Court of Appeal finds that the test for assessing the parties’ intention in rectification for common mistake cases is both objective and subjective

The claimant, FSHC Group Holdings Ltd, claimed rectification of two deeds executed in November 2016 which provided security over a shareholder loan that FSHC had previously agreed to provide in connection with a corporate acquisition in 2012, but which was missing from the original documentation. The defendant, GLAS Trust Corporation Ltd, was the other party to the deeds.

At first instance, the judge found that when the deeds were executed both parties understood and intended them to do no more than provide the missing security. However, the mechanism chosen to achieve this had the effect of not only providing the missing security, but of imposing additional, onerous obligations on FSHC. The judge found that no one involved in the transaction realised before or at the time of execution of the deeds that this was their effect. He also concluded that it was both “objectively” and “subjectively” the common intention of the parties to execute a document that did no more than provide for the missing security. Accordingly, he granted rectification of the deeds so as to exclude the additional obligations.

GLAS appealed the decision, arguing that the test for rectification is purely “objective” and that the judge was wrong to hold that, objectively assessed, the parties had a common intention that was not accurately reflected in the deeds, which included the additional obligations.

Giving the lead judgment (with which Rose LJ and Flaux LJ agreed), Lord Justice Leggatt noted that in Chartbrook Ltd v Persimmon Homes Ltd [2009] UKHL 38, Lord Hoffmann said that where the document in question is a written contract, the relevant test of intention is purely “objective’”, i.e. what a reasonable observer with knowledge of the background facts and prior communications between the parties would have thought their common intention at the time to be.

However, Leggatt LJ said, it is recognised that these observations were obiter dicta and therefore do not create a binding precedent. Nevertheless, since that judgment great weight has been given to them. At the same time, he said, Chartbrook runs contrary to a substantial body of learning and authority.

Leggatt LJ agreed with Lord Hoffmann that rectification “may be regarded as a branch of the doctrine of specific performance”. He agreed that if parties make a binding agreement to execute a document containing particular terms, but instead execute a document containing different terms, the court may specifically enforce the agreement by rectifying the document. Further, in such a case, the terms of the contract to which the subsequent document is made to conform must be objectively determined in the same way as any other contract.

However, Leggatt LJ did not accept that the same reasoning could be applied to a situation in which parties have not made any prior contract, but have a common continuing intention in relation to a particular matter in the document sought to be rectified. Where the analysis in Chartbrook went awry, he said, was in regarding rectification to reflect a common intention where there is no prior contract as also based on the principle that agreements must be kept.

In Leggatt LJ’s view, the principle that a contract should be reformed so as to enforce what the parties have (objectively) agreed has no validity where the prior “agreement” is not a legally binding contract, but a non-binding expression of intent. There is no principle which requires or justifies a court in holding the parties to the terms of an objective consensus reached during negotiations, but never intended to be binding. Further, the principle that parties should keep their promises to each other does not justify giving such a consensus priority over the terms of a formal written contract by which (objectively) the parties intended to be bound. To adopt this course would be to impose on the parties a contract they never made in place of one that they did make.

The justification for rectifying a contractual document to conform to a “continuing common intention” is therefore not found in the principle that agreements (objectively determined) must be kept. Instead, it rests on the equitable doctrine that a party will not be allowed to enforce the terms of a written contract, objectively ascertained, when to do so is inconsistent with what both parties in fact intended (and mutually understood each other to intend) those terms to be when the document was executed. This basis for rectification is therefore entirely concerned with the parties’ subjective states of mind.

Leggatt LJ noted that interpreting a contract objectively has many practical advantages, as it enhances the ability of parties to plan and act in reliance on contracts. However, the reasons for enforcing a contract in this way lose their force where the parties had an agreed understanding or common intention in relation to a particular provision, but the contract as objectively interpreted does not reflect that common intention. In such a situation, provided the common intention is clearly demonstrated, there is no sound justification for giving effect to the meaning that a hypothetical reasonable observer would have attributed to the words used in preference to what the parties actually intended the effect of their contract to be, he said.

There is therefore no anomaly in applying an objective test where rectification is based on a prior concluded contract and a subjective test where it is based on a common continuing intention.

In addition, Leggatt LJ said, applying a purely objective test of intention is inconsistent with authority binding on the Court of Appeal. It is also inconsistent with the law that applies to the rectification of unilateral documents, where it is settled law that it is a party’s actual intention that matters. In addition, it is inconsistent with how the doctrine of rectification is understood and applied in other common law jurisdictions.

Leggatt LJ found that Lord Hoffman’s obiter remarks in Chartbrook therefore do not correctly state the law. Before a written contract can be rectified on the basis of a common mistake, it is necessary to show that either: (i) the document fails to give effect to a prior concluded contract; or (ii) when they executed the document, the parties had a common intention in respect of a particular matter which, by mistake, the document does not accurately record. In the latter case it is necessary to show not only that each party to the contract had the same actual intention with regard to the relevant matter, but also that there was an “outward expression of accord”, meaning that, as a result of communication between them, the parties understood each other to share that intention.

The judge at first instance had found that when the parties executed the accession deeds, they each intended to execute a document that satisfied FSHC’s obligation to grant security over the shareholder loan and did no more than that. Further, communications between the parties showed that this was the parties’ common understanding. In other words there was a shared common intention. The appeal was dismissed. (FSHC Group Holdings Ltd v GLAS trust Corporation Ltd [2019] EWCA Civ 1361 (31 July 2019) — to read the judgment in full, click here).