Blackletter Law – Interpretation of Contracts using practical examples

James Baily

Partner

Herbert Smith Freehills LLP

James Baily, Partner, +44 20 7466 2122, james.baily@hsf.com

THURSDAY, 24 SEPTEMBER 2015

OIL & GAS UK LEGAL CONFERENCE

THE INTERPRETATION OF CONTRACTS

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INTRODUCTION

• The state of play between purposive and literal approaches to the

interpretation of contracts

• The difficulties with considerations of commercial common sense

• What special rules exist, if any, when interpreting limitation and

exclusion clauses

• Should offshore services contracts with knock-for-knock indemnity

provisions be treated differently from other commercial contracts

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PRINCIPLES OF CONTRACTUAL INTERPRETATION

“The ultimate aim of interpreting a provision in a contract, especially a

commercial contract, is to determine what the parties meant by the language

used, which involves ascertaining what a reasonable person would have

understood the parties to have meant”; (Lord Clarke in Rainy Sky S.A. v.

Kookmin Bank [2011] UKSC 50)

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PRINCIPLES OF CONTRACTUAL INTERPRETATION

• Relevant person is one who has all the background knowledge which

would reasonably have been available to the parties in the situation in

which they were at the time of the contract

• Ignore evidence of a party’s subjective intentions and pre-contractual

negotiations

• Where the parties have used unambiguous language, the court must

apply it

• If there are two possible constructions, the court is entitled to prefer

the construction which is consistent with business common sense

• The proper approach may be summarised as “contextual and

purposive” (Lord Mance in Lloyds TSB Foundation for Scotland v.

Lloyds Banking Group [2013] 1 WLR 366)

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THE SHIFT TOWARDS A PURPOSIVE APPROACH

“If a detailed and syntactical analysis of words in a commercial contract is going

to lead to a conclusion that flouts business common sense it must yield to

business common sense” (Lord Diplock in The Antaios [1985] AC 191, 201)

• A recipe for uncertainty?

o How will the courts decide on the commercial purpose of a

transaction

o When will they depart from the strict meaning of the words

used

o More difficult to predict the outcome of the interpretative

process

• The principles may be clear but their application is not

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LIMITS OF CONSIDERATIONS OF COMMERCIAL COMMON SENSE

Arnold v. Britton [2015] UKSC 36

• 99 year leases granted in 1970s

• Annual service charge of £90 increasing at a compound rate of 10% per

annum gives a service charge in 2072 of £550,000

• Supreme Court upheld this interpretation despite the unattractive

consequences because

o effect of the clause was “clear in each lease as a matter of language”

o far from certain that considerations of commercial common sense as

perceived at the date of the contract would make such effect unlikely

• Lord Carnwath (dissenting): “I am not convinced that the ‘natural meaning’ is

that adopted by the Court of Appeal … or that, even if it is, it relieves the court

of the obligation to seek a sensible result”

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LIMITS OF CONSIDERATIONS OF COMMERCIAL COMMON SENSE

Lord Neuberger’s factors in Arnold v. Britton

• Commercial common sense should not be invoked to undervalue the

importance of the language of the provision. What the parties

reasonably meant is most likely to be gleaned from the language

• The court should not embark on an exercise of searching for (let alone

constructing) drafting infelicities in order to facilitate a departure from

the natural meaning

• Commercial common sense should not be invoked retrospectively

• It is not a function of the court to relieve a party from the

consequences of his imprudence. Its purpose is to identify what the

parties have agreed, not what the court thinks they should have

agreed

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SPECIAL RULES WHEN CONSTRUING LIMITATION AND EXCLUSION CLAUSES

• The old intellectual baggage of ‘legal’ interpretation has been

discarded

• Some of the special rules for construing exclusion clauses may no

longer apply – e.g. Canada Steamship rules re clauses that purport to

exclude liability for negligence are “guidelines” not to be

mechanistically applied (Mir Steel v. Morris [2012] EWCA Civ 1397)

• Parties in commercial contracts are generally entitled to apportion risk

of loss as they see fit and provisions which limit or exclude liability are

in general to be construed according to the same principles as other

terms (Moore-Bick LJ in Tradigrain v. Intertek Testing [2007] EWCA

Civ 154)

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SPECIAL RULES WHEN CONSTRUING LIMITATION AND EXCLUSION CLAUSES

• It is clear that clauses which have the effect of limiting or excluding

liability are still to be construed narrowly against the party seeking to

rely on them

• The requirement for clear words demonstrating an intention to exclude

rights:

“A party relying on an exclusion clause must establish that the words show

a clear intention to deprive the other party of a remedy to which it would

otherwise be entitled, because one starts with the presumption that neither

party intends to abandon any remedies for breach arising by operation of

law” (Lord Diplock in Gilbert-Ash v. Modern Engineering [1974] AC 689)

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SPECIAL RULES WHEN CONSTRUING LIMITATION AND EXCLUSION CLAUSES

• The more valuable the remedy that has been abandoned, the clearer

the language will need to be (Moore-Bick LJ in Stocznia Gdynia v.

Gearbulk [2010] QB 27)

• Courts will not readily construe an exclusion clause so as to prevent

any sanction for non-performance since it effectively renders the

agreement devoid of contractual content (Kudos v. Manchester

Central Convention Complex [2013] EWCA Civ 38)

o Widely drafted exclusion clause in respect of all losses “in

relation to this Agreement” found to exclude claim at first instance

o On appeal Tomlinson LJ said that expression means “in relation

to the performance of this Agreement” – therefore not applicable

where there was a refusal to perform or be bound

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TRANSOCEAN V. PROVIDENCE

Transocean Drilling U.K. v. Providence Resources [2014] EWHC 4260 (Comm)

• Contract for the provision of semi-submersible drilling unit (the Arctic III)

• Based on LOGIC standard form but with amendments

• Transocean undertook that it would operate, test, repair and maintain the well

control equipment in good condition at all times

• Serious problems were experienced with the rig’s BOP stack causing a period

of delay from 18 December 2011 to 2 February 2012

• Transocean claimed remuneration at relevant day rates

• Providence counterclaimed for wasted spread costs incurred due to delay

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TRANSOCEAN V. PROVIDENCE

• Judge found that Transocean was in breach of contract because the

rig was not in good working condition and adequate to conduct the

work; nor was the BOP equipment maintained in good condition

• Two key issues:

1. Whether Transocean entitled to remuneration for the “Disputed

Period” from 18 December 2011 to 2 February 2012 during which

operations delayed due to its breach of contract

2. Whether Providence entitled to set-off its spread costs incurred

during the Disputed Period in diminution of Transocean’s claim for

unpaid invoices

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TRANSOCEAN V. PROVIDENCE

ISSUE 1 – Was Transocean entitled to remuneration for the “Disputed

Period”?

Transocean argued:

• Day rates constituted a “complete code” for remuneration

• Appropriate rate applied irrespective of fault providing clarity and

certainty

• This was consistent with other provisions in the contract such as the

knock-for-knock indemnities, demonstrating that the parties were

willing to assume liability for losses even where these were the result

of the other party's negligence

• The Repair Rate was expressed to be payable “in the event of any

failure of CONTRACTOR's equipment …” (emphasis added)

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TRANSOCEAN V. PROVIDENCE

ISSUE 1 – Was Transocean entitled to remuneration for the “Disputed

Period”?

Held:

• None of the day rate provisions entitled Transocean to remuneration where

such entitlement arises from Transocean’s breach of contract

• Rule of construction that, unless a contract contains clear language to the

contrary, it will not be construed as enabling a party to take advantage of its

own wrong (Alghussein Establishment v. Eton College [1988] 1 WLR 587)

• Presumption that neither party intends to abandon any remedies for its breach

arising by operation of law

• These principles apply as much to a drilling contract as to any other contract

for goods and services (Sonat Offshore v. Amerada Hess [1988] 1 Lloyd’s

Rep 145)

• No express language to support Transocean's interpretation beyond “any

failure” in the Repair Rate clause and this was not sufficiently clear

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TRANSOCEAN V. PROVIDENCE

ISSUE 2 – Was Providence entitled to counterclaim its spread costs?

Transocean argued it was excluded under Clause 20 – Consequential Loss:

i. any indirect or consequential loss or damages under English law, and/or

ii. to the extent not covered by (i) above, loss or deferment of production, loss

of product, loss of use (including, without limitation, loss of use or the

cost of use of property, equipment, materials and services including

without limitation, those provided by contractors or subcontractors

of every tier or by third parties), loss of business and business

interruption, loss of revenue … loss of profit or anticipated profit, loss

and/or deferral of drilling rights …

whether or not such losses were foreseeable … and in respect of paragraph

(ii) only, whether the same are direct or indirect.

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TRANSOCEAN V. PROVIDENCE

ISSUE 2 – Was Providence entitled to counterclaim its spread costs?

Held:

• Clause must be construed contra proferentem against Transocean

• Spread costs fall within the first limb of Hadley v. Baxendale and were

therefore not caught by subparagraph (i) of the clause

• Subparagraph (ii) widens the scope for certain addition categories of loss

to be construed narrowly

• In context “loss of use” is to be read as connoting loss of expected profit

or benefit to be derived from the use of property or equipment

• “cost of use” adds nothing since it covers the cost of hiring in equipment

or services, or replacing property the benefit of which has been lost, in

order to mitigate the loss of benefit – not the case with spread costs

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TRANSOCEAN V. PROVIDENCE

ISSUE 2 – Was Providence entitled to counterclaim its spread costs?

• Significantly Transocean’s interpretation meant it would not be liable

for any loss suffered by Providence as a result of breach of warranty,

outside the specific knock-for-knock indemnities

• This renders Transocean’s contractual obligations devoid of

contractual content

• A clear indication that Transocean’s interpretation cannot have been

intended by the parties

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DO OFFSHORE INDUSTRY CONTRACTS MERIT SPECIAL CONSIDERATION?

• Do contracts in the offshore industry, with long-established contractual

schemes for sharing risk, merit a special approach – either by way of

factual matrix or having regard to commercial common sense?

• Courts have been resistant:

o “I also have some reservations about having regard to what were said to

be attitudes generally prevailing in the offshore drilling industry towards

risk allocation and the means of providing for it” (Moore-Bick LJ in

Seadrill v. OAO Gazprom [2010] EWCA Civ 691)

o “the applicable principles governing the approach to construction apply

as much to a rig contract as to any other contract for goods and services.

It does not assist Transocean to say that such contracts may commonly

contain knock for knock clauses” (Popplewell J in Transocean v.

Providence [2014] EWHC 4260 (Comm))

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CONCLUSION

• Offshore industry contracts will be construed in the same way as

other commercial contracts

• Clarity in drafting, especially with exclusion clauses, is the key –

including defining and enumerating specific heads of loss

• Consequential loss exclusions – the danger of being a victim of

your own success when drafting the clause

• The law of contract is “designed to enforce promises with a high

degree of predictability” (per Lord Hoffmann)

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QUESTIONS