Court of Appeal refuses to depart from "natural and ordinary" meaning of commercial indemnity clause
26 February 2020
The Court of Appeal has considered the construction of an indemnity clause in a trust deed holding that the words used should be given their natural and ordinary meaning. The case highlights the importance of clear and careful drafting as the courts will not readily rescue parties from the effects of the words used even where this means an unexpected advantage for a party.
This case highlights the importance of clear and unambiguous drafting in commercial contracts. Where there is no evidence of an error and the words make commercial sense, it will be difficult to displace the ordinary and natural meaning of the words. This is the case even where the outcome may seem unfair or where it appears that a party may be acting opportunistically.
The case is also a reminder that the court will look at: the words themselves; the contract as a whole; and the wider documentary, factual and commercial context to give the words their ordinary and natural meaning.
Additionally, indemnity clauses should be drafted carefully to ensure they cover what is needed and intended. If it is intended that the indemnity will cover liabilities of third parties, this should be made explicit.
The dispute in First National Trustco & another v McQuitty& Ors  EWCA Civ 107 related to payment of Spanish taxes (Euro 2.7m) in relation to timeshare apartments. The timeshare apartments were held in a club structure under which the legal ownership of the individual apartments had vested in an owning company, namely Bahia Blanca Club B Limited (“BBCB”). BBCB was wholly owned by an independent trustee, First National Trustco (“FNTC”), a professional trustee operating in the timeshare leisure business, which held and controlled the company in trust for the benefit of the timeshare owners. The timeshare owners were members of the Bahia Blanca Holding Club (“the Club”) and subject to the Constitution of the Club.
BBCB, as the legal owner of the apartments, incurred various tax liabilities in Spain. BBCB and FNTC sought to rely on an indemnity clause contained in a Deed of Trust under which FNTC would be indemnified by the Club for expenses incurred by it in connection with the timeshare properties.
At first instance, the claim was dismissed on a number of grounds. The only ground subject to appeal concerned the construction of the indemnity clause which read:
“…the Trustee [FNTC] shall be kept fully indemnified by the Club and the Founder Member against all losses, claims, demands, expenses and other liabilities made or incurred in connection with the Trust Property or in any other way in connection with the holding by the Trustee of the office of custodian trustee hereunder...”
At first instance, the Judge held that the clear words and a literal reading of the indemnity clause, meant there was no scope for FNTC to recover BBCB’s liability for taxes from the Club as the liability was not one that FNTC had incurred itself.
The Court of Appeal
On appeal FNTC and BBCB submitted that the indemnity could and should be read in a way that meant that the members of the Club were liable to pay the taxes or, alternatively, to put in funds to discharge BBCB’s obligation to the pay the taxes. It was submitted that construing the words literally produced a commercially absurd outcome which rendered the timeshare scheme unworkable. This was because it meant that the Club members could choose whether (or not) to pay outgoings incurred by BBCB as the legal owner meanwhile BBCB itself, as a company without other assets, had no means of paying these liabilities.
The Club members submitted that the indemnity was clear and it did not extend to liabilities that had not been incurred by FNTC. In the face of such clear and unambiguous language, there was no scope for departing from the words of the clause.
The Court of Appeal confirmed that the principles to be applied when construing a commercial contract are no different in the case of a deed of trust. Further, in general, the principles are familiar in that the aim is to identify the intention of the parties to the agreement and ascertain the objective meaning of the language that the parties have chosen.
The Court unanimously dismissed the appeal. The indemnity was an indemnity given to FNTC in respect of liabilities arising in connection with the Trust Property or by holding the office of trustee. It had nothing to do with BBCB and could not sensibly be construed to extend to it. The fact that the Club members acted as if they might be responsible for the Spanish taxes to the extent that they saved for them and persistently appealed against them made no difference. The Court of Appeal stated it was not concerned with whether the Club members’ actions “might be regarded as opportunistic, but rather with their legal obligations under the agreement setting up the timeshare scheme”.
Aside from looking at the wording of the indemnity, the Court held that the same conclusion is reached by considering the context of all the documents and provisions in the timeshare agreement. No provisions stretched beyond considering the powers and protections of FNTC.
The Court then considered the factual and commercial context taking into account that members of the Club had to be aware of their potential liabilities. If the intention was for members to be liable for general taxation by way of an indemnity (in an unspecified or even unlimited way), it would have been positively necessary to say so in the agreement.
The Court disagreed with the submission of FNTC and BBCB that the literal construction of the indemnity led to a commercial absurdity or an unworkable arrangement. Although the arrangement that members can pay what they want by way of taxes may not be the clearest or tidiest arrangement, it had worked throughout the lifespan of the timeshare until the dispute arose and did not amount to a commercial absurdity.