Contract Update: Make Sure your Intentions are Clearly Recorded

Two recent cases in the Court of Appeal have highlighted the importance of clear contract drafting. The first Chartbrook Limited v Persimmon Homes Limited, Stephen Vantreen [2008] EWCA Civ 183 (the Chartbrook case) reaffirms the two exceptions to the non-admissibility of pre-contractual negotiations as evidence rule; the second, Schweppe v Harper, [2008] EWCA Civ 442 (the Schweppe case) reminds us of why it is wise to ensure that contractual terms are recorded in writing.

The Chartbrook Case - The Facts

The Claimant, Chartbrook Limited (Chartbrook), was the owner of a building site and the Defendant, Persimmon Homes Limited (Persimmon), was a construction company.  Chartbrook entered into an agreement with Persimmon for the construction of a residential development. The payment term of the agreement provided for Persimmon to pay Chartbrook a base sum of £4,683,565 and what the contract termed an '"Additional Residential Payment" which was defined as meaning "23.4% of the price achieved for each Residential Unit in excess of the Minimum Guaranteed Residential Unit Value less the Costs and Incentives" (the Balancing Payment).

For present purposes it is unnecessary to delve into the nature of the defined terms that made up the formula for the Balancing Payment. Instead it is sufficient to note that the two sides differed in their interpretation of what comprised the Balancing Payment. Persimmon's interpretation, which the pre-contractual negotiations showed, was that Persimmon had agreed to pay Chartbrook a base sum and an additional sum of 23.4% of the net residential sales minus the base sum. Chartbrook's interpretation, which the Court agreed was the common sense interpretation, was that Persimmon had agreed to pay Chartbrook a base sum and a percentage of all profits in excess of that sum.

The difference amounted to £3.5 million in Chartbrook's favour.

Admissibility of Negotiations

Of note of course is that the pre-contractual negotiations suggested that Persimmon's interpretation of the term was correct but, despite this, it was unsuccessful at first instance and on appeal. Why was this?

Terms that are defined within the contract must be construed by referring to the language of the contract and admissible background facts (ie those not relating to negotiation) which are reasonably available to the parties at that time. Collins LJ stated that "there is no doubt about the starting point, which is that "for reasons of practical policy" the law excludes from the admissible background the previous negotiations of the parties (emphasis added)" citing the House of Lords authority Investors Compensation Scheme Ltd v West Bromwich Building Society [1998] 1 WLR 896 at 913 (the West Bromwich Case).

So while outside evidence can be used to establish the background to a contract; pre-contractual negotiations cannot. Collins LJ referred at paragraph 111 of the Chartbrook case to the policy reasons for not allowing pre-contractual negotiations as suggested by Lord Nicholls LJ in "My kingdom for a horse: the Meaning of Words" (2005) 121 LQR 577 which were: 1) increased uncertainty and unpredictability in dispute resolution; 2) adverse affect on third party rights; 3) use of the evidence would be unhelpful; 4) subversion of the objective approach and added his own, that "without such a rule sophisticated and knowledgeable negotiators would be tempted to lay a paper trail of self serving documents."

The Two Exceptions to the Rule Excluding Pre-contractual Negotiations

However, the lack of clarity in the rule excluding pre-contractual negotiations has been used as a means to introduce evidence of pre-contractual negotiations when seeking to interpret a written agreement. Consequently two exceptions to the rule have emerged: rectification and the 'private dictionary principle'. These exceptions have been justified by the courts on the basis of "practical policy".  For example Lord Hoffman in the West Bromwich case stated "The law excludes from the admissible background the previous negotiations of the parties and their declarations of subjective intent. They are admissible only in an action for rectification. The law makes this distinction for reasons of practical policy and, in this respect only, legal interpretation differs from the way we would interpret utterances in ordinary life".

Rectification

Rectification is an equitable remedy where the court corrects a mistake made within a written contract.  The party seeking rectification needs to show that the provision in the contract does not represent the true intentions of the parties and that correcting the provision will reflect the parties' intentions. To show this, the party seeking rectification can rely on pre-contractual negotiations.

At paragraph 163 Collins LJ, in the Chartbrook case, stated that "Persimmon had, in my judgment, a very powerful case for rectification. But this was not a case where the Judge overlooked the points in their favour."  The burden rests with the party seeking rectification, and in the Chartbrook case Briggs J found Chartbrook's evidence to be "honest, careful and realistic" and held at first instance that Persimmon did not satisfy the burden of proof. This was not a finding with which the Court of Appeal could interfere.

Private Dictionary Principle

When interpreting a contract words should be given their natural and ordinary meaning. If a particular phrase does not have a natural and ordinary meaning and where it is argued that the phrase was used by the parties in a specific way, evidence from the parties' pre-contractual negotiations are admissible in order to decide what the phrase actually means. In the Chartbrook case the Balancing Payment was expressly defined and so the court at first instance found the principle did not apply to this case. The Court of Appeal also held that the principle did not apply, although Collins LJ's starting point before reaching this conclusion was open to the Court, but that there was not a sufficiently clear evidential burden for it.

The Schweppe Case

Mr Schweppe, the Claimant, offered to try and have Mr Harper's bankruptcy annulled by seeking finance from third parties. Mr Schweppe claimed he was to be paid a sum of £50,000 for undertaking this task which was allegedly agreed at a meeting on 26 November 2003. Having made considerable efforts on behalf of Mr Harper, and while engaged with the work, Mr Schweppe found that his authority to deal with Mr Harper's affairs had been revoked. Mr Harper subsequently obtained finance from another source.

The Importance of Certainty and Written Contracts

In the Schweppe case the Court of Appeal dismissed a claim for payment for work done towards completing a task on the grounds that the arrangement between the parties was too uncertain to amount to a contract. However, the judge at first instance had, in fact, found that there was a bilateral contract1 for services, but if Mr Harper chose to obtain his own finance the fee would not be due and he found that any contract between Mr Schweppe and Mr Harper was terminable at will. This was in essence a result of the lack of certainty in the agreement between the two parties.

There was a fundamental conflict of accounts between the two parties of what had occurred at the meetings between them. By leaving matters on an oral basis, Mr Schweppe had left himself open to the possibility that Mr. Harper could "change horses at any time" before the deal was concluded. 

The central issue in the case was whether the bilateral agreement which the judge at first instance found to have been made was too uncertain to be a contract and was therefore not binding. The majority of the Court of Appeal came to the conclusion that the arrangement between the two parties was too uncertain to constitute a binding contract. 

Of course the key here would have been to ensure that a clearly written contract was in place. This would have allowed Mr Schweppe to ensure that his position was sufficiently and clearly protected, for example, by ensuring that the contract was not terminable at will and perhaps by providing for payment to be made in instalments for work done.

Comment

Once again contractual certainty is paramount when negotiating contracts. The intentions of the parties must be recorded accurately and clearly in writing. Unfortunately, this is easier said than done and does not reflect the commercial reality because contractual terms continue to be disputed in the courts.

Contacts

The information in this newsletter is for general guidance only and is not intended to be a substitute for specific legal advice. If you would like any further information please contact:


George Mingay
Associate, Commercial Litigation - London
t: +44 (0) 20 7556 4615
e: GMingay@eapdlaw.com


Kendall Evans
Trainee - London
t: +44 (0) 20 7583 4055
e: KEvans@eapdlaw.com