UK: Commercial Purpose Beats Red Ink: Chartbrook Ltd v Persimmon Homes Ltd And Ors (2009)

Despite the apparently well established rule that when a court comes to construe a contract evidence of pre-contractual negotiations is inadmissible, commentators have suggested that the law in this area is in a state of flux. The recent House of Lords decision in Chartbrook Ltd v Persimmon Homes Ltd & Ors, makes their Lordships' views on the debate clear, and also offers useful guidance on the construction and rectification of contracts.

The Facts

Persimmon and Chartbrook entered into a development agreement in 2001 by virtue of which Persimmon, the well-known house builder, would construct a mixed residential and commercial development on land in Wandsworth owned by Chartbrook.

The contract provided for Persimmon to pay Chartbrook a fixed sum and a further payment, the amount of which depended upon the revenues generated by the residential element of the development (the "Additional Residential Payment" or "ARP"). The parties could not agree on the amount of the ARP which led to Chartbrook commencing proceedings against Persimmon and a counterclaim by Persimmon for a declaration as to the proper construction of the agreement or for rectification. The clause in the agreement which was the subject of the dispute stated that the amount of the ARP should be calculated as:

"23.4% of the price achieved for each Residential Unit in excess of the Minimum Guaranteed Residential Unit Value less the Costs and Incentives"

where the Minimum Guaranteed Residential Unit Value ("MGRUV") was the fixed sum Persimmon agreed to pay to Chartbrook, which had been calculated as 23.4% of the revenue the parties anticipated the development would generate, and the Costs and Incentives ("C&I") were the costs Persimmon incurred in inducing sales of the residential units (such as the installation of better fixtures and fittings or an agreement to pay the purchaser's stamp duty).

Chartbrook's case was that the ARP should be calculated as:

Persimmon's case was that the ARP should be:

The difference between these formulae (leaving aside the impact of the C&I) can be demonstrated by a simple worked example:

• Expected price = £10 million
• MGRUV (23.4% of expected price) = £2.34 million
• Actual price achieved = £11 million

Chartbrook's interpretation:

Persimmon's interpretation:

On the facts of the case, the parties' rival interpretations made a difference of more than £3.5 million.

The Preceding Judgments

In the High Court, Briggs J held that Chartbrook's interpretation of the contract was the right one. He was of the view that it accorded with the natural reading and ordinary syntax of the words used in the definition of the ARP.

The Court of Appeal upheld Briggs J's decision. However, Lawrence Collins LJ dissented and held that when construing the contract the court should have regard to the commerciality of the clause in question.

A significant issue before the courts was the relevance of the parties' pre-contract negotiations. Persimmon argued that the pre-contractual negotiations demonstrated that the parties had agreed a formula which accorded with their interpretation of the clause. They sought to persuade the courts that they should have regard to that when construing the contract on the grounds that the correspondence did not demonstrate that the parties had divergent negotiating positions but rather showed what it was they had agreed. The High Court and the Court of Appeal refused to allow Persimmon to adduce evidence of the parties' pre-contract negotiations in relation to the question of construction.

As to the issue of rectification, the High Court and the Court of Appeal also favoured the evidence of Chartbrook's witnesses, who stated that, although the pre-contract documentation did appear to support Persimmon's interpretation, nevertheless that was not their understanding of the agreement at the time they entered into the contract. The witnesses could not explain how they had reached this conclusion, since on re-reading the correspondence for the purposes of the litigation they accepted that they could see how it supported Persimmon's interpretation.

The House Of Lords

Their Lordships unanimously overturned the decisions of the High Court and the Court of Appeal. This was primarily on the basis of the issue of the construction of the contract, but there were also some significant obiter comments on the rectification claim.

Construction Of The Contract

The House of Lords agreed with the approach of Lawrence Collins LJ. In his final judgment before his retirement, Lord Hoffman said: "I think that to interpret the definition of ARP in accordance with ordinary rules of syntax makes no commercial sense... the striking feature of this case is not merely that the provisions as interpreted by the judge and the Court of Appeal are favourable to Chartbrook. It is that they make the structure and language of the various provisions... appear arbitrary and irrational, when it is possible for the concepts employed by the parties (MGRUV, C&I etc) to be combined in a rational way."

One of the main reasons for Lord Hoffman's comments was that Chartbrook's interpretation made a nonsense of the MGRUV: only if there was a depression in the property market beyond anything imaginable (far more severe than the consequences of the current slump) would the price achieved for the development be lower than the MGRUV such that no ARP would be payable. Given that the purpose of the minimum guaranteed payment was to protect Chartbrook from a downturn in the market from its level in 2001, and the ARP was to be an additional payment over and above that guarantee to reward Chartbrook for any extra value extracted from the development, this interpretation did not make sense.

Lord Hoffman gave some helpful guidance on the purposive approach which should be taken in construing agreements which should help contracting parties to avoid unnecessary litigation where the wording of a contract plainly does not reflect the objective intention of the parties. He said: "I do not think that it is necessary to undertake the exercise of comparing this language [i.e. Persimmon's interpretation] with that of the definition in order to see how much use of red ink is involved. When the language used in an instrument gives rise to difficulties of construction, the process of interpretation does not require one to formulate some alternative form of words which approximates as closely as possible to that of the parties. It is to decide what a reasonable person would have understood the parties to have meant by using the language which they did... there is not, so to speak, a limit to the amount of red ink or verbal rearrangement which the court is allowed. All that is required is that it should be clear that something has gone wrong with the language and that it should be clear what a reasonable person would have understood the parties to have meant."

Evidence Of Pre-Contract Negotiations

The House of Lords gave a significant amount of consideration to Persimmon's argument that they should be permitted to rely upon evidence of the pre-contractual negotiations in relation to the construction of the contract on the grounds that it demonstrated the terms of the parties' true agreement. However, their Lordships declined to alter the well-established rule that such evidence should be excluded and this was summed up by Lord Rodger: "No-one could possibly say that the rule is based on some error of law or misconception. On the contrary, the main pros and cons of having regard to prior negotiations when interpreting a formal contract have been known and discussed for centuries... The rule could scarcely be more firmly embedded in our law." In the event, of course, it was unnecessary for the House of Lords to have regard to the pre-contract negotiations because the correct interpretation of the contract could be divined without reference to them.

Rectification

For the same reason, the arguments on rectification were also redundant. However, some points are worth noting, even though they are strictly obiter dicta. Chartbrook's case on rectification was that there was no mistake on its part as to the meaning of the contract and that its interpretation of the ARP was precisely what it understood Persimmon to be offering. Their evidence in that regard had been accepted by Briggs J even though it conflicted with documentary evidence.

In the House of Lords, Persimmon had introduced an argument that, when investigating the parties' true consensus for the purposes of deciding whether an agreement should be rectified, the court should have regard to an objective reading of the documentation which evidences their consensus, rather than the parties' subjective accounts of their understanding. On this basis, Lord Hoffman concluded that the pre-contractual correspondence, read objectively, demonstrated that Persimmon and Chartbrook had agreed to a formula for the calculation of the ARP which accorded with Persimmon's case. Therefore, if Chartbrook had succeeded with its construction of the contract then that interpretation would not have reflected the parties' mutual accord and would have been rectified. Baroness Hale commented that this approach to rectification would "go a long way towards providing a solution" to the problems that can be created by the rule preventing the use of pre-contractual negotiations in relation to construction.

This case had the potential to create an upheaval in the way the courts approach disputes over the construction of contracts. However, in the end the House of Lords took a pragmatic approach to the construction of commercial agreements, consistent with previous authorities such as Mannai Investment Co Ltd v Eagle Star Life Assurance Co Ltd [1997] AC 749 and Investors Compensation Scheme Ltd v West Bromwich Building Society [1998] 1 WLR 896, and also made some helpful observations with regard to the law on rectification. In doing so, the court has also avoided opening what many feared would be the floodgates to a wave of claims involving pre-contractual negotiations as an aid to construction.

The comments of Lord Hoffman in relation to the court's wide powers to make sense of agreements (that regard should always be had to the bigger picture of commercial purpose) should stand the test of time and act as a valuable point of reference for commercial parties and help avoid litigation in cases of this kind: a fitting end to his judicial career.

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