Chartbrook v Persimmon Homes and the impact on contractual negotiations in the construction industry
Last week, the House of Lords, in a case called Chartbrook Limited v Persimmon Homes Limited, handed down an important judgment on the interpretation of contract clauses. The judgment has important implications for both developers and others involved in contractual negotiations in the construction industry.
This case primarily concerned how a court will approach a contractual dispute, where the issue centres on the interpretation of a particular clause. Should they always stick with the literal interpretation of a clause?
Persimmon appealed a Court of Appeal decision in favour of Chartbrook which concerned the interpretation of a development agreement involving a site in Wandsworth owned by Chartbrook. Under the development agreement, Persimmon were granted a licence to construct a mixed residential and commercial development and then sell the properties on long leases. Chartbrook would grant these leases at the direction of Persimmon, who would receive the sale proceeds from the purchasers, and then pay to Chartbrook an agreed proportion of those proceeds, representing the agreed land price per unit.
Planning permission was duly granted and the development was built, but a dispute arose over the price to be paid for the land by Persimmon to Chartbrook.
The land price had two elements to it.
Firstly, there was a basic land price arrived at by multiplying an agreed price per square foot by the areas of residential and commercial development for which permission had been granted, and adding to that a set figure per consented parking space. Secondly, there was an additional payment designed to capture a proportion of any increase in the residential sales value of the development after the date of the contract. This proportion was equal to that which had been applied pre contract to the anticipated sales values, in order to calculate the basic land price.
The definition of this second element was somewhat clumsy and this became the source of the dispute. We would précis the definition as follows:
“23.4% of the price achieved for each residential unit in excess of the basic land price per unit less the sales costs and incentives incurred in the sale of that unit”.
Chartbrook argued that this calculation worked on the following basis.
You start by taking the price achieved for a residential unit, and then in turn deduct from that figure the basic land price per unit, and the sales costs and incentives relating to that unit. Then you calculate how much 23.4% of the resulting figure amounts to, and this then becomes the additional land price for that unit. This was a literal interpretation of the clause, and gave a total additional land payment of £4,482,862.
Persimmon, on the other hand, argued that the clause should be read as follows.
You calculate 23.4% of the amount by which the price achieved for that residential unit exceeds the anticipated sales price, and then deduct from that figure the sales costs and incentives relating to that unit. Persimmon’s calculation of the additional land payment was £897,051.
This is a stark difference to Chartbrook’s calculation. When added to the basic land price this represented a healthy top-up to reflect the prices achieved for the flats, rather than the almost doubling of the overall land price which would be the result of Chartbrook’s calculations.
The question for the court was how to approach the interpretation of the clause. Should a literal interpretation be made (as is usual under English law) which would have meant the court finding in favour of Chartbrook, or should the court delve deeper into considering the intention of the parties at the time the contract was made?
In deciding the approach to be taken, the court stated that when interpreting contracts, the question for them is what a reasonable man having all the background knowledge which would have been available to the parties, would have understood the contract to mean. This means that while a court would not easily accept that people have made linguistic mistakes in formal contracts, in some cases the “context and background” would drive a court to the conclusion that something had gone wrong, allowing them to reconsider the interpretation of the clause.
The court concluded that to interpret the definition of the additional land price in accordance with the ordinary rules of language and syntax (as Chartbrook were arguing) made no commercial sense. The commercial purpose of the additional price was to capture the land element of any net increases in sales values, which arose after the date of the contract.
Whilst the case was therefore decided on the basis of an interpretation of the additional land price clause, the court also considered a long-established rule that evidence of pre-contractual negotiations is inadmissible in interpreting contractual wording.
The reasoning behind excluding consideration of pre-contractual negotiations is that such evidence is usually unhelpful as the parties’ positions constantly change as the agreement is negotiated. It is only therefore the final document which records the consensus reached.
The court confirmed that the established rule was correct, and that the pre contract negotiations are inadmissible.
Significance of the decision
The significance of this decision is to confirm that the courts will not always apply a literal interpretation to a particular clause in a dispute. They will be keen to keep to the doctrine of certainty of contract, but if the literal meaning leads to a commercial nonsense, then the court will look at the background to the case. Whether they do so though will be at their discretion, and may depend upon how much of a commercial nonsense has resulted.
In practical terms, though, the message is as clear as it has ever been. By getting the wording right in the first place, these types of disputes will be avoided. Whilst the court does have some discretion to look beyond the actual wording, there is absolutely no guarantee that they will do so. If there is an issue with the wording of the contract, there is an inherent risk that they will decide that the literal interpretation is not absurd, and will endorse a result that you have not bargained for.
It is therefore always worth bearing mind the following best practice points:
• Use clear, unambiguous language to set out exactly what all parties have agreed.
• If using a formula for any calculation, make sure that the formula can only be calculated one way and that you have put numbers through the clause to check it works. Be prepared to use formulas and/or worked examples to illustrate the intention.
• When drafting clauses of this nature, it is advisable to make reference to the commercial purpose of the clause as well. This judgment has made it clear that the judiciary may take this into account and may even use the commercial purpose to overturn actual wording in a contract if the two are inconsistent.
Above all though, the lesson is still very much – get the drafting right first time!
Reviewed in 2015