Textualism and Contextualism

Working out what an ambiguously drafted clause in a contract means (or what a court is most likely to decide it means) is one of the trickier tasks for us lawyers.  The case law provides guidelines on the principles of contractual interpretation, but they do sometimes seem to conflict.

In Rainy Sky SA v Kookmin Bank in 2011 the Supreme Court took the contextualist approach, looking at the factual context and preferring the interpretation most consistent with business common sense. In Arnold v Britton in 2015 (which I blogged about here) the Supreme Court took the textualist approach, preferring the literal interpretation of the words used even if they gave an unjust result to one party.  So have the courts now "rowed back" from contextualism towards textualism?

Not according to the Supreme Court in the latest case on the principles of contractual interpretation, Wood v Capita Insurance Services Ltd.  According to Lord Hodge, "Textualism and contextualism are not conflicting paradigms in a battle for exclusive occupation of the field of contractual interpretation. Rather, the lawyer and the judge, when interpreting any contract, can use them as tools to ascertain the objective meaning of the language which the parties have chosen to express their agreement."

Which tool you use depends on the contract.  Sophisticated contracts which have been professionally drafted are more likely to be interpreted textually.  But the court recognised that "negotiators of complex formal contracts may often not achieve a logical and coherent text because of, for example, the conflicting aims of the parties, failures of communication, differing drafting practices, or deadlines which require the parties to compromise in order to reach agreement".  (This all sounds familiar from my experience of negotiating deals.)  More informal contracts which have been drafted without professional assistance are more likely to be interpreted contextually (perhaps because they may not make sense if taken out of the context and read literally).

Having made all that clear, the Supreme Court in Wood proceeded to uphold the Court of Appeal's literal interpretation of the contract (overruling the first instance judge's more contextual interpretation), but explained that this also made sense in the context.  The clause in question was an indemnity in a share purchase agreement by which Capita acquired a motor insurance broker specialising in classic cars.  It read (my highlighting):

“The Sellers undertake to pay to the Buyer an amount equal to the amount which would be required to indemnify the Buyer and each member of the Buyer’s Group against all actions, proceedings, losses, claims, damages, costs, charges, expenses and liabilities suffered or incurred, and all fines, compensation or remedial action or payments imposed on or required to be made by the Company following and arising out of claims or complaints registered with the FSA, the Financial Services Ombudsman or any other Authority against the Company, the Sellers or any Relevant Person and which relate to the period prior to the Completion Date pertaining to any mis-selling or suspected mis-selling of any insurance or insurance related product or service.”

Capita claimed £2.4m under the indemnity re the cost of a remediation scheme required by the FSA (now the FCA) to compensate customers for mis-selling, but the problem was that it had not followed and arose out of complaints by customers but from self-reporting by the company in accordance with regulatory requirements.  On textual analysis of this "opaque" provision the Supreme Court held that it did not cover losses which followed or arose otherwise than out of complaints.  Also looking at the context, it noted that there were wider warranties which did cover the loss (but were subject to a 2 year time limit which Capita had, for some reason, missed) and "It is not contrary to business common sense for the parties to agree wide-ranging warranties, which are subject to a time limit, and in addition to agree a further indemnity, which is not subject to any such limit but is triggered only in limited circumstances."

This last comment is very true, but in my experience indemnities usually focus on particular potential liabilities against which the buyer requires specific protection, and are not (or should not be) dependent on whether the liability arises in a particular way.  This looks more like a case of poor drafting to me.  But, as the court pointed out, it is not their function to improve a bad bargain.

All in all this is a helpful case in explaining how to go about interpreting contracts and what are the tools for the job, and it is good to see the Supreme Court showing such understanding of the realities of negotiating and drafting share purchase agreements.

I'm thinking of having a bumper sticker made for my BMW: "No tools of textual or contextual exegesis are left in this vehicle overnight".

The Dangers of Going Ahead Before Agreeing the Contract

Samuel Goldwyn is famously misquoted as having said that a verbal contract isn't worth the paper it's written on, and there’s much truth in the saying.

Surprisingly often, solicitors are engaged to advise on contract terms but, due to commercial pressures or over-eagerness, the parties go ahead with the work before they’ve agreed all the terms, or they agree the terms but then don’t sign the contract.  The courts will usually find that there is a contract where there has been actual performance, but it won’t be a written one, and so the question arises what are its terms?

In the case of Arcadis Consulting (UK) Ltd v AMEC (BSC) Ltd [2016] EWHC 2509 Hyder carried out design works for Buchan, the sub-contractor on two large building projects.  Over 15 years later one of the designs proved to be defective and Buchan claimed £40M of damages from Hyder, who argued that their liability was subject to an agreed cap of £610,515.  The problem was that the parties had never reached agreement on the terms of their contract, but had gone ahead with the work anyway.  There were three competing versions of the terms and conditions, all of which included a cap on Hyder’s liability, but none of which had been agreed.

The judge held that that:

• there was a simple contract between the parties that Hyder would carry out design work and would be paid for that work by Buchan;
• the contract did not include any of the three different sets of proposed terms and conditions; and
• that there was no limitation on Hyder’s liability - despite the fact that every set of proposed terms and conditions included some sort of provision to that effect.

He was critical of Hyder’s unco-operative approach to negotiations and concluded his judgment by saying:

“This case starkly demonstrates the commercial truism that it is usually better for a party to reach a full agreement (which in this case would almost certainly have included some sort of cap on their liability) through a process of negotiation and give-and-take, rather than to delay and then fail to reach any detailed agreement at all.”

Where terms have been agreed but the contract just hasn’t been signed, the court is likely to find that the full unsigned terms apply, so long as the parties have acted consistently with them (at least up to the point the dispute arose).  But where one or both parties have made it clear that they do not agree to a term, the court will not find that they are bound by it just because they have gone ahead with the transaction.  A sneaky negotiator might therefore think there’s scope to dispute the terms you don’t like and to go ahead without signing the contract, on the basis that the remaining terms will apply.  The Arcadis case shows the dangers of this: you could end up with none of the terms applying - including ones in your favour that the other party was prepared to agree.

As a lawyer I always try to achieve certainty for my clients. Unsigned contracts mean uncertainty, with increased risk of a dispute ending up in court, which is always costly even if you win the case at the end of the day.

Why bother with the formalities when you can "Duomatic" it?

I was recently asked to advise on some new Articles of Association a client company proposed to adopt.  When I asked about the Special Resolution of the shareholders to adopt the new Articles, I was told the Directors intended to agree them at their next Board meeting and they thought it was just "a paperwork exercise".  Well it usually is, but I do try to get the paperwork right.  I advised that the necessary resolution should be passed by a 75% majority at a General Meeting convened for the purpose or by circulating a Written Resolution for signature.  However, it turned out that there were only a small number of shareholders, all of whom were on the Board of Directors.  As a recent case illustrates, the "Duomatic principle" would in fact have validated the client’s informal procedure.  So did I really need to bother with the correct, formal advice?

It is a well-established principle of company law that where all shareholders who have a right to attend and vote at a general meeting of the company assent to some matter which a general meeting of the company could carry into effect, that assent is as binding as a resolution in general meeting would be (Re Duomatic Ltd [1969] 2 Ch 365).  There are a number of cases where amendments to the Articles of companies have been held valid in this way, despite a lack of the formalities prescribed by the Companies Act.

The recent case of Randhawa & Ors v Turpin & Anor [2016] EWHC 2156 (Ch) is a good illustration of just how far the Duomatic principle can go.  75% of the shares in the company were held by the sole Director as nominee for his father, who was disqualified from acting as a director, with the remaining 25% being registered in the name of an Isle of Man company which had been dissolved in 1996.  The sole Director had purported to hold a Board meeting at which he had appointed Administrators.  But the Articles provided that a sole director only had power to convene a general meeting or appoint an additional director.  A creditor (which had taken an assignment of the debt owed to the company’s solicitors) challenged the validity of the appointment of the Administrators.  However this was only after they had lost at a previous hearing seeking to challenge the amount of their fees, when they had not taken this point, so the judge was unsympathetic, saying that at best this smacked of abuse of process.

But he decided the case on the Duomatic principle.  From 2009 to the appointment of the Administrators in 2013 both the disqualified father (who was the beneficial owner of 75% of the shares and in reality in control of the company) and the son (who was sole director and registered holder of the 75% shareholding at the time) had acquiesced in the son exercising the full powers of the Board of Directors.  The father had also acquiesced in the appointment of the Administrators, though not actually present at the meeting appointing them.  This was held to be an effective variation of the Articles under the Duomatic principle to allow the sole Director to appoint the Administrators.  The 25% shareholder did not count because it had been dissolved, and so was unable to exercise its voting rights.

The Duomatic principle can be very useful to cure formal defects in procedure where the reality is that all the shareholders whose formal consent was needed had agreed to the matter.  But to go back to my original question, why bother with the formalities then?

The answer is that you do not want to rely on a Court decision to validate things.  It is always best to get it right first time, so there can be no argument about it.  You would need to prove the shareholders all agreed, and the best way to do this is to get them to pass a resolution in the first place.  If they don’t all agree then you will need to pass the resolution by the requisite majority, because Duomatic requires 100% consent or acquiescence (from those who exist and are entitled to vote at least).

Update: on 1 August 2017 the Court of Appeal allowed an appeal against the decision of the High Court in Randhawa v Turpin, disagreeing that the dissolved 25% shareholder could be ignored.  It remained a member of the company (despite not existing) and could not have given its informal consent when it did not exist.  Which supports my original point, that it is best to get the formalities right in the first place.

Warranties and Representations

It is common in share purchase agreements for the warranty clause (the first draft of which is prepared by the Buyer's solicitors) to use wording such as "The Sellers warrant, represent and undertake that…"  Whilst this may just be a case of lawyers preferring to use three words when one will do, there is often more to the use of such language than meets the eye.

A warranty is a contractual promise that something is so; e.g. that the Company does not have any liability in respect of a particular matter.  If that turns out not to have been so, the Buyer has a claim for breach of contract.  Such claims are subject to carefully-negotiated limitations of the Buyer’s liability under the share purchase agreement; typically a cap of the amount of purchase price received, a minimum threshold for claims, and a time limit for bringing claims of 1 to 3 years (or 6 or 7 years where tax is involved).

A representation is a statement of fact that induces a party to enter into a contract.  If it turns out to have been untrue, the other party may claim damages for misrepresentation.  This is a claim in tort (a legal wrong), not a claim for breach of contract, and the damages are calculated differently.  The limitations of liability in the share purchase agreement are not usually drafted to cover liability for misrepresentation.  This is why buyers’ solicitors try to include the language of representation, and sellers’ solicitors seek to delete it.  Such deletions are usually accepted without serious argument - though private equity investors' solicitors may take a tougher line, and be in a stronger negotiating position.

An undertaking is a contractual promise to do something (or not to do it).  This is completely inappropriate language for the warranties in a share purchase agreement, and is either bad drafting or a cunning attempt to hide the word "represent” amongst some apparent bad drafting.

Acting for the Seller, one therefore always seeks to avoid the language of representation, and to include the usual boilerplate "entire agreement" clause to the effect that this is the entire agreement between the parties, it supersedes all prior negotiations, and the Buyer acknowledges it is not relying on any previous representations.  This language is intended to exclude liability for misrepresentation, and with an express exception for liability for fraudulent misrepresentation is generally considered to be reasonable if negotiated at arms’ length between commercial parties with the benefit of legal advice (This is important because under the Misrepresentation Act 1967 liability for misrepresentation can only legally be excluded to the extent the exclusion is reasonable.)

In the case of Idemitsu Kosan Co Ltd v Sumitomo Corporation [2016] EWHC 1909 (Comm) (27 July 2016), Idemitsu were out of time for bringing a contractual claim for breach of warranty under a share purchase agreement (the agreed 18 month time limit for non-tax warranty claims having expired without a claim having been made), so they sought to get round this by bringing a claim for misrepresentation under s.2(1) of the Misrepresentation Act 1967.  Sumitomo responded with an application under CPR Part 24 for summary judgment dismissing that claim, on the basis that it had no real prospect of success and there was no other compelling reason why it should be disposed of at a trial.

Such cases always depend on the wording of the agreement, and Idemitsu were in some difficulty there, as the relevant clauses only used the language of warranties.  The word "representation" only appeared in the entire agreement clause, apparently intended to exclude them.  However there were conflicting previous cases on the point: in one Arnold J. had decided that warranties could of themselves amount to representations, and in another Mann J. had decided that they could not.  Both are eminent judges.  Idemitsu’s Counsel also ran a clever argument that by putting forward the agreement with the warranties for execution, Sumitomo had made representations inducing Idemitsu to enter into the agreement.  The target Company had interests in North Sea oil and gas fields, had been sold for US$575M, and Idemitsu was seeking to recover a claimed loss of US$105.9M (as against a contractual cap on warranty claims of US$1,5M) relating to liability for sharing the operating expenses of a floating production storage and offshore loading vessel.  So it must have seemed worth a try.

Andrew Baker QC sitting as a judge of the High Court was unconvinced by Idemitsu’s Counsel’s arguments, and preferred the reasoning of Mann J. from the previous cases.  He held that a warranty is (without further language) a contractual promise: nothing less, but nothing more.  He upheld the entire agreement clause as effective to exclude misrepresentations, of which there were none.  He therefore gave judgment for the defendant.

The case is welcome confirmation that my deletions of representation wording when acting for sellers were not in vain, and should be of comfort to sellers that their limitations on liability do mean what they thought they did.  However, given the amount at stake and the conflicting first-instance decisions, it may still go to the Court of Appeal.

Can discrimination claims be an abuse of rights?

In the case of Nils-Johannes Kratzer v R+V Allgemeine Versicherung AG the Court of Justice of the European Union had to decide whether a person who was clearly not seeking employment, but merely the status of applicant in order to bring claims for compensation, was qualified to bring such claims under the EU Directives on age and sex discrimination.  Was this an abuse of rights under EU law?’

In March 2009 R+V advertised trainee positions for graduates in the fields of economics, mathematical economics, business informatics and law.  Mr Kratzer applied for a legal trainee position, emphasising that he fulfilled all the requirements in the advertisement and his experience as a lawyer and former manager with an insurance company.  When his application was rejected, Mr Kratzer responded with a written complaint demanding compensation of EUR 14,000 for age discrimination.

R+V invited Mr Kratzer to an interview with its head of HR, stating that the rejection of his application had been automatically generated and was not in line with its intentions.  But Mr Kratzer declined the invitation and suggested a discussion of his future with R+V once his compensation claim had been satisfied.

He then brought an action for the EUR 14,000 for age discrimination before the Wiesbaden Labour Court in Germany, and on finding out that R+V had awarded the four trainee posts to women only, although the 60+ applicants were divided almost equally between men and women, he increased his claim by EUR 3,500 for sex discrimination.

The Wiesbaden Labour Court dismissed the action, and the Hesse Regional Labour Court dismissed his appeal.  He appealed again to the German Federal Labour Court, which referred the above questions to the CJEU for a ruling.  The CJEU delivered its judgment on 28 July 2016 - over 7 years after the dispute first arose.

Unsurprisingly, the CJEU gave Mr Kratzer’s claims short shrift.  Dispensing with the usual Advocate General’s Opinion and looking at the underlying purpose of the Directives to ensure equal treatment of persons seeking employment, they held that “a situation in which a person who in making an application for a post does not seek to obtain that post but seeks only the formal status of applicant with the sole purpose of seeking compensation does not fall within the definition of ‘access to employment, to self-employment or to occupation’, within the meaning of those provisions, and may, if the requisite conditions under EU law are met, be considered to be an abuse of rights”.  They left the decision on costs of the case to the referring court, which one suspects is unlikely to rule in favour of Mr Kratzer if he has been abusing his rights.

Courts are never going to be sympathetic to claimants who are merely seeking compensation without having suffered a genuine loss.  Mr Kratzer’s mistake would appear to have been making payment of the compensation a precondition to the job interview.  If he was genuinely interested in the job, he should have reserved his rights and gone ahead with the application.  R+V would then have had the opportunity (if well-advised) to carry out a scrupulously fair and documented selection process for all the applicants, which could have been used in defence of his claim if he was ultimately rejected.

The case is of some comfort to companies who receive speculative discrimination claims for job applicants - though they would do well to note R+V’s careful initial response.

No Snoopers' Charter for Employers

The case of Barbulescu v Romania, in which the European Court of Human Rights gave judgment on 12 January 2016, was widely claimed in the press to have given the green light to employers to monitor their employees' emails for personal use.  It is true that the employer's monitoring of the employee's emails was upheld by the ECHR in that case, but the facts were somewhat unusual and the actual decision was more nuanced.

Mr Barbelescu worked for a company in Bucharest as an engineer in charge of sales.  His employer asked him to create a Yahoo Messenger account for responding to clients' enquiries.  The company had a policy that "It is strictly forbidden to disturb order and discipline within the company’s premises and especially ... to use computers, photocopiers, telephones, telex and fax machines for personal purposes."  When the employer informed Mr Barbulescu that it had monitored his Yahoo Messenger communications over the course of a week and that it considered he had used the account for personal purposes in contravention of this policy, he replied in writing that he had only used it for professional purposes. The employer responded with a 45 page transcript of his Messenger communications for that week, including messages with his brother and his fiancee that contained intimate personal information about his health and sex life. The employer disciplined Mr Barbulescu and dismissed him for unauthorised personal use of the internet.

The ECHR held by a majority that Mr Barbelescu's right to privacy for his correspondence under Article 8 had been engaged, but that the interference had been proportionate within the State's margin of appreciation.  Previous cases that had gone the other way were distinguished on the basis that in those cases the employer had tolerated some personal use of the internet.  The Romanian courts in this case had considered it important  that the employer accessed the Yahoo Messenger account in the belief that it contained only professional communications (as the employee had claimed). It was not unreasonable for an employer to want to verify that employees are working during working hours.  The monitoring was limited in scope and therefore proportionate.

Whilst the Barbeslescu case is an example of an employer's monitoring of an employee's emails being upheld, it actually held that the right to privacy applies, and the monitoring was only justified on the basis of the strict policy forbidding personal use and the employee's specific denial of any breach of that policy.  Most employers in the UK do allow some personal use of work computers and telephones, and in such cases a clear policy that they will be monitored to check there is no abuse needs to be clearly communicated to employees and any such monitoring needs to be proportionate.

The Information Commissioner's Employment Practices Code provides some useful guidance to employers on monitoring communications in Part 3.

No safe harbour in the US

As has been widely reported, on 6 October 2015 the Court of Justice of the European Union gave judgment in the case of Maximillian Schrems v the Data Protection Commissioner for Ireland, holding that the European Commission Decision creating the "safe harbour" for the transfer of personal data from the EU to the US was invalid.

European data protection law prohibits the transfer of personal law outside the EU except to a country which "ensures an adequate level of protection" for personal data or where certain exceptions apply - for example where the data subject has given "unambiguous consent" to the transfer, or where "binding corporate rules" have been agreed to provide a contractual means of protection.  There is a very limited list of countries which have been found by the EU to ensure an adequate level of protection.  But, crucially, by Commission Decision 2000/520/EC of 26 July 2000 it included the EU/US "safe harbour" agreement, with which US companies could self-certify their compliance.  The US safe harbour was of vital importance to the large number of international businesses which transfer customer data to their US operations, and with the growing importance of the Cloud even companies with no US operations are increasingly storing data on servers which are physically located in the US - and have therefore been relying on their Cloud service providers' confirmation that they are signed up to the safe harbour.  (Or at least they should have been relying on it if they had properly addressed their minds to the issue.)

All this was thrown into doubt when Edward Snowden revealed that the US intelligence agencies, and in particular the NSA, carried out widespread and indiscriminate surveillance of data stored by US companies.  We now know that US companies have to give access to their data to the NSA, and so are unable to guarantee the necessary adequate level of protection for their personal data to persons in the EU, as the surveillance is carried out on an indiscriminate basis, rather than a proportionate basis where necessary for national security purposes - such as to combat terrorism.

Mr Schrems (who is an Austrian citizen) therefore brought a case requiring the Irish Data Protection Commissioner to prohibit Facebook Ireland (which held his personal data on Facebook) from transferring that data to servers operated by Facebook Inc in the US for processing.  The Irish High Court considered it was bound by Commission Decision 2000/520/EC on the safe harbour, but had its doubts as to the validity of the decision in the light of the Snowden revelations, so referred to the CJEU the question whether it was bound to follow the safe harbour Decision.

The CJEU held that it was not, and that national data protection authorities are not prevented by Commission Decisions from carrying out their own assessment.  However, the Court went on to take the opportunity to hold (despite not having been expressly asked to do so by the Irish court) that Decision 2000/520/EC is invalid - particularly in the light of subsequent revelations.

So where does this leave the many companies that have been relying on the safe harbour to transfer customer data to their US operations, or just to store it in the Cloud?  They cannot just wait and see what happens when the case goes back to the Irish court to decide in the light of the CJEU's guidance, as the CJEU has already held the safe harbour invalid.  Nor can they wait for the EU and US to conclude their current negotiations for an amended safe harbour, as that will take some time and they need to continue transferring personal data.  Binding corporate rules or standard contractual clauses in the form approved by the EU should be an option, but it is difficult to see how a US company could comply with any contractual data protection obligations it might undertake, given it would be bound to give the NSA access to its data.  There is a limited exception where "the transfer is necessary for the performance of a contract between the data subject and the controller", which might arguably be used to perform existing contracts with customers.  But for the moment, the only viable option seems to be to obtain the unambiguous consent of customers to transferring their data to the US by an express opt-in, warning them of the risk of surveillance by the NSA (in case anybody isn't already aware of this, or doesn't appreciate that it could happen in this case).  Realistically this would involve stopping providing the service to the customer unless they click to confirm their opt-in to a clear warning message.

The alternative is to find a non-US Cloud service provider with servers in the EU or a country which is still considered to offer adequate protection; the list being Andorra, Argentina, Canada, Faeroe Islands, Guernsey, Israel, Isle of Man, Jersey, New Zealand, Switzerland and Uruguay.