Supreme Court: contractual interpretation depends on a combination of text and context

In a recent judgment, Supreme Court judge Lord Hodge said that commentators who believed courts had placed more emphasis on the words of the document at the expense of commercial common sense since the Supreme Court's decision in Arnold v Brittain in 2015 had been mistaken. Recent cases involving contractual interpretation should be seen as involving "continuity rather than change", he said.

"One of the attractions of English law as a legal system of choice in commercial matters is its stability and continuity, particularly in contractual interpretation," he said.

"Textualism and contextualism are not conflicting paradigms in a battle for exclusive occupation of the field of contractual interpretation. Rather, the lawyer and the judge, when interpreting any contract, can use them as tools to ascertain the objective meaning of the language which the parties have chosen to express their agreement. The extent to which tool will assist the court in its task will vary according to the circumstances of the particular agreement or agreements," he said.

The court had been asked to rule on the correct interpretation of an indemnity clause in a sale and purchase agreement (SPA) governing the acquisition of a boutique motor insurance company by a larger insurer.

Commercial litigation expert Craig Connal QC of Pinsent Masons, the law firm behind Out-Law.com, said that the Arnold v Brittain case had been seen by many as "placing a great deal more emphasis on the words of the document and a great deal less emphasis on 'business common sense' or other factors than had perhaps been apparent in previous decisions".

"As such, while not a radical alteration, it was seen as a shift away from a perceived tendency to minimise the importance of the written word and emphasise some broader ascertainment of party intention which could be applied, in an extreme case, while paying very little attention to what was on the page," he said.

"In this case, the court strongly asserted that nothing in Arnold altered the guidance in previous cases. Unfortunately for advisers, in so doing, the court has emphasised the conundrum. In effect, the court has said that the words will be important, the context and business commercial sense will be important and which holds sway will depend on all the circumstances. Many will ponder the extent to which this case will be of assistance in advising companies on the likely approach to interpretation taken by a court," he said.

The case turned on whether the indemnity clause entitled the purchaser to recover the cost of compensation for mis-selling from the previous owners of the company. The mis-selling was uncovered after the sale following an internal review, and the compensation paid on a voluntary basis. The wording of the indemnity clause limited recovery to the cost of "all fines, compensation or remedial action or payments imposed on or required to be made by the company following and arising out of claims or complaints registered with the FSA, the Financial Services Ombudsman or any other authority against the company, the sellers or any relevant person".

Although the High Court originally found that the clause required the seller to indemnify the purchaser even if there had been no claim or complaint, the Court of Appeal disagreed. The Supreme Court backed the appeal court's conclusions. The clause did not restrict the scope of the warranty and made sense in the context of the contract as a whole, which included further, detailed warranties which expired after two years and which "probably covered the circumstances which eventuated".

"All of the parties to the SPA were commercially sophisticated and had experience of the insurance broking industry," Lord Hodge said.

"It is not contrary to business common sense for the parties to agree wide-ranging warranties, which are subject to a time limit, and in addition to agree a further indemnity, which is not subject to any such limit but is triggered only in limited circumstances. From [the purchaser's] standpoint the SPA may have become a poor bargain, as it appears that it did not notify the sellers of a warranty claim within two years of completion. But it is not the function of the court to improve their bargain," he said.