The Interpretation of Contracts – Again

April 20, 2020

By Simon Whitfield

Teeside Gas Transportation Ltd v CATS North Sea Ltd & Ors. [2020] EWCA Civ 503

Appellate courts often say that they hope their decision will be the final word on a particular legal issue.  This hope however, is often in vain.

One might have thought that the line of authorities concerning the interpretation of contracts, from ICS v West Bromwich BS in 1998, Rainy Sky in 2011, Arnold v Britton in 2015 to Wood v Capita in 2017 had settled the question of the proper approach to contractual interpretation. In Wood v Capita, Lord Hodge said;

“I do not accept the proposition that Arnold involved a recalibration of the approach summarised in Rainy Sky. Once one has read the language in dispute and the relevant parts of the contract to provide its context, it does not matter whether the more detailed analysis commences with the factual background and the implications of rival constructions or a close examination of the relevant language in the contract, so long as the court balances the indications given by each…  Some agreements may be successfully interpreted principally by textual analysis because they have been negotiated and prepared with the assistance of skilled professionals. The correct interpretation of other contracts may be achieved by a greater emphasis on the factual matrix, for example because of the informality, brevity and the absence of skilled professional assistance.”

Complex commercial agreements may nevertheless often fail to achieve clarity because of conflicting commercial aims, deadlines, compromises etc.

Despite the detailed guidance that the courts have given over the years, disputes concerning the meaning of provisions still find their way to the Court of Appeal, perhaps not surprisingly when as here, some £37m was at stake.  On the 7th of April 2020 the Court of Appeal once again examined the principles underlying contractual interpretation in Teeside Gas Transportation Ltd V CATS North Sea limited & Ors.

The Central Area Transmission System (CATS) is a gas pipeline transmission system which transports natural gas from fields in the North Sea to an onshore processing terminal in Teeside.

In 1990 Teeside entered into an agreement with the CATS owners by which it reserved capacity in CATS over a 25 year period beginning in 1993. Teeside was to pay a fee for the reserved capacity which was fixed for the first 20 years and calculated by reference to a contractual formula for the latter five years (“Capacity Fee”).

Complex provisions in the agreement determined how the Capacity Fee should be calculated. Essentially it was calculated by apportioning the operating and capital expenses payable by Teeside on the basis of the proportion of total pipeline capacity reserved to it under the contract and then applying a 15% uplift.

For the purpose of this note, it is not helpful to consider the precise wording of the disputed provisions which are highly technical. What is helpful is to look at the approach of Butcher J at first instance and the Court of Appeal thereafter.

At first instance, the judge identified several points that would guide his approach:

  1. The contract was lengthy and complex and had been the subject of detailed negotiations between expert advisors resulting in numerous revisions. Despite this (and indeed perhaps because of this), it should not be assumed that the document is “…elegantly crafted or as logically integrated as it might be desired.” or that the drafter will have envisaged every possible scenario that may arise over the contract’s term.
  2. The contract could be categorised as long-term meaning it was appropriate for the court to adopt a flexible approach to issues of interpretation to give effect to the reasonable expectations of the parties.
  3. That flexible approach would extend to a certain degree of co-operation between the parties but not to go so far as to imply a duty of good faith.
  4. The ordinary principles of construction require the court to engage in a “unitary” construction exercise by which it tests rival meanings of words and phrases against alternative meanings, the remainder of the contract and the contract’s commercial purpose and background to its formation – per Lord Hodge in Wood v Capita.

The Court of Appeal upheld the judge’s decision.  It adopted the unitary exercise of construction by considering;

  • The language of the disputed clause.
  • Other relevant provisions of the contract.
  • The overall structure of the contract’s payment provisions.
  • The background circumstances known to the parties at the time of the contract.
  • Commercial common sense.

The Court of Appeal concluded on the question of construction;

“While there is considerable force in TGTL’s proposed construction if the focus is confined to the terms of clause 4.6(a)(vii) itself, the position is more nuanced if clause 4.6 is considered as a whole. However, when the Agreement is construed as a whole and is seen in its commercial setting, the true construction of the clauses relevant to this dispute is reasonably clear. In my judgment, for the reasons which I have given, the CATS Parties’ construction of the Capacity Fee provision makes better sense of the contract, including the terms of clause 4.6, and is to be preferred. Although the language is not entirely free from difficulty on either party’s construction of the contract, I consider that the judge was right to accept the construction proposed by the CATS Parties. It is of some interest, if only to confirm that this is not a manifestly uncommercial construction, that it was only belatedly challenged by TGTL.”

Whilst this decision affirms the proper approach to the interpretation of contracts and follows Wood v Capita, it does highlight the uncertainty that arises from the courts’ willingness to stand back from the close literal interpretation of words in an agreement and to consider the broader context of an agreement’s formation and operation.

It seems that litigation over the meaning of contracts will continue.