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Contract terms must be put to test - and then again and again

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legal matters

Drafting contracts is a tricky job into which those of us at the litigation end of the law seldom delve. Lawyers who write contracts have to 'try on' their proposed terms with several hypothetical situations to test the results in much the same way as lawyers who draft legislation have to consider the many and varied effects of their drafting. Despite the best efforts of the drafters, once a particular set of facts has arisen and the contract is looked at to see what happens next, the results are sometimes surprising and occasionally baffling.

In Casson v Ostley , a case that went to the Court of Appeal last year, two key terms in a contract between a building owner and a builder were in issue. The first placed on the owner the risk of all damage caused to work or materials other than damage caused by the builder's negligence. The second gave the owner the risk of all fires and obliged him to insure against it, with no mention of fires caused by the builder's negligence being treated any differently.

There was a fire. The parties went off to court to ask, assuming that the fire had been caused by the builder's negligence, who was to carry the risk of the damage. The judge in the first instance decided that the builder was exempt from liability. The Court of Appeal disagreed.

In giving his judgment in the Court of Appeal, Lord Justice Sedley observed that, although words may appear quite straightforward, they may make little or no sense when applied to real situations, and cited the example of a proposal to put a World War Two tank on a plinth in a park regulated by a bye-law banning motor vehicles.

His Lordship went on to say that construing a contract may call for significant creativity. 'Construction has two meanings, one derived from the verb to construe, the other from the verb to construct. It may be as well to admit that under the guise of the first, the courts in cases like this are doing the second.

'We mitigate the uncovenanted effects of literalism, not by nakedly writing a new contract for the parties but by construing the words according to principles which enable the contract, in effect, to be reconstructed.'

As to the Court of Appeal's reasoning in this particular case, the builder used its standard terms. The builder drafted them, so it could have clearly and unambiguously exempted itself from particular liabilities. As to what the other side intended, the court's starting point was that one party does not ordinarily agree to absolve the other of its negligence. It followed that any ambiguity in the builder's terms was to be resolved against it.

The court applied a three-step test. First, was the builder expressly exempted from liability for damage caused by a negligently started fire? It was difficult to reconcile the two clauses and, resolving the doubt against the builder, the answer was no. If the answer had been yes, the exemption would have been effective, subject to possible arguments as to fairness.

As the contract did not do what the builder wanted on the first step of the test, the court moved on to the second. Although not expressly saying so, were the words wide enough to protect the builder from liability for a fire started due to negligence? Yes.

The court then asked the third question posed by the test: while the words were wide enough, was there another plausible way by which a fire might have started? If so, the contract wording had a sensible commercial purpose even if it did not protect the builder from the consequences of its own negligence. That would be fatal to the builder's contentions. The court decided there were several ways the builder could find itself liable for the consequences of fire started other than by its own negligence, for example acts of third parties.

It followed that there was no effective exemption from liability for fires that started because of negligence .

So exemption clauses must be as clear as possible if they are to work (although even then they may be ruled unfair). More generally, when looking at contract terms, remember to consider how they might work in a variety of circumstances.And hope that something even stranger does not crop up.

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