Pre-contractual negotiations and contract interpretation

Be careful what you say or do (or even omit to do) during pre-contractual negotiations

This brief article is concerned with the potential effect of pre-contractual negotiations on the interpretation of contracts that are governed by English law. Other legal systems may have different approaches.

In English law, pre-contractual negotiations cannot be used as an aid in interpreting a contract. This is clear (or, at least, I used to think so!).

In a leading authority for this rule, Lord Rogers has stated

“ The rule could scarcely be more firmly embedded in our law.”

The inability to use pre-contract negotiations in order to interpret contracts extends to heads of terms and drafts of contracts. So put away your pre-contractual terms sheets, drafts and notes when reading the final version of the contract.

However, the rule does not mean that something said or done during negotiations can never have an effect — but it cannot be used to interpret the contract — unless it can if it forms part of the factual matrix or reveals the genesis and aim of the transaction. Confused?

The recent Court of Appeal case of Merthyr (South Wales) Ltd v Merthyr Tydfil County Borough Council [2019] EWCA Civ 526 has introduced a degree of added ambiguity to this rule.

Practice point

There is an obvious point that does not need saying, but I will say it anyway:

The tip for drafters must be: strive to be as clear as possible in the contract wording itself to ensure that the contract clearly reflects the intentions of the parties. By so doing, we can limit the inherently uncertain potential effect of what was said or done during pre-contract negotiations

Can what happens during pre-contract negotiations have any effect on interpretation?

Yes — if what was said or done during negotiations do not amount to negotiations.

While pre-contractual negotiations cannot be used to interpret a contract, they can be used as part of the “factual matrix” or background.

For example, during negotiations, the parties may say things that clearly show that they both believe that a licence has been granted (this is taken from an actual case) or that a factual state of affairs exist or that the law is mistakenly X (when it should be Y).

We can see that these factors are not part of the negotiations even though they were expressed during the pre-contract phase. As such, they form part of the factual background and can be used to ascertain the intentions of the parties.

But the Court of Appeal has now added some (further) ambiguity. The judgment states that pre-contract negotiations cannot be used to interpret the contract but can be used to identify, as part of the background, the “genesis and aim of the transaction”.

Genesis and aim

So the “genesis and aim” can be used but not to interpret particular clauses.

Anyone else confused?

In Merthyr, Leggatt LJ recognises that there may be a fine line between using pre-contractual negotiations to identify the genesis and aim and using them to interpret a contract in stating:

“I would accept that there may be borderline cases in which the line between referring to previous communications to identify the “genesis and aim of the transaction” and relying on such evidence to show what the parties intended a particular provision in a contract to mean may be hard to draw.”

[As an aside I am of an age now when I am seriously considering retiring. This may have helped me in making my decision!]

Who threw away our dictionary?

The judgment of Leggatt LJ seems to have denied the existence of the so-called “private dictionary” exception.

There are dicta in a 2006 Court of Appeal case and elsewhere that refers to an exception to the rule that pre-contract negotiations cannot be used when interpreting a contract. This exception will apply if the parties have used words in an unconventional way. In essence, the argument is that the parties are using their own dictionary and this can be ascertained from pre-contract negotiations. In the House of Lords case of Chartbrook Limited v Persimmon Homes Limited and others [2009] UKHL 38, Lord Hoffmann seemed to accept the principle of the private dictionary exception but then went on to reject the decision in the leading case on the point.

Given Lord Hoffmann’s emphasis on the requirement for the use to be unconventional, it might be that there has always been very limited scope for making use of the private dictionary exemption.

The recent Court of Appeal case seems to have gone further and to have taken a different view of what Lord Hoffmann intended. Indeed, it now seems that there is no such private dictionary exemption.

Leggatt LJ (with whom the other two Lord Justices agree) states:

“It is also clear from the Chartbrook case that it is not only statements reflecting one party’s intentions or aspirations which are excluded for this purpose but also communications which are capable of showing that the parties reached a consensus on a particular point or used words in an agreed sense.”

While some may not agree that this is “clear” from the judgment in Chartbook, if this recent statement from the Court of Appeal is correct, the 2006 dicta did not survive the 2009 case of Chartbrook.

What now?

As I have stated above, the possibility of pre-contract negotiations being used to interpret a contract can be limited, and even excluded, if the contract is sufficiently clear in setting out the intentions of the parties. And this should be the goal of the draftsperson, certainly as regards a contract governed by English Law.

Note that pre-contractual negotiations can be use when claiming rectification. But that is another matter.

And also, as a further aside, a misleading statement (or act or even omission) during pre-contract negotiations may amount to a misrepresentation — a danger that can be partly mitigated by a clear statement of non-reliance in the contract — but not for fraud. If a party is lying or is reckless as to whether a statement is true or not, there is nothing we can do in the agreement to provide protection.

Michael Twomey, solicitor and director of legal training company, Legal and Commercial Training Limited, www.legalandcommercial.com