Lords ruling reduces contracts' certainty, says expert

The House of Lords, England's highest civil court, has stepped in to effectively rewrite a "commercially absurd" contract term in a way which reflected the commercial intentions of the parties rather than "ordinary rules of syntax".

George Lubega, a contract law specialist at Pinsent Masons, the law firm behind OUT-LAW.COM, said that the ruling will make court wrangles over contracts both more likely and more expensive.

"This undermines the certainty of contracts, it makes outcomes less certain and increases the arguments available to lawyers when there is a dispute over the interpretation of a contract," he said.

Builder Persimmon won its argument that a contract should have meant that it owed landowner Chartbrook £900,000 rather than £4 million. Lord Hoffman overturned a Court of Appeal ruling and said that the contract made no commercial sense, and that the court had the right to interpret the nonsensical part of it in a way which took into account the commercial background to the case.

"In such a case, the law did not require a court to attribute to the parties an intention which a reasonable person would not have understood them to have had," he said in his ruling.

"There is not, so to speak, a limit to the amount of red ink or verbal rearrangement or correction which the court is allowed," he said. "All that is required is that it should be clear that something has gone wrong with the language and that it should be clear what a reasonable person would have understood the parties to have meant. In my opinion, both of these requirements are satisfied."

In order to make sense of the Persimmon contract, Lord Hoffman said that it was permissible to use the context and background to the case. He reaffirmed the rule that contractual negotiations are not to be admitted, though.

But Lubega said that while the balance the court sought between contractual negotiations and background facts was admirable, the line between facts and negotiation will often be difficult to define in practice.

"How do you distinguish where the factual matrix stops and the negotiation of the contract begins?" he said. "Most companies will find that the two are almost inextricably interwoven."

Lubega said that the House of Lords ruling was not the radical reinterpretation of the law which some in the legal profession had expected in response to Persimmon's argument that the law should be changed to take account of pre-contract negotiations, but that it did change its nuance.

"What the House of Lords is trying to do is to maintain the consistency of contractual interpretation, but the effect will still be to decrease certainty because parties may submit large amounts of background information in the hope of persuading the judge in their case that the disputed part of their contract is commercially absurd," he said.

"I think what is likely to happen is that we will see more legal teams using factual information from the pre-contract phase to argue about a contract's construction," he said.

The ruling echoes one made ten years ago involving West Bromwich Building Society in which Lord Hoffmann said that courts could take into account the background knowledge which the parties could be expected to have when interpreting a contract.

"The House of Lords is trying to tread the line between black letter law which gives certainty but could end up resulting in absurd judgments and having a law so up for grabs that everybody litigates everything," said Lubega. "This ruling shifts the balance towards litigation."

Lord Hoffmann said that he would have allowed Persimmon's arguments based on rectification had he needed to, but that he did not need to.

Editor's note, 06/07/2009: The final sentence in the original version of this story claimed that Lord Hoffmann had rejected Persimmon's arguments based on rectification. That is not the case and the story has been updated accordingly. We apologise for the error.