Interpretation of commercial contracts: Macintyre House Ltd v Maritsan Developments Ltd

This Outer House case ([2011] CSOH 45)provided Lord Hodge with the opportunity to summarise the rules of interpretation of commercial contracts in Scots law.

The agreement between the parties was governed by Clause 2 of the contract, as follows:
"2.1 MHL or Maritsan shall identify Development Projects which they shall make available to Maritsan.
2.2 Maritsan undertakes that it shall use all of its reasonable endeavours to ensure that such permissions and consents as shall be required to sell on each Development Project to property developers and builders at the best price are obtained.
2.3 MHL shall provide consultancy services as reasonably required by Maritsan and such services shall in particular relate to the planning process generally. MHL shall make such services available to Maritsan in relation to Development Projects which they introduce."

The mechanism for payment by Maritsan to MHL was contained in Clause 3:
"3.1 Maritsan agrees that it shall remit a sum which is equal to one half of the Net Profits for and in respect of each Development Project to MHL within five working days of the settlement of the Sale. …"

Both parties had instructed the same firm to draft the agreement as a joint venture agreement.  The firm produced a different kind of agreement, and ceased to act on behalf of Maritsan, advising it to obtain independent legal advice.  From this point onwards, although the director of Maritsan continued to revise the agreement that had been produced, he did so without the benefit of legal advice.  The parties had entered into a prior agreement concerning land at Braidwood.  At that time, they had operated as a joint venture.  This being the case, no VAT was payable on MHL’s share of the profits.  Despite the fact that both parties had initially instructed the preparation of a joint venture agreement, the finally agreed document specified that the parties did not intend to enter into a partnership (in clause 7).

The dispute related to the terms of the agreement in relation to the payment of VAT.  This was dealt with in clause 4 of the agreement:
"All sums of money payable under this Agreement are, save where the context otherwise requires, expressed exclusive of Value Added Tax but if Value Added Tax shall be due on any payment due this shall be paid provided a valid Value Added Tax invoice in respect of such payment has been issued. Any taxes to be borne in respect of sums received by the parties to this Agreement shall be borne by the recipient which shall indemnify the other party in respect of any such liability."

Section 19 of the Value Added Tax Act 1994 is also relevant to this discussion.  It provides that a sum of money payable under a contract for a supply of goods or services is inclusive of any VAT on it.  Counsel for the defender referred to both Hostgilt Ltd v Megahart Ltd [1999] STC 141 and Wynn Realisations Ltd (in administration) v Vogue Holdings Inc. [1999] STC 524 as authorities illustrative of this point.

Parties’ submissions
Counsel for MHL argued that the meaning of the agreement was clear.  Clause 3 required Maritsan to remit a sum to MHL Ltd equal to one half of the "Net Profits" and clause 4 obliged Martisan to pay the VAT on that sum. 

Counsel for Maritsan argued that, in the event that his plea for rectification of the contract to provide it with a commercially sensible construction was unsuccessful, clause 3.1 should be interpreted in one or other of two ways which he put forward.  The first was that the sum to be given by Maritsan to MHL was inclusive of VAT.  Maritsan would receive one half of the net proceeds, give one half to MHL, and MHL would be bound to pay VAT out of its half.  The alternative submission was that clause 3.1 should be interpreted so that, after payment of VAT, each of the parties should end up with the same amount of net profit in their hands.

Perhaps not surprisingly, given that one party was not legally represented in the negotiations, Lord Hodge commented (para [29]):
“The contract is not easy to interpret and one is left with the feeling that the parties have given insufficient thought to the expression of their intentions.”

On the rules of interpretation of commercial contracts in Scots law Lord Hodge stated (at para [26]):
“There was no dispute between the parties as to the correct approach to the interpretation of commercial contracts and the exclusion of pre-contractual negotiations as an aid to construction. I was referred to Investors Compensation Scheme Ltd v West Bromwich Building Society [1998] 1 WLR 896, Lord Hoffmann at p.912 and Chartbrook Ltd v Persimmon Homes Ltd [2009] 1 AC 1101.”

In relation to the prior agreement concerning the land at Braidwood, Lord Hodge classed this as a pre-contractual negotiation, and as such the court could not consider its terms in order to interpret the contract before them (para [27]).   

On the applicable rules of interpretation, Lord Hodge stated (para [28]):
“There is no need to reiterate in any detail the principles which govern the interpretation of commercial contracts which judges of this court have summarised in various cases since the decision of the House of Lords in Investors Compensation Scheme Ltd (above). In this case the significant rules are that the court should (i) construe individual provisions of the contract in the context of the whole contract, (ii) apply an objective construction by reference to the meaning which a reasonable third party, who is aware of the commercial context in which the contract occurs, would give to the words which the parties have used, and (iii) adopt a commercially sensible construction, when the court is faced with competing interpretations. Further, the court cannot re-make the contract for the parties on what it considers would be sensible terms or disregard contractual terms. Where parties have included a provision in their contract, the court should strive to give a proper meaning to it: see, for example, Wynn Realisations Ltd (above) Morritt LJ and Clarke LJ at p.529b-e and h-j respectively.”

On clause 4, the clause which governed VAT Lord Hodge commented (para [31]):
“I am left with the clear impression that clause 4 has been lifted from another contract and inserted into this agreement in a context in which nobody has applied his mind to what the effect of VAT would be. I am not persuaded that the ordinary expectation that parties to a formal document have chosen their words with care is met in this case. But the court cannot reframe a formal contract, even if it is not skilfully drafted. As I have said, I have to consider what a reasonable businessman standing in the shoes of parties would have understood the parties to have meant by the words which they have used in the context of the contract as a whole and having regard to the relevant commercial background.”

In response to MHL’s argument Lord Hodge stated (para 34]):
“It makes no business sense that the parties should have agreed such an arrangement. While it is always necessary in construing a contract to bear in mind the possibility that one party has made a bad bargain, I am satisfied that the context, of which clause 4 speaks, qualifies the general rule in that clause, as set out below. Thus applying the ill-thought-out clause 4 results in a rejection of the pursuer's construction.”

In response to Maritsan’s argument Lord Hodge stated (para [33]):
“That may not be quite as unlikely an intention as the pursuers' position. But it makes little business sense in the context of the contract as a whole which sought the equitable deduction of costs, including irrecoverable VAT on the development costs.”

Lord Hodge’s approach can be understood from the following quote (para [36]):
“…I construe clause 3.1 in the context of the agreement as a whole as requiring the parties to share the actual net profits equally and the VAT charge on MHL's services to be calculated accordingly. I thus give effect to the rule in clause 4 but qualify it, rather than exclude it, to reflect the intention of the parties which I derive from the agreement as a whole.”

Finally Lord Hodge set out his calculation of the effect of the agreement (in para [37]).  First of all the net profits were calculated.  Then, one had to acknowledge that VAT was due on the sum payable to MHL as its share of the agreement.  It was necessary to allocate equally between the parties the burden of the VAT in order finally to arrive at the share of net profits payable to each party.
The result was that MHL was entitled to further sums from Maritsan in terms of the contract.  The challenge to the relevancy of the submissions made on behalf of Maritsan failed.  Maritsan was held entitled to a proof before answer on its counterclaim. The case was put out by order to determine further procedure.

Lord Hodge’s judgment is useful for those seeking a brief statement of the governing principles of interpretation of commercial contracts in Scots law.  Beyond that, it suggests that parties should be slow to seize upon an interpretation favourable to them, which has arisen fortuitously as a result of ambiguous drafting.  Such attempts are unlikely to succeed given that the courts, construing the contract as a whole, seek to identify a “commercially sensible” construction. 

The case is an interesting illustration of the difficulties arising where one of the parties has not been represented by a solicitor.  Clearly the parties had contracted in the past and had adopted the format of a joint venture.  VAT was not therefore payable on profit shares on that occasion.  In the transaction which was the subject of this new dispute, the parties had rejected the form of a joint venture, but did either of them realise that decision resulted in a payment to VAT?  Certainly, the party lacking representation seems not to have realised these consequences.  In such circumstances, few of us would be persuaded that the unrepresented party should benefit from more favourable interpretative rules. Nevertheless, given that the eventual contract is likely to be difficult to interpret, it potentially presents a more pressing case for the operation of the “commercially sensible” construction, looking both to the terms of the contract as a whole and the overall transaction contemplated by the parties.