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The December House of Lords decision in Sirius International Insurance Co (Publ) v FAI General Insurance Ltd & Ors (2004) highlighted the continuing debate among litigators between the literal reading of a contract's words and the context in which it is has been written. The case suggests that despite a string of cases which appear to have broadened the range of material on which contractual interpretation by judges can be based, the law in this area is still not settled.
Reinsurer Sirius claimed against its retrocessionaire FAI for $22.5bn (£12.05bn) under a letter of credit. The letter and the claim were linked to a suite of other agreements between Sirius, FAI and a third party, Agnew. The following was provided by the Tomlin order settling Sirius's claim: that FAI was indebted to Sirius to the sum of $22.5m; that Sirius was to drawdown that sum under the letter of credit; that Sirius was to place proceeds in escrow pending the resolution of the parties' claims, if any, under the letter of credit; that the position and all Sirius/FAI's arguments were preserved "notwithstanding the terms of this schedule"; and that, apart from the parties' rights with respect to the letter of credit and the agreements associated to the letter of credit, the terms of the schedule would be in full and final settlement of all claims raised by either party in the arbitration proceedings.
When Sirius applied to remove the drawdown from escrow, FAI objected. FAI relied on the reservation in clause four of the Tomlin order, contending that the reservation meant there was no admission that Sirius was entitled to the proceeds. Sirius contended that, when clause one was read in context, FAI had admitted that Sirius was entitled to the drawdown.
Thus, the dispute was a conflict between FAI's literal reading of one clause and Sirius's reading of the order in context.
The House of Lords held that Sirius's construction was correct. The two leading judgments from Lord Justices Steyn and Walker emphasised that the Tomlin order was to be construed in context. On that basis, the reservation of rights was to be given a limited scope. Walker LJ reached his conclusion on the basis that "meticulous verbal analysisÃ¢Â€Â¦ is not appropriate, at any rate not to the exclusion of common sense, or its commercial context".
Steyn LJ's analysis found that the House of Lords' decisions in cases such as Mannai Investment Co Ltd v Eagle Star Life Assurance Co Ltd (1997) and Investors Compensation Scheme Ltd v West Bromwich Building Society (1998) represented a new and developing trend in the common law. He also ruled that literalism - that "words say what they mean, nothing more" - was an inappropriate means by which to construe contracts and that the preferred approach was context-based.
For present purposes, it is literalism versus contextualism that merits further analysis.
At one level, contextualism poses little difficulty, being identical to previous, uncontroversial statements made by Steyn LJ. Furthermore, when Sirius has since been considered, the courts have found it consistent with established principles (see Mitsubishi Corporation v Eastwind Transport Ltd & ors (2004) and ProForce Recruit Ltd v The Rugby Group Ltd (2005)). On another level, there are wider issues to consider. Ignoring the debates that have bedeviled English and philosophy faculties for years, four spring to mind. First, how is the context defined? An answer would be "by the terms of the contract itself" - thus a letter of credit in an international trade context, subject to the uniform customs and practice, is a contract with a limited context. Similarly, the prudent draftsperson will define the context in the contract itself, perhaps by extensive use of recitals. But what will the court do when faced with a contract that rigidly and unfairly defines the context, or a contract that includes a morass of irrelevant and inappropriate information?
Second, how far can one go in exploring context? One reaction to Investors Compensation Scheme Ltd v West Bromwich Building Society was that litigators immediately introduced volumes of matrix evidence. Doing this not only increased costs (see the criticisms in both National Bank of Sharjah v Dellborg & Ors (1997) and Scottish Power v Britoil (Exploration) Ltd & Ors (1997)) but raised the question of relevance and admissibility and of precisely where the boundaries should be set. Sirius raised the identical problem.
Third, to date, English law has excluded pre-contractual negotiations and post-contractual actions in construing the contract. This is so because of the principle that contracts are objectively construed, in that negotiations and post-contractual conduct articulate a party's subjective views of the contract's meaning, and the idea that negotiations are ultimately self-serving. English law arguably has been right to do so, even though some Continental systems do not adopt that approach; yet the parties' negotiating positions and their actions would undoubtedly be considered to be part of the context by, say, a non-lawyer carrying out a critical analysis of the contract as a text. If context is not given a narrow, specifically legal meaning, an assault on these exclusionary principles is bound to follow.
Fourth, literalism has one advantage, that of certainty. Contextualism creates uncertainty as to what the context is as a matter of theory and as applied to the facts. It is unclear how the context will be established (by what documents and by what evidence?) and as to how far the context goes (can it completely override contractual language?). Uncertainty generates cost at the transactional level as clients price in extra risk, and in litigation as lawyers give less accurate advice and wider evidence gathering exercises are undertaken. The issue that Sirius inevitably raises is: where is the line between achieving the right result in any given case, due to the context and the social and legal costs of greater uncertainty, to be drawn?
Sean Wilkin and Jess Conners are barristers at 39 Essex St.