Contractual construction vs rectification: High Court judgment illustrates the contrasting approaches

The High Court has found that a novation agreement in respect of an aircraft lease, properly construed, transferred the right to recover outstanding arrears of rent to the new lessor. However, in what the court described as an unusual finding to make in a commercial context, it held that the novation agreement should be rectified on the basis of mutual mistake: SATA Internaçional - Azores Airlines SA v Hi Fly Ltd [2024] EWHC 2762 (Comm).

The decision illustrates the fundamental differences in approach between interpreting a contract and considering whether it should be rectified. The court considered that the clause in question in the present case admitted only one possible interpretation. The wording was clear, and in considering the impact of commercial common sense the court could not take account of circumstances that were not known to all three parties to the novation. The parties' subjective intentions were also irrelevant, and the contents of the parties' negotiations could not be considered for the purposes of this exercise.   

In contrast, however, when it came to considering the claim for rectification, the parties' subjective intentions and the contents of their negotiations were key to the court's decision. The court held that the parties had all positively believed at the time of entering into the novation agreement that it operated to entitle the original lessor (not the new lessor) to recover outstanding arrears, and the agreement should be rectified to reflect that shared intention.  

Background

The claimant, SATA, a regional air carrier based in the Azores, leased an Airbus A300 from the defendant, Hi Fly. The lease was set to expire in March 2021. However, by 2019, SATA was experiencing financial difficulties. The aircraft was not in use, and SATA had fallen behind on its rent and monthly maintenance reserve payments to Hi Fly, with default interest accruing on the overdue amounts.

A deal was agreed between SATA, Hi Fly and another aircraft leasing company, AELF, consisting of three agreements: (i) a sale agreement under which Hi Fly sold the aircraft to AELF; (ii) a novation agreement providing for AELF to take over as the lessor; and (iii) a termination agreement under which AELF agreed to an early termination of the lease in exchange for a lump sum payment. When these agreements were executed on 8 April 2020 (defined as the "Effective Date"), SATA owed Hi Fly just under USD 3 million. Of this amount, around USD 1 million related to rent that had been outstanding since before 1 September 2019 (the "Economic Closing Date"), which the parties agreed was owed to Hi Fly. The balance related to rent that had become due after 1 September 2019, and the parties disputed how that rent should be treated under the novation agreement.

SATA argued that the rent for the period after the Economic Closing Date ceased to be due to Hi Fly, and became due to AELF instead. This would mean SATA's obligation to pay the rent had been settled under the termination agreement. Hi Fly and AELF argued that the rent for this period remained owing to Hi Fly, meaning it was still due.

Decision

The High Court (Paul Stanley KC sitting as a deputy High Court judge) was tasked with two questions: how the novation agreement should be construed, and whether it should be rectified.

Construction

The first question was whether, as a matter of construction, the novation agreement transferred the right to recover rent accruing after the Economic Closing Date from Hi Fly to AELF.

This required an examination of the language and structure of the novation agreement. Clause 2.1 of the agreement generally released SATA from its obligations to Hi Fly under the lease, and Hi Fly agreed it had no further rights against SATA, but this was stated to be subject to the provisions of clause 2.3 and clause 7.

Clause 2.3 preserved Hi Fly’s rights under the lease in respect of any losses, liabilities, or claims attributable to the period before the novation agreement was executed. Clause 7.3 specifically addressed the payment of rent, maintenance reserves, and default interest. It stated that amounts relating to the period before the Economic Closing Date had to be paid by SATA to Hi Fly, and amounts relating to the period afterwards would be paid by SATA to AELF. If any amounts were paid by SATA to the wrong party, then the clause provided that they had to be promptly transferred to the other party.

SATA considered that the language of the contract was clear: clause 7.3 transferred the right to receive rent during the period after the Economic Closing Date from Hi Fly to AELF, and the preservation of Hi Fly's rights under clause 2.3 was subject to this provision. However, Hi Fly and AELF argued that clause 7.3 was only concerned with the mechanism of payment, and did not alter Hi Fly's actual entitlement to be paid the rent, which was preserved under clause 2.3. They argued that rent due after the Economic Closing Date would remain due to Hi Fly, but would just have to be paid to AELF in accordance with clause 7.3.

The court heard evidence from the parties' representatives who negotiated the contracts, and reviewed various records of contemporaneous correspondence, and made findings in relation to the parties' subjective intentions at the time the novation agreement was entered into. In short, the court found that, at the time of concluding the agreement, Hi Fly and AELF had believed the rent from the relevant period would remain payable to Hi Fly, and SATA did not believe that the deal would transfer all of Hi Fly's debt to AELF.

However, stepping back from those findings, the court summarised the key principles of contractual construction, about which there was no dispute:

• Construction is an objective exercise – it never involves considering the parties' subjective intentions or beliefs. Nor does it allow the court to take into account how the contract was negotiated. The court therefore had to ignore its conclusions about what the parties said to each other during the negotiations and their actual intentions and expectations.
• The court must construe a contract in the context of the factual circumstances known to all of the parties, including the relevant background facts which could be assumed to be common knowledge.
• Where the contract is a written commercial agreement, the court will adopt an expectation that the parties intended to achieve commercially sensible results.

Applying the above principles, the court held that the clear language and structure of the novation agreement admitted only one possible interpretation. Hi Fly released all of its rights under the lease, subject to clauses 2.3 and 7. Since clause 7.3 provided a specific regime for a particular class of payment obligations (rent, maintenance reserve payments and default interest) from a specified date, any contradiction between clauses 2.3 and 7.3 had to be resolved in favour of clause 7.3. The interpretation put forward by Hi Fly and AELF, suggesting that clause 7.3 only related to the mechanism of payment and not the obligation to pay rent, would create a "finicky mechanism" serving no useful objective. It also made no sense in this context of Hi Fly's obligation to pay on to AELF any rent it received relating to the relevant period.

The court rejected Hi Fly and AELF's arguments based on commercial common sense, namely that: (i) it should be assumed that a novation would leave the lessee liable to make payments to the old lessor (ie Hi Fly) until ownership transferred; and (ii) under the sale agreement Hi Fly bore the cost of all outstanding payments (through an adjustment to the purchase price) so, logically, it should be entitled to recover them.

The court accepted that the first point might be valid in many cases, but it was inconsistent with the express terms of the agreement which included an “Economic Closing Date” distinct from the date of the novation, effectively structuring the deal so as to backdate its economic consequences. In any event, the court was not assisted by consideration of what would be “usual” in a novation; the evidence was that the present issue would not usually arise, because a new lessor would refuse to take over a plane that was in arrears. As for the second point, the court could not take account of that aspect of the sale agreement in construing the novation agreement, as it was not known to SATA.

The court therefore concluded that, properly construed, the novation agreement transferred the right to recover rent due after the Economic Closing Date to AELF.

Rectification

However, despite that being the correct interpretation, the court went on to consider whether the novation agreement should be rectified on the basis of mutual mistake, ie a shared mistaken belief that the novation agreement would leave Hi Fly entitled to recover arrears predating that agreement. In other words, it considered whether the contract should be corrected so as to provide that the rent remained due and payable to Hi Fly, notwithstanding what the contract actually said.

For this purpose, the court was required to consider the parties' subjective beliefs at the time they entered into the contract, and was permitted to consider evidence about the negotiations (in contrast with the approach to construction outlined above). To order rectification, the court needed to be satisfied that, at the time of the novation agreement: (i) each of the parties believed that SATA would remain liable to pay Hi Fly rent, and they all knew that the others had the same expectation; or (ii) AELF and Hi Fly had that belief, and SATA knew (or wilfully shut its eyes to the fact) that Hi Fly had that belief.  

The court found, on the balance of probabilities, that the parties all shared a common intention that Hi Fly would retain the right to recover the outstanding rent. The court noted that it would also have found that the alternative criteria was met, ie that SATA knew Hi Fly was expecting to be paid arrears.

The court noted that this was not a normal case: the point in issue had been focussed on by the parties and the subject of regular communication around the time the contract was concluded, SATA had accepted that Hi Fly and AELF shared a common intention that the rent would remain owing to Hi Fly, and it was common ground that the novation agreement did not reflect that intention. Also, the COO of SATA had never read the draft novation agreement, so it was common ground that the document did not provide any useful evidence of his own intentions.  

Therefore, on the basis that there had been a shared mistaken belief as to how the contract operated, the court found that the parties were entitled to have the agreement rectified to reflect their common intentions: SATA remained liable to pay rent to Hi Fly for the period after the Economic Closing Date.