Saturday, October 22, 2011

Limits to the ICS Approach and the Implication of Terms into a Contract

Sir Guenter Treitel has said that Diplock LJ’s judgment in Hongkong Fir Shipping v Kawasaki Kisen has a fair claim to being the most important judicial contribution to English contract law in the past century.” Perhaps not too far behind is Lord Hoffmann’s speech in Investor Compensation Schemes v West Bromwich Building Society [“ICS”], where the “modern” approach to the construction of contracts was established. ICS is so well-known that the remarkable result in it is sometimes overlooked. In that case, a Board, which had been created to compensate certain investors who had claims in tort against the Building Society, became the assignee of these claims. The assignment clause said that the investors assigned all claims to the Board exceptany claim (whether sounding in rescission for undue influence or otherwise)”. The result of a literal interpretation of this clause was “commercial nonsense”, for it meant that the assignee could not sue for damages. Lord Hoffmann set out “five principles” of interpretation the application of which to this clause produced the following result: investors assigned all claims except “any claim sounding in rescission (whether for undue influence or otherwise)”. The essence of Lord Hoffmann’s five principles is that the meaning of a document is not the meaning of its words simpliciter, but the meaning those words would have conveyed to a “reasonable person having all the background knowledge which would reasonably have been available to the parties in the situation in which they were at the time of the contract”. “Background knowledge”, save in two exceptional cases that we can ignore for the present purpose, does not include pre-contractual negotiations (see ICS, Chartbrook and Oceanbulk).
In parallel to this objective approach to interpretation is the ability of the courts to resort to “implication of terms”. Again, Lord Hoffmann’s speech in AG Belize v Belize contains a masterly exposition of the law, and clarifies that the implication of terms is not an exercise by which the court “adds” terms to the instrument to “improve” it or supply “defects”, which is impermissible, but one which asks whether a “reasonable addressee” of the instrument would understand the instrument “to mean something else” even though is silent as to the consequences of a certain event. In those rare cases, the Court, by “implying” the term, does no more than give effect to what was the intention of the parties, understood objectively. It is notable that both ICS and Belize are founded on the principle that the meaning of an instrument is not the sum of its words, but the meaning those words would convey to a reasonable addressee, even if that meaning in a certain case is not the ordinary meaning of that word in the dictionary.
However, just like Lord Hoffmann’s “assumption of responsibility” approach to damages, it is noticeable that the conventional approach will yield the correct result in a majority of cases. This is not because Lord Hoffman’s test in ICS is deliberately intended to apply to a predefined set of “exceptional” cases, but simply because the “reasonable person” in ICS would in most instances assume that the meaning of an instrument is the dictionary meaning of its words grammatically construed, with no additions, just as the “reasonable addressee” in Belize would normally assume that if a contract is silent as to the happening of a certain event, it was intended that that event has no legal consequences. In other words, neither ICS nor Belize permits a court to rewrite a contract for the parties, even if there is an error in drafting it.
The recent judgment of the Court of Appeal in Estafnous v London and Leeds Business Centres is an interesting case that makes this point.  The London and Leeds Business Centres [“LLBC”] held all the issued share capital of a company called Drillray Properties Ltd [“Drillray”], which was the owner of the leasehold interest in a building known as Regent House Business Centre [“Regent House”]. Drillray held the leasehold in Regent House on trust for LLBC, which was a wholly owned subsidiary of a company that was itself wholly held by a Mr Robert Kidd and two others interested in the business of LLBC.  In early 2001, Mr Estafnous approached Mr Kidd with a proposal to introduce to LLBC a potential buyer for the leasehold in the Regent Street land on the condition that he would be paid £2 million on completion of the sale. Mr Estafnous and LLBC accordingly concluded a contract which provided that “LLBC has agreed to a party to be introduced by Mr Estafnous” and “in consideration of the introduction of the Intending Buyer to LLBC and upon the Intending Buyer (or any other party related to or associated with the Intending Buyer) completing a purchase of the Property LLBC will forthwith upon such completion pay to Mr Estafnous or as he may direct the sum of 2 million pounds sterling” [emphasis added].
Mr Estafnous introduced the buyer, a Mr Kapoor. After protracted negotiations between Mr Kapoor and LLBC, it was decided that the sale would be completed not as a sale of the property itself, but through the sale of shares in the company that held the land. This was done to avoid the payment of the stamp duty that would become due on the sale of the property simpliciter. As a result of corporate restructuring carried out for this purpose, a company called IMCO became the ultimate holding company of LLBC, and Mr Kapoor’s company acquired all the issued shares of IMCO. The question that arose was whether this triggered LLBC’s obligation to pay Mr Estafnous the sum of £2 million.
The Court of Appeal held that it did not. It was irrelevant that the parties had all along intended that Mr Estafnous would be paid for introducing a buyer who would gain “control” over Regent House, since the contract, which was not in the least ambiguous, clearly provided that the obligation to pay the sum arose when: (i) the seller is LLBC; and (ii) the property sold is Regent Street. As it happened, this was not the case – the seller was the owner of the shares of IMCO, and the property sold was those shares. Regent House was owned in exactly the same way as before the agreement – legal title with Drillray, held beneficially for LLBC.
The Court of Appeal rejected counsel’s attempt to invoke ICS and Belize, even though it accepted that the purpose of the contract was to pay commission on the acquisition by Mr Estafnous’ party of control over Regent Street. As to ICS, the Court said, rightly, that:
That case is not a licence for the courts to rewrite contracts.  Indeed, as Lord Hoffmann himself said in BCCI v Ali [2002] 1 AC 251 at 269, the primary source for understanding what the parties meant is their language interpreted in accordance with conventional usage.   Interpreted in that way, there can be no doubt, I consider, that the Agreement has the literal meaning identified to which Mr Newman refers.
And as to Belize:
In my judgment, there is no room in the present case for the implication of any term which would have the result for which Mr Newman contends.  This is one of those cases where those involved did not think about what was to happen in certain circumstances, namely if the property sale were restructured as a share sale.  It is not surprising that they did not do so because the individuals concerned – Mr Estafnous for himself and Mr Kidd on behalf of LLBC – made the Agreement against the background of a deal which had already been struck, subject to contract, and it was in relation to that deal or a deal of that sort that commission was to be payable [emphasis added].

This is perhaps a case that is at the very edge: it may be that a “reasonable addressee” would have considered that the £2 million is payable in whatever way control over land is transferred to a party introduced by Mr Estafnous. One may ask whether a claim by Mr Estafnous for breach of contract would have succeeded if, for example, LLBC had sold the land itself to a shell company incorporated for the purpose, and then effected a sale of the land from that company to Mr Kapoor. It was perhaps the fact that the property sold was itself different that was decisive. The case is a good illustration of the true nature of and limits to ICS and Belize.


vswami said...

"The Court of Appeal rejected counsel’s attempt to invoke ICS and Belize,....As to ICS, the Court said, rightly, that: >That case is not a licence for the courts to rewrite contracts.<

Indeed, as Lord Hoffmann himself said in BCCI v Ali [2002] 1 AC 251 at 269, >the primary source for understanding what the parties meant is their language interpreted in accordance with conventional usage.<...


Anonymous said...

Thanks for article. It is quite good.

Would you be able to guide as to where and how to track judgements of UK courts on commercial laws?

V. Niranjan said...

There may of course be an analogy between ICS and construction of statutes, but perhaps only to the extent that in neither case is the court entitled to substitute or improve the instrument it is construing.

@Anonymous, UK Court websites provide RSS feeds. The UK Supreme Court Blog ( also has updates on Supreme Court decisions.

Anonymous said...

What's the point in practicing law if the people in the uk are not going to use to enforce justice. To me it looks like the claimant was effectively robbed of his commission.

Vishnu said...

Good piece

Renu Gupta said...

Do you not think that the interpretation given by the court in this case was rather literal, devoid of taking account of the intention of the parties (intention to make payment of commission was evident), ending up as a business nonsense interpretation?

I appreciate the position whether the courts do not rewrite the contract, but that should perhaps not be a blind rule, incapable of being mended in a situation which warrants it.

V. Niranjan said...

@Renu, while perhaps this is a borderline case, I tend to agree with the Court's view. English law today seems to have principally three allied devices to deal with cases in which it appears that there is some error in the contract as drafted - one is rectification, which was not pleaded in this case; there is the fifth ICS principle (which requires commercial absurdity - "something must have gone wrong" with contract drafting) and the third is implication of terms (which applies when the contract is silent). Bearing in mind that pre-contractual negotiations are inadmissible in cases two and three, I do not think the Court could have concluded that LLBC's interpretation was commercially absurd in this sense - the sale of shares was simply an event the parties had not provided for, perhaps because it may have had several consequences other than the transfer of control over land. Moreover, courts have been slow to conclude that "something has gone wrong" - in the leading examples (ICS itself, Mannai Investment or Chartbrook), the ordinary interpretation produced so absurd a result that it was clear that "something had gone wrong". I don't think that is true of LLBC's interpretation of the clause in question.

Renu Gupta said...

Thank you for your response. It may be useful to look at an Indian Supreme Court judgment, Standard Chartered Bank/Citibank NA, by Justice S.B Sinha.

Anonymous said...

A stimulating and clear post. Thank you.