What were we thinking? – New guidance on rectification of contracts6 September 2019

Mistakes can happen. What happens when, as a result of such a mistake, parties enter into a contract which does not reflect their prior agreement or their intentions? Such situations can cause commercially absurd results or lead to a party taking on onerous obligations that it never contemplated when negotiating the contract. The English court has a well-established power to rectify a contract to give effect to the parties’ intentions or prior agreement. However, the circumstances in which the courts will exercise that power, and in particular the relevance of the parties’ state of mind, have been the subject of substantial controversy for the past decade following obiter dicta comments of Lord Hoffmann in an influential House of Lords decision, Chartbrook Ltd v Persimmon Homes Ltd. [2]

Following the trend towards a more literal approach to the interpretation of contracts, focussing on the natural and ordinary meaning of the language used[3], the principles governing the alternative remedy of rectification have taken on increased significance. The Court of Appeal’s decision in FSHC Group Holdings Ltd v GLAS Trust Corp Ltd is therefore a welcome and timely confirmation of the law in this area.

The legal uncertainty in rectification

Though rectification is often expressed as a single remedy, it is available in various circumstances which have their basis in either contract or the court’s equitable jurisdiction. In this judgment, the court focussed on rectification for “common mistake”, where both parties have a common intention and understanding as to the effect of a contract. However, when the contract is executed it operates differently to that intention. The requirements have been summarised in Swainland Builders Ltd v Freehold Properties Ltd,[1] which explains that a party seeking rectification in such circumstances must show:

1. That the parties had a “common intention”, whether or not amounting to an agreement, in respect of a particular matter in the contract to be rectified;
2. There was “an outward expression of accord” – i.e. that the parties had made clear their understanding to each other through communication (though in limited circumstances the understanding could be so obvious as to go without saying);
3. The intention continued at the time of the execution of the contract to be rectified; and
4. By mistake, the contract did not reflect the common intention.

How the court goes about establishing whether a party meets these requirements has been the source of ongoing controversy. To what extent should the court take into account the subjective views of the parties as to their intentions? Or should the court only consider an objective view of the situation to assess whether there is a common intention, and disregard subjective views?

In Chartbrook, Lord Hoffmann contended that the court should only consider objectively what a reasonable observer would have understood from the pre-contractual state of affairs between the parties. In effect, he considered that the approach should be the same as when interpreting a contract, where the subjective views of the parties are disregarded for a focus on the view of a reasonable objective observer. Although not binding, this emphasis on objective views has been controversial, forming the subject of numerous journal articles and speeches, despite being (reluctantly) followed by the Court of Appeal in Daventry District Council v Daventry & District Housing Ltd.[2]

Facts

In this case, the claimant was the parent company of Four Seasons Health Care Group, the largest independent provider of elderly care services in the UK (“FSHC”). The defendant was the successor security agent to Barclays Bank Plc (“Barclays”), which had acted as security agent in relation to the financing of the acquisition of the FSHC group by an investment fund in 2012.

In terms of the legal test for rectification, the confirmation that the court should look to the subjective intentions of the parties will lead to greater flexibility, and avoid injustice. However, this flexibility does not necessarily mean that successful rectification claims will become more common. The court emphasised that “as a matter of policy, rectification should be difficult to prove”, with parties being required to show “convincing proof” to dislodge the normal rule that a written contract is an accurate record of what the parties agreed.

As this case shows, mistakes are inevitable, particularly in large and complex commercial transactions. However, while the Court of Appeal upheld the trial judge’s decision to order rectification, it will remain a difficult task to convince a court to rectify a contract and it is worth observing that the facts in this case were unusual (in particular that the IRSAs were being entered into to comply with a specific pre-existing obligation, which significantly influenced the discussion between the parties leading up to the execution of the IRSAs). In this context, one final lesson from the judgment is that the best way to protect against mistakes is to maintain both good internal records and inter-partes correspondence demonstrating a common understanding of the deal so that, if worst comes to worst, a claim for rectification can be fully evidenced.

(This article was co-authored by Paul Hogarth).