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Contractual interpretation

Summary

In Rainy Sky S.A. & Ors v Kookmin Bank [2011] UKSC 50, the Supreme Court held that where language used in a contract has more than one potential meaning, it is generally appropriate to adopt the construction that is most consistent with business common sense.

The case arose out of the defendant bank’s provision of refund guarantees (“Bonds”) given in favour of the claimant purchasers in respect of pre-delivery instalment payments under various shipbuilding contracts. The shipbuilder encountered financial difficulties and entered into a debt workout procedure under Korean law. Under the contracts, that event triggered a right of the purchasers to be reimbursed for the instalments already paid, the contract then reverting to a payment on delivery mechanism – if the shipbuilder ultimately delivered the vessels. The purchasers sought reimbursement from the bank under the Bonds. The bank refused to pay on the basis that the Bonds did not apply to that situation.

The key issue between the parties concerned the proper construction of two paragraphs in the Bond documentation. The second paragraph of each Bond provided that the purchasers were entitled to “repayment of the pre-delivery instalments” upon their “rejection of the vessel…termination, cancellation or rescission of the Contract…”. The third paragraph of each Bond stated that, in consideration of each purchaser’s agreement to make the pre-delivery instalments, the bank undertook to pay “all such sums due to you under the Contract”. The bank argued that “such sums” referred only to the limited circumstances referred to in the second paragraph, which did not include where repayment was triggered by an insolvency event. The purchasers argued that “such sums” simply meant the pre-delivery instalments, however they may become repayable.

The legal issue

At first instance, the Court found in favour of the purchasers, holding that the bank’s construction would lead to a surprising and uncommercial result. The Court of Appeal found (by a majority of 2:1) in favour of the bank, holding that it had no alternative but to give effect to a contract’s terms unless the most literal meaning of the words produced a result so extreme it would suggest that it was unintended. To do otherwise would risk imposing obligations on the parties which they were never willing to assume and in circumstances which amount to no more than guesswork on the part of the Court.

The Supreme Court adopted a different approach and unanimously allowed the purchasers’ appeal. The central approach to the construction of the Bonds was not in dispute. Lord Clarke (who gave the sole judgment and with whom all the other judges agreed) concluded that the long line of case law in this area (including Lord Hoffmann’s judgment in Chartbrook Ltd v Persimmon Homes Ltd [2009] UKHL 38) had established that the Court’s task was to determine what a reasonable person, who had all of the background knowledge reasonably available to the parties at the relevant time, would have understood the parties to have meant by the words that they used.

The question for the Court was the role to be played by considerations of business common sense in determining what the parties meant. The Court held that where the terms of the contract were clear and unambiguous, effect would be given to them without any consideration of business common sense, even if the result is improbable. However, where there were two possible constructions of the language used (as would often be the case), the construction that was most consistent with business common sense would generally be adopted. It was not necessary to conclude (where more than one construction was available) that a particular construction would produce an absurd or irrational result before proceeding to have regard to considerations of business common sense.

Adopting this approach, the Court held that, although the purchasers were unable to provide a very good reason why the second paragraph was included in the Bonds, a construction of the third paragraph which excluded the shipbuilder’s insolvency from the situations that triggered the bank’s refund obligations would make no commercial sense – it would have been one of the key events against which the purchasers would have wanted to obtain protection. Accordingly, of the two possible constructions of the third paragraph of the Bonds, the purchasers’ construction was preferred.

Comment

The Supreme Court has provided helpful clarification of the circumstances in which the Court will invoke considerations of business common sense. The decision will not assist a party seeking to avoid a bad bargain where the wording of the contract is clear and unambiguous, even if the result seems improbable or uncommercial. However, as acknowledged by Lord Clarke, the language used by the parties will often have more than one potential meaning. In such cases, the Court will adopt the interpretation that is most consistent with business common sense. It will therefore often be the case that, where a contractual dispute has arisen, considerations of business common sense will come into play.

This article first appeared in Law-Now, CMS Cameron McKenna's free online information service, and has been reproduced with their permission. For more information about Law-Now, click here.

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