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Common sense prevailing in contracts

The Supreme Court has confirmed in Rainy Sky SA and others v Kookmin Bank that they are prepared to ignore large parts of the original contract wording that can sometimes seem ambiguous and inconsistent in order to take a more commercial approach and apply common sense. This case demonstrates the continuous move away from a strict and literal approach to contractual constructions by applying common sense in order to eliminate the ambiguous wording of contracts which can cause disagreements amongst the parties with the wording often having more than one meaning.

In Rainy Sky SA and others v Kookmin Bank the Supreme Court unanimously overturned the previous decision of the Court of Appeal. The facts of the case are complicated because it’s a Maritime case and outside the remit of this blog. Therefore, briefly, the drafting of the guarantee agreement was the main cause of disagreement between the parties, as the drafting did not match that as stated in the shipbuilding contracts. Where the shipbuilding contracts had stated that should one party enter into insolvency then the buyers would have a right to rescind the contract and therefore obtain a refund for payments made pursuant to the contract, the guarantee agreement did not. Paragraph 2 of the guarantee stated that the buyers would be entitled to a refund if they exercised their right to “termination, cancellation or recission” their contracts and paragraph 3 provided the guarantee obligation that the defendant would pay the buyers “all such sums due to you under the contract”. But when one party began having financial difficulties and entered into a form of insolvency the defendant refused to give them a refund on the guarantee paid pursuant to the contract because the defendant argued that the insolvency was not “termination, cancellation or rescission”. The claimants argued that this literal interpretation made no business sense and that there was no good reason why insolvency should be excluded.

The courts decided to approach the contractual wording with what a reasonable person would have understood the parties to have meant, keeping in line with the consistency of the commercial purpose of the bonds. This approach to construction has been used in previous case law, notably Mannai Investment Co Ltd v Eagle Star Life Assurance Co Ltd where it was held that the ultimate aim of interpreting a provision in a contract is to determine what the parties meant by the language used, which involves ascertaining what a reasonable person would have understood the parties to have meant. However in Rainy Sky SA and others v Kookmin Bank [2001] UKSC 50 they were faced with the question of what happens if the reasonable person is capable of reaching two different interpretations from the same words? The court found it necessary to use the construction in a manner consistent with business common sense, as a language capable of producing an absurd or irrational result was held not to prevail over the commercial purpose of the agreement. The court therefore held that insolvency would be included in the list of grounds on which the parties could rely on in order to terminate the agreement and have the bond returned.

So why did the court allow common sense to prevail and what does it mean for the future? Language can be deemed as flexible in the sense that what might seem reasonable to one, isn’t deemed reasonable to the other. Thus meaning that although the presumption of a reasonable person can be used in most situations, it cannot be used in every situation that arises.

What does this mean to landlords and letting agents?
This case means that contracts, and particularly guarantee agreements, will be looked at by the Courts with an eye to giving them the force that the parties reasonably intended. They will not normally allow a guarantor to escape their obligations by reading a piece of ambiguous wording in an overly restrictive manner.

However, this should not be seen as a licence not to take care with documents. No landlord or agent would wish to undergo the expense of the multiple appeals that this case required.

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