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Text or context makes little difference if you enter a bad bargain

The Supreme Court's decision last month in Wood v Capita Insurance Services Ltd [2017] UKSC 24, underlines the importance of both context and text…

The Supreme Court's decision last month in Wood v Capita Insurance Services Ltd [2017] UKSC 24, underlines the importance of both context and text when drafting an effective indemnity clause.

Summary of the facts

As reported in these pages back in October 2015, Capita Insurance Service Ltd contracted to purchase the entire issued share capital of Sureterm Direct Limited (Target), a specialist car insurance broker.

The share purchase agreement (SPA) contained an indemnity (Indemnity) whereby the Sellers agreed to:

“…pay to [the Buyer] an amount equal to the amount which would be required to indemnify [the Buyer]…against all actions, proceedings, losses, claims, damages, costs, charges, expenses and liabilities suffered or incurred, and all fines, compensation or remedial action or payments imposed on or required to be made by [Target] following and arising out of claims or complaints registered with the [Financial Services Authority or other regulator]…against [Target]…and which relate to the period prior to the Completion Date pertaining to any mis-selling or suspected mis-selling of any insurance or insurance related product or service.”

In addition, the Sellers gave further warranties, including that:

  • Target was conducting and had conducted its business in accordance with all applicable financial services laws
  • Target had no reason to believe any action would be taken against it based on any non-compliance with or infringement of any applicable financial services laws.

Following completion, the new owners carried out an internal review after certain employees had raised concerns about the Target’s sales processes and in particular that there had occurred potential instances of mis-selling during the Sellers’ ownership. The Buyer reported its findings to (what was then) the Financial Services Authority (FSA) in accordance with applicable regulatory requirements. The FSA concluded that Target’s customers had been treated unfairly, and redress was due accordingly. With the agreement of the Target and Capita, the FSA conducted a customer remediation exercise resulting in approximately £1.35 million being paid in customer compensation.

The Buyer then sought to recover under the Indemnity.

The claim was disputed by the Sellers who argued that the Indemnity was sufficiently narrow in its construction that is was not triggered since the requirement to compensate arose only because Target had self-reported suspected mis-selling to the FSA, and not as a result of a claim by Target’s customers or a complaint by those customers to the FSA.

The High Court found in favour of the Buyer but the Sellers appealed the decision.

The Court of Appeal reversed the finding of the High Court, deciding that the proper construction of the Indemnity meant that in order for the Sellers to be liable either:

  • a mis-selling claim had to have been made against the Target; or
  • a complaint had to have been registered with FSA.

On appeal to the Supreme Court, the Buyer explored the argument that the Court of Appeal had ruled incorrectly, as it had placed too much weight on the text of the Indemnity and insufficient weight on the factual context in which the Indemnity was given. The Buyer argued that only the “fines, compensation or remedial action or payments” imposed on the Target had to arise out of complaints made to the FSA and that recovery against “all actions, proceedings, losses, claims, damages, costs, charges, expenses and liabilities suffered or incurred” was not conditional on a complaint to the FSA.

Decision of the Supreme Court

The appeal was rejected with the Supreme Court concluding the Indemnity was not triggered in circumstances where the Target self-reported mis-selling to the FSA.

The judgment made a number of pertinent observations on contractual interpretation:

  • The court’s task is to ascertain the objective meaning of the language used in the contract. This is not a literalist exercise focused solely on an analysis of the grammar of the wording of a particular clause. The contract must be considered as a whole and according to its nature, formality and quality of drafting, with more or less weight given to elements of the wider context.

  • Where there are rival meanings, the court can reach a view as to which construction is more consistent with business common sense. In striking a balance between the indications given by the language and the practical implications of competing constructions, the court must consider the quality of the drafting of the clause, and be alive to the possibility that one side has struck a bad bargain.

  • Contractual interpretation involves an iterative process where each suggested interpretation is checked against the provisions of the contract and its commercial consequences investigated.

  • Textualism and contextualism are not conflicting paradigms. Both can be used as tools to ascertain the objective meaning of the language used in a contract, and the extent to which each tool will assist will vary according to the circumstances. Some contracts might be successfully interpreted principally by textual analysis (for example, due to their sophistication and complexity, or where they have been negotiated and prepared with the input of skilled professionals), while the correct interpretation of others might demand greater emphasis on the factual matrix (for example, due to their informality, brevity or the absence of skilled professional assistance).

Applying this approach to construction to the Indemnity, the court found that:

  • The Indemnity had not been drafted with precision and its meaning was avoidably opaque. In order to consider the implications of the rival interpretations, it was necessary to place the clause in the context of the contract as a whole, to examine the clause in more detail and to consider whether the wider relevant factual matrix gave any guidance as to its meaning.

  • The Buyer’s interpretation of the language used in the Indemnity was unlikely because it would have the effect that the clause failed to specify the identity of the persons against whom a claim must be made so as to trigger a liability under the Indemnity. There must be a limit on the identity of such persons, as it would be absurd for the Buyer to have a claim against the Sellers under the Indemnity resulting from any mis-selling on its own part prior to the acquisition.
  • The contractual context was significant. In addition to the Indemnity, the SPA contained wide-ranging warranties which also addressed mis-selling by the Target, but which were subject to a two-year time limit for notifying claims. The scope of the Indemnity, breach of which gave rise to a liability which was unlimited in time, had to be assessed in the context of the time-limited warranties.

The Court found that it was not contrary to business common sense for the parties to agree wide-ranging warranties, which were subject to a time limit, and in addition to agree a further indemnity, which was not subject to any such limit but would be triggered in limited circumstances only. The agreement might have become a poor bargain for the Buyer, but it was not the court’s function to improve that bargain. In this case, the circumstances triggering the Indemnity were to be found principally in a careful examination of the language which the parties had used.

Implications

The decision underlines the importance of taking care when drafting indemnities to take account of the likely interpretation a Court may place on both the text and context of the clause. Commonly, a sale and purchase agreement will provide for wide ranging warranties which may or may not be tailored to reflect the specific nature of the target. The extent to which any indemnity is inconsistent with the warranties needs to be clear and the language must be specific to reflect the nature and extent of what the indemnity is looking to protect against.

Analysis of a contractual clause does not give rise to a conflict between textual and contextual analysis - both need to be considered - but the weight which is placed on each form of analysis will be subject to the particular circumstances of the contract and the transaction as a whole. Who has undertaken the drafting and the level of professional advice sought will dictate how much emphasis is placed on the text. A skilled lawyer, it will be assumed, will take greater care and precision in the words used to achieve the objective of the clause. Where contracts are concluded with little or no input from lawyers, the Court is likely to adopt a more contextual analysis as to what the parties intended rather than relying more on the literal meaning of the words.

A further point to note from the decision is the Court’s reiteration that it does not have a role to play in redrafting contracts to correct a bad bargain or poor drafting. This of itself underlines that little reliance can be placed on boilerplate “severance” clauses which often seek to allow for post completion reinterpretation of clauses which are invalid or unenforceable. In reality, these will only likely be achieved by a formal variation of the contract, which is unlikely if a provision favours one party over the other.

Roland Hutchins is a partner in the corporate-commercial team, and can be contacted on 0151 243 9539 or email roland.hutchins@weightmans.com.