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N2-11: Contractual interpretation
Statutory regime applies to contractual relations determined under general law
"[139] This authority, like Morris v Baron and British and Beningtons, shows that the common intention of the parties governs the nature of the contractual arrangements between them. If a statutory regime then has to be applied, it is applied to the state of the contractual relations between them as determined under the general law in accordance with their common intention. Morris v Baron, British and Beningtons and Stead v Dawber illustrate the sort of three-stage analysis we have referred to above, which is different from that contended for by HMRC." (R (oao Cobalt Data Centre 2 LLP) v. HMRC [2024] UKSC 40)
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"[23] Unlike some other relational arrangements including agency, the basis in law of employment is necessarily contractual. Rooted in the common law, it depends on the existence of a contract between employer and employee. For many years, some commentators have thought that it would be better based on the relationship itself (see, for example, BA Hepple: Restructuring Employment Rights (1986) 15 ILJ 69) but it has "obdurately persisted" in being based on the individual contract of employment (see Paul Davies and Mark Freedland: Changing Perspectives Upon the Employment Relationship in British Labour Law, Chap 6 in The Future of Labour Law (2004), ed. Catherine Barnard and others, at p 130).
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[26] As noted above, it is the common law concept of employment that is applicable to the tax and National Insurance legislation relevant to this appeal." (Professional Game Match Officials Ltd v. HMRC [2024] UKSC 29)
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- Unless distinct statutory standard intended
"[125] The Variation Issue arises only on the footing, contrary to our opinion, that the phrase "incurred under a contract entered into [etc]" in section 298(1)(b) refers to the general law of contract and does not import any distinct statutory standard of its own.
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[150] We revert briefly at this point to the section 298 Issue. The difficulties and uncertainties involved in applying the general common law as regards treatment of a change in contractual relations as a variation or a replacement of an original contract are further reasons why it is not plausible to think that the legislative regime as regards what happens in the second 10 year period was supposed to operate solely by reference to common law theory. That would make this tax legislation too uncertain in its effect and would improperly elevate taxpayer choice as to how it should operate above implementation of the policy purpose behind the 10 year time limit." (R (oao Cobalt Data Centre 2 LLP) v. HMRC [2024] UKSC 40)
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General test
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- Identify objective intention of parties by reference to known background
"[10] The court’s task is to ascertain the objective meaning of the language which the parties have chosen to express their agreement. It has long been accepted that this is not a literalist exercise focused solely on a parsing of the wording of the particular clause but that the court must consider the contract as a whole and, depending on the nature, formality and quality of drafting of the contract, give more or less weight to elements of the wider context in reaching its view as to that objective meaning. In Prenn v Simmonds [1971] 1 WLR 1381 (1383H-1385D) and in Reardon Smith Line Ltd v Yngvar Hansen-Tangen [1976] 1 WLR 989 (997), Lord Wilberforce affirmed the potential relevance to the task of interpreting the parties’ contract of the factual background known to the parties at or before the date of the contract, excluding evidence of the prior negotiations. When in his celebrated judgment in Investors Compensation Scheme Ltd v West Bromwich Building Society [1998] 1 WLR 896 Lord Hoffmann (pp 912-913) reformulated the principles of contractual interpretation, some saw his second principle, which allowed consideration of the whole relevant factual background available to the parties at the time of the contract, as signalling a break with the past. But Lord Bingham in an extra-judicial writing, A new thing under the sun? The interpretation of contracts and the ICS decision Edin LR Vol 12, 374-390, persuasively demonstrated that the idea of the court putting itself in the shoes of the contracting parties had a long pedigree."
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"[15] When interpreting a written contract, the court is concerned to identify the intention of the parties by reference to "what a reasonable person having all the background knowledge which would have been available to the parties would have understood them to be using the language in the contract to mean", to quote Lord Hoffmann in Chartbrook Ltd v Persimmon Homes Ltd [2009] UKHL 38, [2009] 1 AC 1101, para 14. And it does so by focussing on the meaning of the relevant words, in this case clause 3(2) of each of the 25 leases, in their documentary, factual and commercial context..." (Arnold v. Britton [2015] UKSC 36, Lord Neuberger)
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- Assess ordinary meaning, other provisions, purpose and commercial common sense
"[15] ... That meaning has to be assessed in the light of (i) the natural and ordinary meaning of the clause, (ii) any other relevant provisions of the lease, (iii) the overall purpose of the clause and the lease, (iv) the facts and circumstances known or assumed by the parties at the time that the document was executed, and (v) commercial common sense, but (vi) disregarding subjective evidence of any party's intentions. In this connection, see Prenn at pp 1384-1386 and Reardon Smith Line Ltd v Yngvar Hansen-Tangen (trading as HE Hansen-Tangen) [1976] 1 WLR 989, 995-997 per Lord Wilberforce, Bank of Credit and Commerce International SA (in liquidation) v Ali [2002] 1 AC 251, para 8, per Lord Bingham, and the survey of more recent authorities in Rainy Sky, per Lord Clarke at paras 21-30." (Arnold v. Britton [2015] UKSC 36, Lord Neuberger)
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- Iterative exercise
"[77] This unitary exercise involves an iterative process by which each of the rival meanings is checked against the provisions of the contract and its commercial consequences are investigated (Re Sigma Finance Corp ([2009] UKSC 2) [2010] 1 All ER 571, para 12 per Lord Mance). But there must be a basis in the words used and the factual matrix for identifying a rival meaning. The role of the construct, the reasonable person, is to ascertain objectively, and with the benefit of the relevant background knowledge, the meaning of the words which the parties used. The construct is not there to re-write the parties' agreement because it was unwise to gamble on future economic circumstances in a long term contract or because subsequent events have shown that the natural meaning of the words has produced a bad bargain for one side. The question for the court is not whether a reasonable and properly informed tenant would enter into such an undertaking. That would involve the possibility of re-writing the parties' bargain in the name of commercial good sense. In my view, Mr Morshead's formulation (para 67 above), on which his case depends, asks the court to re-write the parties' leases on this illegitimate basis." (Arnold v. Britton [2015] UKSC 36, Lord Hodge)
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- Does not matter whether detailed analysis commences with factual background or relevant language
"[12]This unitary exercise involves an iterative process by which each suggested interpretation is checked against the provisions of the contract and its commercial consequences are investigated: Arnold para 77 citing In re Sigma Finance Corpn [2010] 1 All ER 571, para 10 per Lord Mance. To my mind once one has read the language in dispute and the relevant parts of the contract that provide its context, it does not matter whether the more detailed analysis commences with the factual background and the implications of rival constructions or a close examination of the relevant language in the contract, so long as the court balances the indications given by each." (Wood v. Capita Insurance Services Limited [2017] UKSC 24)
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"[61] It happened that the approach the FTT took was to examine the circumstances it considered relevant to commercial context before it then considered the contract terms. As Mr Tolley KC pointed out, that was a perfectly legitimate approach and one that was envisaged by Lord Hodge, in Wood v Capita [2017] UKSC 24 where he had explained that it mattered not whether the analysis started with terms and then looked at circumstances or vice versa." (Exchequer Solutions Ltd v. HMRC [2024] UKUT 25 (TCC), Flaux J and Judge Raghavan)
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- Not to start with preconceived view of commercial intentions
"[37] I should say at the outset that I am not persuaded that the judge's conclusion is vitiated or incorrect for any of the reasons advanced by the appellant. By placing commercial common sense at the forefront of his argument, the appellant, as it seems to me, relegates the language used by the parties in their agreement to far too subservient a role in the process of construction. It is obviously wrong in principle to start with a preconceived view as to the commercial benefits to be derived by a party from an agreement and then to shoe-horn the language of the agreement to conform with that view. In Arnold v Britton [2015] AC 1619, a case in which he described the commercial consequences for the leaseholders as "alarming", Lord Neuberger emphasised that "save perhaps in a very unusual case" the ascertainment of what the parties meant through the eyes of a reasonable reader "is most obviously to be gleaned from the language of the provision"." (Ortiz-Patino v. MGI Golf & Leisure Opportunities Fund Limited [2024] EWCA Civ 862, Floyd, Asplin, Snowden LJJJ)
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- Perspective of the reasonable reader, not necessarily a pedantic lawyer
"[47] There is no doubt or dispute about the principles of English law that apply in interpreting the policies. They were most recently authoritatively discussed by this court in Wood v Capita Insurance Services Ltd [2017] UKSC 24; [2017] AC 1173 in the judgment of Lord Hodge and are set out in the judgment of the court below at paras 62-66. The core principle is that an insurance policy, like any other contract, must be interpreted objectively by asking what a reasonable person, with all the background knowledge which would reasonably have been available to the parties when they entered into the contract, would have understood the language of the contract to mean. Evidence about what the parties subjectively intended or understood the contract to mean is not relevant to the court's task.
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[77]...In any event, the overriding question is how the words of the contract would be understood by a reasonable person. In the case of an insurance policy of the present kind, sold principally to SMEs, the person to whom the document should be taken to be addressed is not a pedantic lawyer who will subject the entire policy wording to a minute textual analysis (cf Jumbo King Ltd v Faithful Properties Ltd (1999) 2 HKCFAR 279, para 59). It is an ordinary policyholder who, on entering into the contract, is taken to have read through the policy conscientiously in order to understand what cover they were getting.
[78] The notion that such a policyholder who is presumed to have reached p 93 of the RSA 3 policy wording would understand the general exclusion of contamination or pollution and kindred risks on that page to be removing a substantial part of the cover for business interruption loss that was ostensibly conferred on p 38 is as unreasonable as it is unrealistic. The reasonable reader would naturally assume that, if the intention had been to put a further substantive limit on the risk of business interruption specifically insured by the extension for infectious diseases in addition to the geographical and temporal limits stated in the extension itself, this would have been done transparently as part of the wording of the extension and not buried away in the middle of a general exclusion of contamination and pollution risks at the back of the policy. The reference in the exclusion to “disease” would reinforce the understanding that the general exclusion could not have been intended to apply to the cover for business interruption caused by an infectious disease, as it would obliterate that cover. It could not sensibly be thought to make a difference that the word “disease” was part of a composite phrase “disease and epidemic”. No reasonable reader would suppose that, although one part of this phrase was not intended to apply to the business interruption cover, the other part was." (FCA v. Arch Insurance UK Ltd [2021] UKSC 1)
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Relevance of tax motive
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- Tax context may be a very important part of identifying shared intention
"[154] ​According to Lewison LJ, the Developer and the Contractor had a mere subjective desire to avoid tax and this could not be taken to affect their intentions, as objectively assessed. With respect, we disagree. The tax context in which the Golden Contract was entered into and the later contractual arrangements were made was known to both parties and was a very important part of the factual background for the making of the Golden Contract and those later arrangements. We agree with Newey LJ that the tax context in which an agreement or series of agreements is made can be part of the relevant background for assessing the intention of the parties. It often will be. This is all the more so where it may be said that the achievement of the relevant tax advantage was, as here, a shared goal.
[155] When the parties confronted the question of altering the relationship constituted by the Golden Contract in terms of whether they wished to vary or replace it, as they did when agreeing Variation 1 and Variation 2, they clearly intended to make the alterations by way of variation rather than replacement. That is evident from the express label of "variation" which they gave to the new contracts which made those alterations. But even if they had not attached that label, we consider that in this tax context both parties understood the importance of maintaining a position that any subsequent expenditure could be taken to be incurred under the Golden Contract, so that EZAs could be claimed, and that their intention would have been assessed to be to vary the Golden Contract rather than replace it. It may not matter that they were mistaken in thinking that the use of the mechanism of variation was sufficient to secure the advantage of satisfying section 298. It is enough that they probably thought it was, or at least that its use gave them a better argument in any later dispute with HMRC than if they had opted for replacement.
[156] Newey LJ addressed the difficult question whether the alterations in the contractual arrangements consequent on Change Order 2 and Change Order 3 were intended to be by way of variation or replacement. He considered that because the choice of building allowed by the Golden Contract, as varied by Variation 2, had already been exercised by the Developer issuing Change Order 1, the better view was that the later Change Orders took effect by way of replacement rather than variation. We are doubtful about that. If the parties had appreciated that they needed a new agreement to alter the Golden Contract in order to issue Change Order 2 and Change Order 3, and agreed to do so, we are by no means sure that in applying the common law it would have been right to assess their intention as being to replace rather than vary the Golden Contract. In view of the degree of respect afforded by the common law to party autonomy and the relevance of the tax context, we would incline to the view that such alterations would in such circumstances have been assessed to be by way of variation rather than replacement. But, as we explain below, the point does not arise for decision and it is not necessary or appropriate to say any more about this.
(R (oao Cobalt Data Centre 2 LLP) v. HMRC [2024] UKSC 40)
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Primacy of words used
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- Meaning is most obviously gleaned from words used
"[17] First, the reliance placed in some cases on commercial common sense and surrounding circumstances (eg in Chartbrook, paras 16-26) should not be invoked to undervalue the importance of the language of the provision which is to be construed. The exercise of interpreting a provision involves identifying what the parties meant through the eyes of a reasonable reader, and, save perhaps in a very unusual case, that meaning is most obviously to be gleaned from the language of the provision. Unlike commercial common sense and the surrounding circumstances, the parties have control over the language they use in a contract. And, again save perhaps in a very unusual case, the parties must have been specifically focussing on the issue covered by the provision when agreeing the wording of that provision." (Arnold v. Britton [2015] UKSC 36, Lord Neuberger)
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- Poor drafting may justify departing from ordinary meaning more readily
"[18] Secondly, when it comes to considering the centrally relevant words to be interpreted, I accept that the less clear they are, or, to put it another way, the worse their drafting, the more ready the court can properly be to depart from their natural meaning. That is simply the obverse of the sensible proposition that the clearer the natural meaning the more difficult it is to justify departing from it..." (Arnold v. Britton [2015] UKSC 36, Lord Neuberger)
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- Even professionally drafted contracts may lack clarity
"[13] Textualism and contextualism are not conflicting paradigms in a battle for exclusive occupation of the field of contractual interpretation. Rather, the lawyer and the judge, when interpreting any contract, can use them as tools to ascertain the objective meaning of the language which the parties have chosen to express their agreement. The extent to which each tool will assist the court in its task will vary according to the circumstances of the particular agreement or agreements. Some agreements may be successfully interpreted principally by textual analysis, for example because of their sophistication and complexity and because they have been negotiated and prepared with the assistance of skilled professionals. The correct interpretation of other contracts may be achieved by a greater emphasis on the factual matrix, for example because of their informality, brevity or the absence of skilled professional assistance. But negotiators of complex formal contracts may often not achieve a logical and coherent text because of, for example, the conflicting aims of the parties, failures of communication, differing drafting practices, or deadlines which require the parties to compromise in order to reach agreement. There may often therefore be provisions in a detailed professionally drawn contract which lack clarity and the lawyer or judge in interpreting such provisions may be particularly helped by considering the factual matrix and the purpose of similar provisions in contracts of the same type. The iterative process, of which Lord Mance spoke in Sigma Finance Corpn (above), assists the lawyer or judge to ascertain the objective meaning of disputed provisions." (Wood v. Capita Insurance Services Limited [2017] UKSC 24)
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- Not to search for infelicities
"[18] ... However, that does not justify the court embarking on an exercise of searching for, let alone constructing, drafting infelicities in order to facilitate a departure from the natural meaning. If there is a specific error in the drafting, it may often have no relevance to the issue of interpretation which the court has to resolve." (Arnold v. Britton [2015] UKSC 36, Lord Neuberger)
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- Alive to the possibility that a provision may be a negotiated compromise due to inability to agree more precise terms
"[11]...Similarly, the court must not lose sight of the possibility that a provision may be a negotiated compromise or that the negotiators were not able to agree more precise terms." (Wood v. Capita Insurance Services Limited [2017] UKSC 24)
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Commercial common sense​
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- Not to be invoked retrospectively
"[19] The third point I should mention is that commercial common sense is not to be invoked retrospectively. The mere fact that a contractual arrangement, if interpreted according to its natural language, has worked out badly, or even disastrously, for one of the parties is not a reason for departing from the natural language. Commercial common sense is only relevant to the extent of how matters would or could have been perceived by the parties, or by reasonable people in the position of the parties, as at the date that the contract was made. Judicial observations such as those of Lord Reid in Wickman Machine Tools Sales Ltd v L Schuler AG [1974] AC 235, 251 and Lord Diplock in Antaios Cia Naviera SA v Salen Rederierna AB (The Antaios) [1985] AC 191, 201, quoted by Lord Carnwath at para 110, have to be read and applied bearing that important point in mind." (Arnold v. Britton [2015] UKSC 36, Lord Neuberger)
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- Slow to reject clear meaning simply because it appear imprudent
"[20] Fourthly, while commercial common sense is a very important factor to take into account when interpreting a contract, a court should be very slow to reject the natural meaning of a provision as correct simply because it appears to be a very imprudent term for one of the parties to have agreed, even ignoring the benefit of wisdom of hindsight. The purpose of interpretation is to identify what the parties have agreed, not what the court thinks that they should have agreed. Experience shows that it is by no means unknown for people to enter into arrangements which are ill-advised, even ignoring the benefit of wisdom of hindsight, and it is not the function of a court when interpreting an agreement to relieve a party from the consequences of his imprudence or poor advice. Accordingly, when interpreting a contract a judge should avoid re-writing it in an attempt to assist an unwise party or to penalise an astute party." (Arnold v. Britton [2015] UKSC 36, Lord Neuberger)
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- Use to choose between possible constructions
"[11] ... Interpretation is, as Lord Clarke stated in Rainy Sky (para 21), a unitary exercise; where there are rival meanings, the court can give weight to the implications of rival constructions by reaching a view as to which construction is more consistent with business common sense. But, in striking a balance between the indications given by the language and the implications of the competing constructions the court must consider the quality of drafting of the clause (Rainy Sky para 26, citing Mance LJ in Gan Insurance Co Ltd v Tai Ping Insurance Co Ltd (No 2) [2001] 2 All ER (Comm) 299 paras 13 and 16); and it must also be alive to the possibility that one side may have agreed to something which with hindsight did not serve his interest: Arnold (paras 20 and 77)..." (Wood v. Capita Insurance Services Limited [2017] UKSC 24)
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"[76] This conclusion is not a matter of reaching a clear view on the natural meaning of the words and then seeing if there are circumstances which displace that meaning. I accept Lord Clarke's formulation of the unitary process of construction, in Rainy Sky SA v Kookmin Bank [2011] 1 WLR 2900, para 21:
"[T]he exercise of construction is essentially one unitary exercise in which the court must consider the language used and ascertain what a reasonable person, that is a person who has 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 contract, would have understood the parties to have meant. In doing so the court must have regard to all the relevant surrounding circumstances. If there are two possible constructions, the court is entitled to prefer the construction which is consistent with business common sense and to reject the other."" (Arnold v. Britton [2015] UKSC 36, Lord Hodge)
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- Clause not interpreted as obligation that both parties knew could not in practice be complied with
"[74] There was no error of law in this orthodox application of the Arnold v Britton principles. In ascertaining what the parties had agreed when they referred to “work” being provided, the FTT had to give that term a meaning which reflected the particular relevant circumstances, namely that, in respect of the gap periods, both parties knew ESL was not expected nor in any position to provide work. The FTT was not ignoring the use of the term “work”; it was saying that, given the relevant circumstances, the parties’ agreement can only have referred to ESL using its best efforts to put itself in a position where its likelihood of being able to act as employer was increased. There was no error of approach in the FTT construing the language in this way and the conclusion was, in the light of the findings the FTT made, plainly one the FTT was entitled to reach. ESL is not able to point to any findings which explain why the FTT would have been duty bound to find otherwise." (Exchequer Solutions Ltd v. HMRC [2024] UKUT 25 (TCC), Flaux J and Judge Raghavan)
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- Not commercially absurd for profit share only to apply to sale of assets, not sale of shares in group owning assets
"[59] Mr Blaker's complaint about the commercial consequences of the judge's interpretation was that it gave the respondent an easy way of "circumventing" the obligation to pay a profit share. This is a rather contentious way of putting things, because it assumes that it was intended by the parties that a profit share would become payable in the event of a sale of the whole group, by means of a sale of the shares in Soto, as opposed to only becoming payable on the sale of Real Estate Assets owned by Valsa and Vesa. For my part, when the matter is considered against the admissible factual background, I do not think it is absurd or unrealistic for an agreement to have been reached which provided for a profit share only on the sale of Real Estate Assets. That, after all, was what was under immediate consideration in the prospectus. If that venture had gone forward JOP would have received a profit share on the sale of lots adjoining the golf course. The fact that the venture did not proceed in that way does not mean that it was absurd or unrealistic to think that it might.
[60] It is true that the deal which the parties reached, on the judge's interpretation, is not as favourable to JOP as one in which the known route to realising a profit from the golf course land was also deemed to be a triggering event for the profit share. I cannot, however, regard the fact that it is not so treated as commercially unrealistic or absurd. JOP was in a weak bargaining position, with Banif calling the shots in the negotiation. The 2012 SPA had advantages for JOP in that it dealt with his liability to his creditor, Banif, on whose loan he had defaulted. If the respondent was not prepared to pay more in the way of primary consideration, some deal, even a bad deal, would no doubt have been regarded as better than no deal on the profit share aspect. Mr Blaker suggested that this was impermissibly to stray into the domain of the parties' subjective intentions, but I do not agree. JOP's financial peril must have been obvious not only to him but to the respondent, given the close involvement of Banif in the negotiations towards the agreements. It formed part of the admissible factual matrix reasonably available to the parties against which the contract is to be construed. It would not be commercially realistic to ignore it." (Ortiz-Patino v. MGI Golf & Leisure Opportunities Fund Limited [2024] EWCA Civ 862, Floyd, Asplin, Snowden LJJJ)
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Facts known to the parties​
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- Only facts known or reasonably available to both parties at time of contracting
"[21] The fifth point concerns the facts known to the parties. When interpreting a contractual provision, one can only take into account facts or circumstances which existed at the time that the contract was made, and which were known or reasonably available to both parties. Given that a contract is a bilateral, or synallagmatic, arrangement involving both parties, it cannot be right, when interpreting a contractual provision, to take into account a fact or circumstance known only to one of the parties." (Arnold v. Britton [2015] UKSC 36, Lord Neuberger)
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Unforeseen events​
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- Court will strive to give effect to what parties would have intended if it is clear
"[22] Sixthly, in some cases, an event subsequently occurs which was plainly not intended or contemplated by the parties, judging from the language of their contract. In such a case, if it is clear what the parties would have intended, the court will give effect to that intention. An example of such a case is Aberdeen City Council v Stewart Milne Group Ltd [2011] UKSC 56, 2012 SCLR 114, where the court concluded that "any … approach" other than that which was adopted "would defeat the parties' clear objectives", but the conclusion was based on what the parties "had in mind when they entered into" the contract (see paras 17 and 22)." (Arnold v. Britton [2015] UKSC 36, Lord Neuberger)
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Contra proferentem ​
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- Not unforeseen if language indicates parties did address their minds to possibility
"[67] In my judgment, the present case is not of the kind referred to by Lords Neuberger and Hodge in the passages referred to. At least in general terms, the possibility of a sale of shares in a company which directly or indirectly owns a relevant asset instead of a sale of the asset itself was plainly something to which, as the language of the contract shows, the parties had addressed their minds: see clause 3.7 final sentence, clause 4.6 final sentence and clause 5. In the present case, the internal context of the contract points away from rather than towards a re-writing of clause 3.2 to create a triggering event upon a sale of shares in a holding company. Furthermore, at the time of entering into the PSA the parties also entered into the 2012 SPA. That itself was a sale and purchase of the holding company of a group in which group members held underlying assets. I find it difficult to suppose, reading the two documents together, that the parties had not contemplated in general terms that there could be a further onward sale of the shares in Soto and Campo. Indeed, in respect of Campo, clause 5 treats such a sale as a triggering event. It cannot be said that the parties must have intended the same to apply to a sale of shares in Soto, Valsa and Vesa when they appear to have chosen not to do so." (Ortiz-Patino v. MGI Golf & Leisure Opportunities Fund Limited [2024] EWCA Civ 862, Floyd, Asplin, Snowden LJJJ)
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- Ambiguity construed against party who proferred that drafting
“Because of the extravagant result which the former view involves, I think that the latter construction is the one which the court ought to adopt. We are presented with two alternative readings of this document and the reading which one should adopt is to be determined, among other things, by a consideration of the fact that the defendants put forward the document. They have put forward a clause which is by no means free from obscurity and have contended that, on the view for which they argued, it has a remarkably, if not an extravagantly, wide scope, and I think that the rule contra proferentem should be applied and that the result is that the present claim is not one which obliges the first plaintiffs to give to the defendants a release and an indemnity.” (John Lee & Son (Grantham) Ltd v. Railway Executive [1949] 2 All ER 581 at 584)
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Contractual powers/discretions to be exercised in good faith​
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- Well established principle in absence of very clear language to the contrary
"[18] Contractual terms in which one party to the contract is given the power to exercise a discretion, or to form an opinion as to relevant facts, are extremely common. It is not for the courts to re-write the parties' bargain for them, still less to substitute themselves for the contractually agreed decision-maker. Nevertheless, the party who is charged with making decisions which affect the rights of both parties to the contract has a clear conflict of interest. That conflict is heightened where there is a significant imbalance of power between the contracting parties as there often will be in an employment contract. The courts have therefore sought to ensure that such contractual powers are not abused. They have done so by implying a term as to the manner in which such powers may be exercised, a term which may vary according to the terms of the contract and the context in which the decision-making power is given.
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[31] But whatever term may be implied will depend upon the terms and the context of the particular contract involved. I would add to that Mocatta J's observation in The Vainqueur José, that "it would be a mistake to expect [of a lay body] the same expert, professional and almost microscopic investigation of the problems, both factual and legal, that is demanded of a suit in a court of law" (577). Nor would "some slight misdirection" matter, at least if it were clear that, had the legal position been properly appreciated, the decision would have been the same. It may very well be that the same high standards of decision-making ought not to be expected of most contractual decision-makers as are expected of the modern state." (Braganza v. BP Shipping Limited [2015] UKSC 17)
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"[91] Counsel for the claimants relied on the now well established principle that in the absence of very clear language to the contrary, a contractual discretion must be exercised in good faith for the purpose for which it was conferred, and must not be exercised arbitrarily, capriciously or unreasonably (in the sense of irrationally): see e.g. Abu Dhabi National Tanker Co v Product Star Shipping Ltd, (The 'Product Star')(No 2) [1993] 1 Lloyd's Rep 397, 404; Paragon Finance Plc v Nash [2002] 1 WLR 685, paras 39-41; Socimer International Bank Ltd v Standard Bank London Ltd [2008] 1 Lloyd's Rep 558, 575–577; British Telecommunications Plc v Telefónica O2 UK Ltd [2014] UKSC 42, para 37. That principle applies to discretions in relation to remuneration like any other contractual discretion. The leading authorities in which the principle has been applied to payments of discretionary bonuses are Clark v Nomura International plc [2000] IRLR 766, Horkulak v Cantor Fitzgerald International [2004] EWCA Civ 1287, [2005] ICR 402, and Keen v Commerzbank AG [2006] EWCA Civ 1636, [2007] ICR 623. As expressed by Burton J in Nomura at para 40:
"My conclusion is that the right test is one of irrationality or perversity (of which caprice or capriciousness would be a good example) ie that no reasonable employer would have exercised his discretion in this way."
[92] This principle is buttressed in the employment context by the overarching obligation implied by law as an incident of the employment contract that an employer will not without reasonable and proper cause conduct itself in a manner calculated or likely to destroy or seriously damage the relationship of confidence and trust between employer and employee: see Malik v Bank of Credit and Commerce International SA [1998] AC 20. The essence of this obligation is one of fair dealing: see Johnson v Unisys Ltd [2001] UKHL 13; [2003] 1 AC 518, para 24, per Lord Steyn. As explained by Lord Nicholls (with whom Lords Hoffmann, Rodger and Brown agreed) in Eastwood v Magnox Electric plc [2004] UKHL 35; [2005] 1 AC 503, para 11, it means "in short, that an employer must treat his employees fairly in the conduct of his business" and that "in his treatment of his employees, an employer must act responsibly and in good faith". It allows "a balance to be struck between an employer's interest in managing his business as he sees fit and the employee's interest in not being unfairly and improperly exploited": see Lord Steyn in Malik at 46D." (Brogden v. Investec Bank Plc [2014] EWHC 2785 (Comm), Leggatt J)
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- Applies where one party given responsibility for making judgment
"[100] Both on the authorities and as a matter of principle, it seems to me that where a contract gives responsibility to one party for making an assessment or exercising a judgement on a matter which materially affects the other party's interests and about which there is ample scope for reasonable differences of view, the decision is properly regarded as a discretion which is subject to the implied constraints that it must be taken in good faith, for proper purposes and not in an arbitrary, capricious or irrational manner. Those limits apply in circumstances where the decision is final and binding on the other party in the sense that a court will not substitute its own judgment for that of the party who makes the decision. There is therefore also a discretion in the second sense distinguished earlier. The concern, as Rix LJ observed in Socimer at para 66, is that the decision-maker's power should not be abused. The implication is justified as a matter of construction to give effect to the presumed intention of the parties. In the employment context it is further reinforced by the obligations of good faith and fair dealing which, as discussed above, are a necessary incident of the employment relationship.
[101] As I have construed the bonus clause in the claimants' contracts of employment, the clause conferred on Investec a discretion in the relevant sense to determine the EVA generated by the equity derivative business – a determination which involved numerous and substantial exercises of judgement and which fixed the amount of bonus that the claimants were entitled to receive. I conclude that the assessment of EVA was subject to implied requirements of good faith and rationality, as contended for by the claimants as their alternative case." (Brogden v. Investec Bank Plc [2014] EWHC 2785 (Comm), Leggatt J)
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- Applies to powers to determine bonuses and profit shares
"[38] One of the bonus-related cases referred to by Lord Hodge was Horkulak v Cantor Fitzgerald International [2004] EWCA Civ 1287, [2005] ICR 402 ("Horkulak"). The relevant contract specified that the bonus decision was in the "sole discretion" of Cantor Fitzgerald's president. Potter LJ, giving the judgment of the court, gave the following explanation at [30]:
"It is pertinent to observe that, in cases of this kind, the implication of the term is not the application of a 'good faith' doctrine, which does not exist in English contract law; rather is it as a requirement necessary to give genuine value, rather than nominal force or mere lip-service, to the obligation of the party required or empowered to exercise the relevant discretion. While, in any such situation, the parties are likely to have conflicting interests and the provisions of the contract effectively place the resolution of that conflict in the hands of the party exercising the discretion, it is presumed to be the reasonable expectation and therefore the common intention of the parties that there should be a genuine and rational, as opposed to an empty or irrational, exercise of discretion. Thus the courts impose an implied term of the nature and to the extent described."
[39] In Horkulak the court concluded that, on the facts, the discretion was subject to a requirement to exercise it on a bona fide and rational basis. In reaching that conclusion Potter LJ commented at [46] that:
"…the clause is one contained in a contract of employment in a high-earning and competitive activity in which the payment of discretionary bonuses is part of the remuneration structure of employers. In this case, the objective purpose of the bonus clause on the evidence…was plainly to motivate and reward the employee in respect of his endeavours... Further, the condition precedent that the employee should still be working for CFI and should not have given notice or attempted to procure his release, demonstrates that the bonus was to be paid in anticipation of future loyalty. In such a case, as it seems to me, the provision is necessarily to be read as intended to have some contractual content, i.e. it is to be read as a contractual benefit to the employee, as opposed to being a mere declaration of the employer's right to pay a bonus if he wishes, a right which he enjoys regardless of contract."
[40] The Braganza principle has also been considered in the context of profit sharing in an LLP. In Reinhard v Ondra LLP [2015] EWHC 26 (Ch), [2016] 2 BCLC 571 an investment banker who was summarily dismissed from an LLP brought proceedings which included claims in respect of his alleged partnership share. Warren J considered that decisions taken regarding Mr Reinhard's bonus (qua member) and about whether his profit share should be increased were subject to an obligation to exercise the discretion in good faith and rationally: see at [412], [447] and [457].
[41] It must be right that the Braganza principle can in principle be applied where an individual works in a business as a member of an LLP rather than as an employee. Although the focus in Braganza was on employment, the relevant considerations, in particular a "significant imbalance of power" and reliance on discretionary remuneration arrangements, may well be present." (HMRC v. HFFX LLP [2024] EWCA Civ 813 Falk, Asplin, Whipple LJJ)
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- Difficult but not impossible to exclude
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"[74] The fetter that is reflected in the Braganza principle is hard to remove. Mid Essex Hospital Services NHS Trust v Compass Group UK and Ireland Ltd [2013] EWCA Civ 200, [2013] BLR 265 was a case relating to a contract between an NHS trust and a service provider which allowed the trust to deduct amounts for service failures. Reversing the decision of the judge below, this court concluded that there was no need to imply a term fettering the trust's power on the facts because the express contractual provisions effectively addressed the issue. However, Jackson LJ considered other pre-Braganza authorities and said at [83]:
"An important feature of the above line of authorities is that in each case the discretion did not involve a simple decision whether or not to exercise an absolute contractual right. The discretion involved making an assessment or choosing from a range of options, taking into account the interests of both parties. In any contract under which one party is permitted to exercise such a discretion, there is an implied term. The precise formulation of that term has been variously expressed in the authorities. In essence, however, it is that the relevant party will not exercise its discretion in an arbitrary, capricious or irrational manner. Such a term is extremely difficult to exclude, although I would not say it is utterly impossible to do so…"" (HMRC v. HFFX LLP [2024] EWCA Civ 813 Falk, Asplin, Whipple LJJ)
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Right to change specification not interpreted as allowing change to something entirely different
"[118] Interpreting those words in context leads to a conclusion that this is the correct construction. The basic structure of the Golden Contract was to give the Developer a right to select one of six different buildings, identified in each Works Option by reference to purpose and location, each for a different price, across what was cumulatively a very wide price range. Upon selection of one of them by a Notice to Proceed, the Golden Contract then became a much more standard type of building contract, for the construction of the particular building selected, but with the usual right of the employer to require changes (ie alterations or modifications) in design, quality and quantity, attributable to that building, subject to the Contractor's consent (not to be unreasonably withheld) and to consequential increases (but not reductions) in price attributable to the need to give effect to those alterations. The right to require a Change plainly did not extend to changing from one (already selected) building to that specified in a different Works Option, still less to choosing, by way of a supposed Change, some completely different type of building, on a different site, outwith the confines of any of the six Works Options. Yet both of those alternatives would fall within the right enjoyed by the Developer, on the taxpayers' construction." (R (oao Cobalt Data Centre 2 LLP) v. HMRC [2024] UKSC 40)
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Variation v. replacement of contract
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- Generally to be determined by intention
"[151] However, having heard argument on the point, we think it is appropriate to state our view that the centrality and force of the principle of freedom of contract means that, purely in terms of the general common law, parties to an agreement have a wide margin of choice in deciding whether an alteration in their contractual relationship should be achieved by the mechanism of variation or replacement. This is generally a matter to be determined according to their common intention, assessed in the usual objective way, within wide parameters and subject to limits only at the margins which we have attempted to describe."​ (R (oao Cobalt Data Centre 2 LLP) v. HMRC [2024] UKSC 40)
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- But there are limits (e.g. a change of subject matter)
"[148] In Plevin, for the purposes of determining whether a statutory regime applied in relation to conditional fee arrangements made at a particular time, this court had to decide whether two deeds of variation in relation to an original conditional fee agreement, which were expressly agreed to be a variation of that agreement, took effect as variations of that agreement rather than as a replacement of it. At para 13, Lord Sumption (with whom the other Justices agreed) said "[w]hether a variation amends the principal agreement or discharges and replaces it depends on the intention of the parties" and referred to Morris v Baron. He concluded, "While the description given to the transactions by the parties would not necessarily be conclusive if the alleged variation substituted a different subject matter, that cannot be said of either of the deeds of variation". Therefore they took effect as variations of the original agreement. However, Lord Sumption's statement indicates that there is a limit to the ability of the parties to an agreement to specify that a change in their contractual rights and obligations constitutes a variation rather than a replacement of it. We agree that there is.
[149] It has to be acknowledged that these are vague standards which, as purely abstract statements, are not very informative about where precisely the limits lie of the ability of the parties to specify that a change to a contract is a variation rather than a replacement and by doing so to bring about some substantive legal result. If it is borne in mind that the choice between variation and replacement is between alternative mechanisms for the alteration of contractual relations, rather than just a labelling exercise, it may not be too difficult to discern the probably rare cases where the chosen label simply does not match the mechanics actually deployed. We do not think we can usefully say more. This court deals with practical legal questions and does not seek to provide exhaustive abstract statements of the law."​ (R (oao Cobalt Data Centre 2 LLP) v. HMRC [2024] UKSC 40)
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Mistakes
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- Can only correct clear mistakes through interpretation if it is clear what the correction ought to be
"[78] Nor is this a case in which the courts can identify and remedy a mistake by construction. Even if, contrary to my view, one concluded that there was a clear mistake in the parties' use of language, it is not clear what correction ought to be made. The court must be satisfied as to both the mistake and the nature of the correction: Pink Floyd Music Ltd v EMI Records Ltd [2010] EWCA Civ 1429, para 21 per Lord Neuberger MR. This is not an unusual case, such as KPMG (above) in which a mistake was obvious on the face of the contract and the precise nature of the correction had no effect on the outcome." (Arnold v. Britton [2015] UKSC 36, Lord Hodge)
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