Companies: Beware of Relying on Precontractual Negotiations

June 10, 2019

The recent decision in Merthyr (South Wales) Ltd v Merthyr Tydfil County Borough Council [2019] EWCA Civ 526, considered the extent to which precontractual material, such as precontractual negotiations or a proposal, may be relied upon in court. In this case, the Court of Appeal reiterated the rules relating to the admissibility of evidence used to adduce the objective or “genesis” and aim of a transaction, or indeed, a specific contractual provision.

Merthyr (South Wales) Ltd operated an open cast coal mining business in South Wales and was granted conditional planning permission by the local planning authority to conduct mining operations on some land. The conditions of the planning permission stated that once the mining works concluded, the company was to restore the land to its prior condition at its own cost.

Some years after the planning permission was granted, the company and Merthyr Tydfil County Borough Council entered into an escrow agreement that required the company to make quarterly payments of £625,000 into an escrow account. The agreement stated that if the company failed to make these deposits, the amount due on the next quarterly instalment date would increase by the amount unpaid. It also stated that if the company did not make payment on the final deposit date, the full sum would be due by the contractual longstop date.

The company failed to make any of the required deposits into the escrow account, so the council sought an order compelling the company to do so.

High Court Decision

At first instance, the court granted summary judgment in favour of the council and ordered the company to make the outstanding payments into the escrow account without further delay. The company appealed this decision on the basis of the interpretation of the payment obligations in the escrow agreement; namely, that an enforceable obligation did not exist until the contractual longstop date.

Court of Appeal Decision

The company sought to interpret the relevant provisions of the escrow agreement to mean that if the company was unable to make a payment, then such outstanding payments would be rolled into the next quarterly payment with the full amount payable on the longstop date with no obligation to make any payment until such date. In support of this analysis, the company sought to rely on material from precontractual documents, including the proposal for the escrow agreement and the subsequent report prepared by the council.

The court held that there are limitations on the extent to which precontractual evidence of the parties’ intention is admissible and that evidence of the factual background known to the parties is admissible only with regard to discerning the commercial aim of the transaction. The court did not agree with the company that this was to be interpreted so broadly as to allow precontractual material to point to the purpose of an individual clause within the agreement. Rather, the court considered that such material may be used only to ascertain the surrounding circumstances of a transaction in order to determine the objective aim of the parties overall.

Therefore, as the precontractual information the company sought to rely on did not provide any information relating to the overarching commercial purpose of the transaction or its application to the specific clause, the court ruled it inadmissible. The court declined to take an expansive view on the rule based on practicalities, such as the lack of certainty a written contract would provide if clauses could be interpreted in such a way.

Key Takeaways

This case reaffirms the importance of incorporating a sufficient level of detail into transaction documents to ensure that each clause gives effect to the precise intention of the parties. Whilst courts are willing and able to allow precontractual evidence that points to the overall commercial purpose of agreement, they will not allow use of such evidence to determine the meaning of a specific clause. This decision therefore serves as a reminder that all matters or terms agreed in precontractual material should be included in the definitive agreement, as it is unlikely that such material will be deemed admissible when interpreting the meaning of specific provisions in such agreements.