Common sense comes out on top in contract dispute
17th November 2011
Victory for common-sense as judgment is given in long running battle over bank payout
Courts should apply business common sense when interpreting commercial contracts according to a judgment delivered this week (2nd November).
The Supreme Court has ruled in the case of Rainy Sky SA and Others v Kookmin Bank,  UKSC 50
that when the wording of a contract could be read in either of two ways, the court should opt for the interpretation that makes business common sense and reject the other.
The case involved a number of ship-owning companies which had placed orders for new ships to be built by Jinse Shipbuilders, a Korean company. Each contract provided that the buyer should pay a deposit on placing the order and for repayment of the deposit in certain circumstances including rejection of the ship on delivery, destruction of the ship before delivery, and the insolvency of Jinse. The contract also required the shipbuilder to provide a bank guarantee or bond for the repayment of the deposit, and these bonds were provided by Kookmin Bank.
In the event, Jinse Shipbuilding became insolvent and the buyers all called on Kookmin Bank to refund their deposit. Kookmin Bank refused, arguing that they did not need to pay out as the bond did not specifically list insolvency of the builder as being covered.
The Supreme Court has now said that if the bank's interpretation were accepted, it would lead to the "surprising and uncommercial result” that the buyer could not call in the bond upon the insolvency of the builder, which was the very event most likely to require security.
Lord Clarke of the Supreme Court went on to say that, where there are two possible interpretations of a contract, the interpretation that is to be preferred is the one that is consistent with the commercial purpose of the contract.
There are two important principles that the courts apply when interpreting contracts and other legal documents. One is that the court should interpret the document in such a way as to give effect to the intention of the parties; the other is that the courts must give effect to the ordinary meaning of the words.
The two principles are often at odds with each other and both have their limitations. The previous Court of Appeal judgement in this case went on a "literal" approach which found in the favour of the Bank. Now the Supreme Court has gone for an "intentional" interpretation.
The problem with the intentional approach is that the intention of the parties is often the thing that is in dispute and the only evidence of their intention is the words they have used.
The problem with the literal approach is that often the wording of a document is like an optical illusion or double picture that can be seen in different ways. You can see both images but not at the same time; they are irreconcilable and neither is the "correct" image.
So, when interpreting legal documents, you need some external factor to help decide what is right. That is what Lord Clarke was saying in his judgment, namely that business common sense needs to be applied.
The lesson is that a badly-drafted document can be a hostage to fortune and businesses need to get commercial contracts drafted correctly, by a specialist.
If you have concerns about the interpretation of a contract or require general advice on this area, please contact Chris Bowler on 01491572138 or by e-mail firstname.lastname@example.org.
This information is not intended as legal advice