Stephen McColgan Partner in the Land Acquisition Department provides a reminder of the need for crystal clarity in drafting commercial contracts.

The House of Lords (in one of its final judgments before morphing into the new Supreme Court) gave this reminder in its decision in the case of Chartbrook Limited  v  Persimmon Homes Limited and Other (1 July 2009).

The facts of the case involved the interpretation of an uplift or overage provision in the development contract between a land owner and a developer.  The land owner’s interpretation produced a value of £4.6 million for the payment due, whereas the developer’s calculation was £900,000.00.  With £3.7 million at issue both parties, firmly convinced of their respective interpretations dug in and appealed to the highest court.

The main issue was whether in understanding and applying the uplift provisions the parties had to look at the final version of the document or were entitled to refer back to the negotiations and bring these in to the interpretation.

The House of Lords forcefully confirmed that the agreement has to be construed objectively.  Where it is clear that something has gone wrong in understanding the meaning of the language used in a contract, the Court will make its interpretation and decision on the basis of what a reasonable person would have understood the parties to have meant, taking the relevant background into account.  Something had clearly gone wrong between the parties in that their respective understandings lead to a difference in valuation of £3.7 million.  The case was ultimately decided on the facts in favour of the developer, such that the correct interpretation valued the uplift payment at £900,000.00.

The Court however confirmed that it is not there to trawl through the files and computer records of the negotiations and to hear testimony from the participants in order to conclude the common intention.  It would, however, objectively interpret the final written agreement as signed by the parties.

The leading judgment by Lord Hoffman reviews the decided cases on the legal principle of what is known as the “Exclusionary Rule”.  Evidence of pre-contract negotiations is not admissible when construing a contract.  This embedded rule of English law is re-affirmed by the case, and to change it would require new legislation.

Some of the immediate practical implications from this reminder to those involved in negotiating, drafting and implementing commercial contracts are :

1.    Make sure that the drafting is crystal clear.
2.    Understand the commercial terms and record them in unambiguous language.
3.    Defined terms must be able to stand on their own within the context of the document.  There should be no need to look outside the document for meaning and interpretation.
4.    If a ‘private dictionary’ has been used, where a specific term or phrase has a particular meaning from the negotiations, this must be brought into the definitions in the final version of the contract.  It may not be enough just to use a word or phrase that has a shorthand meaning between the parties to the negotiations.  If it has a special meaning, this must be clear objectively on the face of the document and be readily understood to someone later reading, interpreting and applying the contract.
5.    Where calculations or mathematical formulae are key to achieving an agreed result consider including worked hypothetical examples clearly to show how the calculation is intended to work.