The Court Of Appeal offers clarity on test for contract rectification

In FSHC Holdings Ltd v Glas Trust Corporation Ltd[1], the Court of Appeal considered the circumstances when a contract should be rectified because it did not reflect the parties’ common intention. The Court held that the parties’ intention needs to be judged subjectively rather than objectively, unless the intended terms are specified in an earlier binding contract. In doing so, the Court departed from Lord Hoffmann’s controversial obiter opinion in Chartbrook Ltd v Persimmon Homes Ltd[2] that a purely objective approach should be adopted.

Doctrine of rectification

Parties may ask the court for rectification (i.e. the correction) of a written agreement where it does not reflect the terms purportedly agreed. The purpose of rectification is to resolve an accidental inconsistency between the parties’ common intentions and what was ultimately committed to paper.

In Chartbrook, it was held that for the purposes of rectification based on common mistake, the existence and nature of a common intention of the parties had to be determined by reference to what an objective observer would have thought the parties’ common intention would have been. This objective test was also used in Daventry District Council v Daventry and District Housing Ltd[3].

Parties seeking rectification of an instrument on grounds of common mistake must also show that there was an outward expression of their shared intention (i.e. such as conversations or emails between the parties, or non-binding heads of agreement). An intention held by each party, but not communicated between them, is insufficient.

Facts

In FSHC Holdings Ltd v Glas Trust Corporation Ltd, the parties had entered into a private equity financing transaction in 2012 which required the claimant to provide security over a shareholder loan as part of the overall funding. In 2016, it was discovered that the relevant security documentation had either never been provided or could not be located, and so the claimant sought to provide that security by way of two accession deeds, thereby assuming far more onerous obligations than were required.

High Court decision

In the first instance decision[4], Carr J found that nobody involved in the transaction at the time had reviewed the security agreements and therefore nobody had realised that the accession agreements would have the effect of binding the claimant to the additional obligations. He held that this result was both objectively and subjectively unintended, so that it did not matter whether the objective or subjective test was correct. He therefore ordered rectification of the two deeds so as to exclude the additional obligations.

The Court of Appeal decision

The defendant appealed on the basis that (following Chartbrook and Daventry): (i) the existence and nature of a common intention for the purposes of rectification based on common mistake had to be determined by reference to what an objective observer would have thought the parties’ common intention to have been; and (ii) an objective observer would have concluded that the parties intended the additional obligations to be binding on the claimant.

Having undertaken a detailed analysis of the authorities, the Court of Appeal concluded that Lord Hoffman’s approach in Chartbrook did not correctly reflect the existing law, noting that cases in which rectification is available can be divided into two categories:

a) Rectification to reflect a prior contract:

Where two parties enter into a binding agreement to enter into a second, future agreement on particular terms, the court will assess the earlier agreement objectively to ascertain the parties’ common intention in entering into the second agreement. The principle here is that agreements must be kept. As such, the usual contractual test should be applied, which is an objective test.

b) Rectification to reflect a common continuing intention (i.e. no prior contract):

In circumstances where there is no prior agreement, but the parties share a common intention which by mistake is not reflected in the executed contract, the court will determine the correct terms by reference to the parties’ subjective intention. Here, the basis for granting rectification is the equitable doctrine that a party will not be allowed to enforce the terms of a written contract, objectively ascertained, when to do so is against conscience because it is inconsistent with what the parties in fact intended (and mutually understood each other to intend) those terms to be, when the document was executed.

The Court of Appeal therefore held that as there was no prior contract, the applicable test was the subjective one. Based on the findings at first instance that: (i) the parties had intended to execute a document which satisfied the claimant's obligation to grant security over the shareholder loan; and (ii) such understanding had been communicated between them, the Court concluded that rectification should be ordered and the defendant’s appeal was dismissed.

Implications

This is an important judgment which establishes at Court of Appeal level, the test for rectifying a contractual document on grounds of common mistake, on which there had been conflicting authority and some uncertainty as to the state of the law.

With its focus on the parties’ actual intention, in any case where there was no formal prior contract, the new subjective test sets a much higher hurdle for claimants to overcome when seeking rectification on the basis of a common mistake and may lead to fewer contracts being rectified. As a matter of policy, the Court considered this as a positive development emphasising the primacy of the final, agreed, written terms of a contract and noting that “rectification should be difficult to prove”.

The judgment is a good reminder to contracting parties, and their legal advisers, to ensure that the written terms of any agreement accurately reflect the parties’ intentions but also highlights the importance of keeping good records of any negotiations prior to entering into an agreement (such as meeting minutes, notes, emails and non-binding heads of terms), which may be significant should a future dispute arise.