Court Follows New Approach To Interpreting Commercial Contracts

Businesses should note the courts’ current approach to interpreting contractual clauses, and take great care in negotiating and agreeing commercial terms to avoid ambiguity.

A bakery had insufficient capacity to bake all its own cupcakes, and entered into an agreement giving a supplier the exclusive right to provide it with cupcakes. Under the agreement, the supplier and the bakery would share production of cupcakes for the first two months, and then the supplier would produce 100 per cent of the bakery’s forecasted sales.However, the agreement also said: “For the avoidance of doubt, [the bakery] may manufacture the Products for itself”.

The bakery continued to make its own cupcakes beyond the initial two-month period. The supplier argued that the agreement was ambiguous. On the one hand it said the supplier would make 100 per cent of the cupcakes. On the other hand, the agreement said the bakery could continue to make its own cupcakes. The supplier said the court should look at pre-contract information and construe the contract accordingly. On that basis, it argued that the bakery was prohibited from making its own cupcakes after the initial two-month period and, by doing so, it was breaching the agreement.

The High Court disagreed. It found that there was no ambiguity, and to find that there was would “do extreme violence to the language of the Agreement”. The agreement clearly stated that the bakery could make its own cupcakes, which must include being able to do so after the first two months. This was not inconsistent with the clause saying the supplier would make 100 per cent of the bakery’s forecasted sales, as it was possible that demand for cupcakes might exceed the forecast. If the parties had wanted the agreement to stop the bakery producing any cupcakes after the initial two months they should have clearly said so in the agreement.

This ruling follows another recent Supreme Court decision in which it ruled that clear, unambiguous words in a contract should not be overturned merely because they are not commercially sensible – even if the outcome is commercially disastrous. It confirmed the following principles to be applied when interpreting commercial contract clauses:

• The aim of the court in construing a commercial contract is to ascertain objectively the aim of the parties
• For this purpose, the court must put itself in the position of a reasonable person in possession of all background information reasonably available to both (not just one of) the parties at the time the contract was entered into
• When unambiguous, ordinary language has been used in a contract, the court will normally give effect to that language. It will not rewrite a bad bargain, or change what was agreed just because it was imprudent, unwise or even if the outcome is disastrous. Particularly, it will not apply hindsight to determine whether or not an agreement is commercially sensible
• When there are two possible interpretations, the court will prefer that which made the most commercial sense at the time. However, commercial common sense and surrounding circumstances should not be used to override the importance of the words used – words specifically chosen by the parties at the time

These principles show that the courts will give contractual words their natural meaning, whether commercially sensible or not. The Court applied these five principles when coming to its conclusions in this case.

Operative date

• Now

Recommendation

• Businesses entering into commercial contracts should be aware of how the courts will now interpret them in the event of a legal dispute ,and draft them accordingly to avoid uncertainty

Case ref: Honeyrose Bakery Ltd v Lola’s Kitchen Ltd (t/a Lola’s Cupcakes) [2015] EWHC 1856

21 September 2015