Supreme Court confirms new exception to the 'without prejudice' rule

In its judgment handed down on 27 October 2010 in Oceanbulk Trading & Shipping SA v TMT Asia [2010] UKSC 44, the Supreme Court added a new exception to the 'without prejudice' rule. It held that facts communicated between parties in the course of 'without prejudice' negotiations should be admissible, if they would otherwise be admissible as part of the 'factual matrix' to aid contractual construction.

Key points

• Parties to 'without prejudice' negotiations should be aware that 'objective facts' which emerge in their negotiations may later be admissible as an aid to interpret any resulting settlement agreement (not just to decide whether there was a concluded agreement)
• Admissibility depends on whether such evidence forms part of the 'factual matrix' demonstrating the background facts known to the parties and therefore falls outside the 'exclusionary rule' – a rule of evidence which generally restricts the admissibility of pre-contractual negotiations in the interpretation of contracts
• The task of determining when evidence of pre-contractual negotiations will be admitted and when it will be excluded is less than straightforward, but following this judgment the test is the same for without prejudice negotiations as for open negotiations

Background

The 'without prejudice' rule blocks the admission into evidence of communications between parties made in a genuine attempt to settle a dispute, subject to certain exceptions, or mutual waiver by the parties.

The separate 'exclusionary rule' excludes evidence of pre-contractual negotiations for the purpose of drawing inferences about what a contract means. However, Lord Hoffman noted in Chartbrook v Persimmon [2009] UKHL 38 that: "It does not exclude the use of such evidence for other purposes: for example, to establish that a fact which may be relevant as background was known to the parties, or to support a claim for rectification or estoppel."

Oceanbulk and TMT had entered into 'without prejudice' negotiations to resolve a dispute arising out of forward freight swap agreements. The negotiations resulted in a settlement agreement (the 'Agreement'). Oceanbulk later claimed against TMT for breach of the Agreement. TMT tried to rely on the parties' 'without prejudice' communications in support of its interpretation of the Agreement, as well as its case on remoteness of damages and estoppel.

Oceanbulk applied to strike out TMT's defence insofar as it was based on the 'without prejudice' communications, seeking a declaration that the evidence was inadmissible, absent mutual waiver. For the purposes of the application, Oceanbulk did not seek to exclude the evidence on the ground that it did not form part of the admissible factual matrix, although it reserved its right to invoke the exclusionary rule at trial. Accordingly the application proceeded on the assumption that, but for the 'without prejudice' rule, the evidence would be admissible.

The High Court (Andrew Smith J) decided that the evidence was admissible as a further exception to the without prejudice rule; however, his decision was overturned on appeal to the Court of Appeal (Ward LJ dissenting). The Supreme Court's judgment unanimously reverses the Court of Appeal's decision.

The Supreme Court judgment

The Supreme Court's starting point was that the 'without prejudice' rule has undergone significant development over the years, becoming very much wider and having its importance judicially stressed on many occasions. The court referred to the House of Lords' recent decision in Ofulue v Bossert [2009] AC 990 (see post), noting the two bases of the rule: the public policy imperative of settlement of disputes, and an implied agreement between the parties not to use material from without prejudice negotiations later in proceedings.

The court accepted that, because of the importance of the without prejudice rule, its boundaries should not be lightly eroded. Nevertheless, the court decided that justice 'clearly demanded' a new exception to the rule, as sought by TMT. Materially:

• There are numerous occasions on which the rule does not prevent the admissibility of without prejudice communications. Some of the more important exceptions are set out by Robert Walker LJ in Unilever plc v Procter & Gamble[2001] 1 All ER 783.
• One exception is where the issue is whether without prejudice communications have resulted in a concluded settlement agreement. Although it is not included in the Unileverlist, another recognised exception is where a party pleads rectification, as 'no sensible line' can be drawn between admitting communications to resolve whether an agreement has been reached, and admitting them to resolve what the agreement was.
• The principles governing the approach to interpretation of contracts have also developed, or been clarified, over the years. The key question is what a reasonable person, having all the background knowledge available to the parties, would have understood the contract to mean.
• Where the negotiations that result in a contract are not without prejudice, evidence of the facts known to the parties – the so-called 'factual matrix' – is admissible as an aid to interpretation of the contract, even if that evidence formed part of the negotiations (as per Lord Hoffman's judgment in Chartbrook).
• Trial judges frequently have to distinguish between material which forms part of the pre-contractual negotiations which is part of the factual matrix (and therefore admissible as an aid to interpretation) and material which forms part of the pre-contractual negotiations but which is not part of the factual matrix (and therefore is not admissible).
• The court could see no reason why ordinary principles of interpretation should be any different where the negotiations in question were 'without prejudice'. In both cases, the evidence is admitted to make an objective assessment of the parties' intentions. Parties would expect the agreement to mean the same in both cases.
• In the court's opinion, the public policy imperative of encouraging frank discussion and therefore settlement was likely to be fostered by adding the new exception, as parties would know that if a dispute arose, objective facts which emerged during negotiations would be admitted to assist the court to determine their true intentions.
• Any other approach would introduce an unprincipled distinction between interpretation of contracts and the other recognised exceptions to the without prejudice rule. In particular, given the close relationship between interpretation and rectification, there was no sensible basis on which without prejudice negotiations should be admissible in considering the latter but not the former.

Comment

The Supreme Court's decision means that the test for admitting evidence of pre-contractual negotiations as an aid to construction of the resulting agreement will now be the same regardless of whether the pre-contractual negotiations took place on a without prejudice basis. Parties to settlement negotiations should therefore be aware that what is said may become admissible if a dispute later arises as to the proper construction of the contract.

Whether this significantly erodes the policy objective of the without prejudice rule may be open to debate. Parties have hitherto been aware that the content of their negotiations might be admitted into evidence if the counterparty pleaded rectification or estoppel. Only time will tell whether this further exception will have an impact on parties' willingness to speak freely in trying to settle their disputes.

The significance of the erosion resulting from this decision might depend to some extent on how the exclusionary rule, and its exceptions, are applied following this decision. In its judgment, the Supreme Court stresses that it is not seeking either to underplay the importance of the without prejudice rule or to extend the exception beyond evidence which would otherwise be admissible "to explain the factual matrix or surrounding circumstances" in accordance with the principles identified in previous authorities including Chartbrook. The judgment states: "In particular, nothing in this judgment is intended otherwise to encourage the admission of evidence of pre-contractual negotiations".

Intended or not, however, the judgment might have that effect, with its clear statement that matters going to the factual matrix, whether or not emerging from pre-contractual negotiations, fall outside the exclusionary rule. This may give renewed impetus to parties who would like to rely on such evidence in their dispute.

In any event, if parties want to prevent matters discussed in their settlement negotiations being brought before the court, the best advice is to ensure, so far as possible, that the drafting of any settlement agreement is clear and unambiguous.

Recognised exceptions to the without prejudice rule following Oceanbulk:

• To show whether a concluded settlement has been reached
• To aid construction of a settlement agreement (if the communications  would otherwise be admissible as part of the factual matrix)
• To support a claim for rectification
• To support an estoppel argument
• To show whether a settlement should be set aside on grounds of misrepresentation, fraud or undue influence
• Where excluding the evidence would act as a veil for perjury, blackmail or other 'unambiguous impropriety'
• Where the fact of negotiations (not their detail) is needed to explain delay or apparent acquiescence
• Exceptionally, to show reasonable steps taken to mitigate loss
• "Without prejudice save as to costs" communications
• Communications during matrimonial conciliation attempts