Exclusionary rule and pre-contract negotiations

In a recent case in the Court of Session, Lord Braid has taken what will be regarded by many practitioners as a reassuring approach to the interpretation of contracts and has reiterated the importance of the exclusionary rule regarding pre-contractual negotiations.

In Dragados (UK) Ltd v DC Eikefet Aggregates AS [2021] CSOH 117 the court dealt with a supply contract agreement for the supply and delivery of armourstone by the defender to the pursuer. The pursuer needed to use the stone for construction work which it had undertaken to carry out at Aberdeen harbour. The issue at the heart of the dispute was what the parties' contract meant and, in particular, whether it is legitimate in ascertaining that meaning, to have regard to pre-contractual discussions and communications between the parties.

The circumstances in which pre-contractual discussions can be referred to were set out with great clarity by Lord Hoffmann in Chartbrook Ltd v Persimmon Homes Ltd [2009] UKHL 38; [2009] 1 AC 1101, and indeed by Lord Wilberforce in the earlier decision of Prenn v Simmonds [1971] 1 WLR 1381 which is cited with approval in Chartbrook.

More recently, in this jurisdiction, Lord Hodge has set out the relevant principles in Luminar Lava Ignite Ltd v MAMA Group plc [2010] CSIH 01; 2010 SC 310: “The general rule is that the court will not have regard to statements of parties or their agents in the course of negotiation of a contract as an aid to the construction of the words which the parties use in the final version of the contract between them which alone expresses their consensus” (Lord Hodge, para 39; emphasis added). As Lord Rodger said in Bank of Scotland v Dunedin Property Investment Co Ltd 1998 SC 657, it is inadmissible if its purpose is to put a gloss on the contract.

However, the rule is not absolute and evidence of the factual background is relevant where the facts are known to both parties and those facts can cast light on either (i) the commercial purpose of the transaction objectively considered, or (ii) the meaning of the words used in the contract (Lord Hodge at para 42).

Upholding the rule

In Dragados, the defender based its defences on pre-contractual discussions taking place over a number of months and said that those prior communings gave the parties "a shared understanding of the intended specification of the stone to be supplied" under the relevant contract. They pled that the "mutual intention of the parties [fell] to be determined in light of that shared understanding", and that "regardless of the terms [of the contract] the pursuer could not reasonably have believed that the defender had agreed to supply anything other than category B stone". Accordingly, the defender sought to have the contract interpreted by reference to the pre-contractual negotiations. These negotiations, it said, assisted the court in its understanding of parties' intentions.

Senior counsel for the pursuer argued that evidence of prior communings/negotiations (as distinct from the background circumstances) was excluded even if the contract might admit of more than one meaning. Accordingly, even where there was ambiguity, reference to pre-contractual negotiations was not permitted. In relation to the supply of different categories/specifications of stone, senior counsel pointed out that the court's task in construing a contract which expressly incorporated a requirement to supply category A stone would not be assisted by knowing that in pre-contractual negotiation, the parties had referred only to category B stone. If the contract was said not to reflect the parties' mutual intention then rectification ought to have been pled, but it was not.

Lord Braid had no hesitation in rejecting the defender's argument. He held that, having regard to the relevant test outlined above, any evidence led in relation to these averments would be clearly inadmissible. The defender was essentially taking a subjective approach to contractual interpretation in that it was seeking to ascertain the proper construction of the contract by reference to what the parties thought it meant. Accordingly, an averment "about what the pursuer would reasonably have believed, apart from being speculative, is irrelevant".

Lord Braid continued by saying that the defender's averments were "no more and no less than an attempt to have regard to statements made in the course of the negotiations as an aid to the construction of the contract, or to put a gloss on its terms, which is precisely what the rule excludes".

The defender relied partially on Lady Wolffe's recent judgment in Paterson v Angelline (Scotland) Ltd [2021] CSOH 101 (which is currently being appealed), in which the pursuer had relied extensively on the background circumstances as being relevant to construction. Lord Braid held that Paterson was simply an example of a case which had been held to fall outwith the exclusionary rule, and each case turned on its own facts.

However, Lord Braid was being generous. The commercial judge in Paterson appeared in her judgment to make no distinction between relevant factual background and negotiations between the parties. Indeed, the pursuer expressly relied on the emails between the parties during negotiations and previous iterations of a share purchase agreement as being relevant to the contractual interpretation question. Such evidence is, as Lord Braid outlines in Dragados, inadmissible.

Pragmatic basis

The importance of the exclusionary rule ought not to be understated. As senior counsel alluded to in Dragados and as Lord Hodge outlined in Luminar Lava Ignite, the "pragmatism, which underlies the exclusionary rule, is concerned with predictability and economy. There is considerable scope for dispute about the meaning of the statements, whether oral or in writing, which parties make in their negotiations. This may distract attention from the construction of the words which parties eventually used to express their consensus and cause greater uncertainty of outcome in contractual disputes. Admission of evidence of the negotiations will… as Lord Hoffmann observed in Chartbrook…, ‘add to the cost of advice, litigation or arbitration’".

Courts have a duty to ensure that parties can rely on their finalised contractual commitments, whether clearly expressed or not. Legal certainty will suffer if one party is entitled to look behind the contract and use what was said or done in negotiations as a means of understanding the parties' mutual intention.

This was perhaps best outlined by Lord Wilberforce in Prenn v Simmonds where he said: "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".