UK - What does my contract mean? Textualism v contextualism

“Lawyers are now lucky enough to live in a world overflowing with appellate guidance on how to construe contracts.”

Jackson LJ, Sutton Housing v Rydon [2017] EWCA Civ 359

The latest iteration of that guidance is the decision of the Supreme Court in Wood v Capita [2017] UKSC 24. At its heart is the tension between textualism and contextualism. When should the words of a contract have priority, and when should the literal meaning give way to the wider commercial context?

The Supreme Court decided these concepts are not in conflict and are not mutually incompatible. Instead they are tools that should be given varying weights depending on the sophistication of the contract and other surrounding factors. While this appears to call for a truce, Lord Sumption’s subsequent extra-judicial speech, “A Question of Taste”, suggests the debate is not yet over.

The indemnity

The decision arose out of the sale of an insurance company by Mr Wood, amongst others, to Capita. To protect against mis-selling claims, the share purchase agreement contained a series of warranties and an indemnity.

Shortly after purchasing the company, Capita became aware that insurance had been mis-sold. It reported the matter to the Financial Services Authority who ordered it to put in place a remediation scheme, at a cost of approximately £2.5milllion. The time limits for claiming under the warranties had expired, so Capita instead claimed under the following indemnity:

“The Sellers undertake to pay to the Buyer an amount equal to the amount which would be required to indemnify the Buyer and each member of the Buyer's Group against [1] all actions, proceedings, losses, claims, damages, costs, charges, expenses and liabilities suffered or incurred, and [2] all fines, compensation or remedial action or payments imposed on or required to be made by the Company [A] 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 [B] 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.” (underlined text added for clarity)

The indemnity is not an example of good drafting. It consists of a single “avoidably opaque” sentence running to 119 words without any clear structure. The Court was presented with two competing interpretations:

• The indemnity did not apply as liability under [1] and [2] is conditional on both limb [A] and [B]. In other words, for any liability to arise there must always be “claims or complaints” with the FSA (limb [A]). No such claims or complaints had been made as the issue had been self-reported by Capita.
• The indemnity applied as liability under [1] was only conditional on limb [B]. In other words, it is possible to recover costs, charges liabilities etc without there needing to be “claims and complaints” with the FSA (limb [A]).

The Court of Appeal found the indemnity did not apply. Capita appealed to the Supreme Court on the basis this placed too much emphasis on the words, and too little on the wider factual matrix. Capital claimed this was mistaken and based on the misconception that the Supreme Court’s decision in Arnold v Britton [2015] AC 1619 meant contract must now be interpreted more literally.

Textualism v contextualism

The Supreme Court started by rejecting the suggestion there had been a shift towards literalism or that Arnold v Britton had recalibrated the Court’s approach.

Instead, textualism and contextualism are tools to help ascertain the objective meaning of the language and the weight given to each tool will vary according to the circumstances:

• A textual or literal approach will be more appropriate where the contract is complex or sophisticated or has been prepared by skilled professionals. In such a case, the meaning is likely to primarily arise from the words of the contact. However, if the contract does not achieve a “logical or coherent text” (i.e. doesn’t make sense) a contextual approach may still be of assistance.
• A contextual or purposive approach will be more appropriate where the contract is particularly short or informal or has not been prepared by skilled professionals. In such a case, the Courts are less closely tied to the words.

This is a unitary exercise involving an iterative process by which each suggested interpretation is checked against the provisions of the contract and its commercial consequences, applying a suitably textual or contextual approach. However, the Court must always consider the possibility that, in hindsight, one party has simply made a bad bargain.

How did these principles apply in this case?

In this case, the share purchase agreement was a detailed and professionally drafted contract, but the meaning of the indemnity was not clear and so it was necessary to ask if the wider context provides guidance on its interpretation. That wider context:

• Includes the fact Mr Wood had given extensive warranties that Capita could have used to recover its losses had it notified its claim in time.
• Meant business common sense plays little part in the analysis. Capita would have pushed for as broad an indemnity as possible, and Mr Wood the opposite: “in the tug o’ war of commercial negotiation, business common sense can rarely assist the court in ascertaining on which side of the line the centre line marking on the tug o’ war rope lay, when the negotiations ended”.

In terms of the textual analysis, the Supreme Court considered the indemnity in detail. The liability in head [1] was very broad so to make this only dependent on limb [B], would effectively make the rest of the clause otiose (i.e. head [2] and limb [A] would have no purpose). This was not only unlikely but would remove essential detail, such as the fact the liability must relate to the company being bought (as identified in head [2]).

The position is perhaps more succinctly summarised by the Court of Appeal’s colourful analogy with the phrase “I like cats and dogs which are black and fluffy”. That might mean: (a) "I like cats and dogs which, in each case, are both black and fluffy"; or (b) "I like cats of any kind, and dogs that are black and fluffy". However, it is most unlikely to have the meaning sought by Capita: "I like cats which are fluffy and dogs which are black and fluffy".  

In the end, the case was primarily decided by a careful analysis of the language. Capita may have struck a bad bargain but it is not the Court’s role to improve it.

A question of taste

The judgment provides a useful guidance on when to use the complementary tools of textualism and contextualism.

However, the suggestion that Arnold v Britton has not led to a move toward textualism needs to be read in light of Lord Sumption’s subsequent extra-judicial speech in May, “A Question of Taste”.

In that speech, he recognises that instinct and mood play an important part in judicial analysis and suggests that Arnold v Britton has indeed changed the mood music. While the Courts should not adopt a “wooden adherence to disembodied meaning of words”, Lord Sumption emphasised that interpretation involves elucidating the meaning of those words, not modifying or contradicting those words in pursuit of what appears to a judge to be a reasonable result.

The diaries of Samuel Pepys are used to illustrate his point. In 1663, Pepys records the negotiation of a contract to construct a mole at the port in Tangiers. The individuals negotiating the contract were variously ill-informed, incompetent or dishonest. They produced a document Pepys described as incomprehensible. Lord Sumption suggests that to use a hypothetical objective and reasonable third party, fully armed with all the facts, to reconstruct this deal is an artifice. It is no more likely to reflect the true deal than the language of the contract itself.

Similarly, in many commercial agreements an apparently harsh or unreasonable term may have been agreed by way of compromise or in exchange for concessions in other areas or because the deal was concluded at 3 a.m. and one of the parties was more interested in going to bed than in the finer points of drafting. The terms may be incoherent, foolish or unfair but “fairness has nothing to do with commercial contracts”.

In Lord Sumption’s view, the Supreme Court’s decision in Rainy Sky 2011 does reflect a high point for contextualism which may have been “a disservice to commercial parties by depriving them of the only effective means of making their intentions known”. Arnold v Britton sounds a “muffled” retreat from this “loose approach to the construction of commercial documents”.

All this suggests, the tension between textualism and contextualism is not entirely resolved. Lawyers may have the good fortune of further appellate guidance in due course.

By Peter Church, London