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Elements in a Contract - Contract Interpretations

Updated on July 29, 2017

Just like the words in an enactment or a statute can lead to an ambiguity, similarly words in a contract can also sometimes be a source of confusion. Therefore, the courts have developed certain guidelines in addition to the existing rules of interpretation (see statutory interpretation) to make the law more flexible.

In Investors Compensation Scheme Ltd v West Bromwich Building Society (1998) Lord Hoffman set out five guidelines to aid with the interpretation of contracts. They are as follows: -

1) The terms in a contract should be looked at from the perspective of the reasonable man after taking into account all the background knowledge that was available to the parties at the time of entering into the contract.

2) The background knowledge that is to be taken into account is what is known as the matrix of facts or the factual matrix that was put forward by Lord Wilberforce and it includes anything, as long as the information is available to the parties, which would have affected the way in which the language of the document would have been understood by a reasonable man.

For example, in the case of Reardon Smith Line v Hansen Tangen (1976) the charterers agreed to take ownership of a tanker that was being built in a specific shipyard. The contract identified the tanker as Osaka No. 354 corresponding to the shipyard that it was being built in. Due to unspecified reasons the work could not be completed in the shipyard and the building of the tanker was subsequently transferred to another shipyard. The tanker was completed satisfactorily but it was no longer designated Osaka No. 354.

In the meantime, that world tanker market had taken a turn for the worse. The charterers refused to take possession of the tanker and claimed that the tanker did not fit the description as per s13 of the Sale of Goods Act – “Where there is a contract for the sale of goods by description, there is an implied condition that the goods shall correspond with the description ….”. The courts held that the designations i.e. Osaka No. 354 and the following designation were merely labels and were not valid descriptions as per the act and that there was in fact a valid contract in place

3) Previous negotiations or any other past declaration of intent however is no included it what is deemed or termed as background knowledge. Lord Wilberforce in Prenn v Simmonds (1971) said that the reason for not admitting evidence of these exchanges is not a technical one or even one of convenience. It is simply that such evidence is unhelpful.

By the nature of things, where negotiations are difficult, the parties’ positions, with each passing letter, changes. It is only the final document which records a consensus.

4) The meaning of the words that have been used and the meaning of the words incorporated in a document may not be the same as that which is perceived or understood by an ordinary man. Words and sentences have numerous meanings. The meaning of the words in a contractual document is what the parties using those words against the relevant background would reasonably have understood the words to mean.

In Mannai Investment Co Ltd v Eagle Star Life Assurance Co (1997), the appeal was concerned with the question of whether a notice given by a tenant pursuant to a break clause in a lease was effective notice, Lord Hoffman said that it is of course true that the law is not concerned with the speaker's subjective intentions. But the notion that the law's concern is therefore with the “meaning of his words” conceals an important ambiguity. The ambiguity lies in a failure to distinguish between the meanings of words and the question of what the words would mean to a person who uses the words.

5) The “rule” that words should be given their “natural and ordinary meaning” excludes the probability that people can make mistakes especially when it comes to formal documents. The law does not attribute to the parties an intention that they clearly could not have had.

In The Antaios Compania Neviera S.A. v. Salen Rederierna A.B. (1984) Lord Diplock said that “if detailed semantic and syntactical analysis of words in a commercial contract is going to lead to a conclusion that flouts business commonsense, it must be made to yield to business commonsense.”

© 2017 Kathiresan Ramachanderam and Dyarne Jessica Ward

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