English Law Governed Agreements: Hidden Value Points

01 – OverviewConstruing commercial contracts

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 very true now, fifty years after he made it:

As part of the English law of contract, the courts have developed techniques of going about the determination of 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 now by the very familiar trio of Supreme Court cases.^[1] Of course, new intakes of higher courts judges continue to recite, refine and gloss over these principles, and there is no shortage of authority that examines almost every conceivable nuance in their application. Still, the basics are agreed for the time being, and the current judicial attitude may be encapsulated in an (unofficial) maxim:

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

Legal dogma has it that there is only one “true” meaning of any contractual provision. The court’s task is to find it. Contractual words and expressions which fall to be construed make the starting point and throughout the process remain the firm foundation of the entire exercise. Arguments from redundancy are of little weight and are seldom persuasive: every word counts and must be interpreted in the context of the relevant phrase, provision, clause and the entire contract, so as to produce a coherent true meaning. A construction must not be over-literal to the point that it loses sight of business common sense and commercial consequences of adopting the literal meaning. Yet a court must be careful not to rewrite the contracting parties’ improvident bargain which by its clear terms does not make good business sense for any or all of them.

After some vacillation, the courts have rejected attempts to elevate commercial common sense to the overarching test of construction. Resort to commercial common sense is only allowed in cases of genuine ambiguity in the language of the contract: if there are two genuinely rival meanings, the court will prefer that which accords better with business common sense. But if the meaning is clear then the courts will not second guess the commercial effect of that meaning. Courts do not mend bad bargains, and the loss from a bad bargain will be left to lie where it falls.

02 – Bespoke exerciseEach contract is construed on its own

Construction of contracts, though subject to general principles, is a bespoke exercise. Past cases in which specific contractual language was construed to arrive at a certain meaning are not considered strictly binding on issues of construction arising from the language of a different contract, however similar. (The only exception is construction of standard forms employed for making contracts in various industry sectors, such as shipping or commodities trading.) Each contract is construed on its own, with its own language and peculiar background to it. Some judges have expressed clear impatience with arguments by analogy from other contracts considered in other cases. Even the most minute differences in language are pored over closely and every nuance and shade of meaning are debated at length. This sometimes results in fairly simple cases of construction generating lengthy hair-splitting arguments which come with enormous costs.

03 – Magic wordsWords with consequences defined by law

Some words in a contract have acquired a specialised technical meaning which produces defined consequences as a matter of law. In the course of contractual negotiations, it repays recognising these words and taking account of their distinctive characteristics.

“Represents” or “warrants”

Consider two variants of a provision in a contract for the sale of shares in a company:

Each word has its own consequence in terms of both liability and quantum in case the statement is untrue.

As for liability, a warranty will be breached if as a matter of fact the EBITDA for 2025 was lower than $1m. Nothing more is required. However, for there to be a misrepresentation, the purchaser must in addition to the factual inaccuracy of the statement also show that it had relied on the statement in the actual belief that it was accurate. If the seller shows that the purchaser was indifferent to the EBITDA, or had its own independent knowledge that the statement was inaccurate, the purchaser will have no claim.

As for differences in quantum, if we postulate that the actual EBITDA for 2025 was $500k, what is the compensation due to the purchaser?

An untrue warranty sounds in damages which are designed to place the purchaser in the same position as if the warranty had been true. This calls for compensation for loss of bargain, determined as a difference between (1) the true market price of the sold shares at the time of sale had the EBITDA been $1m as warranted and (2) the true market price of the shares at the time of sale with the actual EBITDA of $500k. Both figures are a matter of evidence. Figure (1) may or may not turn out to be the same as the actual price paid: the true market value of the shares may be higher or lower. If the purchaser underpaid against the market, he will recover a profit. If he had overpaid, the overpayment will be ignored and he will not recover it.

A misrepresentation sounds in damages designed to place the purchaser in the same position as if there had been no misrepresentation (i.e. no sale). The purchaser is compensated for loss on the actual deal, which is the difference between (1) the actual price paid and (2) the true market price of the shares at the time of sale with the actual EBITDA of $500k. If the purchaser overpaid against the market, he will recover the overpayment. If he underpaid, he will not get compensated for the loss of a good bargain.

“Condition”

What if a contractual term is broken? The common law makes a distinction between three types of terms. Consequences of a breach of a term will depend on what type of term it is.

• Condition: any breach, however slight, entitles the aggrieved party to treat the contract as at an end.
• Warranty: a breach sounds only in damages; no termination of the contract.
• Intermediate term: a breach may or may not allow a party to terminate. That depends on whether the breach has deprived the other party of substantially the whole benefit which on the true construction of the contract the party was to obtain from the proper performance of the term which was breached.

In the modern times, the word “condition” has lost its magic somewhat, in that it still falls to be construed in the context of the entire agreement. Loose employment of the word or absurd consequences of literal construction may lead the courts to treat it as an innominate term and not a true condition. That possibility was established in the Wickman Machine case discussed below.

“Time of the essence”

In the course of their commercial practice, AKTA lawyers frequently observed draft commercial contracts including language along the lines of “Time shall be of the essence of this contract”. The true significance of this form of words is not always appreciated, and they are often found buried among general boilerplate provisions rather than used judiciously in relation to specific obligations where their use would be appropriate.

What they do is render every contractual time or deadline into a true condition. That means that if a party misses the deadline by as long as one second, the other party may declare the contract at an end. Importantly, that effect is not liable to be diluted by construction: we are not aware of a reported case in which the words “time of the essence” were not treated as a true condition. It is easy to imagine the havoc which can be wrought by the generic, undiscriminating use of such language in a complicated contract which includes stipulations of time of varying degrees of importance.

AKTA lawyers have employed this technique in a situation of a sale of corporate securities upon exercise of an option. The option contract had no stipulation of time being of the essence. The purchaser party failed to complete the sale, and notice was given of a new extended deadline that was made of the essence. When completion did not occur by the new deadline, notice of rescission was given and the seller was able to retain the shares and resell them at a substantial premium over the option price.

“Trust”

Provisions of commercial contracts dealing with distribution or retention of funds may use the words “shall hold in/on trust for”. One has to beware of these words because they move the relationship out of the realm of contract and into the rules of equity governing trusts. That is a whole different world with complicated rules and significant consequences arising from a trust:

• split of ownership into equitable and legal;
• fiduciary duties of a trustee: a duty of loyalty (no self-dealing, no conflict of interest, account for secret profit) and a duty of care;
• proprietary remedies (i.e. the ability to recover the funds as property, not as debt or damages);
• tracing remedies (i.e. the ability to follow the funds into assets purchased with them and proceeds of sale of those assets);
• equitable compensation remedies (somewhat akin to damages).

These incidents must be closely considered in the context of the contract and may be tempered (though not excluded entirely) by appropriately phrased disclaimers.

04 – ReprieveCorrection, rectification and common sense

In some cases, a reprieve may be available from the effects of a contractual provision which the party has, in the fullness of time since making the contract, come to find disagreeable or disadvantageous. A misnomer or error will be corrected as a matter of construction, e.g. the parties’ names, “seller” for “purchaser”, “2011” for “2001”, where the correct meaning is obvious from the context. A party may pursue an action for rectification of the contract on the basis that the words as written do not reflect the actual common intention of the parties which they shared when the contract was made. For this purpose, admissible evidence includes the parties’ negotiations leading up to the making of the contract: by contrast, this evidence is not admissible in construing the contract.

Commercial common sense is a reprieve of last resort but it is not a licence to rewrite the contract. The courts’ approach may be summed up in this way:

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

The law is stated as at the date of publication. The information contained in this document is provided for general informational purposes only, does not constitute legal advice, and does not purport to be an exhaustive analysis of the issues addressed herein. Neither AKTA nor any of its employees accept any responsibility for any actions (or lack thereof) taken as a result of relying on or in any way using information contained in this document, and in no event shall they be liable for any losses resulting from reliance on or use of this information. For advice on specific circumstances, please contact AKTA.