In the recent case of Wood v Sureterm Direct Ltd & Capita Insurance Services Ltd , the Court of Appeal has given further guidance on the use of "business sense" in the interpretation of commercial contracts.
In overturning a decision at first instance, the Court made clear that the wording of the clause, an indemnity, should be interpreted in accordance with its plain meaning, even if this made the clause uncommercial for one party.
The dispute arose from the sale of Sureterm Direct Limited to Capita Insurance Ltd. Mr Wood was one of a group of sellers.
Following the acquisition, various concerns were raised about Sureterm's pre- acquisition conduct and whether customers paid more for insurance than originally quoted. Sureterm conducted an internal review and referred its findings to the FSA, who concluded that misspelling had occurred. Accordingly, Sureterm introduced a customer compensation scheme which resulted in sums of approximately £1.35million being paid.
Capita subsequently sought to recover the compensation paid from the sellers, relying on the following indemnity:
'The Sellers undertake to pay to the Buyer an amount.to indemnify the Buyer.against all actions, proceedings, losses, claims, damages, costs, charges, expenses and liabilities suffered or incurred, and all fines, compensation or remedial action or payments imposed on or required to be made by [Sureterm] following and arising out of claims or complaints registered with the FSA, the Financial Services Ombudsman or any other Authority against [Sureterm], the Sellers or any Relevant Person and which relate to the period prior to the Completion Date pertaining to any mis-selling or suspected mis-selling of any insurance or insurance related product of service.'
The sellers rejected this claim on the basis that the indemnity was not intended to cover compensation paid due to Sureterm reporting itself to the FSA.
The High Court considered that: 'following and arising out of claims or complaints registered with the FSA...' should be interpreted so as only to apply to 'all fines, compensation or remedial action.' and not to 'all actions, proceedings, losses, claims, damages, costs, charges, expenses and liabilities suffered or incurred'. Accordingly, Capita could recover the payments because they constituted a sum suffered or incurred falling within the first section of the clause.
This interpretation was considered appropriate in light of commercial considerations; there was deemed to be no good reason why the indemnity should apply if an FSA investigation was triggered by a customer complaint, but not if it was triggered by whistleblowing or self-reporting.
Court of Appeal
The Court of Appeal agreed unanimously that no liability could be imposed on the sellers in the absence of a customer claim or any complaint of mis-selling of an insurance-related product being made to a relevant authority.
Clark LJ interpreted the indemnity as imposing an obligation on the sellers to indemnify Capita for two distinct heads of loss, both of which are qualified by the obligation that they follow and arise out of 'claims or complaints registered with the FSA.'
The Court of Appeal took guidance from the recent Supreme Court decision of Arnold v Britton  in which it was emphasised that businesses often make poor business decisions for a number of reasons e.g. poor negotiation skills. To effectively re-write a contract to the benefit of one party would simply discredit the importance of the language actually chosen.
The emphasis in this case was on the contract's wording rather than considerations of commercial fairness. In this vein, the Court concluded:
'The fact that the deal may have been.from [the Buyer's] view, a poor one, is not, in my view, a circumstance which should dictate a different interpretation from that which, for the reasons that I have stated, I derive from the words used.'
Contractual interpretation: a brief history
Over time, contractual interpretation has seen a shift from a literal approach to a more purposive approach. The demise of legalism stemmed from a perception that parties were being unfairly tripped up by drafting mistakes. Accordingly, the modern courts have asserted that their role is to identify and interpret the deal struck between parties, not to re-write it. This much is clear.
The problems come when the wording is not so clear. What should be done in these situations? In answer, the courts will determine what the parties intended the contract to mean using an objective approach: what would a reasonable person in the position of the parties and with all the information available to both parties have intended?
To this end, the concept of 'business sense' has developed and is clearly evident in the Supreme Court case Rainy Sky v Kookmin Bank , in which it was determined that where there are multiple contractual interpretations, it is appropriate to adopt that most consistent with business sense. Under this approach, the courts tread a fine line between interpretation and re-writing contracts and, correspondingly, there has been growing unease with how far the courts have been willing to depart from the natural meanings of words.
The rules of contractual interpretation are easy to recite, but not so easy to apply and the pendulum has swung between a focus on the literal meaning of the wording used and seeking to apply a 'business sense' meaning.
This case clarifies that where the wording used is clear and unambiguous, the Court will not step in to remedy a party's bad bargain. In the absence of absurdity, the plain meaning of the words should usually be the start and end point of interpretation.
Businesses should heed this as a warning as to the importance of clear, accurate and unambiguous drafting for all types of contractual clauses, particularly when drafting indemnities, which provide the most valuable protection to companies.
This document is for informational purposes only and does not constitute legal advice. It is recommended that specific professional advice is sought before acting on any of the information given.