Supreme Court considers business common sense rule in contract interpretation

Practical Law UK Legal Update 1-510-8311 (Approx. 7 pages)

Supreme Court considers business common sense rule in contract interpretation

by PLC Commercial

The Supreme Court has ruled on a question of contract interpretation, including the important question of when, if at all, the court can consider arguments based on business common sense (Rainy Sky SA and others v Kookmin Bank [2011] UKSC 50). (free access)

Speedread

The Supreme Court had to consider the role of business common sense in contract interpretation. They held unanimously that, where the parties have used unambiguous language, then the court must give effect to it, no matter how unreasonable the result may seem. However, where two interpretations are possible, the court should usually prefer the interpretation which is most consistent with business common sense. On this ground, the court can not only reject an interpretation that defies commercial common sense, but also choose between two interpretations, both arguable and perhaps even finely balanced, neither of which flouts commercial common sense. It is not necessary to conclude that a particular interpretation would produce an absurd or irrational result before having regard to the commercial purpose of the agreement. (Rainy Sky SA and others v Kookmin Bank [2011] UKSC 50.)

Facts

The case concerned the interpretation of refund guarantees issued by Kookmin Bank to protect advance payments made by buyers to a shipbuilder under shipbuilding contracts.

A long and poorly-drafted clause required the bank to pay "such sums". The question was which sums these words referred back to. Two interpretations were possible, as follows:

The buyer's case. These sums were "Instalments" mentioned earlier in the same sentence (sums due under the shipbuilding contract, including the refund of advance payments on the shipbuilder's insolvency); or
The bank's case. These sums were those mentioned in the previous sub-clause (payable on various guarantee trigger events but not insolvency).

The shipbuilder suffered financial difficulties and the buyer claimed under the guarantees. The bank argued that, properly interpreted, its guarantee obligations were not triggered by the shipbuilder's insolvency. Insolvency was not specifically mentioned in the guarantee bond but other events such as rejection or total loss of the vessel were. Under the shipbuilding contract, however, the shipbuilder was required to refund advance payments if it became insolvent. The arguments were finely balanced; at first instance the judge ruled in the buyer's favour but the Court of Appeal overturned the decision by a majority.

Background

The principles of modern contract interpretation, summarised in Investors Compensation Scheme Ltd v West Bromwich Building Society [1997] UKHL 28, place great weight on the commercial purpose of the agreement, which may even take priority over the literal meaning of the words used. For more information, see Practice note, Contracts: interpretation.

This decision considers the precise relation between these two factors in the process of contract interpretation. The courts below had expressed two views:

Sir Simon Tuckey in the Court of Appeal and the judge at first instance had said that, between two possible interpretations, the court should reject the one that flouts business common sense.
Patten and Thorpe LJJ had said the court must give effect to the most natural meaning of the words, unless that effect was so extreme that the parties could not have meant it.

Decision

The Supreme Court expressly considered the role to be played by business common sense to decide what the parties meant. In the rare case where the parties have used completely unambiguous language, the court must apply it. However, in many cases, as here, two interpretations are possible. Often, neither of them will flout business common sense. In that case, it is generally appropriate to prefer the interpretation which is most consistent with business common sense. It is not necessary to conclude that a particular interpretation would produce an absurd or irrational result before having regard to the commercial purpose of the agreement.

If they had looked only at the language, the Supreme Court's judgment suggested they might have preferred the buyer's interpretation. However, the argument that proved fatal to the bank's interpretation was that it would lead to what the judge called a "surprising and uncommercial result". On the bank's interpretation, the guarantees would cover every situation in which the buyers could claim a refund, except the situation in which they were most likely to need it - the shipbuilder's insolvency. The bank could not suggest any commercial reason for the buyer to have agreed to this. The Supreme Court therefore, agreeing with the judge and Sir Simon Tuckey in the Court of Appeal, preferred the buyer's interpretation, because it was consistent with the commercial purpose of the guarantees in a way that the bank's was not.

Comment

The case provides useful guidance on a key rule of contract interpretation.

(Soon after this decision, the Supreme Court again endorsed this approach, but chose an implied term rather than interpretation to achieve the commercially sensible outcome (Aberdeen City Council (Respondent) v Stewart Milne Group Limited (Appellant) (Scotland) [2011] UKSC 56).)

Case

Rainy Sky SA and others v Kookmin Bank [2011] UKSC 50, 2 November 2011, Lord Phillips, President, Lord Mance, Lord Kerr, Lord Clarke, Lord Wilson.

End of Document

Also Found In

Resource ID 1-510-8311

Law stated as at 27-Feb-2012

Resource Type Legal update: archive

Jurisdictions

England
Wales