Identifying and interpreting contractual terms

1. The law’s response to a party’s disappointed expectation from entering a contract depends on the status of the expectation. Where it arises from a term, the law will aim to secure that expectation, which is not the case for representations or ‘mere puffs’.

2. Contractual terms may be express or implied. In relation to express terms, where the parties have recorded their contract in a document, the parole evidence rule prohibits the parties from going outside the document to adduce extrinsic evidence which adds to, varies, or contradicts it. However, the rule is subject to so many exceptions that it is unlikely to present an obstacle in practice (apart from mistaken identity claims after Shogun).

3. One exception is when collateral terms or collateral contracts are alleged; such terms and contracts can add to, vary and even contradict terms contained in the contractual document, including exemption clauses; they also confer remedial advantages over representations. Entire agreement clauses exclude the finding of collateral terms.

4. Terms can be incorporated by signature, reasonable notice or previous dealing or custom. A party is bound by a document she has signed, whether or not she has read or understood it, unless: (i) non est factum; (ii) misrepresentation;  or (iii) other vitiating factors can be made out; or (v) the document signed was non-contractual.

5. A party is bound by an unsigned document if: (i) it has been incorporated into the contract by notice given at or before the time of contracting; (ii) it is contained in a document intended to have contractual effect; and (iii) the level of notice is reasonable (ie commensurate with how onerous or unusual the term sought to be enforced is).

6. A party may also be bound by terms in an unsigned document due to a consistent course of previous dealing or the custom of the relevant trade.Interpretation of terms

7. Once terms have been been identified, the courts must interpret what they mean. Until recently, the trend in interpreting contracts wasfrom a literal to a contextual approach. Investors Compensation Scheme v West Bromwich BS established that contractual documents should be interpreted in the way that they would be by a reasonable person having all the background knowledge which would reasonably have been available to the parties at the time of contract formation. Interpretation was about attributing meaning to persons and not merely to words. If the background and context indicated that ‘something had gone wrong with the language’, courts need not give the words their ‘natural and ordinary meaning’ and attribute to the parties an intention they plainly could not have had.

8. Recent Supreme Court decisions appear to signal a renewed focus on the language used by the parties; however, the approach to be adopted still contains significant flexibility. The court’s task is to ascertain the objective meaning of the parties’ language (not their intentions), which is a unitary and iterative exercise balancing textualism and contextualism. Where rival interpretations are possible, guiding factors include the nature, formality and quality of the drafting and the coherence of the agreement. 

9. However, the following evidence is inadmissible in interpreting the contractual document: the parties’ subjective declarations of intention, their pre-contractualnegotiations, hindsight, what a reasonable and properly informed party would have intended. and their conduct subsequent to contract formation.12. The courts have traditionally been very hostile in interpreting exemption clauses. This is evident from:

  • the ‘fundamental breach’ doctrine;
  • the sometimes extreme way that the contra proferentem (against the party relying on the document) construction has been applied; and
  • the artificial construction of clauses exempting liability for negligence and for indirect and consequential losses.

10. These techniques of hostile construction have not been overruled but, in practice, they are overtaken by the direct mechanisms for controlling unreasonable exemptions and other unfair terms provided in the Unfair Contract Terms Act 1977 and the Consumer Rights Act 2015.

11. In addition to terms expressed by the parties, terms may be implied into contracts:

  • in fact, from the circumstances of the particular contract (as an exercise in construing the meaning of the contract, read as a whole against the relevant background) in order to give effect to the parties’ unexpressed intention; or
  • in law, as declared by the courts (in prescribing the necessary duties of a definable category of contractual relationship on wider considerations of fairness), by statute (eg the Sale of Goods Act 1979) or by custom (if a term is certain, well known, recognised as binding, reasonable and not contradicted by the express terms).

12. Courts have used the implied term device to restrict the exercise of discretionary power conferred by the contract, and to impose some good faith obligations in performing certain types of contract.