IN Chartbrook Ltd v. Persimmon Homes Ltd [2009] UKHL 38; [2009] 1 A.C. 1101 (noted [2009] C.L.J. 510), the House of Lords affirmed the rule that pre-contractual negotiations are not to be included in the factual matrix relevant to interpreting a contract. However, this exclusionary rule is not absolute: for example, evidence of negotiations may be used to establish that a fact was, objectively, known to both parties, and this fact may be included in the matrix. But what if the pre-contractual negotiations were conducted “without prejudice”? Can such negotiations be used in order to establish relevant background facts which would assist the interpretative exercise? The Supreme Court has answered this question in the affirmative: Oceanbulk Shipping & Trading SA v. TMT Asia Ltd [2010] UKSC 44, [2010] 3 W.L.R. 1424.
Oceanbulk had entered into a series of forward freight agreements with TMT, under which the parties were essentially betting on the fluctuating daily rate of time charter hire for capsize bulk carriers. TMT accrued substantial liability under these contracts, and failed to pay Oceanbulk an instalment when due. This triggered a liquidated damages clause in the agreement. The parties then entered into “without prejudice” negotiations to resolve the matter, and ultimately reached a written settlement agreement. But the parties later disputed the correct interpretation of that contract. The preliminary question for the courts was whether TMT could rely upon the negotiations which led to the settlement in order to support its interpretation of that agreement.
Negotiations conducted “without prejudice” are generally inadmissible for reasons of public policy: settlement of disputes without recourse to the courts is to be encouraged, and parties are more likely to speak frankly, and therefore reach agreement, if nothing said in the course of negotiations can later be relied upon in court. Lord Clarke, with whom the other Justices agreed, recognised the importance of this principle, and thought that its boundaries should not lightly be eroded. However, he emphasised that “without prejudice” negotiations are admissible in order to establish whether a compromise agreement has been concluded, and considered that “no sensible line” can be drawn between this and admitting such evidence to establish the content of such an agreement (at [30]). He noted that “without prejudice” negotiations may be used in support of a claim for rectification, and that it should therefore follow that the same evidence might be admissible for the purpose of interpretation.
The conclusion that “without prejudice” negotiations can be used when interpreting the contract appears sensible. Indeed, Ward L.J., dissenting in the Court of Appeal, thought that any other conclusion would be “illogical” ([2010] EWCA Civ 79, [2010] 1 W.L.R. 1803, at [37]). The result does not represent a great inroad into the general principle that “without prejudice” negotiations are inadmissible: since parties already know that their negotiations may be used to prove the existence of an agreement, or that the agreement should be rectified, they are unlikely to be more reserved simply because their negotiations might be used to resolve matters of interpretation. Lord Clarke even suggested that the decision in Oceanbulk might encourage settlement, rather than the reverse, since parties may be reassured by the fact that previous communications can be relied upon to help the court reach an accurate interpretation of the agreement.
However, the practical impact of Oceanbulk is uncertain. This is because pre-contractual negotiations, whether conducted “without prejudice” or not, are of limited utility in the interpretative process. Oceanbulk did not argue, at this interlocutory stage, that the negotiations did not form part of the admissible factual matrix, so the Supreme Court did not have to decide whether the pre-contractual negotiations would actually help TMT. At first instance, Andrew Smith J. thought that such evidence might be “crucial”, but Longmore L.J. in the Court of Appeal had doubts on this point. The main difficulty lies in deciding whether evidence of pre-contractual negotiations is being adduced to prove a fact which is objectively known to the parties, or to establish what the contract means. Only the former is admissible as part of the relevant background used in the interpretative exercise. Lord Clarke acknowledged that it may not be easy to distinguish between the two, a point which might well continue to vex the courts. For example, Flaux J. has recently observed that the dividing line between admissibility and inadmissibility regarding pre-contractual negotiations is “so fine it almost vanishes” (Excelsior Group Productions Ltd v. Yorkshire Television Ltd [2009] EWHC 1751 (Comm) at [25]).
Of course, problems surrounding the boundary between the admissible and inadmissible would simply disappear were pre-contractual negotiations allowed to assist the court regarding all matters of interpretation. In Oceanbulk, Lord Phillips, in a short judgment, emphasised that evidence of facts within the parties' common knowledge is admissible for questions of interpretation, but the general principle remains that pre-contractual negotiations may not be included in the factual matrix used for interpretation. This limitation of the permissible factual matrix is somewhat artificial, and it may be that judges will seek to circumvent it by finding that the negotiations establish an objectively known fact which is part of the admissible background, applying the approach of Oceanbulk. However, this might undermine the exclusionary rule which received the support of the House of Lords in Chartbrook.
It might therefore be better for the courts simply not to have recourse to pre-contractual negotiations at all when considering the correct interpretation of a commercial contract. This might make the court's task easier, and help to avoid a deluge of material being introduced to support a particular interpretation. This would not render pre-contractual negotiations irrelevant: they may still be necessary to support a claim for rectification. Admittedly, the relationship between interpretation and rectification is growing ever closer, as Lord Clarke recognised in Oceanbulk, citing Sir Richard Buxton's strong critique of the functional overlap between the two doctrines at [2010] C.L.J. 253. If pre-contractual negotiations are to be increasingly used as regards interpretation, rectification may become virtually redundant. Conversely, restricting the use of such evidence in the interpretative exercise would lead parties to rely upon rectification. The relationship between interpretation and rectification is an important topic which deserves further clarification from the courts.
