Business Common Sense and the Interpretation of Commercial Contracts

What role does business common sense play in the interpretation of commercial contracts? This issue was recently addressed by the Supreme Court of the United Kingdom in Rainy Sky S.A. v. Kookmin Bank. The answer: “where a term of a contract is open to more than one interpretation, it is generally appropriate to adopt the interpretation which is most consistent with business common sense”. Since there is currently some uncertainty in Canada on the point, Rainy Sky is an important case to consider.

Decision

At issue was the proper interpretation of a performance bond that had been issued in support of a contract to construct a ship. The shipbuilder had defaulted on the contract by entering into insolvency proceedings. The ship buyers called on the performance bond. The bank that had issued the bond refused to pay, arguing that insolvency of the shipbuilder was not a risk covered by the bond. The operative sentence of the bond was an undertaking to pay “all such sums due to you under the [shipbuilding contract]”. The bank argued that the phrase “such sums” referred to certain specifically enumerated payments, which did not include amounts due upon an insolvency. The ship buyers argued that the phrase applied to all sums owing to them under the shipbuilding contract, including those triggered by the shipbuilder’s insolvency.

The bank’s argument failed at first instance, with a judge of the Commercial Court in London holding that it made no commercial sense for the parties to exclude from coverage the very event for which coverage was most needed, namely the shipbuilder’s insolvency.

The English Court of Appeal reversed, in a split decision that squarely raised the issue to be decided by the Supreme Court. The majority held that commercial sense was not to be considered in interpreting a contract unless “the most natural meaning of the words produces a result which is so extreme as to suggest that it was unintended”. Without such an approach, reasoned the majority, there would be too much risk of the court imposing a contract on the parties rather than simply applying what they had agreed. The dissenter would have imposed a much lower threshold, applying business common sense whenever the text of the contract is susceptible of more than one meaning.

Significance

In a unanimous decision, the Supreme Court reversed again and restored the decision at first instance. Calling contractual interpretation “essentially one unitary exercise” and “an iterative process, involving checking each of the rival meanings against other provisions of the document and investigating its commercial consequences”, the Supreme Court favoured the dissenting view in the Court of Appeal. Noting that no credible commercial reason had been advanced for excluding insolvency from the scope of the bond’s coverage, the Supreme Court found that the text of the bond supported both competing interpretations, and preferred the buyers’ interpretation as more consistent with the commercial purpose of the bond.

Rainy Sky is important in Canada because the question of the role of commercial sense in contractual interpretation is a live one, with the Ontario Court of Appeal having sent mixed messages over whether contractual ambiguity is a precondition to the consideration of sound commercial principles (the apparent approach in Ventas, Inc. v. Sunrise REIT, at para. 24) or not (Scanlon v. Castlepoint Development Corporation (1992), 11 O.R. (3d) 744 (C.A.) at 770, Kentucky Fried Chicken v. Scott’s Food Services Inc. at para. 27 and Schneeberg v. Talon International Development Inc.). When the time comes for the Ontario Court of Appeal to clarify this conflicting case law – and it will – Rainy Sky will be an important authority for it to consider.

Case Information

Rainy Sky S.A. v. Kookmin Bank, [2011] UKSC 50

Judgment Date: November 2, 2011

commercial sense contractural interpretation insolvency of shipbuilder interpretation of performance bond United Kingdom Supreme Court

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