Blackletter Law – Interpretation of
Contracts using practical examples
James Baily
Partner
Herbert Smith Freehills LLP
THE INTERPRETATION OF CONTRACTS
OIL & GAS UK LEGAL CONFERENCE
THURSDAY, 24 SEPTEMBER 2015
James Baily, Partner, +44 20 7466 2122, james.baily@hsf.com
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
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