September 19th, 2017 by Matthew Nicholson
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Introduction

Ambiguity in contracts is not unheard of. In the recent case of Wood v Capita Insurance Services Limited[1], we found the opportunity to have a closer look at the Supreme Court’s guidance on contractual interpretation. The exercise was so instructive that we thought we would share it. We hope that you find this useful too.

The Facts

Mr Wood was a director and the majority shareholder of Sureterm Direct Limited (“Sureterm”), a motor insurance broker. In 2010 Sureterm was purchased by Capita Insurance Services Limited (“CISL”). Included within the Sales And Purchases Agreement (“SPA”) governing the sale was an indemnity clause, as seen below:

“The Sellers undertake to pay the Buyer an amount equal to the amount which would be required to indemnify the Buyer and each member of the Buyer’s Group against all actions, proceedings, losses, claims, damages, costs, charges, expenses and liabilities suffered or incurred, and 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 and which relate to the period prior to the Completion Date pertaining to any mis-selling of any insurance or insurance related product or service.”

The indemnity was not time-bound.

In addition, the SPA also included a set of 2-year time-limited warranties, stated in the following form:

“(a) The Company conducts, and has conducted the Business in accordance with the requirements of all Competition laws and Applicable Financial Services Laws applicable to the business and has not been and is not being investigated for any alleged non-compliance or infringement of such Competition Laws and Applicable Financial Services Laws. …

(c) The Company has no reason to believe that any action will be taken against it in relation to any of its current or past activities based on any alleged non-compliance or infringement of any Competition Laws and Applicable Financial Services Laws.”

Shortly after completion of the purchase, employees of Sureterm raised internal concerns regarding possible mis-selling of insurance policies by Sureterm Staff. An internal review confirmed the veracity of the claims, following which Sureterm notified its regulator, the Financial Services Authority (“FSA”), of the issue. Consequently, the FSA required Sureterm to undertake a programme of redress for affected customers pursuant to the indemnity clause for the cost of £2.4 million against Mr Woods.

The Court’s Approach to Contractual Interpretation

The court described its basic task as “to ascertain the objective meaning of the language which the parties have chosen to express their agreement”.[2] This would require the court to ‘put itself in the shoes of the contracting parties’[3], but to avoid any interpretation which would serve only to improve a poor bargain made by one of the parties[4] and to remain mindful of the fact that the parties may have reached a negotiated compromise or might have been unable to agree upon more precise terms. Evidence of prior negotiations[5] and statements of subjective intent (for example, where a witness expresses a view on what they thought a provision was supposed to mean)[6] are both irrelevant considerations. However, the court is entitled to consider the factual background known to the parties at or before the date of the contract[7] (this can include knowledge of the relevant law).[8]

The court described two tools that can be used to determine the most appropriate interpretation – “Textualism” and “Contextualism”. Textualism is the analysis of the text against the surrounding provisions in the contract. Contextualism is the process whereby the commercial consequences of a suggested interpretation are investigated. When using these tools, the court must identify “what a reasonable person having all the background knowledge which would have been available to the parties would have understood them to be using the language in the contract to mean”[9].

The court employed an ‘iterative process’ – checking text against the context, re-checking against the text of the contract (considered as a whole) – was essential in ascertaining the interpretation most consistent with “business common sense”.

As well as describing the tools of Textualism and Contextualism, the court identified a number of factors which are relevant in determining the relative weight to be given to each tool when interpreting the meaning of a contract:

Factors weighing towards Textualism Factors weighing towards Contextualism
Formality Informality
High quality of the drafting Poor quality of drafting
Complexity of document Brevity of document
Sophisticated counterparties Unsophisticated counterparties
Experienced counterparties Inexperienced counterparties
Legally advised counterparties Non-advised counterparties
Clarity of meaning Lack of clarity

The Decision

The court held that CISL could not rely on the indemnity, as there was no ‘claim or complaint registered’ with the FSA, but rather Sureterm had self-reported the existence of mis-selling.

The parties were found to be sophisticated, experienced and legally advised. As such, the decision was principally based on a “careful examination of the language”[10] used within the indemnity clause (i.e. “Textualism”). The court found that CISL’s interpretation of the clause was “unlikely” as

(a) it would render other parts of the indemnity otiose, and

(b) would allow CISL to claim against Mr Wood for any mis-selling (even if wholly unrelated to Sureterm) – something which the court regarded as “absurd”.[11]

However, the contractual and commercial context were also “significant” in terms of the court’s decision. The primary contextual factor was held to be the existence of the warranties. The warranties also provided protection to CISL against mis-selling by Sureterm. However, this protection was of a type that was wider in scope but limited in time. As such, the court considered that they supported the view that the indemnity should be interpreted as providing protection which was limited in scope, but unlimited in time.[12]

Final Thoughts

The detailed analysis by the court of the rival interpretations of the indemnity advanced by counsel for Mr Wood on the one hand, and CISL on the other are worth reading as they provide an excellent case study into how lawyers, in their attempts to make protections such as indemnities as all-encompassing as possible, can actually introduce ambiguity into contracts which serves only to undermine the objective they are trying to achieve.

The decision also serves to highlight that, where sophisticated parties are negotiating complex documentation – such as loans, securitisations or derivatives master agreements – Textualism, i.e. the actual words used, is likely to be the primary tool of the court. As such, the lesson is clear – be clear, be concise and don’t overcomplicate matters.

[1] [2017] UKSC 24

[2] Wood v Capita Insurance Services Limited Paragraph 10, [2017] UKSC 24

[3] Wood v Capita Insurance Services Limited Paragraph 10, [2017] UKSC 24

[4] Wood v Capita Insurance Services Limited Paragraph 41, [2017] UKSC 24

[5] Wood v Capita Insurance Services Limited Paragraph 10, [2017] UKSC 24

[6] BP Gas Marketing Ltd v La Societe Sonatrach [2016] EWHC 2461 (Comm)

[7] Wood v Capita Insurance Services Limited Paragraph 10, [2017] UKSC 24

[8] Metlife Seguros de Retiro SA v JP Morgan Chase Bank, National Association [2016] EWCA Cov 1248

[9] Arnold v Britton Paragraph 15 [2015] UKSC 36

[10] Wood v Capita Insurance Services Limited Paragraph 42 [2017] UKSC 24

[11] Wood v Capita Insurance Services Limited Paragraph 35 [2017] UKSC 24

[12] Wood v Capita Insurance Services Limited Paragraph 40 [2017] UKSC 24

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