Court of Appeal reiterates limited scope for reference to pre-contractual material when interpreting contracts

A recent Court of Appeal decision has illustrated the strict operation of the common law rule against relying on evidence of pre-contractual negotiations to interpret contracts. The decision confirms that, while it is permissible for a court to take into account pre-contractual material for the limited purpose of understanding the genesis and commercial aim of the transaction as a whole, this does not extend to admitting material in order to shed light on the genesis and aim of a particular contractual provision: Merthyr (South Wales) Ltd v Merthyr Tydfil County Borough Council [2019] EWCA Civ 526.

Importantly, the decision illustrates that it is not only statements reflecting one party’s subjective intentions or aspirations which are excluded for the purpose of interpreting a contract, but also communications that are capable of showing that the parties reached a consensus on a particular point or used words in an agreed sense.

As a practical matter, the decision shows the importance of ensuring that all contractual provisions are drafted clearly. To the extent that any underlying assumptions or background information might be necessary to understand the purpose and intended operation of a particular provision, these should be included in the contract itself, if necessary as recitals. While evidence of negotiations may be admissible if there is a claim for rectification or estoppel, it is clearly preferable to avoid the need for recourse to such arguments.

Background

The dispute arose out of a planning permission granted by a local authority to a mining company, which included a requirement that the company fund restoration of the land after its mining operations concluded. In 2015, an escrow agreement was executed establishing a fund to secure £15 million of the restoration costs.

Clause 4.2(a) of the agreement provided that "subject to [subclauses (b) and (c)] ... on each Funding Date, the Company shall deposit an amount equal to £625,000 (as adjusted pursuant to [subclauses (c) and (d)]) ... into the Account".

Funding dates occurred quarterly and subclauses (b) and (c) provided that, subject to subclause (d), if a deposit or consecutive deposits were missed, the amount due on the next funding date would increase by the amount outstanding. Subclause (d) was a longstop provision, specifying that if the final deposit was missed, the company was to pay the outstanding balance of the £15 million by 30 June 2022.

The company made no deposits, and the local authority sought an order for specific performance. The company's position was that the relevant provisions permitted it not to make quarterly deposits as long as it paid £15 million by the longstop date. The trial judge rejected that construction and granted summary judgment, ordering the company to pay into the escrow account the deposits outstanding at that time.

Decision

The Court of Appeal dismissed the appeal. Lord Justice Leggatt gave the lead judgment, with which Lord Justices Longmore and David Richards agreed.

Textual analysis and business common sense

The mining company argued that the the agreement should reasonably be understood to mean that, if a quarterly payment was missed, there was no enforceable obligation to make the payment until the longstop date. This was said to follow from: the fact that the requirements to make the quarterly payments were expressed to be "subject to" the provisions stating that missed payments would be rolled forward to the next funding date; the words "as adjusted" in clause 4.2(a) which had similar effect; and the longstop provision in clause 4.2(d) (which would be unnecessary on the contrary interpretation).

The court rejected the company's interpretation, both on a textual analysis and because it would be "an extraordinary and improbable intention to attribute to contracting parties", which was contrary to business common sense. The court acknowledged that the Supreme Court's decision in Arnold v Britton [2015] UKSC 36 cautioned against relying on considerations of commercial common sense where to do so would undervalue the importance of the contractual language used. However, Leggatt LJ considered that in this case no question arose of rejecting the natural meaning of the contractual language as there were, in his view, no words in the agreement which had as their natural meaning that the amount to be deposited on each funding date ceased to be due if the company failed to pay it.

To imply any such term would in fact be inconsistent with the express terms of clause 4.2, which used terminology ("shall", "fails to pay", "payable" and "outstanding") clearly indicating that payment of the amounts on the funding dates was a legal obligation rather than merely a statement of non-binding intention. Further, such a construction would undermine the commercial purpose of the agreement, which was to ensure that a fund of restoration money was built up from the revenue generated from the mine. That purpose would be defeated if the mining company could delay making any payments until the operations were concluded, exposing the local authority to the risk that the company might by that time have insufficient resources to fund the account.

The court accepted that, if clause 4.2(a) created enforceable obligations, the longstop provision in clause 4.2(d) would be redundant. However, the court referred with approval to a number of authorities observing that redundancy arguments seldom carry great weight, as it is not uncommon to find contractual clauses that are unnecessary and could be omitted without disadvantaging either party. In any event, such a redundancy argument "did not even begin to justify" an interpretation which, as in this case, would contradict the contract's express language, defeat its commercial purpose and be contrary to business common sense.

Pre-contract communications

The mining company also sought to rely on a passage in its proposal for the escrow arrangement, and the council's report recommending acceptance of the proposal.  This stated that if the company was unable to make a quarterly payment it could roll it forward, subject to full payment being made by the longstop date. The company argued that this showed the object or aim of clause 4.2 was to establish an arrangement whereby, if payments were not made on the funding dates, they would be simply be rolled forward, with no other consequence of missing a payment.

The court referred to the classic statement of the principle that evidence of the "genesis" and "aim" of the contract is admissible, in Prenn v Simmonds [1971] 1 WLR 1381. In that case Lord Wilberforce stated that evidence of negotiations or the parties' intentions are not admissible, but that evidence of the factual background known to the parties – the so-called  "factual matrix" – is admissible, including evidence of the genesis and objective aim of the transaction.

The mining company argued for an expansive application of the principle in Prenn, so that evidence of pre-contractual negotiations would be admissible to show the genesis and objective aim not just of the transaction as a whole, but also of a particular provision in a contract. In support, it relied on certain passages to that effect from a number of authorities subsequent to Prenn.

The court rejected that as a matter of law. It noted that the authorities relied on were decided before the authoritative House of Lords decision on contractual interpretation in Chartbrook Ltd v Persimmon Homes Ltd [2009] UKHL 38. To the extent that the earlier authorities had suggested that pre-contractual material could be relied on to show the purpose of a particular contractual provision (as distinct from the contract as a whole), such suggestions had not survived the restatement of the law in Chartbrook.

In the light of Chartbrook, the legal principles regarding pre-contractual material were clear. A court may look at previous documents for the purpose of ascertaining the surrounding circumstances and thereby understanding the commercial aim of a transaction. What is not permissible is to seek to rely on evidence of what was said during the course of pre-contractual negotiations for the purpose of drawing inferences about what the contract should be understood to mean. This excludes not only statements reflecting one party’s subjective intentions or aspirations but also communications that are capable of showing that the parties reached a consensus on a particular point or used words in an agreed sense.

Leggatt LJ noted that the House of Lords' refusal to relax the rule to allow such evidence was not because it would necessarily be irrelevant but, rather, because of the practical difficulties and lack of predictability that would result from allowing such evidence.

The court noted that there may in some cases be a fine line between referring to previous communications to identify the "genesis and aim of the transaction" and relying on such evidence to show what the parties intended a particular provision to mean, but said this was not such a case. The passage the mining company sought to rely on did not shed any light on the commercial purpose of establishing the escrow account. It was, at best, evidence of a provisional agreement about one aspect of the proposed arrangements. Even if admissible, it would not justify the desired conclusion, as it was premised on the company's inability to pay, which had no equivalent in clause 4.2. Construing clause 4.2 objectively simply led to the conclusion that the previously expressed intention was superseded by a different provision.  The material was not admissible.