Rectification for common mistake
FHSC v Glas (Court of Appeal) [2019]
Rectification is an equitable remedy by which the court may amend the terms of a legal document which, because of a mistake, fails accurately to reflect the intention of the parties to it.
Facts:
The parties had entered into a corporate financing transaction which required FHSC to provide security over a loan from a shareholder. Several years later it was discovered that the relevant security documents had either never been entered into or could not be located. Rather than produce new documentation, FHSC suggested that it accede to two existing Intercompany Receivables Security Assignments (IRSAs) which provided a mechanism for the necessary security. However, by doing so FHSC assumed additional onerous obligations which were not required under the original transaction and neither party had apparently realised this.
FHSC sought an order ‘rectifying’ the accession documentation so as to exclude the additional obligations.
Decision:
At first instance, the judge granted rectification of the accession documents, on the basis that he found as a matter of fact that the parties' actual common, subjective, intention had been to execute a document that did no more than provide the missing security. He also held that this was also their common intention if the matter were assessed objectively (what a reasonable observer with knowledge of the background facts and communications between the parties would have thought their common intention at the time of contracting to be). Glas appealed.
The Court of Appeal refused the appeal. It held that whether the parties had a common intention in respect of a particular matter should depend on their subjective intentions, as evidenced by their outward expressions (Note that a different, ‘objective’, test would apply in circumstances where rectification was being sought in relation to an allegedly defective secondary contract which had been entered into pursuant to an earlier binding contract).
In doing so the Court of Appeal bent over backwards to justify why it was not following the comments of a judge sitting in an earlier House of Lords case and why it was permitted to do so in this case.
It held that if, by mistake, the parties’ common continuing intention at the time of executing the contract is not reflected in its actual terms, the court can rectify the document based on the equitable principle of good faith. The test in this case is subjective. However, the parties must not merely have had the same subjective intention, but must have communicated that intention to each other.
Points to Note:
- The focus on the parties' subjective intentions is a reminder of the need to keep proper records of pre-contract negotiations. Rectification requires convincing proof to displace the natural presumption that the written contract is an accurate record of what the parties agreed. A further requirement is that some ‘outward expression of accord’ contained in communications ‘crossing the line’ between the parties must exist. Without it any claim for rectification will not succeed.
- It is interesting to note another example of a senior judge invoking the principle of ‘good faith’. “The underlying principle can be characterised as being that persons who make a contract have to observe certain standards of good faith”. An interesting statement by the Court of Appeal given that implied duties of good faith have, for a very long time, not been a part of English contract law.
- There has been some suggestion that this decision is very significant. However, we would argue that the reality is that whether a subjective or an objective test applies the focus will still be on the contents of communications which passed between the parties pre-contract. However in our view the focus on seeking to identify the subjective intention of each of the parties is something of a concern. The courts have routinely sought to exclude evidence of subjective intent from the factual matrix when interpreting contracts and for perfectly valid reasons of certainty. This would seem to be a step in the opposite direction.
- The most obvious example of an ‘outward expression of accord’ would be some form of non-binding Heads of Terms or Heads of Agreement. Such documents very often precede the final binding contract as a normal part of the process of negotiating and finalising a contract. The courts will have to determine whether differences between the Heads and the final signed contract represent a renegotiation or a mistake. That determination will arguably be more difficult if the courts have to ascertain the subjective intention of the individuals involved in the negotiation and this can only lead to greater uncertainty of outcome.