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It is now a well established principle of modern English contract law that the Courts, when considering the meaning of a contract, can look at objective facts which occurred during pre-contractual negotiations to help them interpret the parties’ true intention.  It is also a well established (and indeed, longer established) principle that anything said and done during the course of without prejudice negotiations is not so admissible.  What happens when the twain meet?

That was the question that arose in the recent Oceanbulk v TMT Asia appeal.  In a unanimous judgment handed down on 27 October, a 7 strong Supreme Court (Lords Phillips, Rodger, Walker, Brown, Mance, Clarke and Sir John Dyson) confirmed the existence of a new exception, to the without prejudice rule, called the “interpretation exception”.  This means that evidence which would otherwise have been inadmissible under the without prejudice rule may now be admitted as an aid to the construction of a settlement agreement.

Facts

The facts of the case are set out in our previous post about the Court of Appeal decision.  In short, the collapse of prices in the shipping freight market in 2008 had left the Appellants liable under a series of forward freight agreements to pay Oceanbulk large sums of money (potentially $300 – 400m of liquidated damages).  The parties entered into without prejudice negotiations and signed a settlement agreement in June 2008.  However, Oceanbulk then brought proceedings for damages for breach of the settlement agreement, and the dispute turned on the exact meaning of the settlement agreement.
The Appellants, in defence, claimed the agreement had to be interpreted in light of four representations which were made by Oceanbulk during negotiations.  The High Court agreed, holding that these representations were admissible, notwithstanding the without prejudice rule.  However, the Court of Appeal (Longmore and Stanley Burnton LJJ; Ward LJ dissenting) overturned the decision, and the case reached the Supreme Court in July.

Issues

The question for the Supreme Court to decide was, in Lord Clarke’s words, “whether facts which are: (i) communicated between the parties in the course of without prejudice negotiations; and (ii) would, but for the without prejudice rule, be admissible as part of the factual matrix or surrounding circumstances as an aid to the construction of an agreement resulting from the negotiations, should be admissible by way of exception to the without prejudice rule.”  In other words, should the process of interpreting a settlement agreement, which was negotiated without prejudice, be the same as interpreting any other agreement which was not negotiated without prejudice?

Judgment

The Court’s answer was an emphatic “yes”.  Lord Clarke, giving the sole judgment of Court, started the analysis with the development of the without prejudice rule.  The rule was founded on public policy (the importance of allowing parties to speak freely when seeking compromise), and on implied agreement between parties.  As such, the rule had a “wide and compelling effect” and “should not be lightly eroded”.

However, caselaw (in particular, the Court of Appeal’s judgment in Unilever v Proctor & Gamble [2000] 1 WLR 2436) has developed a number of exceptions to the rule, where admissibility is in the interests of justice (the most common exceptions where there is a question as to whether a compromise agreement has in fact been concluded or not, or should be rectified or not, or should be set aside on grounds of misrepresentation, fraud or undue influence).  Should there be added to these existing categories a new, “interpretation exception”?

The law of contractual interpretation has developed rapidly in recent years, particularly following the House of Lords’ decisions in Investors Compensation Scheme v West Bromwich BS [1998] 1 WLR 896 and Chartbrook v Persimmons Homes [2009] UKHL 38.  The Courts are moving away from strict interpretations of words and their literal meaning (applying the ‘parole evidence’ rule to exclude wider factors), towards purposive, commercial interpretations based on what the parties must have intended in all the circumstances.  The test for contractual meaning is now (per Lord Hoffman in Investors Compensation) “what a reasonable person having all the background knowledge which would have been available to the parties would have understood them to be using the language in the contract to mean” (emphasis added).

As a result, objective facts which emerge during pre-contract negotiations are considered part of the background ‘factual matrix’, and are admissible as an aid to construction.  Was there any reason to treat without prejudice negotiations differently?  No, said Lord Clarke.  His Lordship’s core reasoning was as follows:
(i) the modern principles of construction of contracts should be applied as consistently as possible;
(ii) negotiating parties would surely expect their end agreement to mean the same, whether it was negotiated without prejudice or not;
(iii) in fact, it would arguably encourage settlement if a party to negotiations knew that objective facts which emerged during negotiations would be admitted to assist the court to interpret the contract to reflect the parties’ true intentions; and
(iv) finally, since rectification (correction of an agreement where it does not, by mistake, reflect the parties’ common intention) was already an exception to the without prejudice rule, there could be no “principled distinction” to the position with contractual interpretation (construction of the meaning of an agreement based on the parties’ common intention).

Implications

Thus the “interpretation exception” has been introduced into English law, and the concepts of rectification and interpretation continue to merge. What are the implications for commercial parties?  What is clear is that the Courts are not seeking to undermine the without prejudice rule.  Things said and done subjectively during off the record settlement discussions will remain inadmissible.  Parties should, in Lord Clarke’s words, “speak frankly to promote settlement”.  However, if a dispute arises as to exactly what was agreed, the Courts can now look wider than before in their search for the parties’ meaning and pull back the without prejudice veil to see what facts were within the common (or objective) knowledge of both parties.  What in principle the Courts are trying to achieve is to decrease the risk of contracting parties suffering an injustice when a settlement agreement does not reflect their true intention.  Since settlements are often hastily assembled under pressure, that is an aim which should be welcomed both by business and by lawyers.

Ros Mitchell and Oliver Gayner are both associates in Olswang’s commercial litigation team