Approach to the interpretation of clauses with two possible meanings – common sense prevails
RAINY SKY v KOOKMIN BANK (SC) [2011]
The Supreme Court (SC) has confirmed that the Court will look to adopt a commercial approach when there are ambiguities in commercial contracts.
Facts:
- R (and some others) contracted to buy ships under agreements with a shipbuilder. In accordance with the shipbuilding contracts, the builder arranged for certain ‘refund guarantees’ to be issued by K. These took the form of bonds designed to protect the advance payments made by the buyers under the shipbuilding contracts. The bonds provided for a refund to be given if certain events occurred (such as termination, cancellation or rescission) but the insolvency of the shipbuilder was not expressly mentioned. The drafting of the bonds did not match the wording of the shipbuilding contracts, the latter of which stated the shipbuilder was required to refund payments made to the purchasers if it became insolvent.
- The shipbuilder suffered financial difficulties, became insolvent and the buyers claimed a refund of payments made. When the shipbuilder refused, the buyers claimed under the bonds.
- K argued the right to repayment had not been triggered as no right to terminate, cancel or rescind the contracts had at that point arisen. However, the buyers’ argument was that this literal interpretation made no business sense as there was no good commercial reason why insolvency should be excluded.
- The High Court agreed with the purchasers and found that the wording of the bond should be interpreted in such a way that K would have to pay out if the shipbuilder became insolvent. K appealed to the Court of Appeal which overturned this ruling and the purchasers then further appealed to the SC.
Decision:
- The SC considered the role to be played by ‘business common sense’ to decide what the parties meant. In doing so, it confirmed the correct approach to contractual construction as referred to in previous judgments, “The ultimate aim of interpreting a provision in a contract, especially a commercial contract, is to determine what the parties meant by the language used, which involves ascertaining what a reasonable person would have understood the parties to have meant... The relevant reasonable person is one 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”.
- The subjective intention of a contracting party is seemingly irrelevant as is the mere fact that an individual term in a contract appears to be particularly unfavourable to one party. What is required is ambiguity of meaning – where the parties have used unambiguous language the Courts must apply it. However, where two interpretations are possible the SC approved a ruling from a previous case which said, “If a clause is capable of two meanings…it is much more appropriate to adopt the more, rather than the less, commercial construction”.
- K’s interpretation would have led to a "surprising and uncommercial result” - the bonds would cover every scenario in which the buyers could claim a refund except the shipbuilder’s insolvency, which was the very situation for which the security of an advance payment bond was most likely to be needed.
- K was unable to put forward any “credible commercial reason” as to why the purchasers would have agreed to this. The SC therefore preferred the buyers' construction of the wording of the bond “because it is consistent with the commercial purpose of the bonds in a way in which the bank’s construction is not”.
- The SC also commented, “The importance attached … to the obligation to refund in the event of insolvency can be seen from the fact that the [buyers] required the refund to be made immediately. It defies commercial common sense to think that this, among all other such obligations, was the only one which the parties intended should not be secured. Had the parties intended this surprising result, I would have expected the contracts and the bonds to have spelt this out clearly but they do not do so”.
- K was ordered to give the buyers a refund under the bonds.
Points to Note:
- This decision provides useful guidance on one of the rules of contract interpretation. Where there are two or more possible interpretations of a provision, it is generally appropriate to prefer the interpretation which is most consistent with ‘business common sense’.
- Whilst recognising that “loyalty to the text of a commercial instrument... is the paramount principle of contract interpretation” (“where the parties have used unambiguous language the courts must apply it”), the Court went on to say that “language is a very flexible instrument” and will very often have more than one possible interpretation.
- The Courts are apparently unimpressed with “technical interpretations and [those which place] undue emphasis on niceties of language”. It was clearly significant to the conclusion reached that K had been unable to provide any commercial reason why insolvency should be excluded from the scope of the bond.
- The reality is that very rarely indeed will wording be completely immune from having more than one possible interpretation, particularly when the background context is taken into account. The Judges therefore seem to have reserved to themselves a significant degree of discretion in ascertaining the meaning which most closely accords with business common sense. It might be argued that this increases fairness but this may be at the expense of greater uncertainty and encourage the need for resort to the Courts to resolve any ‘uncertainties’.
- The better the drafting the narrower the scope will be for the Courts to intervene. However, “the poorer the quality of the drafting, the less willing the Court should be to be driven by semantic niceties to attribute to the parties an improbable and unbusinesslike intention”.