Textualism vs. contextualism: the English Supreme Court revisits contractual interpretation

In Wood v Capita Insurance Services Limited the English Supreme Court revisited the balance to be struck between the language used and the commercial context in which a clause was drafted when deciding between competing meanings of a clause. The principles were most recently restated by the Supreme Court in Arnold v Britton, following previous guidance it had given in Rainy Sky SA v Kookmin Bank. 

Key points to note:

• The Supreme Court's decision in Arnold in 2015 raised the question of whether English law was moving towards a more literal approach to contractual interpretation, with considerations of commercial common sense assuming lesser importance. The Court clarified that this was not the case: the approach taken in Arnold and Rainy Sky is consistent: the "recent history of the common law of contractual interpretation is one of continuity rather than change".
• The Supreme Court confirmed that the court will look to both the language used (textualism) and the commercial context in which it was drafted (contextualism) in order to ascertain the objective meaning of the clause in question. The extent to which each is used will vary according to the circumstances. 
• As a general rule, greater emphasis is likely to be given to textual analysis in complex, detailed contracts drafted by experienced lawyers. Commercial context will often be more relevant where the agreement is more informal, or lacking in detail. That said, there will always be exceptions: every case will be decided on its own facts. 
• In Wood v Capita the Supreme Court had to consider competing interpretations of an indemnity provision in a share purchase agreement. When looking at the indemnity provision in isolation, commercial common sense favoured a more liberal interpretation (favouring Capita as the indemnitee). However, the natural meaning of the language used and the overall contractual context of the agreement tipped the balance in favour of a more restrictive interpretation. The indemnity provision as drafted formed part of an overall risk allocation regime within the SPA and therefore had to be read in conjunction with the extensive warranties in the document. As such, a narrowly construed indemnity was not contrary to commercial common sense when considered in light of those warranties.
• Wood illustrates that while commercial common sense remains relevant to contractual interpretation, the court will consider what makes commercial sense in the context of the agreement as a whole – not merely by reference to the provision in dispute. In contracts drafted by sophisticated parties, the court is less likely to be willing to depart from a literal reading of a provision unless to do so would place the parties' overall allocation of risk at odds with commercial common sense. 
• Commercial contracts typically contain different contractual mechanisms to manage risk, including warranties, indemnities, and limitation and exclusion clauses. While Wood does not make new law, the decision emphasises the importance of interpreting these provisions alongside each other, and in the context of the parties' broader commercial bargain. It also demonstrates the importance of precise and careful drafting, and of ensuring that your contract works as a cohesive whole at the drafting stage. 

Facts

Capita bought a specialist classic car insurance company (the Company) from the Sellers under a sale and purchase agreement. Under the terms of the SPA the Sellers:

• gave warranties to the effect that the Company was not in breach of any regulations or laws and they were unaware of any action or claims against it. Written notice of a warranty claim had to be given to the Sellers within two years, otherwise they were time-barred; and 
• indemnified Capita in respect of losses derived from the mis-selling or suspected mis-selling of insurance products prior to the sale. 

Capita later discovered that the Company had possibly mis-sold insurance to customers. It was obliged to inform the Financial Services Authority and in due course agreed to put in place a remediation scheme to compensate customers who might have been affected. 

Capita sought to recover its losses under the indemnity which provided that the Sellers would indemnify Capita 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 the Company following and arising out of claims or complaints registered with the FSA, the Financial Services Ombudsman or any other Authority against the Company, 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 or service.”

It was accepted by all that the clause was opaque and could have been drafted more clearly. Competing interpretations were argued for.

The Seller's more restrictive interpretation would mean Capita could not recover under the indemnity unless there had been a claim made against the Company, or a complaint registered. Since Capita had referred the Company themselves to the FSA this would not apply. Capita's interpretation would, in principle, allow it to recover the compensation on the footing that this would fall within (1). 

The Commercial Court Decision

The Court preferred Capita's interpretation. In particular, the judge thought that there was no good reason why the happenstance of what triggered an FSA investigation should determine the Sellers' obligation to indemnify. In addition, a number of more minor linguistic and syntactical points supported this construction, such as the comma after "incurred" at the end of (1) and the absence of any such comma after "Company" in (2). 

The Court of Appeal Decision

The Court of Appeal disagreed, and determined that the indemnity did not apply in the absence of claims or complaints registered with the FSA.

Christopher Clarke LJ preferred the Seller's construction: the clause naturally appears to start with an obligation to indemnify against two categories of loss, both qualified by the requirements that follow and arising out of claims or complaints registered with the FSA or others. 

In addition, it would not make sense if the second part of (A) "against the Company, the Sellers or any Relevant Person" did not apply to provision (1) as that fails to contain any provision about the person against whom the action must be sought. 

Christopher Clarke LJ also considered the contractual context, in particular, the fact that Capita could have claimed under the warranties before the two year time limit expired. He stated "the fact that the deal may have been, in this respect from Capita'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". 

The Supreme Court decision

The Court dismissed the appeal and agreed with the Court of Appeal.

In doing so, the Court rejected an argument based on the proposition that Arnold had altered the guidance given in Rainy Sky, making it more likely that a literal rather than commercial interpretation of contractual provisions would be favoured. The Supreme Court clarified that the approach taken in Arnold and Rainy Sky is consistent: the "recent history of the common law of contractual interpretation is one of continuity rather than change".

As such, the Court confirmed that the courts will look to both the language of the clause (textualism) and the commercial context in which it was drafted (contextualism) in order to ascertain the objective meaning of the clause in question. The extent to which each is used will vary according to the circumstances. Greater emphasis is likely to be given to textual analysis where the dispute concerns complex agreements agreed between sophisticated parties and with the assistance of skilled professionals. Conversely, commercial context will play more of a role where the agreement is more informal, or lacking in detail. That said, there are always exceptions and every case will be decided on its own facts. 

On the facts, the Court acknowledged that applying business common sense helped identify the purpose of the clause: to protect Capita against the adverse consequences of mis-selling. However, that has to be considered against the language used and the contractual context.

The Court preferred the Seller's more limited construction of the clause, the balance being tipped in its favour by both the language used and, more importantly, the contractual context:

• On language, the Court agreed with the Court of Appeal's analysis. It also rejected detailed points of style and syntax which it thought were of little assistance in construing an opaque clause.
• The contractual context favoured a more restrictive approach. Although Capita clearly had an interest in obtaining as broad an indemnity against mis-selling as possible, the Sellers had already covered similar matters by giving warranties which the parties had agreed should be limited in quantum and time. The sellers had an interest in limiting any further exposure after that time had elapsed. The scope of the indemnity therefore had to be assessed against those warranties. It was not "contrary to business sense" for the parties to agree wide-ranging warranties which were subject to a time limit, and in addition to agree a further indemnity that is not subject to a time limit but is triggered only in limited circumstances (i.e. claims or complaints to the FSA).

Had the indemnity stood on its own, and not formed part of an overall risk allocation regime, the Court may well have reached a different conclusion. However, as the Supreme Court reiterated, it is not the place of the courts to relieve a party of a bad bargain.

Comment

This case confirms that the recent decisions on interpretation had not muddied the waters, despite some commentators' views. As confirmed by the Supreme Court in Arnold and Rainy Sky, interpretation is still a unitary process: where there are conflicting meanings, business common sense is a consideration for the court. However, that does need to be balanced against the natural meaning of the language used and the contractual context. How that balance will be struck will always be fact-dependent.

More importantly the case demonstrates the importance of precise and careful drafting: the courts will not freely interpret badly drafted provisions in a party's favour when the meaning can be found in the language. It also highlights the importance of ensuring that your contract works as a cohesive whole. Had the indemnity stood on its own, it is likely that a more liberal interpretation would have been applied. However, when read together with the warranty regime, the commercial context suggested that any additional indemnity protection should be triggered only in the specific circumstances referred to.

Cases considered:

Wood v Capita Insurance Services Limited [2017] UKSC 24

Arnold v Britton [2015] UKSC 36

Rainy Sky SA v Kookmin Bank [2011] UKSC 50