English Law Governed Agreements — Hidden Value Points

English courts pride themselves on their commercial pragmatism and readiness to uphold and give effect to commercial bargains freely struck between willing participants, however infelicitously expressed.

A salutary remark by Lord Reid in Moschi v Lep Air Services Ltd [1973] A.C. 331, 344 continues to hold true now, fifty years after he made it:

01 — ConstructionHow contracts are construed

As part of the English law of contract, the courts have developed techniques for determining what an agreement means. At a high level of abstraction, the current iteration of the basic principles has been settled for close to a decade by a familiar trio of Supreme Court cases — so familiar they need no citation. New intakes of senior judges continue to recite, refine and gloss these principles, and there is no shortage of authority examining almost every conceivable nuance. Still, the basics are agreed for now, and the current judicial attitude may be captured in an unofficial maxim:

Construction is an iterative process in which all pleaded rival meanings of disputed words are considered against the entirety of the contract and in light of their commercial consequences. The courts weigh both the internal construction of each clause and its inter-relation with every other. They select as true the meaning that best accords with the words used, the commercial tenor and purpose of the agreement, and the admissible factual background.

Legal dogma holds that there is only one "true" meaning of any contractual provision, and the court's task is to find it. The words that fall to be construed are the starting point and remain the firm foundation throughout. Arguments from redundancy carry little weight: every word counts and must be read in the context of its phrase, provision, clause and the whole contract, so as to produce a coherent meaning. A construction must not be so over-literal that it loses sight of business common sense — yet a court must not rewrite an improvident bargain whose clear terms simply make poor commercial sense.

After some vacillation, the courts have rejected attempts to elevate commercial common sense into the overarching test of construction. Resort to it is allowed only in cases of genuine ambiguity: where two genuinely rival meanings exist, the court prefers the one that accords better with business sense. But where the meaning is clear, the courts will not second-guess its commercial effect. Courts do not mend bad bargains; the loss from a bad bargain is left to lie where it falls.

02 — MethodA bespoke exercise

Construction, though governed by general principles, is a bespoke exercise. Past cases in which specific language was construed are not strictly binding on the construction of a different contract, however similar — the only exception being standard forms used in sectors such as shipping or commodities trading. Each contract is construed on its own language and against its own peculiar background.

Some judges have shown clear impatience with arguments by analogy from other contracts in other cases. Even the most minute differences in language are pored over, and every nuance and shade of meaning debated at length. The result is that fairly simple questions of construction can generate lengthy hair-splitting arguments — and enormous costs.

03 — VocabularyMagic words

Some words in a contract have acquired a specialised technical meaning that produces defined consequences as a matter of law. In the course of negotiations, it repays recognising these words and accounting for their distinctive characteristics. Used carelessly, they can reshape liability, quantum and the right to terminate without anyone at the table intending it.

"Represents" or "Warrants"

Consider two variants of the same provision in a share-purchase agreement:

Each word carries its own consequence for both liability and quantum if the statement proves untrue.

On liability: a warranty is breached if, as a matter of fact, 2025 EBITDA was below $1m — nothing more is required. For a misrepresentation, the purchaser must additionally show reliance: that it actually believed the statement and acted on it. If the seller shows the purchaser was indifferent to EBITDA, or had independent knowledge that the figure was wrong, there is no claim.

On quantum, suppose actual EBITDA was $500k. An untrue warranty sounds in damages designed to place the purchaser where it would have been had the warranty been true — compensation for loss of bargain, the difference between the market price the shares would have commanded at $1m EBITDA and their true price at $500k. If the purchaser had underpaid against the market, it recovers a profit; if it overpaid, the overpayment is ignored.

A misrepresentation sounds in damages designed to place the purchaser as if there had been no sale — compensation for loss on the actual deal, the difference between the price actually paid and the true value at $500k EBITDA. Here, an overpayment against the market is recoverable, but the loss of a good bargain is not.

"Condition"

What happens when a term is broken depends on what type of term it is. The common law draws a three-way distinction:

• Condition: any breach, however slight, entitles the aggrieved party to treat the contract as at an end.
• Warranty: a breach sounds only in damages; there is no right to terminate.
• Intermediate (innominate) term: a breach may or may not allow termination, depending on whether it deprived the other party of substantially the whole benefit it was to obtain.

In modern practice the word has lost some of its magic. It still falls to be construed in context; loose use, or absurd consequences from a literal reading, may lead the courts to treat it as an innominate term rather than a true condition — a possibility established in the Wickman Machine case discussed below.

"Time of the Essence"

AKTA lawyers frequently see drafts containing language such as "Time shall be of the essence of this contract." Its true significance is not always appreciated, and it is often buried in boilerplate rather than deployed judiciously against the specific obligations where it belongs.

What it does is turn every contractual deadline into a true condition. Miss the deadline by a single second, and the other party may declare the contract at an end. That effect is not liable to be diluted by construction. It is easy to imagine the havoc wrought by undiscriminating use of such language in a complex contract with time stipulations of widely varying importance.

Practice note. Where time is not of the essence under the express terms, it can be made so by unilateral notice — once a deadline is missed, the innocent party may serve a notice that:

1. sets a new and reasonable deadline;
2. requires performance within it;
3. expressly makes time of the essence, stating that the contract may be terminated if complete performance is not tendered in time.

Termination on this footing is only available if failure to meet the extended deadline is, in its own right, a sufficiently serious breach — which depends on the nature of the performance owed. AKTA has used this technique on a sale of securities exercised under an option. The option contract made no provision for time being of the essence; when the purchaser failed to complete, a notice fixed a new deadline made of the essence. When completion still did not occur, rescission followed and the seller retained the shares, reselling at a substantial premium over the option price.

"Trust"

Provisions dealing with the distribution or retention of funds may use the words "shall hold in/on trust for." Beware these words: they move the relationship out of contract and into the rules of equity governing trusts — a different world, with complicated rules and significant consequences:

• a split of ownership into legal and equitable;
• fiduciary duties of the trustee — loyalty (no self-dealing, no conflict, account for secret profit) and care;
• proprietary remedies — recovery of the funds as property, not merely as debt or damages;
• tracing remedies — following the funds into assets bought with them and their proceeds;
• equitable compensation, somewhat akin to damages.

These incidents must be considered closely in context and may be tempered — though not excluded entirely — by appropriately phrased disclaimers.

04 — ReliefReprieve

In some cases relief may be available from a provision a party has, in time, come to find disadvantageous. A misnomer or obvious error will be corrected as a matter of construction — "seller" for "purchaser," "2011" for "2001" — where the intended meaning is plain. A party may also seek rectification, on the basis that the words as written do not reflect the parties' actual common intention. For that purpose, the negotiations leading up to the contract are admissible — by contrast, that evidence is not admissible in construing the contract itself.

Commercial common sense is a reprieve of last resort, not a licence to rewrite. The courts' approach can be summed up:

• where the language is unambiguous, it must be applied whatever the commercial consequences;
• ambiguity may yet be found if literal application yields a commercially improbable result;
• where the language is ambiguous, the court prefers the construction more in line with commercial common sense.