Out-Law News 2 min. read

Commercial sense can determine ambiguous contractual meanings, Supreme Court rules


Courts should apply "business common sense" when construing the meaning of disputed ambiguous contractual terms, the Supreme Court has ruled. 

The Court said that judges should consider what a reasonable person would consider contract terms to mean and choose what makes most commercial sense if there are "two possible constructions" of that meaning. The Court was ruling in a dispute over ship building contracts and the money buyers said they were owed when the builder entered into financial difficulty.

"It is not in my judgment necessary to conclude that, unless the most natural meaning of the words produces a result so extreme as to suggest that it was unintended, the court must give effect to that meaning," the Supreme Court ruling (21-page / 75KB PDF) said.

"The language used by the parties will often have more than one potential meaning. I would accept the submission made on behalf of the [ship buyers] that the exercise of construction is essentially one unitary exercise in which the court must consider the language used and ascertain what a reasonable person, that is a person who has all the background knowledge which would reasonably have been available to the parties in the situation in which they were at the time of the contract, would have understood the parties to have meant. In doing so, the court must have regard to all the relevant surrounding circumstances. If there are two possible constructions, the court is entitled to prefer the construction which is consistent with business common sense and to reject the other," the Court said.

Six companies had agreed to pay a shipbuilder to build each of them a vessel. The buyers had agreed to part-pay the builder in instalments prior to the completion of the build in return for the builder providing a bank guarantee to repay those sums if the construction was not completed. When the builder suffered financial problems during construction the buyers claimed they were owed their instalment payments back under the terms of their contract. The buyers asked the bank, with whom the builder had organised guarantee bonds over the repayments, for the money, but the bank refused claiming that the repayment clause had not been triggered as a result of the wording in its guarantee arrangement and the buyers' contracts with the shipbuilder.

The guarantee arrangement had referred to the bank repaying "all such sums due to [the buyers] under the [shipbuilding] contract", which the buyers argued made them entitled to repayment of the instalment fees. However, the bank said that the contract terms did not give buyers the right to claim repayments if the shipbuilder's business went insolvent.

The Supreme Court conceded that both claims were arguable but said that it made no commercial sense to accept the bank's argument because "insolvency of the builder was the situation for which the security of an advance payment bond was most likely to be needed" by the buyers.

"What this ruling does is reaffirm previous decisions that have shown that only in limited circumstances, where there is clear and unambiguous language, can the courts rely on the rule of strict interpretation of the wording of contracts," Claire McCracken, contract law expert at Pinsent Masons, the law firm behind Out-Law.com said.

"Where there is ambiguity, the correct approach is to look behind the terms and attempt to ascertain what a 'reasonable person' would have understood the parties to have meant when agreeing to enter into contractual negotiations. If the contact is ambiguous, then the court will seek to look behind the terms of the contract and can reject the interpretation which is unreasonable and which flouts business commonsense. The reason for this approach is that a commercial construction is likely to give effect to the true intention of the parties," McCracken said.

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