Court’s approach on interpreting contracts

by Josh Makin

In Wood v Capita Insurance Services Limited, the Supreme Court has shed some much-needed light on the law surrounding contractual interpretation and in particular, the contrasting arguments behind allowing a clause to be interpreted widely to reflect the wider intentions of the parties and enforcing the terms which had been agreed between the parties before a dispute arisen.

To summarise the case, Capita entered into a share purchase agreement with three directors to purchase the entire share capital of the company, which sold insurance products. Shortly after Capita took over ownership of the company, employees raised concerns about the company’s sales process before Capita’s ownership. Capita subsequently found out that the company had misled customers as to the reasons why their initial quotations had increased. This meant that Capita and the company were required to not only notify the Financial Services Authority of the mis-selling of the insurance products, but they also had to pay compensation to those customers affected.

As is usual with most share purchases, indemnities had been agreed whereby the directors had agreed to indemnify Capita for certain losses. In particular, one clause stated how 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…”. Capita sued the previous directors of the company under this indemnity as they had suffered loss in the form of compensation they had paid out to customers. The directors disputed this claim on the basis that the compensation had not resulted from a claim by the company’s customers to the company or to the FSA and as a result, the above indemnity had not been triggered.

In giving its judgment, the Supreme Court found in favour of the directors and voiced how it would not have been common sense, as argued by Capita, for the directors to agree to an indemnity which was wider than that contained in the share purchase agreement. The Supreme Court held that interpreting contracts based on either their text or their context should not be contrasting principles and instead, these principles should be used as tools to allow the court to determine the objective meaning of the contract when considering also the facts of any given case.

Although there is still some uncertainty as to the approach the courts will take when interpreting contracts, this case is a useful reminder that parties should tread carefully when drafting an agreement and as the Supreme Court concluded when giving its judgment in Capita, “it is not the function of the court to improve their [Capita’s] bargain”.