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How should you interpret a commercial contract?

It may not be a glamorous topic but it can be an important one.

Businesses enter into contracts every day; with suppliers, customers, landlords, sub-contractors and more. Some of those contracts, and how the wording in them is understood, can have significant ramifications for a business. A recent example of this can be found in a decision just issued by the Inner House of the Court of Session in a case:  Ashtead Plant Hire Company Ltd v Granton Central Developments Ltd.

The case concerned a lease at Granton Harbour of a substantial area used by the tenant for storing and hiring heavy machinery required in the construction sector. Some buildings stood on the land when the lease was entered into and others were built afterwards. The lease was for a very long period - 1988 to 2096 – and contained a rent review clause. 

The question for the Court was how should a rent review clause be interpreted? Given the length of the lease, this was a particularly important question for the parties. 

The tenant pointed out that the rent review clause said the value of “any buildings….erected” on the land should be disregarded in assessing the open market value of the leased land.  This meant, said the tenant, that all buildings regardless of when they were built should be ignored when assessing the open market value of the land to assess the appropriate rent.  This would produce a lower rent.  

The landlord disagreed.  It said that despite the reference to “any buildings” in the rent review clause that should be understood as meaning any building erected on the leased land after the start of the lease should be disregarded, but the pre-existing buildings should be taken into account. This would produce a higher rent.

In their decision, the Court took the opportunity to set out the principles to bear in mind when interpreting any commercial contract. The exercise involves assessing what a reasonable person would understand the parties to the contract meant at the time the lease was entered into. In short:  

  • The disputed passages have to be looked at in the context of the contract as a whole.
  • An objective view should be taken. That is, what would a reasonable person in the position of the parties have understood the contract to have meant?
  • What were the fundamental objectives that a reasonable person contracting in the circumstances would have been trying to achieve?
  • Where there is ambiguity, an interpretation which is more in line with commercial common sense should be preferred.

Applying these considerations, the Court held that there was some ambiguity in the reference to “any buildings” in the rent review clause. Other parts of the lease suggested the rent should reflect the state of the land at the outset of the lease, including buildings existing at that time. Applying the principles, the Court concluded that only those buildings constructed after grant of the lease should be disregarded in working out the new rent. The alternative result, the Court said, would not be in line with commercial common sense.

It is worth noting that these principles of interpretation will apply only where there is ambiguity as to what is meant by the words in a contract. If the contract terms are entirely clear and consistent, no question of interpretation should arise. However, as the Court in Ashtead noted “language is inherently ambiguous”.   

The principles are certainly helpful in understanding how contracts should be interpreted but they will not always produce a clear answer. For instance, what is commercial common sense for one person, may not be for another.

Ensuring that contracts are carefully drafted is paramount. But if a dispute arises further down the line it can often be worthwhile paying close attention to the wording of the contract, bearing in mind the principles, to assess the merits of any competing interpretations before deciding on a course of action.

Colin Sandilands, partner

Dispute Resolution & Head of Inverness office 

 

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