Construction of Contract Terms


Construction of Contract Terms

9.1   General Principles of Construction

It remains a fundamental tenet of contract law — and, therefore, of insurance contract law — that the parties are free to make their agreement. This means that most of the rules of insurance law may be excluded, waived or varied by the parties. It is, therefore, to the insurance contract that the lawyer must turn in order to determine the rights and obligations of the parties, and an insurance contract is construed according to the same principles that apply to all contracts. The situation is somewhat different in many other countries where terms and premium rates are controlled (for example in the USA, see KS Abraham, Insurance Law and Regulation (New York, Foundation Press, 2000 and Part 9.3).

The starting point for English judges when approaching the construction of a contract was succinctly stated by Mance LJ in Sinochem International Oil (London) Co Ltd v Mobil Sales and Supply Corpn [2000] 1 Lloyd’s Rep 339 (CA): ‘The Court cannot either re-write contracts or impose on parties to them what the Court may think would have been a reasonable contract.’

[901] Prenn v Simmonds [1971] 3 All ER 237 (HL)

Lord Wilberforce:

‘There were prolonged negotiations between solicitors, with exchanges of draft clauses, ultimately emerging in clause 2 of the agreement. The reason for not admitting evidence of these exchanges is not a technical one or even mainly one of convenience…It is simply that such evidence is unhelpful. By the nature of things, where negotiations are difficult, the parties’ positions, with each passing letter, are changing and until the final agreement, though converging, still divergent. It is only the final document which records a consensus. If the previous documents use different expressions, how does construction of those expressions, itself a doubtful process, help on the construction of the contractual words? If the same expressions are used, nothing is gained by looking back; indeed, something may be lost since the relevant surrounding circumstances may be different…In my opinion, then, evidence of negotiations, or of the parties’ intentions, and a fortiori of Dr Simmonds’s intentions, ought not to be received, and evidence should be restricted to evidence of the factual background known to the parties at or before the date of the contract, including evidence of the “genesis” and objectively the “aim” of the transaction.’

[902] Reardon Smith Line Ltd v Hansen-Tangen [1976] 3 All ER 570 (HL)

Lord Wilberforce:

‘It is less easy to define what evidence may be used in order to enable a term to be construed. To argue that practices adopted in the shipbuilding industry in Japan, for example as to subcontracting, are relevant in the interpretation of a charterparty contract between two foreign shipping companies, whether or not these practices are known to the parties, is in my opinion to exceed what is permissible. But it does not follow that, renouncing this evidence, one must be confined within the four corners of the document. No contracts are made in a vacuum: there is always a setting in which they have to be placed. The nature of what is legitimate to have regard to is usually described as “the surrounding circumstances” but this phrase is imprecise: it can be illustrated but hardly defined. In a commercial contract it is certainly right that the court should know the commercial purpose of the contract and this in turn presupposes knowledge of the genesis of the transaction, the background, the context, the market in which the parties are operating. I give a few illustrations. In The Utica City National Bank v Gunn the New York State Court of Appeals had to consider the meaning of “loans and discounts” in a contract of guaranty. The judgment of Cardozo J (222 NY 204 at 208) contains this passage:

“The proper legal meaning, however, is not always the meaning of the parties. Surrounding circumstances may stamp upon a contract a popular or looser meaning. The words ‘loans and discounts’ are not so clear and certain that circumstances may not broaden them to include renewals. They often have that meaning in the language of business life…To take the primary or strict meaning is to make the whole transaction futile. To take the secondary or loose meaning, is to give it efficacy and purpose. In such a situation, the genesis and aim of the transaction may rightly guide our choice…”

…It is often said that, in order to be admissible in aid of construction, these extrinsic facts must be within the knowledge of both parties to the contract, but this requirement should not be stated in too narrow a sense. When one speaks of the intention of the parties to the contract, one is speaking objectively — the parties cannot themselves give direct evidence of what their intention was — and what must be ascertained is what is to be taken as the intention which reasonable people would have had if placed in the situation of the parties. Similarly, when one is speaking of aim, or object, or commercial purpose, one is speaking objectively of what reasonable persons would have in mind in the situation of the parties. It is in this sense and not in the sense of constructive notice or of estopping fact that judges are found using words like “knew or must be taken to have known” (see, for example, the well-known judgment of Brett LJ in Lewis v Great Western Railway Co ((1877) 3 QBD 195 at 207).

…[W]hat the court must do must be to place itself in thought in the same factual matrix as that in which the parties were. All of these opinions seem to me implicitly to recognise that, in the search for the relevant background, there may be facts, which form part of the circumstances in which the parties contract, in which one or both may take no particular interest, their minds being addressed to or concentrated on other facts, so that if asked they would assert that they did not have these facts in the forefront of their mind, but that will not prevent those facts from forming part of an objective setting in which the contract is to be construed.’

[903] Investors Compensation Scheme Ltd v West Bromwich Building Society [1998] 1 All ER 98 (HL)

Lord Hoffmann:

‘…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] 3 All ER 237 at 240–42, [1971] 1 WLR 1381 at 1384–1386 and Reardon Smith Line Ltd v Hansen-Tangen, Hansen-Tangen v Sanko Steamship Co [1976] 3 All ER 570, [1976] 1 WLR 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 Investment Co Ltd v Eagle Star Life Assurance Co Ltd [1976] 3 All ER 352, [1997] 2 WLR 945.

(5)   The “rule” that words should be given their “natural and ordinary meaning” reflects the commonsense 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 Antaios Cia Naviera SA v Salen Rederierna AB, The Antaios [1984] 3 All ER 229 at 233, [1985] AC 191 at 201:

“…if detailed semantic and syntactical analysis of words in a commercial contract is going to lead to a conclusion that flouts business common sense, it must be made to yield to business common sense.”

…Finally, on this part of the case, I must make some comments upon the judgment of the Court of Appeal. Leggatt LJ said that his construction was “the natural and ordinary meaning of the words used”. I do not think that the concept of natural and ordinary meaning is very helpful when, on any view, the words have not been used in a natural and ordinary way. In a case like this, the court is inevitably engaged in choosing between competing unnatural meanings. Secondly, Leggatt LJ said that the judge’s construction was not an “available meaning” of the words. If this means that judges cannot, short of rectification, decide that the parties must have made mistakes of meaning or syntax, I respectfully think he was wrong. The proposition is not, I would suggest, borne out by his citation from Alice Through the Looking Glass. Alice and Humpty Dumpty were agreed that the word “glory” did not mean “a nice knock-down argument”. Anyone with a dictionary could see that. Humpty Dumpty’s point was that “a nice knock-down argument” was what he meant by using the word “glory”. He very fairly acknowledged that Alice, as a reasonable young woman, could not have realised this until he told her, but once he had told her, or if, without being expressly told, she could have inferred it from the background, she would have had no difficulty in understanding what he meant.’

[904] Jumbo King Ltd v Faithful Properties Ltd FACV000007/1999 (Court of Final Appeal (Civil), Hong Kong)

Lord Hoffmann:

‘In the present case, I do not think that there can be any doubt about what the parties intended. In my respectful opinion, the judge’s approach was far too narrow and literal. The construction of a document is not a game with words. It is an attempt to discover what a reasonable person would have understood the parties to mean. And this involves having regard, not merely to the individual words they have used, but to the agreement as a whole, the factual and legal background against which it was concluded and the practical objects which it was intended to achieve. Quite often this exercise will lead to the conclusion that although there is no reasonable doubt about what the parties meant, they have not expressed themselves very well. Their language may sometimes be careless and they may have said things which, if taken literally, mean something different from what they obviously intended. In ordinary life people often express themselves infelicitously without leaving any doubt about what they meant. Of course in serious utterances such as legal documents, in which people may be supposed to have chosen their words with care, one does not readily accept that they have used the wrong words. If the ordinary meaning of the words makes sense in relation to the rest of the document and the factual background, then the court will give effect to that language, even though the consequences may appear hard for one side or the other. The court is not privy to the negotiation of the agreement — evidence of such negotiations is inadmissible — and has no way of knowing whether a clause which appears to have an onerous effect was a quid pro quo for some other concession. Or one of the parties may simply have made a bad bargain. The only escape from the language is an action for rectification, in which the previous negotiations can be examined. But the overriding objective in construction is to give effect to what a reasonable person rather than a pedantic lawyer would have understood the parties to mean. Therefore, if in spite of linguistic problems the meaning is clear, it is that meaning which must prevail.’

[905] MSC Mediterranean Shipping Co SA v Polish Ocean Lines (The Tychy) (No 2) [2001] 2 Lloyd’s Rep 403 (CA)

Lord Phillips MR:

‘With respect to Lord Hoffmann, we are inclined to think that a little intellectual hand luggage is no bad thing when approaching the task of construing a contract. Before taking extrinsic evidence into account, it is important to consider precisely why it is said to assist in deciding the meaning of what was subsequently agreed and to consider whether its relevance is sufficiently cogent to the determination of the joint intention of the parties to have regard to it. It is also important, though not always easy, to identify what is extrinsic to the agreement and what forms an intrinsic part of it. When a formal contract is drawn up and signed, care must be taken to distinguish between admissible background evidence relating to the nature and object of the contractual venture and inadmissible evidence of the terms for which each party was contending in the course of negotiations. Where, as in the present case, an agreement is alleged to have been reached in the course of dealings which do not culminate in the drawing up of a formal contract, the task is to identify whether, and if so which, terms proposed in the course of negotiations have become the subject of a joint agreement.


1.    In Bank of Credit and Commerce International SA (In Liquidation) v Ali [2001] 2 WLR 735 (HL) Lord Hoffmann qualified his earlier view by stating that the factual background to which reference could be made was only such as the reasonable person would regard as being relevant.

2.    There are several problems with Lord Hoffmann’s purposive approach. One is that it raises the prospect of uncertainty as to the meaning of a term because it may be difficult to foresee how a court would define the commercial purpose of any particular agreement and, of course, uncertainty increases litigation and costs. Indeed, the difficulty of fixing a precise meaning was brought home to Lord Hoffmann himself when he was the sole dissenting voice in Bank of Credit and Commerce International SA (In Liquidation) v Ali [2001] 2 WLR 735 (HL) on the issue of how his own principles were to be applied. Another problem lies in the apparent encouragement that Lord Hoffmann’s fourth and fifth principles give to those who wish to remake a contract. The courts have always taken the view that they will apply the clear meaning of words even if that meaning appears unreasonable. On the other hand, as Lord Reid pointed out, ‘The fact that a particular construction leads to a very unreasonable result may be a relevant consideration. The more unreasonable the result the more unlikely it is that the parties can have intended it, and if they do intend it the more necessary it is that they shall make that intention abundantly clear.’ (L Schuler AG v Wickman Machine Tool Sales Ltd [1974] AC 235 at 251)

Speaking before the West Bromwich case of the requirement that the courts look at the surrounding circumstances of the contract, Staughton LJ remarked, ‘Almost every day in these courts there is a contest as to what comes within that description.’ (Youell and Others v Bland Welch & Co Ltd and Others at [908] below) Yet he did not regard this as a cause for alarm. And in truth, the meaning of contracts is not always clear. This is often simply because contracts govern future dealings between contracting parties, who are understandably more focused on performance than breach and who are, perhaps, not gifted with well-honed powers of prophecy. The unforeseen problems that arise as a result and that lead to litigation must, nevertheless, be dealt with by the courts according to what the judge can determine was — on an objective test — the intention of the parties at the time of the contract.

3.    The parol evidence rule is to the effect that ‘parol testimony cannot be received to contradict, vary, add to or subtract from the terms of a written contract’ (Bank of Australia v Palmer [1897] AC 540, per Lord Morris). The Law Commission has commented that the rule turns out to be, ‘no more than a circular statement’ since the cases show that, ‘Evidence will only be excluded when its reception would be inconsistent with the intention of the parties’ (Law Commission, Law of Contract: The Parol Evidence Rule, Law Comm No 154, 1986, paras 2.7 and 2.45). So, for instance, evidence can be admitted to support rectification on the ground that the document does not accurately represent the agreement, or to show the circumstances at the time of the contract, where the policy is unintelligible without them, or to reveal the existence of a collateral contract (see Youell and Others v Bland Welch & Co Ltd and Others at [908] below). In Shepherd v National Mutual Life Association of Australasia Ltd (1995) 5 ANZ Ins Cas 61-233 (Supreme Court of Victoria), the insurers’ agent orally agreed to provide cover from the moment of acceptance, but the written policy which was later provided stated that cover commenced only after three months from the date of acceptance; the agent told the insured that this provision did not apply to him. It was held that the policy should be read subject to the oral promise about immediate cover.

9.2   Construing Insurance Contracts

The general principles of construction are, of course, applied to insurance contracts. This means that cases decided before the line of modern cases beginning with Prenn v Simmonds need to be approached with sensible caution.

[906] Jason v Batten (1930) Ltd [1969] 1 Lloyd’s Rep 281

Fisher J:

‘I have to construe the policy and apply it to the facts which I have found. A policy of insurance is subject to the same rules of construction as any other written contract. The words used in it must be given their plain, ordinary meaning in the context of the policy looked at as a whole, subject to any special definitions contained in the policy. In case of ambiguity the contra proferentum rule will apply but apart from this there is no rule of law which requires me to strain the language of the policy in favour of or against the insured person. It is a bargain by which, in consideration of a relatively small premium, the insurance company agrees to make substantial payments in certain events, and it would be no less of an injustice to compel payment in events not falling within the ordinary meaning of the words used in the policy than to deny payment in events falling within such meaning.’

[907] Harris v Poland [1941] 1 KB 462

[The contents of Mrs Harris’s flat were covered for, among other things, loss by fire. Mrs Harris, fearing burglary, hid some jewellery under wood and coal in the grate. Later that day, forgetting the presence of the jewellery, she lit a fire. It was held that the insurers were liable for the loss.]

Atkinson J:

‘There are one or two well settled rules of construction with regard to policies. One is that the construction depends not upon the presumed intention of the parties but upon the meaning of the words used. In Nelson Line (Liverpool) v James Nelson & Sons (No. 2) [1908] AC 16, 20 Lord Loreburn LC said: “I know of only one standard of construction, except where words have acquired a special conventional meaning, namely, what do the words mean on a fair reading, having regard to the whole document?”

There is another rule which I find summarised in Hamlyn & Co v Wood & Co. [1891] 2 QB 488, 491 from Lord Esher’s judgment: “I have for a long time understood that rule to be that the Court has no right to imply in a written contract any such stipulation, unless, on considering the terms of the contract in a reasonable and business manner, an implication necessarily arises that the parties must have intended that the suggested stipulation should exist. It is not enough to say that it would be a reasonable thing to make such an implication. It must be a necessary implication in the sense that I have mentioned.” Another rule of construction is that as a policy is prepared by the underwriters any ambiguity therein must be taken most strongly against the underwriters by whom it has been prepared. If a policy is reasonably susceptible of two constructions, that one will be adopted which is more favourable to the insured. Again, in West India and Panama Telegraph Company v Home and Colonial Marine Insurance Company (1880) 6 QB D 51, 58, Brett LJ said this: “An English policy is to be construed according to the same rules of construction, which are applied by English Courts to the construction of every other mercantile instrument. Each term in the policy, and each phrase in the policy, is prima facie to be construed according to its ordinary meaning.” Guided by these principles I can see no reason whatever for limiting the indemnity given by the policy in the way claimed by the defendant. In my judgment the risks against which the plaintiff is insured include the risk of insured property coming unintentionally in contact with fire and being thereby destroyed or damaged, and it matters not whether that fire comes to the insured property or the insured property comes to the fire. The words of the policy are just as descriptive of one as the other, and I cannot read into the contract a limitation which is not there. To enable me to accept the contention of the underwriters I should have to read something into the contract — some such words as “unless the insured property is burned by coming in contact with fire in a place where fire is intended to be.”

What justification can there be for so doing? To what absurdities would it lead? A red hot cinder jumps from the fire and sets some paper of value on fire — admittedly there is liability. A draught from the window blows the same paper into the same fire. Is that any less an accidental loss by fire? Are the words in the policy any less applicable to the latter than the former? A draught blows the flame of a candle against a curtain — admittedly there is liability. But what if the curtain is blown against the flame of the candle? Surely the result must be the same? If it is not the same the result is an absurdity. If it is the same, why should the result be different if one substitutes a fire in a grate for the lighted candle in a candle stick?’

[908] Youell and Others v Bland Welch & Co Ltd and Others [1992] 2 Lloyd’s Rep 127 (CA)

[This case concerned reinsurance, which enables insurers to spread the risks they underwrite. A reinsurance contract is entered into by an insurer (who becomes the reinsured) and a reinsurer. The reinsurer agrees to indemnify the reinsured against all or part of any loss under a policy or group of policies. For a brief overview of the subject see, J Lowry and PJ Rawlings, Insurance Law: Doctrines and Principles (Oxford, Hart Publishing, 1999), chapter 14. For a fuller exposition, see JS Butler & R Merkin, Reinsurance Law (Kingston-upon-Thames, Kluwer Publishing, 1999). Y insured some liquefied natural gas carriers, which were being built in the USA. The cover provided for a primary period of insurance with an option to the insured to extend. Y reinsured with B ‘risks attaching for periods as original (up to but not exceeding 48 months)’. The carriers became total losses at a time when still under the cover provided by Y, but more than 48 months after they had come on risk. Y’s claim against B was rejected at first instance and in this appeal].

Staughton LJ:

‘…The problem

A contract of insurance almost invariably defines the period of time within which some relevant event must occur if the insurer is to be liable; or at any rate I have never met one which did not do so…

How is the relevant period of cover to be defined? Generally the requirement is that the loss must occur within a period of, say, one year from the making of the contract. But there are exceptions. A common example arises in the field of professional indemnity insurance. There policies frequently cover not liability for negligent acts or omissions during the policy period, but liability for claims first made during the policy period.

When it comes to reinsurance there are at least two methods that are commonly used. The first is the loss occurring method: the reinsurers are obliged to pay their share of the loss suffered by the reinsured, if it occurred during the period when the reinsurance contract was in force, even if the original insurance commenced before the beginning of that period. The second is the risks attaching method: the reinsurers are then liable for their share of loss suffered by the reinsured, whenever it occurs, provided that risk attached under the original insurance during the period of the reinsurance contract.

The date when the original insurance contract is concluded is not necessarily the same as the date when risk attaches under it. But that is a refinement which need not concern us in the present case…

In the present case one can start with the clause headed “Period of Reinsurance and Termination”. This makes it clear that the period began on a 1 January 1974, and was to continue for a year or any whole number of years until determined by 60 days’ notice. Thus far, the reinsurance might have been either on a loss occurring or a risks attaching basis; all that had been defined was the period of reinsurance. But it is then provided that termination is —

…not to apply to risks for which the Reinsured is already committed or which are already ceded hereunder.

That is, to my mind, an indication that the reinsurance is on a risks attaching basis, or possibly on the basis of insurance contracts underwritten during the reinsurance period.

The point is dealt with further and explicitly by the words “in respect of risks attaching” in the clause headed “Interest and Subject Matter”. It is now clear that the reinsurers are to be liable if during the period of the reinsurance contract risk attaches under an original insurance, and if the insurers become liable for a loss under that original insurance at any time during the period which it provides for, although the loss occurs after the expiry of the reinsurance period. (It is possible that there would be reinsurance cover even if the risk had not attached during the reinsurance period, owing to the words, “for which the reinsured is already committed” in the period of reinsurance clause. But that point does not arise in this case.)

The difficulty arises from 11 words in the interest and subject matter clause:

“…for periods as original (up to but not exceeding 48 months).”

Do these words, as the insurers contend, describe the type of insurance contracts which are to be reinsured? If the original insurance is, as in the present case, for a basic period of 32 months although liable to be extended, is the requirement of those words satisfied? The alternative view, put forward by the reinsurers, is that the contract there contains a cut-off or long-stop, so that they are free from liability for any loss occurring more than 48 months after the original insurance attached, even if its basic period was, for example, 32 months. The reinsurance contract would then be a hybrid, partly on a risks attaching basis and partly on a loss occurring basis…

Practical considerations

One can, I think, readily assume that a reinsurance contract was intended to cover the same risks on the same conditions as the original contract of insurance, in the absence of some indication to the contrary. Of course there may be reinsurance of specific perils which form part only of those covered by the original insurance, such as hurricane or fire; and there may be reinsurance against some types of loss, such as total loss only. But some express provision is required to achieve either of those results. On the other hand it is normal (although not universal) for a reinsurance contract to cover less than 100 per cent of the insurers’ liability, whether by way of share or of excess. In the particular context of this case, I would expect an insurer normally to require back-to-back reinsurance in respect of the period of his liability. If the reinsurance is for a lesser period than that for which he has provided cover, it may be difficult for him later to obtain further reinsurance cover either by way of extension or from other insurers, especially if he has then to disclose circumstances which show that a loss may be imminent. So it can in my view be said that the reinsurance contract would have been a more sensible one from the insurers’ point of view, if it had the meaning which they contend for. In the event of a declaration being made under their open cover with a basic period exceeding 48 months, they would know at once that it did not come within their existing reinsurance, and would have to seek new terms for that particular vessel.

Against that consideration, the reinsurers say that it might not in practice always be possible to tell whether a particular declaration was for a basic period of more or less than 48 months. Both the London Institute clauses for builder’s risks and the American clauses contemplate that a provisional or basic period will be agreed; but in practice this might not happen. There were periods of 32 months declared for the hull and machinery insurances in this case, but none were declared for the ancillary insurance on escalation and charges. It might, I suppose, reasonably be assumed that whatever period was declared for hull and machinery applied also to the ancillary insurances.

I do not consider that significant weight should be given to the fact that this sort of difficulty might arise on the insurers’ interpretation of the reinsurance contract. It is not unknown for parties in this market to create difficulties by failing to operate the procedure which they have agreed on. In such a case the Courts have to do the best they can, in giving effect to the contract so far as possible despite the changed circumstances.

The premium

At first this seemed to me a major point in favour of the insurers. The premium under the original insurance was, as I have said, a fixed percentage of the vessel’s value and another (smaller) percentage for every month of the building period; and the percentage in each case was to be of the contract value of the vessel or the completed value, whichever was the greater. The reinsurers were to receive 25 per cent of the original premium. Yet on their interpretation of the contract they would come off risk when the value of the vessel could be expected to be highest; and however long construction continued after 48 months had expired, they would still receive 25 per cent of the fixed element of the premium under the original insurance.

Against that there was evidence that the parties to the original insurance did in fact calculate the premium as a weighted average of the values at risk from time to time. I am not so much impressed by the fact that they did it, as by the fact that it was possible to make such a calculation and not thought to be an unreasonable interpretation of the original insurance contract. If such a calculation was appropriate as between the original insured and the insurers, a similar calculation could be done so as to allow for the expiry of the reinsurers’ risk after 48 months, and might be thought to be what the reinsurance contract required.

The highest that this point can be put is that, if a cut-off of the reinsurers’ liability after 48 months was intended, it is surprising that there was no express provision as to the premium that would be payable in that event. But it is scarcely a novelty to find a lack of precise detail in a reinsurance contract, or that the parties have left some problem to be resolved by goodwill, good sense or (if necessary) some other means of dispute resolution if it arose.

The slip

Mr Mance for the reinsurers argued that it was permissible to refer to the slip as an aid to the interpretation of the reinsurance contract, and Mr Sumption for the insurers that it was not.

It is now, in my view, somewhat old-fashioned to approach such a problem armed with the parol evidence rule, that evidence is not admissible to vary or contradict the words of a written contract. The modern approach of the House of Lords is that, on the positive side, evidence should be admitted of the background to the contract, the surrounding circumstances, the matrix, the genesis and aim. Almost every day in these Courts there is a contest as to what comes within that description. As Lord Wilberforce said in Reardon Smith Line Ltd v Hansen-Tangen the expression “surrounding circumstances” is imprecise. But so to some extent is “matrix”, if I may say so, although it is a picturesque metaphor. It may well be that no greater precision is possible. The notion is what the parties had in mind, and the Court is entitled to know, what was going on around them at the time when they were making the contract. This applies to circumstances which were known to both parties, and to what each might reasonably have expected the other to know.

The negative aspect of the modern doctrine is that evidence of negotiations is not admissible as an aid to interpretation, at all events unless they show an agreed meaning for the language used….

It can be argued that an insurance slip is different from negotiations for the formation of a contract. It contains a concluded agreement between the parties, albeit one which they may expect, and even agree, to replace by different wording in a formal contract. The nature of the problem which then arises is clearly illustrated by the present case.

The relevant reinsurance slip for present purposes is that which was initialled, wholly or for the most part, in November, 1973. Against the heading “Period” it provided:

“Continuous open cover commencing 1st January 1974 and/or as original subject to 60 days cancellation clause to any anniversary date (not to apply to risks for which reinsureds are already committed or which are already ceded hereunder). Risks attaching basis for periods as original but not exceeding 48 months any one risk.”

There is provision for a particular form to be used, followed by the words —

“…Wording to be agreed by leading London reinsurer.”

There is another heading, “Interest”, which contains much of the wording that subsequently appeared in the policy under “Interest and Subject Matter”, but not any mention of the 48-month limit.”

It is thus readily apparent that somebody, for some reason, has transferred the term as to 48 months from Period to Interest. But that is no help at all. Even if one could confidently discern what the words meant in the slip — which I do not think one can — there would remain the possibility, and perhaps even a probability, that the parties wished to alter that meaning when they prepared and agreed the policy. It is not argued that the leading underwriter had no authority to do so on behalf of others.

I accordingly would hold that the slip, whether admissible or not, is of no assistance in this case.

There was some discussion as to whether the reinsurance contract was ambiguous. I certainly agree that there is room for argument as to which of two meanings is correct; but the ambiguity is patent, or there for all to see. There is no special need for extraneous evidence either to create it or to resolve it. The Court has to determine which of the two meanings is to be adopted.

Contra proferentem

There are two well established rules of construction, although one is perhaps more often relied on with success than the other. The first is that, in case of doubt, wording in a contract is to be construed against a party who seeks to rely on it in order to diminish or exclude his basic obligation, or any common law duty which arises apart from contract. The second is that, again in case of doubt, wording is to be construed against the party who proposed it for inclusion in the contract: it was up to him to make it clear.

I am not wholly sure which of these rules is meant by the Latin maxim verba chartarum fortius accipiuntur contra proferentem. Does it refer to the proferens coram judice (the first rule), or the proferens in contrahendo (the second)? No doubt diligent historical research would produce an answer. But it does not matter. All that we need do is remember the two rules.

In the vast majority of cases the two rules will lead to the same result, for people do not usually propose wording which favours the other party rather than themselves. But here it is possible that the two rules point in different directions. There can be no doubt that the words “up to but not exceeding 48 months” are, in one way or the other, a limit on the primary obligation of the reinsurers. They are either not obliged to accept such risks at all, or their liability ceases when the 48-month period expires. So in case of doubt they fall to be construed against the reinsurers. But it is said that the words were proposed for inclusion in the contract by the insurers, and should be construed against them.

It is here that difficulty arises from the fact that the case was tried in two separate parts. During the trial of the second part, between the insurers and the brokers, there was some evidence as to how the disputed words came to be included in the slip. But the reinsurers were at that stage no longer participating in the trial; they had gone on their way rejoicing, with a decision in their favour on the first part. They no longer had an opportunity to call evidence, or to cross-examine, on this issue. If they had wished to call such evidence, they should have done so in the first stage of the trial.

In those circumstances it seems to me that we must ignore the evidence as to who put forward the disputed wording, when deciding the first appeal. One is left only with the fact that it appeared in the slip, which is normally prepared by or on behalf of the party seeking insurance — or in this case, reinsurance. But if so it is a little odd, as I have indicated, that the wording appeared to contain a limit in favour of the reinsurers. On the whole I conclude that the proferens arguments do not in this case give rise to a presumption in favour of, or against, either party.

The answer

Having considered the various extraneous aids to construction that were relied on, I find that they are of little help, and certainly do not indicate any firm preference for one meaning or the other. So I am left with the language of the contract.

What the insurers are required to cede, and the reinsurers to accept, is as it seems to me a proportion of liability “for periods as original (up to but not exceeding 48 months)”. That, in my view, defines the time during which a proportion of the risk passes to the reinsurers. The words “in respect of risks attaching” are a separate provision, showing that the risks must attach under the original insurance during the year or years when the reinsurance contract remains in force. Those words serve a well known purpose on their own. Here they are as it were a parenthesis, and do not govern “for periods as original” etc.

The language is not elegant, and on any view must be somewhat strained to make any sense. But the alternative view requires the whole phrase —

“…in respect of risks attaching for periods as original (up to but not exceeding 48 months)…”

to be treated as one, describing the kind of liability which the insurers are to cede and the reinsurers to accept. This could be thought more appropriate to a clause headed “Interest and Subject Matter”, but it is to my mind a very strained construction. and “periods as original” must be taken to refer to the basic or provisional periods set out in the London or American clauses, not the periods for which the original insurances are, by their terms, liable to remain in force. That too I find implausible. In consequence I accept the reinsurers’ construction, and would dismiss the insurers’ appeal.’

Beldam LJ:

‘…as it was urged that the learned Judge [Phillips J, at first instance] had correctly held that consideration of the slip would infringe the parol evidence rule, I would make these comments. Firstly the rule (if rule it be) was analysed by the Law Commission in their Report on the Law of Contract — the Parol Evidence Rule (Law Com No 154). In para 1.2 the Commission identified three distinct rules generally rendering inadmissible evidence outside or extrinsic to a document in which the parties have recorded their transaction. The third of these rules was concerned with the interpretation of documents and with the extent to which parol evidence may be adduced to show what the parties to the document intended by the words used. This, as the Commission pointed out, was different from adducing such evidence for the purpose of contradicting, varying, adding to or subtracting from the terms of a written contract where its meaning was plain. The admission of extrinsic evidence as an aid to interpretation where the words of the written contract cannot be given a clear and unequivocal meaning has been the subject of case law defining the extent to which such evidence may be adduced.

For example, such evidence has been admitted to show that a particular expression was used in a special sense, and where one of the parties to the contract contends that the written document mistakenly records what had been agreed or mistakenly omits something which it was their common intention should be within the contractual document and claims rectification. When the written agreement has been rectified, it is not a written agreement with a parol variation. It is in fact the original agreement.

Although the slip initialled by underwriters records the original agreement between the parties, if it contains words showing an intention that the terms will subsequently be incorporated into a policy form, when the policy has been issued it is the policy and not the slip which constitutes the contract or agreement between the parties. Reinsurers who invited the learned Judge to have regard to the wording of the slip as an aid to the interpretation of the contract did not seek rectification. The slip is clearly admissible in evidence for some purposes. Section 89 of the Marine Insurance Act, 1906 provides that reference may be made “as heretofor” to the slip or covering note in any legal proceeding.

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