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Interpretation of contracts: Rainy Sky S.A v Kookmin Bank

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Posted by Laura Heeley on 03 December 2011

Laura Heeley - Litigation Lawyer
Laura Heeley Solicitor Advocate

This case involved a contract in which a shipbuilding company agreed to build and sell one vessel to each of six buyers.  The buyers agreed to make pre-delivery payments for the vessel in return for refund guarantees from the shipbuilder’s bank.  

The shipbuilder experienced financial difficulties and entered into a debt workout procedure under Korean Law.  The buyers sought reimbursement of the pre-delivery payments from the bank.  The bank refused to pay.  The dispute arose out of the interpretation of two clauses within the contract.  One clause stated that the buyers were entitled to repayment of the pre-delivery instalments upon their rejection of the Vessel, their termination, cancellation or rescission of the contract or upon total loss of the Vessel.  Another clause stated that the bank, as primary obligor, irrevocably and unconditionally undertook to pay all such sums due to the buyers under the contract.

The bank argued that the first clause set out the specific and only circumstances in which they would be obliged to reimburse the buyers and that such clause did not include the current insolvency event.  The buyers argued that the second clause obliged the bank to reimburse them for all sums due to them under the contract.  

Interpreting the proper meaning

The court was tasked with interpreting the proper meaning of the two clauses.   Lord Clarke confirmed that the test of interpretation to be applied, which had been established by a long line of case law, was that:

"The court must consider the language used and ascertain what a reasonable person, that is a reasonable person 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, would have understood the parties to have meant.  In doing so, the court must have regard to all the relevant surrounding circumstances.  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."

Lord Clarke went on to note the judgment of Lord Steyn in Society of Lloyd’s v Robinson (1999) in which he stated that "the reasonable person can safely be assumed to be unimpressed with technical interpretations and undue emphasis on niceties of language".

The court held that the insolvency of the shipbuilder was the very situation for which the security of an advance payment bond was most likely to be needed and therefore found that the most commercial common sense interpretation of the two clauses was that the bank had not limited the circumstances in which is was required to reimburse the buyers and was obliged to refund the pre-delivery instalments.

Summary

By way of summary, Lord Clarke held that if parties intend an improbable result, they must go to extra lengths to make that intention clear.  This does not mean that the courts will look to improve the commerciality of a contract between two parties, or indeed allow a party to renege on a bad bargain, however, where a clause has potentially more than one meaning, the meaning that reflects commercial common sense will prevail.

The meaning of words will always appear obvious to the author, but this case reiterates the importance of ensuring your intentions are clear to an objective third party.  The courts will apply unambiguous language, even where the result seems improbable, however, where ambiguous language is used the courts will strive to attribute it a meaning which accords with business sense.

Parties entering into commercial contracts should seek legal advice on the strength and possible interpretation of their intended clauses before they are concluded to avoid any ambiguity that could lead to decisions which the parties did not intend.  There are many ways to skin a cat, but there should ideally be only one way to interpret your contract!

About the author

Laura Heeley

Solicitor Advocate

Laura specialises in commercial disputes resolution, sports regulatory matters and equestrian disputes.

Laura Heeley

Laura specialises in commercial disputes resolution, sports regulatory matters and equestrian disputes.

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