Parties to a complicated commercial contract, signed after endless late night meetings and numerous discarded drafts, often disagree later about its meaning. The traditional English way of construing a written contract was to concentrate on its literal wording “without reference to anything which has previously passed between the parties to it”, aided by legal presumptions encapsulated in Latin maxims. In the 1970s Lord Wilberforce pioneered a modern approach, interpreting words by reference to the transaction's commercial context and background. This was embedded in English law two decades later by several enormously influential speeches of Lord Hoffmann, principally in Investors Compensation Scheme Ltd. v. West Bromwich Building Society [1998] 1 W.L.R. 896. So it is fitting that Lord Hoffmann's last case in the House of Lords, Chartbrook Ltd. v. Persimmon Homes Ltd. [2009] UKHL 38, [2009] 3 W.L.R. 267 concerned the Investors Compensation regime.

Chartbrook owned a site which Persimmon wished to re-develop. Rather than buy the land outright, Persimmon entered into an agreement whereby Chartbrook granted Persimmon a licence to develop the site in accordance with planning permission (to be obtained by Persimmon); in return a price would become payable to Chartbrook once Persimmon sold off the flats and commercial units. Planning permission was granted and the development built, but a dispute arose as to the correct interpretation of an ambiguous provision for calculating Chartbrook's price in respect of the flats.

The agreement provided that Chartbrook would be entitled to two elements: the “total land value” calculated at £76.34 for every square foot of all flats built, plus an “additional residential payment” (ARP). The ARP (simplified slightly) was defined as: “23.4% of the price achieved for each [flat] in excess of the “Minimum Guaranteed Residential Unit Value (MGRUV)”, the MGRUV being, in effect, £76.34 for every square foot of that flat. It only takes a little mathematical knowledge to realise that this ARP definition is ambiguous: does it mean “23.4%×(Price−MGRUV)” or “(23.4%×Price)−MGRUV”? Chartbrook alleged the former, so that, for every flat that sold for more than £76.34 per square foot, it was entitled to receive 23.4% of the excess, as well as the total land value. Persimmon, by contrast, alleged that the latter formula reflected the underlying commercial deal, i.e. that Chartbrook would receive, as a guaranteed minimum amount, the total land value, and would only receive an additional sum if a flat sold for such a high price that 23.4% of the price was higher than the MGRUV for this flat.

The alternative interpretations made a big practical difference: on Chartbrook's the ARP due was over £4.4 million, whereas on Persimmon's it was less than £900,000. Chartbrook's interpretation was commercially unusual and implausible, because it effectively gave Chartbrook additional profit on every flat sale even if the price had fallen below the MGRUV, other thatn in the unlikely event of a catastrophic slump in market values such that the flat sold for less than 23.4% of what the parties thought it would achieve. However it was the more natural interpretation of the ARP definition, from a linguistic and syntactical point of view, and this was enough to convince Briggs J. at first instance ([2007] 1 All E.R. (Comm) 1083), and the majority of the Court of Appeal ([2008] EWCA Civ 183, [2008] 2 All E.R. (Comm) 387) to find for Chartbrook.

The House of Lords unanimously allowed Persimmon's appeal. Applying the Investors Compensation approach of construing the whole agreement in its commercial context, it held that the parties had intended a Persimmon's formula. The structure of the agreement and language used (such as “minimum”, “guaranteed” and “additional”) meant that, according to Lord Walker, Persimmon's interpretation “is not merely linguistically possible, but is linguistically (as well as commercially) compelling.”

But matters are not quite this simple. As Baroness Hale confessed, “I would not have found it quite so easy to reach this conclusion had we not been aware of the agreement which the parties had reached on this aspect of their bargain during the negotiations which led to the formal contract. On any objective view, that made the matter crystal clear.” Yet the one, highly controversial, exception to the Investors Compensation contextual approach is that, “the law excludes from the admissible background the previous negotiations of the parties and their declarations of subjective intent”. This is surprising given that the admissible background otherwise includes, “absolutely anything which would have affected the way in which the language of the document would have been understood by a reasonable man.”

The inadmissibility of prior negotiations is usually justified on the basis that such information is unhelpful, representing the shifting, subjective positions of the parties before their agreement crystallised. But as Lord Nicholls, writing extra-judicially, (2005) 121 L.Q.R. 577, argued, just because such negotiations are usually unhelpful does not justify a rule automatically excluding them, on rare occasions when they might be helpful. Given such distinguished criticism of the rule, the House in Chartbrook was invited to reconsider it, but (obiter) declined to do so, favouring the status quo although without any great enthusiasm for its rationale. This is a pity, since some of Lord Nicholls' compelling criticisms were ignored, particularly the inconsistency that prior negotiations are admissible to prove whether a contract has been formed in the first place, so that a judge who, with the aid of the prior negotiations evidence, has concluded that a contract exists, must immediately banish from his mind those prior negotiations when interpreting that contract.

A further inconsistency is that prior negotiations are admissible in an action for rectification, a plea which is invariably added in litigation about contractual interpretation in order to expose the prior negotiations to judicial scrutiny. This is of course how Baroness Hale knew that the interpretation reached without recourse to the prior negotiations accorded with those negotiations. It is interesting to speculate about whether their Lordships would still have opted for Persimmon's interpretation if the prior negotiations had revealed unequivocally that, unlikely though it might be commercially, Chartbrook's interpretation was correct: if not, then why not openly admit that prior negotiations can be admitted when helpful?

There is another anomaly here, in Lord Hoffmann's consideration of Persimmon's rectification plea (obiter, since Persimmon was successful on its main interpretation argument). The claim was for rectification for common mistake, applicable when the parties have orally agreed (or reached a common intention to agree) “X”, but when the deal is put into writing, it is mistakenly written as “Y”: the court can order the written document to be rectified, changing Y to X to reflect the parties' intentions. Lord Hoffmann clarified that the underlying common intention is tested objectively, like any other issue of contractual consensus, and indicated that, had the interpretation decision not gone in favour of Persimmon, he would have rectified the contract accordingly. But this focus on objectivity neatly sidesteps a finding of fact made by Briggs J. at first instance that Chartbrook's directors were telling the truth when they testified that they had always believed the underlying deal to be in accordance with Chartbrook's interpretation, a matter which persuaded the Court of Appeal that it could not order rectification. Overall, the decision is perfectly sensible (at least if we conveniently forget the finding of fact just mentioned), but is unlikely to be the last word on the admissibility of prior negotiations or rectification for common mistake, hard though it is to imagine the debate continuing without Lord Hoffmann.