Pre-contract negotiations and a couple of last farewells

There is a longstanding rule in both Scotland and England against the use of pre-contractual negotiations in finding out what a contract actually means. Alisdair Matheson examines the rule in the light of recent guidance from the House of Lords.

A court looking at a contract attempts to find the meaning an objective observer would ascribe to a contractual term. They do not wish to hear evidence on the subjective intentions of parties themselves and negotiations, guided by those intentions, have questionable evidential value as Lord Wilberforce said in Prenn v Simmonds [1971] 1WLR 3081 at 3084:

"By the nature of things, where negotiations are difficult, the parties' positions, with each passing letter, are changing and until the final agreement, though converging, still divergent. It is only the final document which records a consensus. If the previous documents use different expressions, how does construction of those expressions, itself a doubtful process, help on the construction of the contractual words? If the same expressions are used, nothing is gained by looking back: indeed, something may be lost since the relevant surrounding circumstances may be different. And at this stage there is no consensus of the parties to appeal to."

The parties may have had different interpretations of the set of words contained in the contract and even recognised those differing interpretations; simply hoping that no dispute would arise. More than anyone else, Lord Hoffman has been identified with the expansion of the background information which is taken into account when construing the terms of a contract.

This resort to background material can have somewhat surprising results. In the recent case of Aberdeen City Council v Stewart Milne Group Ltd 2009 CSOH 80 the Court of Session adopted a very creative construction of the terms of Missives for the sale of land to prevent Stewart Milne from radically increasing their profit by selling the land on to a subsidiary company at a less than market value.

In what was Lord Hoffman's last judgment in the House of Lords before retiring (the first of our last farewells), in Chartbrook Ltd v Persimmon Homes Ltd [2009] UKHL 38, he was able to consider the role of pre-contract negotiations in his leading speech. He expressly avoided reversing the rule against relying on them to construe contracts but said:-

"The rule excludes evidence of what was said or done during the course of negotiating an agreement, for the purposes of drawing inferences about what the contract meant. It does not exclude the use of such evidence for other purposes, for example, to establish the fact which may be relevant as background was known to the parties, or to support a claim for rectification or estoppel [personal bar in Scotland]. These are not exceptions to the rule. They operate outside it."

The casual observer may ask what the difference is. Well, the basic rule is that pre-contractual negotiations cannot be relied upon to actually explain the contract. For example, if one party had inserted a clause into a draft contract and when doing that had explained its meaning to the other party in a letter, that letter could not be referred to to conclusively prove that the clause meant what the proposing party intended it to.

However, the fact that the clause was discussed might be a fact relevant in assisting the construction of a particular element of the contract. In Chartbrook v Persimmon itself, the court was considering a term dealing with whether additional consideration was to be payable to a developer on the final sale of residential properties. The correspondence, despite being pre-contractual negotiations, was considered and the court held the clause's intended meaning set against those facts was that payment was only due if a higher return was received than had been expected when the contract was entered into.
It is a timely reminder that the only safe rule is to have your contracts drafted as clearly as possible but that pre-contractual negotiations may be referred to in a limited context to aid a contract's construction despite the terms of the general rule barring their use. The case widens the material which may go to the factual matrix surrounding a contract and against which it will be construed.

As for the second farewell, this is one of the last decisions to be issued by the House of Lords as from 1st October 2009 the judicial business of House of Lords will be transferred to the new Supreme Court.