Court of Appeal clarifies test for rectifying terms of written contract for common mistake

The Court of Appeal has upheld a decision granting rectification of two deeds on the basis that they did not reflect the parties' subjective common intention: FSHC Group Holdings Ltd v GLAS Trust Corporation Ltd [2019] EWCA Civ 1361.

This is an important judgment which establishes, at Court of Appeal level, the test for rectifying a contractual document on grounds of common mistake, on which there had been conflicting authority and uncertainty as to the state of the law. It determines that, to establish a claim for rectification, a party must prove that the document failed to give effect to either:

1. a prior concluded contract, in which case the terms of the prior contract must be objectively determined; or
2. a common intention shared by the parties, in which case the existence of the intention must be established as a subjective state of mind - though it must also be shown that, as a result of communication between them, the parties understood each other to share that intention.

The court disagreed with Lord Hoffman's (obiter) observations in Chartbrook Ltd v Persimmon Homes Ltd [2009] UKHL 38 that, even for the second limb above, the test is purely objective and subjective intentions are irrelevant. Leggatt LJ, who gave the judgment of the court, explained the doctrine as resting on an equitable principle of good faith - ie that a party will not be allowed to enforce the terms of a written contract when that would be against conscience because it was inconsistent with the parties' mutual intentions at the time of contracting.

Unless and until there is a further appeal to the Supreme Court, therefore, the test to be applied is as set out above. In most cases, this is likely to mean (even) greater difficulty in establishing a claim for rectification for common mistake, in the absence of a prior concluded contract. In particular, a claim will not succeed unless the claimant can establish not only that it had a particular intention but that the defendant shared that intention, and that the parties understood one another to share that intention. (There may however be a claim based on unilateral mistake, if the defendant knew the claimant believed there to be a common intention when that was not in fact the case, and knew the document did not give effect to the claimant's intention).

Background

This was a claim for rectification of two deeds executed by the claimant in November 2016. The purpose of executing the deeds was to provide security which the claimant had previously agreed to provide in connection with a complex corporate acquisition which took place in 2012. The omission of the security – an assignment of the benefit of a shareholder loan – was not noticed until it was spotted by the claimant's lawyers during a review of the security documentation in 2016.

In order to provide the missing security, the claimant entered into deeds to accede to two pre-existing security agreements. However, the effect of acceding to these agreements was not only to provide the missing security but for the claimant to undertake additional, onerous obligations.

The trial judge, the late Henry Carr J, found as a fact that, when the deeds were executed, both parties understood and intended them to do no more than provide the missing security; no one involved in the transaction realised that the effect was to impose the additional obligations. In other words, he found that the parties subjectively had a common intention to execute a document which did no more than satisfy the claimant's obligation to provide the missing security. He also found that an objective observer would have concluded, from the background facts and the communications between the parties, that they had such a common intention. He therefore granted rectification of the deeds so as to exclude the additional obligations from their scope.

The defendant appealed. It did not challenge any of the judge's findings of fact. It argued, however, that: the test for rectification was purely objective; identifying the objective intention of the parties was a question of law, on which the appeal court could form its own opinion; and the judge was wrong to find that, objectively assessed, the parties had a common intention which was not accurately reflected in the deeds.

Decision

The Court of Appeal dismissed the appeal, Leggatt LJ giving the judgment of the court (with Flaux and Rose LJJ). The court conducted a detailed review of the authorities relating to the equitable doctrine of rectification, drawing out various points including the following:

• In the 18th and early 19th century authorities, it was clear that the test was a subjective one, with references to the "intention" of the parties being references to what the parties actually intended.
• However, in the second half of the 19th and early 20th century, there were a number of authorities in support of the view that rectification was permitted only where a contractual document failed accurately to record a contract that already existed before the document was executed.
• The requirement for a pre-existing contract was authoritatively rejected by the Court of Appeal in Joscelyne v Nissen [1970] 2 QB 86, though the court made it clear that some "outward expression of accord" was required – in other words, the requirement was for a common intention which the parties not only each held but understood each other to share as a result of communication between them.
• In Britoil plc v Hunt Overseas Oil Inc [1994] CLC 561, the majority of the Court of Appeal rejected an argument that the parties' subjective states of mind were irrelevant to a claim for rectification of a written contract and that a wholly objective test should be applied. Hoffman LJ (as he then was), dissenting, considered that there should be a wholly objective test.
• In Chartbrook Ltd v Persimmon Homes Ltd [2009] UKHL 38, Lord Hoffman made observations as to the correct test for rectification (an issue which did not arise, given the court's findings on the interpretation of the contract), again expressing the view that the test was wholly objective and that actual subjective intentions were irrelevant. The other members of the appellate committee either agreed or saw no reason to differ from Lord Hoffmann's observations.
• In Daventry District Council v Daventry & District Housing Ltd [2011] EWCA Civ 1153, the Court of Appeal proceeded on the basis that Lord Hoffmann's observations in Chartbrook were correct, while recognising that they were obiter dicta - though two members of the court expressed considerable reservations about the analysis and the members of the court differed as to what an "objective" test required.

In the present case, the Court of Appeal recognised "the immense respect due to an opinion expressed by Lord Hoffmann on a point of law which commanded the unanimous agreement of the House of Lords". Nevertheless, the observations in Chartbrook were expressly acknowledged to be obiter dicta and were therefore not binding authority. As the point arose directly in this case, the court considered it necessary to decide whether Lord Hoffman's opinion was correct in law. The court was satisfied that it was not prevented from doing so by the Court of Appeal's decision in Daventry because, in that case, the court proceeded on the basis that Lord Hoffmann's analysis was correct in circumstances where the parties argued the case on that assumption. Since the analysis was assumed to be correct and not the subject of full argument, the Court of Appeal in this case did not regard itself as bound by its previous decision in Daventry.

In considering whether the approach approved in Chartbrook was correct, the Court of Appeal examined the question from the point of view of (i) principle, (ii) precedent and (iii) policy considerations.

(i) Principle

The Court of Appeal distinguished between two forms of rectification, based on different principles:

1. rectification of a document because it does not reflect the terms of a prior concluded agreement; and
2. rectification where the parties have not made any contract prior to the document sought to be rectified, but had a common continuing intention in respect of a particular matter which was not reflected in the document.

The first type, the Court of Appeal noted, is based on the principle that agreements must be kept and is sometimes regarded as a branch of the doctrine of specific performance. The court should give effect to what the parties have contractually agreed to record in their document. In such a case, the terms of the prior contract  must be objectively determined in the same way as any other contract.

The second type of rectification is not, however, based on the principle that agreements must be kept. The principle that a contractual document should be rectified so as to enforce what the parties have (objectively) agreed has no validity where the prior "agreement" is not a legally binding contract but a non-binding expression of intent. A formal written contract is intended to have priority over any earlier non-binding record of the parties' intention, as objectively assessed.

This second type of rectification is, the court said, entirely concerned with the parties' subjective states of mind, and based on considerations of good faith. As Leggatt LJ put it:

"It rests on the equitable doctrine that a party will not be allowed to enforce the terms of a written contract, objectively ascertained, when to do so is against conscience because it is inconsistent with what both parties in fact intended (and mutually understood each other to intend) those terms to be when the document was executed."

Rectification for unilateral mistake can, the court noted, be understood as an extension of the same basic equitable principle. It is equally contrary to good faith for a party to seek to apply the contract inconsistently with what that party knew to be the parties' common intention at the time of contracting (common mistake) or what it knew the other party mistakenly believed to be the common intention (unilateral mistake).

Either way, the court said, it is fundamental to the doctrine that "an actual mistake was made by one or more real people in believing that the written contract gave effect to what either was or was understood by one party to be the parties' actual common intention".

(ii) Precedent

To apply a purely objective test of intention was also, the Court of Appeal found, inconsistent with precedent, including authority that was binding at Court of Appeal level, in particular Britoil. Leggatt LJ stated that "...in cases where the court is not simply enforcing a contractual obligation to execute a document in particular terms, the doctrine has always been understood and justified as an equitable remedy to correct an actual common mistake – that is to say, an inadvertent failure to give effect to what the parties actually intended."

The court noted that there was no discussion in Lord Hoffmann's judgment in Chartbrook of the history of the equitable remedy of rectification for common mistake, which showed that courts of equity had always been concerned with the actual intention of the parties. Nor was any reference made to the authorities which established the need to prove the reality of the parties' common continuing intention, save for the Britoil case which Lord Hoffmann had sought to distinguish on grounds which, in Leggatt LJ's view, could not be supported. There was no suggestion in Chartbrook that Britoil was wrongly decided or should be overruled. It was not brought to the Court of Appeal's attention in Daventry, but it remained good authority and was binding on the court.

The court also noted that the purely objective approach endorsed in Chartbrook was inconsistent with how the doctrine of rectification was understood and applied in most other common law jurisdictions, most notably Australia.

(iii) Policy 

In the Court of Appeal's view, there were also good policy reasons for applying the subjective test for rectification in cases where there was no prior contract. Leggatt LJ observed that the requirement in such cases to show that the wording of a contractual document was inconsistent with the parties' actual common intention was "rightly a demanding test to satisfy and one which affords appropriate respect to the primacy of the final, agreed, written terms of a contract."

In the court's view, allowing rectification to reflect an objectively determined common intention, even though one party (or even both) actually intended to be bound by the terms of the document as executed, would "not adequately protect the certainty and security of commercial transactions" and could also lead to unfairness.

Conclusion

The Court of Appeal held that, before a written contract could be rectified on the basis of a common mistake, it was necessary to show either (1) that the document failed to give effect to a prior concluded contract or (2) that the parties had a common intention in respect of a particular matter which, by mistake, the document did not accurately record. In the latter case it was also necessary to show that, as a result of communication between them, the parties understood each other to share that intention.

Given the judge's findings of fact, which were not challenged on appeal, and which included express or implicit findings that the parties' common intention had been communicated between them, the appeal had to fail.