Interpreting commercial contracts: Incorporation of terms by reference

In an earlier post, I had briefly looked at the decision of the Supreme Court in M.R. Engineers v. Som Dutt Builders, on when an arbitration clause can be incorporated by reference. The Court had hinted that a special rule may apply in the case of standard form terms and conditions, when it said “A general reference to another contract will not be sufficient to incorporate the arbitration clause from the referred contract into the contract under consideration. There should be a special reference indicating a mutual intention to incorporate the arbitration clause from another document into the contract. The exception to the requirement of special reference is where the referred document is not another contract, but a standard form of terms and conditions of trade associations or regulatory institutions which publish or circulate such standard terms and conditions for the benefit of the members or others who want to adopt the same.”

In a recent decision in Malone v. British Airways, the UK Court of Appeal has elaborated on how principles of incorporation by reference apply in a non-arbitration context. Shantanu Naravane has summarised the decision here. The Court stressed, of course, on the intention of the parties; but the decision is interesting in that it indicates that the practical consequences of the decision to incorporate or not to incorporate the terms is an extremely useful indicator of what the parties intended. In a sense, this is an extension of the general principles of interpreting commercial contracts, where a businesslike interpretation will be preferred (see this post for a Bombay High Court decision on that issue).

However, Shantanu notes in his post that the Court of Appeal has also indicated that the nature of the agreement from which terms are being incorporated is irrelevant to whether they are binding between the parties to the contract into which they are being incorporated. In the context of arbitration, the test in M.R. Engineers would indicate that the character of the underlying document is indeed relevant – this seems to be the better view to take, given the general principles underlying the reasoning in M.R. Engineers. On a broader note, the clearest exposition of the principles of interpretation of commercial contracts is probably found in Lord Hoffman’s judgment in Investors Compensation Scheme v. West Bromwich Building Society, [1998] 1 All ER 98:

"… I think I should preface my explanation of my reasons with some general remarks about the principles by which contractual documents are nowadays construed. I do not think that the fundamental change which has overtaken this branch of the law, particularly as a result of the speeches of Lord Wilberforce in Prenn v. Simmonds [1971] 1 W.L.R. 1381, 1384-1386 and Reardon Smith Line Ltd. v. Yngvar Hansen-Tangen [1976] 1 W.L.R. 989, is always sufficiently appreciated. The result has been, subject to one important exception, to assimilate the way in which such documents are interpreted by judges to the common sense principles by which any serious utterance would be interpreted in ordinary life. Almost all the old intellectual baggage of "legal" interpretation has been discarded. The principles may be summarised 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. (see 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 Antaios Compania Neviera S.A. v. Salen Rederierna A.B. 19851 A.C. 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.’"