Contract drafting was “commercial nonsense”: The House of Lords case of Chartbrook Limited v Persimmon Homes Limited
- Grammatical ambiguity in a contractual payment formula leads to radically different interpretations – which one should be followed?
- Formula was expressed in words, not using mathematical symbols or examples which would have made the meaning clear
- Generally, how much leeway should the court give to poor contract drafting?
- House of Lords declines counsel’s invitation to change the common law and allow the courts to consider the drafting history when interpreting a final agreement
A dispute over the meaning of a defined term in a contract recently reached the House of Lords. In the case of Chartbrook Limited v Persimmon Homes Limited and others  UKHL 38, the phrase in dispute was “23.4% of the price achieved for each Residential Unit in excess of the Minimum Guaranteed Residential Unit Value less the Costs and Incentives”. The “grammatical ambiguity” of this phrase led to radically different payment obligations, depending on the interpretation that was adopted.
Although this case concerned a building contract, it is of wider relevance to many types of commercial contracts, particularly those that include percentage payments. Many of our clients enter into intellectual property licence agreements that include royalty payments based on a defined formula or term, such as Net Sales. We have long recommended that formulae should be drafted with mathematical precision, and that examples should be included where appropriate. The judgments of Lords Hoffmann and Walker support this approach.
The House of Lords was prepared to look at the overall purpose of the clause, without focussing too closely on the individual words in the sentence. In the words of Lord Hoffmann, “there is not, so to speak, a limit to the amount of red ink or verbal rearrangement or correction which the court is allowed. All that is required is that it should be clear that something has gone wrong with the language and that it should be clear what a reasonable person would have understood the parties to have meant.”
“The Drafting was Careless and No-one Noticed”
Chartbrook is an experienced property developer and Persimmon is an experienced building company. Chartbrook owned land in London SW18 and engaged Persimmon to build on the land.
After extensive negotiations, the parties reached agreement on a complex set of payment provisions. Persimmon was to pay Chartbrook various amounts including what was defined as the Total Land Value together with a Balancing Payment. The Total Land Value was straightforward to calculate, and was not in dispute.
The dispute related to the meaning of Balancing Payment (also, confusingly, defined as the Additional Residential Payment (ARP) – the two terms had the same meaning), which was defined as:
23.4% of the price achieved for each Residential Unit in excess of the Minimum Guaranteed Residential Unit Value [MGRUV] less the Costs and Incentives [C&I].
Chartbrook argued that to calculate ARP you take the price achieved [P], deduct the MGRUV and the C&I, and calculate 23.4% of the result. The judge in the High Court, and a majority of the Court of Appeal, agreed with this simple interpretation, which was perhaps the most obvious construction based on the words used in the definition. In the House of Lords, Lord Hoffmann acknowledged that “this construction is certainly in accordance with conventional syntax” (leaving aside, for the moment, the reference to C&I which creates its own confusion). If expressed mathematically, this formula could be rendered thus:
ARP = 23.4% of (P – MGRUV – C&I)
However, the minority judge in the Court of Appeal (Lawrence Collins LJ, since appointed to be a judge of the Supreme Court) and all of the judges deciding the case in the House of Lords, considered that this interpretation was wrong in context. In the words of Lord Hoffmann, “to interpret the definition of ARP in accordance with ordinary rules of syntax makes no commercial sense”, particularly when considered in conjunction with the payment terms in Schedule 6 to the agreement. Leaving aside the question of how to interpret the reference to C&I, Lord Hoffmann (whose judgment was unanimously approved by his fellow judges in the House of Lords) agreed with Lawrence Collins LJ that “ARP must mean the amount by which 23.4% of the achieved price exceeds the MGRUV”.
A further complication in the definition is the reference to C&I, which is tagged on to the end of the definition in a rather illogical way. Ultimately, the House of Lords accepted Persimmon’s argument that this item should be deduced from the price when calculating the 23.4%. If expressed mathematically, the formula accepted by the House of Lords as correct can be rendered as:
ARP = (23.4% of (P – C&I)) – MGRUV
Strictly speaking, this should be further qualified as only applying if the resulting value for ARP is positive. There are, of course, other interpretations of the above-quoted wording, which can be expressed by shifting the brackets around and the position of the different elements in the above formulae. As the judge in the High Court commented, and as Lord Walker in the House of Lords agreed, “the ambiguity [in the definition of ARP] could be resolved by the use of mathematical notation.”
Thus, the dispute could have been avoided if the parties had expressed the definition as a mathematical formula or had given an example of how the calculation would work.
Should the drafting history be taken into account?
Thus, Persimmon won their case based on the House of Lords’ view of the correct interpretation of the definition of ARP. Persimmon’s counsel also advanced two alternative arguments. As it turned out, it was not necessary for their Lordships to decide upon these alternative arguments, as Persimmon had already won based on their primary case. However, as the two alternative arguments raised questions of general importance, their Lordships commented on them.
The first alternative argument was that the House of Lords should overturn the existing common law rule that a court should not consider drafts of an agreement and pre-contractual negotiations when interpreting the final agreement. Their Lordships reviewed the case law in this field and practice in certain other jurisdictions (where drafts and negotiations can be considered) but concluded that there was no good reason for overturning this long-established rule.
The second alternative argument was that the agreement should be “rectified” to reflect what had actually been agreed but not accurately recorded in the signed agreement. Arguments based on rectification are rarely successful but are often attempted. Lord Hoffmann would have been prepared to rectify the agreement in this case, but did not consider this necessary in view of his judgment as to the correct meaning of the words used, as discussed above. His colleagues agreed with this view.
Implications for royalty terms
Many intellectual property licence agreements, and some assignments, include provisions for royalties calculated as a percentage of a base amount. Sometimes the base amount is calculated as a formula where certain items are deducted. For example, Net Sales definitions often have deductible items such as VAT, insurance and carriage, which are not taken into account when calculating Net Sales. Similarly, royalty-reduction provisions (sometimes known as royalty-stacking clauses) sometimes involve a complex formula. In a university context, some technology transfer offices (TTOs) pay a percentage of net income received from licensees to the academic inventors, after deduction of the TTO’s costs and charges. In all of these cases, it is important to ensure that the formula being used is robust and unambiguous. In our view, the best way to do this is to express the formula in mathematical notation and in some cases to provide an example of how the calculation is made, using notional figures.
For further information please contact Mark Anderson or the individual at Anderson & Company with whom you normally deal.
Article posted: 2009-08-20