We’ve talked in previous posts about what a contract is, how to structure it and how to read and write one. This post is about understanding what clauses in a contract, and the contract overall, means. This is known in the law as contract ‘interpretation’ or ‘construction’.
Why does this matter? Why are you bothering me with such a theoretical question, Jas?
Because there’s no real value in writing a contract which is going to be understood differently to how you intended it to be understood. If it doesn’t mean what you want it to mean, you won’t be able to rely on the contract, so it might nearly as well not exist. Therefore, it’s important to have a working understanding of the rules underpinning contractual interpretation. Yes, you can get by much of the same time by sticking down something that looks vaguely right…but why fly by the seat of your pants in business when you can avoid it?
The rules of contract interpretation
There are books and books and books about this topic, so what follows is just my practical summary of some of the major principles, all of which are really just aspects of the golden rule: think carefully about the meaning of a clause before you agree to it. You want more, go read Chitty on Contracts!
(1) Clauses are given their objective meaning
Clauses are read in the way that a reasonable person would understand them to mean. The concept of the ‘reasonable man’ or ‘reasonableness’ is a construct that is frequently seen in many legal systems and can be used by judges to mean any number of things, but basically it means that we need to interpret clauses independently of the parties’ own agendas, commercial interests, personal views etc. What would a reasonably intelligent, independent third person understand the words of a clause actually to mean?
This means in practice:
- Using shorthand, slang or abbreviations someone might misunderstand: bad idea
- Leaving some things unsaid because the other guy will know what you mean: bad idea
- Leaving some unnecessary things in because the other guy will know what you mean: bad idea
- Not being as clear as you possibly can: bad idea
They’re bad ideas because they all depend in some way on someone else filling in the gaps to understand what you’re trying to say, rather than you saying clearly what you mean. As a result, the words you use are liable to be interpreted differently than you meant them.
Example: I advised a client which had signed a contract where revenue from sales of a product was simply stated as ‘revenue’. The other side later argued it really meant revenue NET of x, y and z. We disagreed. The dispute went to an expert determination, who agreed with us: the proper construction of ‘revenue’ doesn’t include deductions unless there is clear agreement to the contrary. Shame it cost the client tens of thousands of pounds to establish that.
(2) The clause will be read both on its own and in light of the contract overall
A clause can make perfect sense just within itself but also make no sense at all if reviewed against other clauses in that same contact. For example, clause 3 says that a developer owns X code and Y art in a game, whereas clauses 5 and 7 says that all aspects of the game belong to the publisher. This means that clauses 5 and 7 throw doubt on the validity of clause 3 and we can’t say with total confidence who owns the code. Practical point: try to ensure internal consistency between the different clauses in a contract.
I cannot tell you the amount of times I’ve seen this mistake being made – a client or even another lawyer writes or analyses a contract and feels happy it covers the interpretation of some quite difficult clauses, only for someone else to point out that the inconsistencies between different clauses meant there were loopholes the other party could drive right through. Not good.
(3) Any ambiguity in a contract will be construed against the party seeking to rely on that ambiguity
Let’s say that a contract entitles you to be paid for certain work net of deductions, but it doesn’t say when or net of WHICH deductions. Let’s say further that you rely on that clause to sue someone who you believe owes you money under the contract, but he/she points out the contract doesn’t actually specify when the money is due or how much is due. If you sue that person, a judge would hold the ambiguities in the contract against you. The reason why is that the law has to choose a side here, because the contract isn’t clear, so by default it chooses to come down on the side of the party defending the argument and against the person bringing it. Depending on the circumstances, this can be fatal to some legal cases. (Btw, it’s known legally as the ‘contra proferentum’ rule).
Practical guidance: always remember that uncertainty in a contract can be used against you. Again therefore, it’s worth beng as clear as you can – ESPECIALLY for clauses that are there for your benefit.
(4) Evidence from outside the contract is generally excluded
If a clause in a contract makes no sense unless you go outside the contract, you could be on risky ground. This is because courts are hostile to importing non-contract evidence when interpreting a contract. This is essentially on policy grounds: there needs to be a line drawn between all the pre-contractual or extra-contractual discussions and the contract itself, otherwise you’d forever have people claiming that actually if you go back to certain emails from before the parties signed the contract then it’s clear that really a clause doesn’t mean X, it means Y, etc. Normally this suits the parites’ interest as much as it does the courts actually, otherwise you’d never have certainty on what you’ve agreed (it’s partly for that reason that entire agreement clauses came into being- to be discussed in a later post). However, sometimes the parties do need to go outside the contract for a just result to be reached.
As a result, the ‘no evidence outside the contract rule’ isn’t a concrete rule – in some circumstances outside evidence can be included, for example if a clause is clearly a mistake or is clearly against the expressed commercial intentions of the parties (though that last reason can get quite contentious). Another useful exception is where clear evidence of industry standards or customs and practices would help explain a particular clause. For example, the use of ‘milestones’ has instant resonance for software developers and, say, building contractors, but their understanding of what it actually means and how it works will vary from industry to industry.
(Don’t rely too much on ‘industry standards’ though, because if they really aren’t an industry-wide and understood standard, you’re just storing up ambiguity for later trouble. I litigated a case between two games companies where the game was meant to be built to ‘industry standards’. Because there is as yet no real consensus on what that means in the games industry, it made it harder for the parties to make their arguments about who was wrong – which cost them both extra money. It could all have been avoided by not using ‘industry standards’ as shorthand for what they really meant to say).
In practice a number of these principles often melt into each other of course and working out the proper answer can become quite difficult in complex cases (which is one of the primary reasons that commercial disputes go to court – because a judge is needed to determine the ‘correct’ interpretation of the contract).
BUT that shouldn’t put you off since, as I said, understanding how contracts are interpreted is a very useful tool to have when negotiating contracts: it helps you spots potential problems down the line, while also making the contract more certain/reliable overall and potentially even spotting weaknesses in the other party’s position which can be exploited (if that’s not too militant a term!)
PRACTICAL TIPS WHEN REVIEWING OR WRITING A CONTRACT:
(1) Think carefully about the words you use, especially in key clauses like the definitions, parties obligations, payment terms, risk allocation and termination. What would the other guy think your wording means? What would the reasonable person think? If they might not agree with your interpretation, change the wording.
(2) Check the WHOLE contract for internal consistency before you finalise it.
(3) Brevity is good, but don’t use 3 words when you really should use 10. As long as you’re following tip 1, it’d better to use more words rather than less to explain what you really mean where it really matters.
(4) As far as possible, your contract should stand on its own feet. Don’t leave things unsaid and don’t rely on things outside the contract. If you must rely on outside documents or information, make them part of the contract itself, either by referring clearly to them or, ideally, annexing them as a schedule to the contract itself.
(5) Don’t be afraid to make sure the other guy interprets the contract in the same way as you. You might think you’re being clever by leaving something in or out that they didn’t pick up and which might help you later on but chances are (unless you’re a lawyer) it is as likely to backfire as it is to help you out.
(6) Speaking of lawyers, consult one when you need to. Your existing lawyers, or another friendly lawyer, should be able to offer opinions or health-checks on contracts you’ve written yourself without just rewriting them. I do it all the time. I have one developer client for example who pretty much only sends me absolutely red-hot important clauses in a pre-written contract for my review. Other clients ask me to write the whole thing. Horses for courses.