How to interpret contracts: Use commercial common sense

How to interpret contracts: Use commercial common sense


Author: Joanna Lane

When the terms of a commercial contract are ambiguous or unclear, the courts will often be given the tricky task of ascertaining how the contract should be correctly interpreted.

The recent Supreme Court case of Rainy Sky S.A. and others v Kookmin Bank has provided important guidance on the role of commercial common sense in contract interpretation.

The facts

Each of the claimants entered into shipbuilding contracts with a shipbuilder in which the claimants made pre-delivery payments to the shipbuilder, and the shipbuilder provided the claimants with payment bonds issued by the defendant bank.

The shipbuilding contracts provided that the shipbuilder was obliged to refund any prepayments made in a number of circumstances, including:

  • where the claimants terminated, cancelled or rescinded the contracts
  • where the shipbuilder became insolvent

The shipbuilder entered into a debt workout procedure under Korean law, and the claimants sought to recover their prepayments from the bank under the payment bonds.

The payment bonds guaranteed the shipbuilder's payment obligations under the shipbuilding contracts but it was unclear from the wording of the bonds which circumstances would give rise to the bank's obligation to pay.

The claimants argued that the wording of the bonds required the bank to pay in a wide range of circumstances including where the shipbuilder became insolvent. The bank argued that the wording only required payment where the claimants terminated, cancelled or rescinded the contracts.

The law

Where unambiguous language is used in a commercial contract, the court must apply it, even if this results in an unfavourable result for one party. This is because the court has not been privy to the negotiations that have taken place before the contract was concluded, and should not therefore impose its own view over what the parties have agreed.

However, where the wording of the contract is ambiguous, the court is entitled to prefer the interpretation which is consistent with business common sense. In deciding this, the commercial purpose of the contract will be given more weight than the niceties of the language used.

The decision

The Supreme Court reversed the decision of the Court of Appeal and found in favour of the claimants, that the shipbuilder's insolvency did invoke the payment bonds, and the claimants were therefore entitled to payment by the bank.

The Supreme Court confirmed that it would be an uncommercial and surprising result if the claimants could not rely on the bonds in circumstances where their security was most likely to be needed (namely, the shipbuilder's insolvency).


The case is a reminder of the importance of ensuring that commercial contracts are drafted with clarity and precision.

Whilst the Supreme Court has affirmed that where there is ambiguity, a commercial common sense approach should be taken, it is nevertheless important that the parties to a contract ensure watertight drafting, in order to prevent a dispute arising.

Case: Rainy Sky S.A. and others v Kookmin Bank [2011] UKSC 50