Contractual interpretation – setting an example

The Court of Appeal has applied the tests in Rainy Sky (business common sense) and Arnold v Britton (natural meaning of the words) to interpret a construction contract. On the facts, figures for minimum acceptable performance levels described as “examples” were found to be binding (Sutton v Rydon).

Although the court did not refer to the most recent statement by the Supreme Court on contractual interpretation, Wood v Capita, it effectively applied that decision by acknowledging that both business common sense and the natural meaning of the words are relevant to contractual interpretation. According to the court lawyers “are now lucky enough to live in a world overflowing with appellate guidance on how to construe contracts”.

Sutton and Rydon entered a contract for maintenance and repair works. The contract contained key performance indicator (KPI) targets by which Rydon’s performance was measured and minimum acceptable performance levels that Sutton was prepared to tolerate. Figures for KPI targets and minimum acceptable performance levels were included in tables labelled “Example of Performance related profit adjustment”. Where performance exceeded the targets, Rydon was entitled to bonuses based on a percentage of its profit margin. Where Rydon’s performance was worse than the minimum acceptable performance levels, Sutton had a right to terminate.

Sutton served a termination notice, citing Rydon’s failure to achieve the minimum performance levels. Rydon argued that the contract contained only illustrative, but non-binding, examples in the tables and so Sutton was not permitted to terminate.

The principal question before the court was whether the figures in the tables were contractually binding or merely illustrative. The court held that:

1. without performance levels, the bonus provisions and the termination provisions would be inoperable;
2. Rydon intended to receive all bonuses due to it and Sutton intended to retain its power to terminate for poor performance (both of which were possible only if the contract specified performance levels);
3. based on 1. and 2. above, both parties must (and any reasonable person would) have intended the contract to specify performance levels; and
4. the performance levels were specified only in the example tables.

Accordingly, the contract must mean that the minimum acceptable performance levels in the example tables were the actual levels and not hypothetical ones for illustration.

The court's decision means that if parties want examples to be non-binding they must say so while ensuring that the contract remains sufficiently certain.