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Common sense should apply when interpreting business contracts

Posted: 1st December 2011   In: Corporate Commercial

Business “common sense” should be applied when interpreting and applying commercial contracts, the Supreme Court has ruled.

Delivering the ruling, Lord Clarke said: “If there are two possible constructions, the court is entitled to prefer the construction which is consistent with business common sense and to reject the other.”

The issue arose in the case of six separate companies that had each contracted to buy a ship for $33m from a Korean manufacturer. Payment was to be in instalments and each company was provided with a refund guarantee by a Korean bank.

The shipbuilder went out of business before the ships were completed so the companies sought to recover their money under the guarantee. A dispute then arose as to the meaning of a phrase in the bond which stated that the bank would pay the buyers “all the sums due to you under the contract”.

The bank insisted that this did not include all of the money that the buyers had paid out. The case went all the way to the Supreme Court, which has now ruled in favour of the buyers. 

Lord Clarke said that the language in a contract “would often have more than one potential meaning”.

He then added: “One would naturally expect the parties to agree (and the buyer’s financiers to insist) that in the event, for example, of the insolvency of the builders, the buyers should have security for the repayment of the pre-delivery instalments which they paid.

“The buyer’s construction is to be preferred because it is consistent with the commercial purpose of the bonds in a way which the bank’s construction is not”.”

Please contact Martin Jackson if you would like more information about contract law or any of the issues raised in this article.