Plain Meaning of the Words Not Always Determinative for Commercial Contracts
25 June 2013
The Dutch Supreme Court decision of 5 April 2013, LJN BY8101 (Lundiform/Mexx) gave an important ruling about the interpretation of commercial contracts that potentially reduces commercial certainty. The ruling reduces the emphasis on the specific wording of a contract, even if it contains an “entire agreement clause” and makes it clear that the courts will consider other factors if it can be shown that the contract does not express the parties’ intentions.
Under Dutch law, if there is a dispute about the meaning of a contract provision, a Dutch court will ascertain this meaning by applying the following standard: what could the parties reasonably have understood that provision to mean and what could they reasonably have expected from each other? For this so-called “Haviltex formula”, all facts and circumstances are relevant, including the conduct of the parties before and after entering into the contract. Until recently, for commercial contracts (such as between financial service providers and professional parties), the plain meaning of the words used has been widely regarded as most important when interpreting the contract, even more so if it contained an ‘entire agreement clause’.
Mexx Europe sells clothes and Lundiform manufactures hardware for shops. During 2007, Lundiform agreed to supply hardware for new Mexx shops. On 27 November 2007, after the agreement had already been partly carried out, the parties confirmed their contract in writing. The contract, in English, stipulated that Mexx had to provide Lundiform with a monthly forecast for new shop openings. Lundiform would provide Mexx with a monthly overview of available Mexx stock and ask Mexx to confirm its forecast. The contract guaranteed that Mexx would purchase all hardware that Lundiform ordered on the basis of Mexx’s confirmed forecast.
In practice, however, the procedure for confirming each of Mexx’s forecasts was not followed and the hardware was ordered on the basis of other data. When the contract was terminated in September 2008, Lundiform claimed that Mexx had to purchase its remaining stock even though it had not been purchased on the basis of confirmed Mexx forecasts. Lundiform argued that the plain words of the contract did not reflect the common intention of the parties. According to Lundiform this was evidenced by email-correspondence between the parties before and after the conclusion of the contract, and a statement by one of Mexx’s procurement officers. Mexx, however, relied on the procedure described in the contract and a so-called entire agreement clause that provided: “This agreement constitutes the entire agreement between the parties and supersedes any earlier written or oral arrangements and agreements made between the parties”.
The District Court and the Court of Appeal ruled in favour of Mexx. The Court of Appeal held that when interpreting a commercial contract concluded between professional parties, primary importance should be attached to the wording of the contract. Moreover, in this case, the existence of an entire agreement clause supported the view that correspondence between and conduct of the parties prior to the conclusion of the contract should be disregarded. The Supreme Court, however, set aside the Court of Appeal’s decision, and ruled in favour of Lundiform.
The Supreme Court held that a textual interpretation only takes priority in a commercial contract if the parties negotiated the relevant terms of the contract and both of them were assisted by legal counsel. In this case, only Mexx had been assisted by legal counsel and the wording of the contract had not been negotiated. The Supreme Court ruled that even in a situation where a textual interpretation is potentially determinative, other circumstances may lead a court to conclude that the parties meant something different from what the wording of the contract literally conveys.
The Supreme Court also considered the use of entire agreement clauses. It held that entire agreement clauses originate from common law jurisdictions and do not have a specific meaning under Dutch law. Their meaning depends on all the facts and circumstances surrounding the transaction, including whether the clause was debated or whether it was a standard provision. An entire agreement clause usually purports to ensure that parties are not bound to earlier arrangements that contradict the agreement of which the clause forms part. However, such a clause does not affect how an agreement should be interpreted. Therefore, the inclusion of an entire agreement clause in a (commercial) contract does not automatically mean that statements or conduct of the parties prior to the contract should be disregarded.
The “Haviltex formula”, expressed for the first time by the Supreme Court in 1981, is deeply rooted in Dutch legal tradition. When interpreting a contract provision, a court will try to retrieve the common intention of the parties and rely on principles of reasonableness and fairness. It will assess what parties could reasonably have understood the provision to mean and what parties could reasonably have expected from each other. For this it will not only consider the plain and natural meaning of the words but also the statements and conduct of the parties prior to, and subsequent to, the contract.
Following two Supreme Court cases in 2007 (Meyer Europe/PontMeyer and Derksen/Homburg), it became widespread opinion that for commercial contracts, concluded between professional parties, the standard for interpretation was that primary importance should be attached to the wording of the contract. On the basis of the Meyer Europe/Pont Meyer decision, it was also generally believed that an entire agreement clause in a contract was a relevant factor pointing to a textual interpretation.
In the Lundiform/Mexx judgment, the Supreme Court challenges both opinions. It clarifies that commercial contracts should also be interpreted according to the Haviltex principle, taking account of all facts and circumstances surrounding the transaction. Only if both parties are assisted by legal counsel and the provisions have been negotiated, may the wording of the commercial contract take precedence over all other factors. The Supreme Court’s decision that an entire agreement clause in itself does not point to a textual interpretation, is new.
The Lundiform/Mexx decision reduces legal certainty for contracting commercial parties, including financial service providers. It confirms that under Dutch law the interpretation of contracts is very fact-specific. The presence of legal counsel on both sides and negotiation of the terms of the contract will favour a textual interpretation. Even then, however, all other facts and circumstances remain relevant and a party will be allowed to prove that the text does not reflect the common intention of the parties. In order to enhance legal certainty, parties could include a clause in their contract that expressly provides that the contract should be interpreted on the basis of its text only. As is now made clear by the Supreme Court, an entire agreement clause is not enough.
Further informationThis case summary is part of the Allen & Overy Litigation Review, a monthly update on interesting new cases and legislation in commercial dispute resolution. For more information please contact Sarah Garvey email@example.com, or tel +44 (0)20 3088 3710.