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Common Sense and Commercial Contracts

Marriott Harrison LLP

London, United Kingdom

A decision of the Supreme Court will have broad application for the future interpretation of commercial contracts, it having unanimously held that where the Court is asked to construe an ambiguous provision in a contract, that meaning which is most consistent with commercial common sense will be preferred.

In the case of Rainy Sky S.A. and others v Kookmin Bank [2011] UKSC 50, the bank had issued advance payment bonds to guarantee the obligations of a shipbuilder under a number of identical shipbuilding contracts. These bonds allowed the buyers to a full refund of pre-delivery payments, in particular where:

  • the buyers exercised their right to reject the vessel or to terminate the contract; or
  • there was an event of default by the shipbuilder, including insolvency.

Insolvency did not, however, entitle the buyers to cancel the contract.

The shipbuilder then ran into financially difficultly, and a dispute arose as to whether the buyers were entitled to a refund of their payments in the event of the shipbuilder’s insolvency or only where the buyers terminated their contracts. The parties agreed that the wording of the bonds was ambiguous.

The Supreme Court allowed an appeal in favour of the buyers, namely that the instalments should be repaid in the event of the insolvency of the shipbuilder, on the basis that this interpretation of the wording in the bonds was the most consistent with the general commercial purpose.

In broad terms and following case law, the Court could take two differing approaches with regards to interpreting the ambiguous wording, namely:

  • a literal approach, with the Court refusing to take into account what would appear to have been the underlying purpose of the provision in question; or
  • a purposive or more liberal approach, and treating the commercial purpose of the contract as more important than the literal meaning of the language used.

The Supreme Court concluded in this case that the appropriate construction of the ambiguous wording was that which was most consistent with commercial common sense. It would have made no commercial sense for the parties to have intended that an insolvency event would not lead to repayment of the instalments under the bonds because this would mean that the security, which the bonds were meant to provide, was not available when it was most needed.

The significance of this decision extends beyond this particular case, to the construction of commercial contracts in general. As well as clarifying the approach the Court should take, the case also highlights the necessity for tight drafting which reflects the commercial intention, to order to best minimise any future disputes, as it is now clear that the Court will also consider the particular commercial purpose of the contract.

For more information about Marriott Harrison LLP, please visit www.marriottharrison.co.uk or the International Society of Primerus Law Firms.

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