 

The band management agreement for the Sex Pistols said that decisions about granting music licences were on the basis of “majority rule”. However, the agreement didn't say how this was to be achieved. The court had no trouble implying a further assurances type-clause, meaning that band members had to follow the will of the majority and execute the licences.

In contrast, an agreement between a designer and property developer for the interior design of a luxury residential development did not require an implied term that the developer would sell the apartments within a reasonable time. 

Examples of implied terms that are worth remembering:

• to act in good faith where there is a relational contract (e.g. Yam Seng)
• in relation to the proper exercise of a contractual discretion (e.g. Braganza)
• that an indefinite contract can be terminated on reasonable notice (e.g Winter Garden Theatre v Millenium) though some cases cast this as a question of interpretation
• not to prevent the performance of a contract (e.g. Mackay v Dick)

Contractual discretion

Contractual discretion—when one party is exercising judgment under a contract that may impact on both parties—is a pet topic of this blog.  It is very hard (but not impossible) to exclude the duty to act rationally in these circumstances (aka the Braganza duty) but the duty is not unduly onerous. Equally, a duty to act “reasonably” can mean rationally or with objective reasonableness. If you mean one rather than the other, it is probably best to specify. If you are the decision-maker you may want to assume the higher standard applies.  

Dictionary corner

1. Endeavours provisions serve a very useful purpose: where an absolute obligation is not appropriate e.g. securing planning permission. While it is apparent that reasonable endeavours entails less than best endeavours, in a given situation it can be remarkably hard to determine what exactly is or is not required. Reasonable endeavours may only require one course of action and generally you don't need to sacrifice your own interests. Best endeavours is an onerous undertaking and can require you to act in a way that would cause financial loss (but not ruin).
2. There is no general principle of good faith but parties can agree to it expressly and a duty to act in good faith may be implied (e.g. into relational contracts). What the standard entails is hard to say and context specific but it would seem to prohibit conduct that, though not dishonest, reasonable and honest people would regard as commercially unacceptable. It is relatively easy to raise arguments of good faith. It is generally much harder to win them.
3. Factors relevant to assessing whether a breach is material may include the size of the breach, effect of the breach on the parties' relationship, possibly the reason for the breach, and the response of the innocent party.
4. Loss of profit is typically a direct, as well as an indirect, loss.  Excluding consequential loss won't protect against a claim for direct loss (which is where the bulk of the loss may lie).