Contract interpretation: potential for relaxing the exclusionary rule

AuthorAndrew Milner
PositionIntegritam, Wakefield, UK
1 Introduction

Disputes concerning the meaning of written commercial contracts are one of the largest sources of commercial litigation, primarily because parties often fail to focus their minds to the terms of the contract ( McMeel, 2003, p. 272 ). This is particularly significant in the context of disputes in the construction industry, where projects usually involve protracted correspondence in the tender period leading up to the making of the contract, and often work starts before any contract is agreed1. When it comes to the interpretation of contracts, English courts adopt the principles summarised by Lord Hoffmann, in Investors Compensation Scheme v. West Bromwich Building Society2. Lord Hoffmann's third principle is:

The law excludes from the admissible background the previous negotiations of the parties and their declarations of subjective intent. They are admissible only in an action for rectification.

In justifying this exclusion, he said:

The law makes this distinction for reasons of practical policy and, in this respect only, legal interpretation differs from the way we would interpret utterances in ordinary life. The boundaries of this exception are in some respects unclear.

Declarations of subjective intent present little difficulty as they reflect the principle that a contract must be interpreted objectively3. The court does not inquire into what the parties themselves thought that the contract meant, or individually intended it to mean, it makes an objective judgment based on the admissible background4. The exclusion of previous negotiations means that where the terms of a contract are set out in writing it is not possible to use pre-contractual evidence to add to, vary or contradict the written terms.

The exclusionary rule is based primarily on pragmatic grounds that the admissibility of such evidence will potentially create uncertainty and unpredictability in the law, increase the cost and time of commercial litigation, and adversely affect third parties5. Nevertheless, the rule has been criticised on the basis that a court should never enforce a contract in accordance with a meaning which reliable evidence of previous negotiations shows is contrary to the actual intention of the parties. Furthermore, the rule is unprincipled, and the pragmatic grounds are unconvincing. In essence, critics of the rule call for it to be either relaxed or abolished6 ( McLauchlan, 2009, pp. 8-14 ; Kramer and Jarvis, 2009, p. 522 ; Burrows, 2007 ; Berg, 2006, pp. 354, 358 ; Nicholls, 2005, pp. 577-91 ; McKendrick, 2003, p. 19 ; McMeel, 2003, pp. 272-97 ). Bespoke construction contracts, and even modern standard forms, are replete with obscure and unconsidered draftsmanship that makes them eminently suitable for a more liberal interpretative approach ( Duncan Wallace, 2004, pp. 1.217-1.2180 ).

Against this backdrop, this article examines the practical policy arguments that justify upholding the rule, and analyses the more principled arguments that support relaxing it.

2 Practical policy arguments
2. 1 Uncertainty and unpredictability in the law

The purpose of interpretation is to understand the words used by the parties and determine their legal effect ( Lewison, 2007, p. 19 ). The modern starting point is Lord Hoffmann's first principle:

Interpretation is the ascertainment of the meaning which the document would convey to a reasonable person having all the background knowledge which would reasonably have been available to the parties in the situation in which they were at the time of the contract7.

This principle contains the fundamental philosophy underlying the English approach to contract interpretation, which is when seeking to interpret a contract an objective test is applied ( Lewison, 2007, p. 6 ). The purpose is not to find out what the parties' subjective statements were as to the meaning to be given to a particular term, but what the language of the contract would mean to a reasonable person having all the background knowledge ( Lewison, 2007, p. 6 ).

Allowing pre-contractual evidence to form part of the interpretation process may encroach on or possibly subvert the objective approach to interpretation. Furthermore, if English law adopted the position that such evidence was permitted to control or change the meaning of a written contract, the encroachment would be greater ( Lewison, 2007 , p. 28). Whilst the exclusionary rule “[…] may lead to the actual intention of the parties being defeated […] the rule is applied to ensure certainty”8.

This means that the exercise of interpretation is to ascertain the parties presumed, rather than actual intention objectively ( McKendrick, 2003, p. 19 ), and the exclusionary rule seeks “to discourage curial exploration of the unfathomable depths of subjective intentions”9. The pivotal theme for the objective approach is that it promotes certainty in the law and predictability in dispute resolution ( Steyn, 1997, p. 434 ).

In the construction case Chartbrook Limited v. Persimmon Homes Limited10, Chartbrook was a land owner with a site in London. It contracted with Persimmon for it to build a mixed commercial and residential development on that site. It was a feature of the case that pre-contractual evidence strongly supported Persimmon's case. Lord Hoffmann, a staunch supporter of the exclusionary rule and one of the judges in the case, did not accept that “it would […] be inconsistent with the English objective theory […] to admit evidence of previous communications ”, only that the background material is objective, whereas pre-contractual evidence is “[…] drenched in subjectivity”11. This view is supported by Burrows (2007, pp. 82-3) who states:

To allow in previous negotiations […] is consistent with an objective approach in that one is still ascertaining a party's intentions through objective evidence. In particular, an objective approach would not permit evidence of undeclared intention or of what a party thought the previous negotiations meant.

Persimmon contended that in stating that pre-contractual negotiations are unhelpful, Lord Wilberforce in Prenn v. Simmonds12 not only justified the exclusionary rule but also set the limits of it to cases in which the negotiations are irrelevant. Consequently, where they prove relevant to an objective observer they should be admitted to determine what the contract means. Lord Hoffmann disagreed, he said:

[…] the exclusionary rule is not qualified in this way. There is no need for a special rule to exclude irrelevant evidence […] admission of pre-contractual negotiations would create greater uncertainty of outcome in disputes over interpretation13.

This statement is difficult to reconcile with the fact that Lord Hoffmann recognised that pre-contractual negotiations may sometimes amount to highly relevant background information when he said “to admit evidence of previous communications[…] as part of the background […] may throw light upon what they meant by the language they used”14.

Certainty demands that potentially relevant evidence should not be made deliberately unavailable, otherwise it has the potential to create uncertainty about what the parties actually meant ( Mitchell, 2010, p. 144 ). In the light of this, it follows that to establish the parties' actual intention with any certainty it should be permissible to examine pre-contractual negotiations to find out what the parties really meant.

Chartbrook's interpretation appeared to be the natural interpretation of the contract term in dispute, while Persimmon's interpretation was supported by pre-contractual negotiations leading up to the conclusion of the contract. The High Court15 and the majority of the Court of Appeal16 upheld Chartbrook's interpretation of the contract, maintaining that Persimmon's interpretation was only supportable in the light of the pre-contractual negotiations and these were inadmissible evidence under the law. Nevertheless, Lord Hoffmann who regarded the issue as one of “[…] very considerable general importance […]”17 rejected the argument. He regarded Persimmon's contextual interpretation as conferring greater commercial sense on the contract without the need for recourse to the pre-contractual negotiations (although he was clearly aware of the content of those negotiations which were undoubtedly highly relevant to the meaning that the parties attributed to the words of their contract)18. This is evident as enunciated by Lawrence L.J. in the Court of Appeal who said:

[…] this is a case in which, if one puts aside the drafts of the Agreement, every contemporary document […] and every piece of paper which throws light on the commercial purpose of the provision, support's Persimmon's case19.

Lords Rodger20, Hope21, and Walker22 agreed with Lord Hoffmann. Only Baroness Hale expressed some doubts, she said:

I would not have found it quite so easy to reach this conclusion had we not been made aware of the agreement which the parties had reached on this aspect of their bargain during the negotiations which led up to the formal contract. On any objective view, that made the matter crystal clear23.

In the light of this, it is difficult to understand why such evidence would make contract interpretation any more uncertain or unpredictable than it already is. Issues of interpretation are already notoriously uncertain and difficult to predict ( Goff, 1984, p. 385 ) as McLauchlan (2009, p. 5) observed:

[…] the division of opinion that one finds in the cases is remarkable. Time and again judges will disagree on such elementary questions as whether...

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