“Business Common Sense” Prevails in Commercial Contract Dispute

Ship in Drydock

The Rainy Sky v Kookmin Bank case pertained to ship-building contracts that weren't fulfilled.

A recent decision by the UK Supreme Court in Rainy Sky S.A. and others v Kookmin Bank marks a subtle but welcome change of approach to the interpretation of commercial contracts including of course insurance contracts.

The case concerned the true meaning of a bond (in effect a promise by the bank to pay) on the occurrence of a particular event. The transactions to which the bond related were a number of ship-building contracts under which a ship builder agreed to build a number of ships in return for payment in five equal instalments at specified points of time.

The payments were themselves subject to refund guarantees in the event that the ships were not delivered. It was these refund guarantees which were the subject of the bank bonds. When the ship builder ran out of money and was unable to meet its refund guarantees, the bank was called upon to pay the bond.

We do not need to delve into the particular controversy surrounding the interpretation of a specific clause in the bond. It was indeed accepted that two interpretations were possible and that, under the first, the bank would have no obligation to pay whilst, under the second, the bank would be liable. At first instance the bank had been found liable to pay whereas in the Court of Appeal the bank had won.

Supreme Court Ruling

The Supreme Court affirmed the general approach to the construction of any contract as:

“…being to determine what the parties meant by the language used which involved ascertaining what a reasonable person would have understood the parties had meant”.

The ruling also quoted Lord Diplock in The Antaios [1984] AC191:

“If detailed and syntactical analysis of words in a commercial contract is going to lead to a conclusion which flouts business common sense it must yield to business common sense.”

Common Sense Prevails

The Supreme Court concluded that the “business common sense” here was that the parties had agreed that in the event of the insolvency of the ship builders, the buyers should have security for the repayment of the redelivery instalments which they had paid. Whilst this “business common sense” was also apparent to the Court of Appeal, that Court nevertheless concluded that:

“Unless the most natural meaning of the words produces a result which is so extreme as to suggest that it is unintended, the court has no alternative but to give effect to its terms.”

The Supreme Court, whilst affirming that contracting parties were free to enter into uncommercial and unreasonable contracts if they so chose, concluded that the more unreasonable the result, the more necessary it was that the intent be made abundantly clear.

The Implications

What this means is that if a contract term makes little or no business common sense and is capable of more than one interpretation, courts are now more likely to be willing to intervene to ensure that the result ultimately “yields to business common sense.”

The decision should be welcome by those wishing to avoid unnecessary legal and forensic battles over the meaning over particular words. That said, we are not anticipating the day on which ambiguity is eradicated from commercial contracts anytime soon.

About Francis Kean

Francis is an Executive Director in Willis Towers Watson's FINEX Global, where he specializes in insurance for Dir…
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