Investors Compensation Scheme Ltd vs. West Bromwich Building Society

Five Principles for Interpretation of Contracts


There was a contract between a Norwegian and a German company for supply of 200 tonnes of haaksjoringskod. This substance could mean shark meat or whale meat. When the German company entered into the contract, the German company intended to import whale meat. However, the Norwegian company thought that the term referred to shark meat and exported it. German company refused to take delivery.

The Court adopted the Objective approach here. Lord Hoffman laid down five principles for interpretation of contracts as listed below-

  1. the right meaning is what the document conveys to a reasonable person;
  2. this includes everything in the “matrix of fact”, or relevant background circumstances;
  3. prior negotiations are excluded from this (a point which has been much criticised since);
  4. the meaning of words is not a literal meaning, but the one reasonably understood from the context, and
  5. the meaning should not contradict a common sense view of what a contract required

 These principles may be summarized as follows-

  1. Interpretation is the ascertainment of the meaning which the document would convey to a reasonable person having all the background knowledge which would reasonably have been available to the parties in the situation in which they were at the time of the contract.
  2. The background was famously referred to by Lord Wilberforce as the “matrix of fact,” but this phrase is, if anything, an understated description of what the background may include. Subject to the requirement that it should have been reasonably available to the parties and to the exception to be mentioned next, it includes absolutely anything which would have affected the way in which the language of the document would have been understood by a reasonable man.
  3. The law excludes from the admissible background the previous negotiations of the parties and their declarations of subjective intent. They are admissible only in an action for rectification. The law makes this distinction for reasons of practical policy and, in this respect only, legal interpretation differs from the way we would interpret utterances in ordinary life. The boundaries of this exception are in some respects unclear. But this is not the occasion on which to explore them.
  4. The meaning which a document (or any other utterance) would convey to a reasonable man is not the same thing as the meaning of its words. The meaning of words is a matter of dictionaries and grammars; the meaning of the document is what the parties using those words against the relevant background would reasonably have been understood to mean. The background may not merely enable the reasonable man to choose between the possible meanings of words which are ambiguous but even (as occasionally happens in ordinary life) to conclude that the parties must, for whatever reason, have used the wrong words or syntax. (Mannai Investments Co Ltd v Eagle Star Life Assurance Co Ltd. [1997] 2 WLR 945)
  5. The “rule” that words should be given their “natural and ordinary meaning” reflects the common sense proposition that we do not easily accept that people have made linguistic mistakes, particularly in formal documents. On the other hand, if one would nevertheless conclude from the background that something must have gone wrong with the language, the law does not require judges to attribute to the parties an intention which they plainly could not have had. Lord Diplock made this point more vigorously when he said in The AntaiosCompaniaNeviera SA v SalenRederierna AB [1985] 1 AC 191, 201- “… if detailed semantic and syntactical analysis of words in a commercial contract is going to lead to a conclusion that flouts business commonsense, it must be made to yield to business commonsense.”

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