How are contracts interpreted?

Although there is no simple set of written laws or rules on how terms may be construed and interpreted (much depends on the facts of each case), some general principles and rules of contract interpretation have been created by case law.

The following five principles set out by Lord Hoffman in Investors Compensation Scheme v West Bromwich Building Society (1998) have become the leading statements on the interpretation of contracts:

1. It is an objective test as to what a reasonable person, having all the background knowledge reasonably available, would have understood the contract to mean at the time of contracting: 
2. Account can be taken of background knowledge and matrix of fact, where such is relevant; 
3. Previous negotiations and subjective intent are excluded (with a few exceptions—eg rectification cases); 
4. The meaning of words used is to be considered in the specific context of the contract as a whole, understood against the factual background; 
5. A common sense approach that the language used is to have its natural and ordinary meaning should be adopted.

In working out the objective meaning of a contractual provision, the courts will look to both the wording of a provision as well as the commercial context in which it was drafted. The court will consider: 

• The natural and ordinary meaning of the provision. 
• Any other relevant provisions of the contract.
• The overall purpose of the provision and of the contract.
• The facts and circumstances known or assumed by the parties at the time the contract was signed.
• Commercial common sense.

The extent to which each is used will vary according to the circumstances. 

The English courts sometime use certain "rules of thumb" when trying to be fair to the parties. But, these are just pointers and the courts will only apply them if a meaning cannot be found using the general rules of interpretation outlined above.

• The court will be reluctant to adopt a meaning that gives an unfair result in the absence of clear drafting. 
• Usually the court will resolve any uncertainty or doubt surrounding a provision against the party who would benefit from the suggested interpretation. This is the so-called "contra proferentem" rule (see below in more detail) whereby the clause is interpreted against the party seeking to rely on it. It applies in particular to the party seeking to take the benefit of an exclusion or limitation of liability. However, recent cases indicate that the rule has a very limited role in relation to commercial contracts negotiated between sophisticated parties of equal bargaining strength.
• Where the preceding words are each part of a common genus or category, subsequent words will be interpreted "ejusdem generis", i.e. read as being part of that same class, in the absence of a contrary indication. So, for example, the words "or other natural disaster" in a provision refering to "fire, flood, storm, tempest" means other similar disasters.

The contra proferentem rule is a principle of contract interpretation that applies when there is ambiguity or uncertainty in the wording of a contract. 

It states that any ambiguity or uncertainty should be resolved against the party who drafted or presented the contract (the proferens). In other words, if there is a dispute or disagreement about the meaning of a contract term, the term will be interpreted against the interests of the party who drafted it.

The rationale behind the contra proferentem rule is to encourage parties to draft clear and unambiguous contracts. It places the burden on the party with greater control over the contract's wording to ensure that the terms are clear and accurately reflect their intentions. 

If the language used in the contract is unclear or susceptible to multiple interpretations, the rule favours the interpretation that is most favorable to the party who did not draft the contract. 

It is important to note that the contra proferentem rule is a rule of last resort and is only applied when other methods of interpretation, such as considering the context and purpose of the contract, have failed to resolve the ambiguity. 

Additionally, the rule is generally applied in cases of standard form contracts or contracts where one party has significantly more bargaining power than the other.

Overall, the contra proferentem rule serves as a safeguard to protect parties who may be at a disadvantage in contract negotiations and encourages clarity and precision in contract drafting.

See also article on Pre-contract discussions- their importance

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