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Friday 13th July 2012
A well-drafted legal contract should reflect the intentions of its contracting parties accurately, unambiguously and so as to give effect to the agreed transaction accounting for all appropriate circumstances. However, disputes regarding the drafting of a contract inevitably arise and judges are asked to adjudicate upon a contract's true meaning, writes Beverley Vara.
19 July 2012
The issue
There are limits to a court's powers, and the extent of this debate has been highlighted in the recent case of Scottish Widows Fund and Life Assurance Society v BGC International.
The first instance decision was recently overturned by the Court of Appeal. Pre-contractual negotiations are not always admissible and parties should ensure that any contract that they enter into carefully reflects the reality of the transaction.
Background
Scottish Widows (SW) underleased premises at One America Square, EC4, pursuant to a 20-year sub-underlease from ING Baring Securities. At the time of the underletting, the premises were 'over-rented' due to an upwards-only rent review in a falling market.
SW subsequently negotiated an underletting of its lease to BGC International (BGC). To compensate for the above-market rent, the parties agreed staggered rent increase mechanics such that SW effectively subsidised BGC's rent liability for a period.
In a rising market, the rent structure (which was linked to rent reviews in 2001 and 2006) would have eventually aligned the rents under the two leases. However, the downturn meant that the 2006 reviewed rent was lower than the 2001 reviewed rent. Consequently, SW continued to receive a shortfall from BGC.
SW issued proceedings for construction or rectification of the BGC lease. The High Court found for SW construing (but not rectifying) the lease to anticipate a falling market in SW's favour.
Appeal
BGC appealed, arguing that the High Court judge had been mistaken. The rent mechanics were contained in a bespoke clause drafted by experienced and skilled solicitors and the wording was clear and unambiguous.
Furthermore, the judge had taken into account inadmissible pre-contract negotiations. On this basis, he had wrongly speculated that the commercial objective of the transaction was that BGC would, via the rent mechanics, receive a reverse premium of £10 million and then take an assignment of the onerous Barings sub-underlease.
Consequently, the judge was wrong in interpreting the rent clause so as to insulate SW against a falling market: the parties had not anticipated this in their drafting of the relevant rent clause. Ultimately, BGC's lease accurately reflected the parties' intentions and the court did
not have the right to disturb the natural outcome.
Response
SW sought to uphold the first instance judgment arguing that the parties had made a mistake at the drafting stage of the BGC lease.If the rent clause were interpreted in the way contended for by BGC, the rents could never be aligned.
However, it was not the parties' intention that SW should subsidise BGC's rental liabilities indefinitely.
In this regard, SW relied both on certain pre-contractual negotiations together with the terms of a supplemental agreement executed at the same time as BGC's underlease. In this agreement, the parties stated that it was their intention that the rent under SW's underlease and BGC's lease should be aligned, following which BGC would take an assignment of SW's lease.
The reference in the rent clause to the 2006 rent review was therefore manifestly wrong.
Decision
The Court of Appeal overturned the first instance decision and upheld BGC's appeal. SW's cross-appeal on rectification also failed.
The trial judge had mistakenly elevated certain inter-party communications regarding a possible £10 million reverse premium payable to BGC from pre-contractual negotiations to the overriding commercial objective of the transaction.
Consequently, the judge had incorrectly interpreted (and in fact re-drafted) the rent clause so as to ensure that this was the commercial effect of the rent clause, even though on an application of the wording as drafted this was not the clear result.
Furthermore, it was stated to be "without prejudice" to the rent mechanics in the BGC lease and therefore these were paramount.
Conclusion
A failure to ensure that a material matter is included in an executed agreement risks ambiguity (and expensive litigation).
In the event that a dispute regarding contractual construction does arise, some salient guidelines are as follows:
Beverley Vara is a partner and head of real estate litigation at solicitors Allen & Overy LLP
The issue
There are limits to a court's powers, and the extent of this debate has been highlighted in the recent case of Scottish Widows Fund and Life Assurance Society v BGC International.
The first instance decision was recently overturned by the Court of Appeal. Pre-contractual negotiations are not always admissible and parties should ensure that any contract that they enter into carefully reflects the reality of the transaction.
Background
Scottish Widows (SW) underleased premises at One America Square, EC4, pursuant to a 20-year sub-underlease from ING Baring Securities. At the time of the underletting, the premises were 'over-rented' due to an upwards-only rent review in a falling market.
SW subsequently negotiated an underletting of its lease to BGC International (BGC). To compensate for the above-market rent, the parties agreed staggered rent increase mechanics such that SW effectively subsidised BGC's rent liability for a period.
In a rising market, the rent structure (which was linked to rent reviews in 2001 and 2006) would have eventually aligned the rents under the two leases. However, the downturn meant that the 2006 reviewed rent was lower than the 2001 reviewed rent. Consequently, SW continued to receive a shortfall from BGC.
SW issued proceedings for construction or rectification of the BGC lease. The High Court found for SW construing (but not rectifying) the lease to anticipate a falling market in SW's favour.
Appeal
BGC appealed, arguing that the High Court judge had been mistaken. The rent mechanics were contained in a bespoke clause drafted by experienced and skilled solicitors and the wording was clear and unambiguous.
Furthermore, the judge had taken into account inadmissible pre-contract negotiations. On this basis, he had wrongly speculated that the commercial objective of the transaction was that BGC would, via the rent mechanics, receive a reverse premium of £10 million and then take an assignment of the onerous Barings sub-underlease.
Consequently, the judge was wrong in interpreting the rent clause so as to insulate SW against a falling market: the parties had not anticipated this in their drafting of the relevant rent clause. Ultimately, BGC's lease accurately reflected the parties' intentions and the court did
not have the right to disturb the natural outcome.
Response
SW sought to uphold the first instance judgment arguing that the parties had made a mistake at the drafting stage of the BGC lease.If the rent clause were interpreted in the way contended for by BGC, the rents could never be aligned.
However, it was not the parties' intention that SW should subsidise BGC's rental liabilities indefinitely.
In this regard, SW relied both on certain pre-contractual negotiations together with the terms of a supplemental agreement executed at the same time as BGC's underlease. In this agreement, the parties stated that it was their intention that the rent under SW's underlease and BGC's lease should be aligned, following which BGC would take an assignment of SW's lease.
The reference in the rent clause to the 2006 rent review was therefore manifestly wrong.
Decision
The Court of Appeal overturned the first instance decision and upheld BGC's appeal. SW's cross-appeal on rectification also failed.
The trial judge had mistakenly elevated certain inter-party communications regarding a possible £10 million reverse premium payable to BGC from pre-contractual negotiations to the overriding commercial objective of the transaction.
Consequently, the judge had incorrectly interpreted (and in fact re-drafted) the rent clause so as to ensure that this was the commercial effect of the rent clause, even though on an application of the wording as drafted this was not the clear result.
Furthermore, it was stated to be "without prejudice" to the rent mechanics in the BGC lease and therefore these were paramount.
Conclusion
A failure to ensure that a material matter is included in an executed agreement risks ambiguity (and expensive litigation).
In the event that a dispute regarding contractual construction does arise, some salient guidelines are as follows:
- Words should be given their natural and ordinary meaning unless the result is one which flouts common sense
- Statements as to contracting parties' intentions may be taken into account, but a court is not bound to construe them as obligations
- Pre-contractual negotiations cannot be considered to aid detailed points of interpretation. They can, however, be considered as a basis for rectification, which requires showing a common continuing intention that did not translate into the engrossed document.
Beverley Vara is a partner and head of real estate litigation at solicitors Allen & Overy LLP