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Legal Update

House of Lords' Judgment on Chartbrook Limited (Respondents) v Persimmon Homes Limited and Another (Appellants)

1 July 2009
Mayer Brown Legal Update

Judgment in this case was handed down today.  It provided an important opportunity for the House of Lords (Lord Hoffman in particular) to consider applicable rules of contractual construction in cases (such as this) where the contractual drafting has obviously gone awry.

As Lord Hoffman said that, in such cases,:

"there is [no] limit to the amount of red ink or verbal rearrangement or correction 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".

The House of Lords found in favour of Persimmon (5-0) on construction reversing earlier rulings of Mr Justice Briggs and a majority of the Court of Appeal.  The House of Lords also went on to make obiter statements about the admissibility of pre-contractual negotiations as an aid to construction as well as upon the law of rectification.  These statements were obiter as the House of Lords had already ruled in Persimmon's favour on the question of construction.

The facts

Persimmon and Chartbrook entered into a Development Agreement in October 2001 pursuant to which Persimmon agreed to develop land belonging to Chartbrook and make certain payments to Chartbrook.  Chartbrook issued proceedings against Persimmon claiming £3.59 million plus interest was due from Persimmon by way of "Additional Residential Payment".  Persimmon argued that on a true construction of the relevant provision of the agreement a much smaller payment was due (which Persimmon paid).  Persimmon further argued, if it was unsuccessful on construction, then the agreement should be rectified to reflect the underlying commercial agreement between the parties.

In February 2007, the action came before Mr Justice Briggs for trial who found in favour of Chartbrook on both the construction and rectification issues.
In December 2007, Persimmon appealed to the Court of Appeal on both the questions of construction and rectification.  The Court of Appeal dismissed the appeal in its entirety by a majority of 2 to 1.  Lord Justice Lawrence Collins dissented on the issue of construction.  His view was that this was a case in which a syntactical analysis must yield to business common sense and that therefore Persimmon’s interpretation of the relevant provisions was the right one.

Persimmon appealed to the House of Lords. 

Construction of the contract

All five of their Lordships held that Persimmon's construction of the contract was correct.  The judgment provides clear encouragement from the House of Lords that the courts should be prepared to intervene and correct mistakes made in the contractual drafting where it is clear that something has gone wrong and equally clear what the parties in fact meant.  This is particularly important where the literal construction of the words used would produce a commercially irrational result.

As Lord Hoffman said:

"There is not, so to speak, a limit to the amount of red ink or verbal rearrangement or correction 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".

Although, it is not easily accepted that people have made linguistic mistakes, particularly in formal documents, where one is required to conclude that something has gone wrong with the language then, as Lord Hoffman put it:

"it is no answer that the interpretation does not reflect what the words would conventionally have been understood to mean". 

Subject to two qualifications, their Lordships adopted Brightman J's approach in East v Pantiles (Plant Hire) Ltd (1981) 263 EG 61 to what Brightman J termed "correction of mistakes by construction".  Brightman J said:

"Two conditions must be satisfied: first, there must be a clear mistake on the face of the instrument; secondly, it must be clear what correction ought to be made in order to cure the mistake.  If those conditions are satisfied, then the correction is made as a matter of construction." 

Their two qualifications are:  First "correction of mistakes by construction" is not a separate branch of the law, a summary version of an action for rectification.  Second, in deciding whether there is a clear mistake, the court can have regard to the background or context of the document.  It is not confined to only reading the document.  The exercise is part of the single task of interpretation and consequently the background and context must always be taken into consideration.

Admissibility of pre-contractual negotiations

Their Lordships declined to deviate from the long established exclusionary rule (Prenn v Simmonds [1971] 1 WLR 1381) that evidence of pre-contractual negotiations is inadmissible as an aid to construction. However, as Lord Hoffman said, whilst the rule:

"excludes evidence of what was said or done during the course of negotiating the agreement for the purpose of drawing inferences about what the contract meant.   It does not exclude the use of such evidence for other purposes: for example, to establish that a fact which may be relevant as background was known to the parties, or to support a claim for rectification or estoppel. These are not exceptions to the rule.  They operate outside it".

It therefore remains the case that when construing a written agreement, evidence of negotiations or the parties' intentions is not admissible but evidence of the background or "factual matrix" is. The factual matrix can include absolutely anything which would have affected the way in which the language of the document would have been understood to a reasonable man.

Of some significance is that Baroness Hale did confess that she would not have found it quite so easy to reach the conclusion that Persimmon's interpretation of the contract was correct had she:

"not been made aware of the agreement which the parties had reached on this aspect of their bargain during the negotiations which led up to the formal contract" and she said, "on any objective view, that made the matter crystal clear. This, to me, increased the attractions of accepting counsel’s eloquent invitation to reconsider the rule in Prenn v Simmonds".

Their Lordships also made some obiter comments on the decision of Kerr J in the Karen Oltmann (Partenreederei MS Karen Oltmann v Scarsdale Shipping Co Ltd [1976] 2 Lloyd's Rep 708 which applied what is known as the "private dictionary" exception to the exclusionary rule in Prenn v Simmonds.  Lord Hoffman said that:

"On its facts, the Karen Oltmann was in his opinion an illegitimate extension of the "private dictionary" principle which, taken to its logical conclusion, would destroy the exclusionary rule and any practical advantages which it may have".

Rectification

Their Lordships endorsed the objective theory of the law of rectification and seemingly would have found for Persimmon had they not been able to decide the case on the basis of construction.  Their opinion was that rectification required a mistake about whether the written instrument correctly reflected the prior consensus, not whether it accorded with what the party in question believed that consensus to have been.  In accordance with the general approach of English law, the terms of the prior consensus were what a reasonable observer would have understood them to be and not what one or even both of the parties subjectively believed them to be.

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