Mistakes in contracts – How to assess the parties’ intentions?

Claims for rectification

To bring a claim for rectification you would usually have to show that:

• the parties had a common intention, whether or not amounting to an agreement, in respect of a particular matter in the contractual instrument;
• there was an outward expression of accord (i.e. communications between the parties which evidence the intention);
• the intention continued at the time of the execution of the instrument; and
• by mistake the instrument did not reflect the common intention. This involves proving two points:
  • the disparity between the instrument and the intention; and
  • as a matter of fact, each party made a mistake about that disparity.

The test for “intention”

In recent years there has been much debate as to how the courts should consider the intentions of the parties.

Until relatively recently, the courts would apply a subjective test when considering the parties’ intention where it is claimed there has been a common mistake – so the parties would have to give evidence as to what was actually in their minds when they agreed to enter into the contract

However, in the case of Chartbrook Ltd v Persimmon Homes Ltd [2009] UKHL 38 Lord Hoffman expressed his opinion (although not strictly relevant to that particular case and therefore not binding) that the test for assessing the parties’ intentions should be an objective one, in line with the test for interpreting a contract. This means that you would consider what a hypothetical independent observer would understand the parties’ intentions to be. Since that decision there has been certain disquiet expressed by legal academics and the judiciary that this is not the correct approach, although the objective test approach was followed in the case of Daventry District Council v Daventry and District Housing Ltd [2011] EWCA Civ 1153.

However, finally this summer the Court of Appeal had an opportunity to review the legal position in the case of FSHC Group Holding Ltd v Glas Trust Corporation Ltd [2019] EWCA Civ 1361. Lord Justice Leggatt gave the lead judgment (with which the other judges agreed).

The facts in FSHC

The dispute concerned the rectification of two deeds made in 2016. The deeds were prepared and executed in order to provide security which the claimant had previously agreed to provide in connection with an earlier corporate acquisition. This had been a complex corporate investment, but unfortunately an omission was made in the original deal and some of the security required had not been entered into owing to an oversight.

When this omission was spotted four years later the parties’ lawyers proposed that new deeds be executed which would accede to two pre-existing agreements. What the parties failed to realise was that these pre-existing agreements contained additional obligations and by entering into the new deeds the security provided would create additional obligations. Both parties failed to notice the mistake when the new deeds were executed.

It was held at first instance by Carr J that both parties understood and intended the deeds to do no more than provide the missing security. There was clearly a common mistake. He said that the mistake was unintended whether construed objectively or subjectively – so it did not matter which test applied.

The Defendant appealed on the basis that the test which should have been applied when assessing the parties’ intentions was the objective one and, if that was correct, the result would be that an impartial observer would conclude that the additional obligations would bind the Claimant.

The Court of Appeal considered the legal position.

The Decision

The Court of Appeal took the opportunity to review legal authorities going back centuries as well as academic articles on the subject. It distinguished between two particular situations where rectification could be granted and held that the test for intention depended on which situation applied.

The first situation is where the parties entered into one or more agreements before the particular contract that the claimant is seeking to rectify and the terms of the earlier agreements were not reflected in the later one (but should have been). In this situation, the test has to be objective one. The remedy is akin to an order for specific performance as what the court is attempting to do is understand the parties’ intentions as expressed in the prior agreement(s). As contracts are interpreted objectively, the court will look at the meaning of the wording of the prior agreement(s), but will not consider the subjective evidence of the parties.

The second situation is where the parties have not made a contract prior to the document that the claimant is seeking to rectify, but had a common, continuing intention in respect of a particular matter not reflected in the document which was executed. In this situation, there is no first agreement to consider so the subjective intention of the parties is what is important. In addition the Court of Appeal also stated that there had to be an “outward expression of accord by the parties” (whether explicitly or tacitly) and proving the subjective intention alone would not be sufficient.

Applying this principle to the facts, the Court of Appeal held that it was the second situation scenario that arose in FSHC. The Judge upheld the first instance decision on the basis there clearly had been a common mistake between the parties which should be considered on a subjective basis. The Order for rectification was upheld as it could be easily seen from the evidence that there was clearly an outward expression of accord.

Comment

To apply an objective test in FSHC’s situation, where there was no formal prior agreement, would have delivered an unfair result in the circumstances. The test put forward by Lord Hoffman for common mistake in respect of the second situation is therefore incorrect. The Court of Appeal’s judgment provides welcome clarification of the test to be applied to rectifying contracts on grounds of common mistake. The test itself is not an easy one and the courts are likely to grant applications for rectification sparingly. It goes without saying that parties should always check any written agreement reflects their intentions before its execution which should include (where appropriate) checking all surrounding documents as well.