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24 Oct 2019

Limited scope for reference to pre-contractual material when interpreting contracts

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Merthyr (South Wales) Limited v Merthyr Tydfil County Borough Council [2019] EWCA Civ 526 - judgment available from Westlaw UK is attached separately

This case demonstrates the limited circumstances in which the Court will rely on evidence of pre-contractual negotiations and communications when interpreting contracts.

While it is permissible for a Court to examine material to understand the genesis and aim of the transaction as a whole, it will not do so for the purpose of understanding the genesis and aim of a particular contractual provision.

Background

The Appellant mining company entered into an Escrow Account Agreement (the Agreement”) with the Respondent planning authority. The Agreement provided for quarterly payments by the Appellant into the escrow account, resulting in payment of £15 million into the account by the long-stop date of 30 June 2022. However, since the execution of the Agreement, the Appellant had made no deposits into the escrow account.

The Respondent applied for summary judgment on its claim seeking specific performance to compel the Appellant to pay amounts outstanding. By an order dated 13 July 2018, the Appellant was ordered to pay £6,250,000 into the escrow account, being the amount that would have been deposited by the Appellant if quarterly payments had been made as envisaged in the Agreement.

The Appellant appealed against this order, asserting that the language of the Agreement in relation to the quarterly payments was permissive and that the only enforceable obligation under the Agreement was that to deposit £15 million into the escrow account by the long-stop date, relying on two points:

  • Textual analysis and business common sense: the Appellant sought to argue that, in the event of a missed quarterly payment, the Agreement permitted the missed payment to be ‘rolled forward’ to the next payment date, and that otherwise the long-stop provision would be rendered unnecessary.
  • Effect of pre-contractual communications: the Applicant sought to rely on evidence of ‘genesis’ of the clause in support of their abovementioned textual interpretation, contained in the report prepared by the Respondent’s chief executive which recommended acceptance of the proposal, which stated that “in the (unlikely) event that the [Appellant] is unable to meet a quarterly payment, then it is agreed with [the Respondent] to roll forward the outstanding payments”.

In relation to these arguments the Court of Appeal held:

  • The Appellant’s proposed textual analysis was inconsistent with the express terms of the contract and made no commercial sense:
    • The result sought by the Appellant required the implication of a term which would provide that the amount to be deposited on each payment date would cease to be payable if the Appellant failed to pay it. Leggatt LJ held that it was conceptually and commercially irrational to attribute such an intention to the parties. Furthermore, this was inconsistent with the express terms of the contract such as ‘outstanding amount payable’, which was irreconcilable with an optional payment because it indicates that the liability still subsists; and
    • The proposed intention was contrary to the commercial purpose of the escrow account, which was to build up a fund over the period when the Appellant was generating revenue, which would then be available to pay for restoration works when coal mining had ceased. Leaving the Appellant free to choose whether to make such payments until after its commercial activities had finished would defeat this purpose.
  • The Appellant’s argument to rely on surplusage did not justify or necessitate the implication of a term of the kind proposed by the Appellant. Leggatt LJ held that an argument based on surplusage cannot justify the attribution of a meaning that the contract, interpreted as a whole, cannot bear.
  • The approach adopted in Prenn v Simmonds [1971] 1 WLR 1 1381 was correct: pre-contractual material can be used to show the surrounding circumstances, and therefore may explain the commercial aim of the transaction as a whole. However, adopting the approach in Elmfield Road Ltd v Trillium (Prime) Property Group Ltd [2016] EWHC 3122 (Ch), Leggatt LJ held that pre-contractual evidence surrounding the genesis of a particular provision would only be admissible if the particular provision is sufficiently important to qualify as part of the genesis and aim of the whole transaction. However, it would not be permissible to seek to rely on pre-contractual evidence in order to draw inferences about what that contractual provision should be understood to mean, including communications which are capable of showing that the parties reached consensus on a particular point or used words in an agreed sense.

Therefore, on a proper interpretation of the agreement, the Appellant was under an existing and continuing obligation to make quarterly payments. The appeal was dismissed and the order for specific performance to compel payment was upheld.

Stephenson Harwood comment

This case highlights that a Court is likely to be extremely reluctant to admit evidence of pre-contractual negotiations as evidence of what a particular provision was intended to mean, unless that provision is so central to the contract that it can be held to qualify as the genesis and aim of the whole transaction.

However, the exclusionary rule will not operate to prevent parties from using evidence of pre-contractual negotiations for the purpose of establishing a fact known to the parties that would be relevant to interpreting the contract, to support a claim for estoppel or rectification.

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