Should contracts be put into context?

The recent Supreme Court decision in Wood v Capita Insurance Services Limited [2017] UKSC 24 has clarified the court's approach to contractual interpretation.

The facts

In Wood, Capita Insurance Services Limited (the "Buyer") entered into a share purchase agreement ("SPA") with the sellers for the entire issued share capital of Sureterm Direct Limited (the "Company"), which specialises in offering insurance for classic cars.

Following the sale, an internal review at the Company uncovered instances of suspected mis-selling of insurance products. In accordance with regulatory requirements, the Company reported these findings to the Financial Services Authority. Following a remediation exercise for those customers potentially affected, the Company paid out around £1.35 million in compensation.

The Buyer sought to recover the compensation paid out along with associated costs and interest, pursuant to an indemnity in the SPA. An indemnity gives an express obligation to compensate for a defined loss upon a particular trigger event.

The sellers argued that the indemnity was only designed to cover mis-selling losses resulting from complaints brought by the Company's customers and because the compensation arose from self-reporting of the suspected mis-selling, it fell outside the scope of the indemnity.

The law

The leading authorities on contractual interpretation are:

• Rainy Sky SA v Kookmin Bank [2011] UKSC 50 - Where contractual provisions are capable of more than one meaning, the court is entitled to prefer the interpretation which is consistent with business common sense.
• Arnold v Britton and others [2015] UKSC 36 - If the meaning of a contract is unambiguous then the court must give effect to the words used by the parties.

At first instance, the High Court held that the indemnity applied. The Court of Appeal then unanimously reversed this decision. The Buyer appealed to the Supreme Court, arguing that the Court had been unduly influenced by the seller's argument that the decision in Arnold had "rowed back" from the guidance set out in Rainy Sky and therefore the Court of Appeal had overemphasised the wording of the indemnity and not sufficiently considered the factual matrix.

Supreme Court decision

The Supreme Court did not accept that Arnold recalibrated the approach in Rainy Sky; In fact, both cases were taking the same approach to contractual interpretation.

In his judgment, Lord Hodge stated: "The court's task is to ascertain the objective meaning of the language which the parties have chosen to express their agreement... this is not a literalist exercise focused solely on a parsing of the wording of the particular clause ... the court must consider the contract as a whole and, depending on the nature, formality and quality of drafting of the contract, give more or less weight to elements of the wider context in reaching its view as to that objective meaning".

Interpretation is an iterative process in which textualism and contextualism are separate (not conflicting) tools which can be used to assist interpretation depending on the circumstances. For example, those contracts which are particularly complex, or have been prepared with input from skilled professionals, are more likely to achieve success from a textual analysis, whereas others may require greater reference to the factual matrix.

On examination of the language used in the SPA in Wood, the court was inclined to read the indemnity as being confined to those losses arising out of a customer complaint. However, because the indemnity clause was not precisely drafted the meaning was ambiguous and so the court needed to go further, to look at the clause in the context of the SPA as a whole.

The SPA contained various warranties, including that the Company had complied with applicable laws and regulatory obligations. The self-reported mis-selling is likely to have been caught by the warranties, but unlike the indemnity these are limited as any warranty claims had to be brought within two years. It is in keeping with business common sense to have both wide ranging warranties and an unlimited indemnity that is only triggered in specific circumstances. It is not the court's role to improve what has become a poor bargain because the Buyer did not make a warranty claim within the required timeframe.

In all the circumstances, the Supreme Court considered that the indemnity did not include losses from self-reporting and so the appeal was dismissed.

Practical implications

This case serves as a reminder that predicting how the courts will interpret contractual provisions is difficult due to dependence on the individual circumstances.

To avoid being caught by interpretation issues, it is important to ensure that contracts are drafted unambiguously and that the implications of particular drafting are considered from the start of contract negotiations. Where an agreement contains both warranties and indemnities, ensure that any linkage between them is made clear.

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This article was written by Leah Rushton. For more information, please contact Leah on leah.rushton@crsblaw.com or at +44 (0)20 7203 5389.