Egan v Static Control Components (Europe) Ltd.

This is an appeal from a decision and order of Mr Recorder Hinchliffe QC sitting in the Oldham County Court. He heard the evidence and argument in June 2003 and circulated his written, reserved judgment in early July; but the order itself was made and dated 10th November 2003. He held the appellant, Mr Paul Egan, liable under a guarantee and gave judgment for the claimant in the sum of £111,883.82 plus interest. Mr Egan now appeals with the permission of Tuckey LJ.

The claimants are Static Control Components (Europe) Limited (“Static Control”). For several years they had regularly supplied components to TBS Cygma PLC (“TBS”). The defendant, Paul Egan, was a director of TBS. Mr Egan personally signed four successive guarantees under which he guaranteed payment to Static Control of certain of the debts of TBS. The first guarantee was signed on 16^th February 1998. It was expressed to expire on 16^th August 1998 and contained a limit of £75,000. The second was signed on 17^th August 1998. It was expressed to expire after 6 months and again contained a limit of £75,000. Both these guarantees were in very “home made” terms. The third guarantee was signed on 25^th September 1998 and was in terms drafted and proffered by Static Control. In fact, apart from the identity of the parties, it was in identical terms to a standard precedent, Form 3, on page 358 of the Encyclopaedia of Forms and Precedents, Volume 17 (2), and must have been obtained directly or indirectly from that source. So far as is material, it read as follows:-

“To Static Control Components (Europe) Ltd.

[address]

Guarantee for supply of goods

IN CONSIDERATION of your having agreed at my request to supply TBS [address] (“The Trader”) with goods for his business, supply of component parts (“Trade Goods”)

NOW I Paul Egan of TBS Cygma PLC AGREE that:-

Pausing there, this guarantee contained no time limit although the right was reserved to revoke it at any time by notice, as to all dealing after the date of such notice.

By 1^st September 1999 goods to the value of just over £143,000 had been supplied but not paid for. Of that sum, just over £68,000 was already overdue as at 1^st September 1999, and by 11^th October 1999 the debt would stand at £143,000 less any amounts paid in the meantime.

Static Control were clearly very concerned about this situation. They wrote a letter dated 1^st September 1999 which required the “overdue balance” of £143,138 to be cleared by six weekly payments of £23,856 made on and between 6^th September and 11^th October inclusive. The letter continued “No product will be released until such times as overdue balance has been settled in full…….. Failure to adhere to the terms set out in this letter will result in the enforcement of the personal guarantee and legal proceedings being issued to recover the balance plus costs and interest….” On 2^nd September 1999 Mr Andrew Jones, the audit manager of TBS, attended a meeting at the premises of Static Control. At paragraph 6 of his judgment the recorder held that “There is no doubt, in my mind, that at that meeting it was made clear to Mr Jones that the claimant required an increase in the personal guarantee from Mr Paul Egan from £75,000 to £150,000. At that time goods to the value of a little over £143,000 had been supplied and the claimant was concerned as to the ability of TBS to make payment in respect of goods already delivered.”

At the meeting, Static Control and Mr Jones, on behalf of TBS, agreed that (i) further stock would be supplied, subject to a limit of £12,000 per week; (ii) the period of credit would be reduced to 45 days from date of invoice; and (iii) there would be a schedule of payments so as to reduce the overall level of credit and debt.

On the same day, 2^nd September 1999, Mr Egan signed the fourth guarantee. This was in identical terms to that of 25^th September 1998 and quoted at paragraph 2 above, with the sole but major difference that maximum liability was now £150,000 in place of £75,000.

In May 2000 TBS was placed into administrative receivership. At that time TBS owed Static Control £111,883.82. There had been “substantial trade between the companies after 2^nd September 1999” but “the vast majority of goods supplied and delivered to TBS after that date were in fact paid for” (see paragraph 2 of the judgment). In short, the bulk of the outstanding debt of £111,883 related to goods supplied before 2^nd September 1999.

Mr Egan contended, and contends, that the guarantee signed on 2^nd September 1999 only bound him to be responsible for the price of goods supplied after that date. If this was correct, then “any debt covered by the guarantee is modest in the extreme” (judgment paragraph 2). Apparently, the amount would be just under £14,000. However, the recorder held that the guarantee bound Mr Egan to pay debts arising before and existing at that date, as well as debts from the supply of goods after that date. So he gave judgment, as I have said, in the full amount of £111,883.82.

At trial and before us, Mr Egan was most ably represented by counsel, Mr Richard Lander. In summary, he submits that a guarantee should be construed strictly; that the words of the document itself are clear; and that they should be given their true and natural meaning. He submits that the full extent of any liability is described and defined by the first limb of paragraph 1, namely “I shall be responsible to you for the price of all trade goods that you may supply to the trader.” The words “you may supply” can only refer to the future and are not apt to relate to the price of goods already supplied. He submits that the remainder of paragraph 1, namely the words “but so that my liability to you shall be in respect of the whole debt but shall in no event exceed the sum of £150,000”, are all words of limitation, particularly as they begin with the word “but” rather than “and”. He points out that the whole guarantee is obviously taken, directly or indirectly, from the Encyclopaedia of Forms and Precedents and has shown us an explanation in the Encyclopaedia for the purpose of, and effect of, the words “shall be in respect of the whole debt” where they appear in paragraph 1. The explanation is that “If the guarantor guarantees only part of the debt and pays the creditor the amount for which he is liable, then if the debter becomes bankrupt, the creditor can only prove in the debtor’s bankruptcy for the balance of the debt, but the guarantor can prove in the same bankruptcy to recover the amount he has actually paid. However, in the case of a guarantee of the whole debt, subject to a limit on the amount that can be recovered from the guarantor, the creditor can prove for the whole debt in the bankruptcy of the debtor, even though the guarantor may have paid, and the guarantor cannot prove in his own right until the creditor has received a dividend of 100p in the pound. A guarantee should therefore be so worded as to put the matter beyond doubt”. (see the Encyclopaedia, Form 3, footnote 2; Form 2, note 2 [3274]; and paragraph 20 [3094] on page 329.) As shorthand, I will call this “the subrogation point.” A further account of the point may be found in Rowlatt on Principal and Surety (5^th Edition) (1999), paragraphs 4 – 39 to 4 – 41.

At paragraph 17 of his judgment, the recorder agreed that if the words “shall be in respect of the whole debt but” were omitted from paragraph 1, then he “would have no hesitation in finding that the guarantee was clear and unambiguous and was designed only to cover the supply of trade goods from the 2^nd September 1999.” However, he considered that the guarantee including those words “could relate only to the debt created from that date, but equally, it could relate to debt which existed at the time he entered the guarantee. I believe it is capable of more than one meaning. Accordingly, in my judgment, I am entitled to look at the surrounding circumstances in order to identify the scope and object of the guarantee. In my judgment it is necessary for the court to construe the guarantee in such a way as to reflect what may fairly be inferred to have been the objective intention and understanding of the parties.” (paragraph 21). The recorder concluded that the guarantee was intended by both parties to extend, and did extend, to the whole trading debt both before and after 2^nd September 1999.

Mr Lander has drawn our attention, as he did that of the recorder, to paragraphs 4.02 and 4.06 in Chapter 4, Construction, of Andrews and Millett, The Law of Guarantees (3^rd Edition) (2000). These describe a general approach that contracts of suretyship “must be strictly construed so that no liability is imposed on the surety which is not clearly and distinctly covered by the terms of the agreement.” But paragraph 4.02 begins with the words “There is a substantial body of authority which indicates that contracts of suretyship are to be construed in the same way as any other contract.” And later, “… the court is entitled to look at the surrounding circumstances in order to identify the scope and object of the contract of suretyship, to the same extent that it would be entitled to look at the factual matrix as an aid to the construction of any other commercial agreement. A guarantee must be given a reasonable interpretation within the context in which it has been given.” Further, the chapter begins with an Introduction, paragraph 4.01, which includes “… a word of caution….one must never lose sight of the fact that ultimately what has to be determined is the intention of the parties to the contract in question. Thus factors such as the context in which a phrase occurs, the wording of other parts of the contract and the factual matrix, may result in identical or similar wordings being given completely different interpretations in two different guarantees.”

In my view the principles described by Lord Hoffmann in Investors Compensation Scheme Ltd v West Bromwich Building Society [1998] 1 WLR 896 at 912 H – 913 F apply to the construction or interpretation of this, or any other, guarantee. Mr Lander placed some reliance upon the particular words under consideration in section 3 (b) of the claim form in ICS v West Bromwich in an attempt to limit the application of the “principles” to a case such as that, in which the relevant wording itself was (in the words of Lord Hoffmann) very strange and badly drafted. But in my view, application of the passage and principles at 912 F – 913 E was not intended to be so limited, and is not and has not been treated as being so limited.

Lord Hoffmann said:

“The principles may be summarised as follows.

(1)

Interpretation is the ascertainment of the meaning which the document would convey to a reasonable person having all the background knowledge which would reasonably have been available to the parties in the situation in which they were at the time of the contract.

(2)

The background was famously referred to by Lord Wilberforce as the “matrix of fact.” But this phrase is, if anything, an understated description of what the background may include. Subject to the requirement that it should have been reasonably available to the parties and to the exception to be mentioned next, it includes absolutely anything which would have affected the way in which the language of the document would have been understood by a reasonable man.

(3)

The law excludes from the admissible background the previous negotiations of the parties and their declarations of subjective intent. They are admissible only in an action for rectification…..

(4)

The meaning which a document (or any other utterance) would convey to a reasonable man is not the same thing as the meaning of its words. The meaning of words is a matter of dictionaries and grammars; the meaning of the document is what the parties using those words against the relevant background would reasonably have been understood to mean. The background may not merely enable the reasonable man to choose between the possible meanings of words which are ambiguous but even (as occasionally happens in ordinary life) to conclude that the parties must, for whatever reason, have used the wrong words or syntax.

(5)

The “rule” that words should be given their “natural and ordinary meaning” reflects the common sense proposition that we do not easily accept that people have made linguistic mistakes, particularly in formal documents. On the other hand, if one would nevertheless conclude from the background that something must have gone wrong with the language, the law does not require judges to attribute to the parties an intention which they plainly could not have had. Lord Diplock made this point more vigorously when he said…. “if detailed semantic and syntactical analysis of words in a commercial contract is going to lead to a conclusion that flouts business commonsense, it must be made to yield to business commonsense.””

I now turn to interpret the guarantee in this case, applying the principles of ICS v West Bromwich. The end question is: what meaning would it convey to a reasonable person having all the background knowledge which would reasonably have been available to the parties at the time of the contract? That background knowledge or matrix of fact would include the following:

i)

There had been a long period of trading between the companies,underpinned since February 1998 by successive guarantees by Mr Egan.

ii)

As at 1^st September 1999 TBS were overdue in payments to the extent of £68,000 and the debt would rise by 11^th October to £143,000 less any amounts paid in the meantime.

iii)

By their letter of 1^st September 1999 Static Control had stated that they would not supply any further goods until the overdue balance (defined in the letter as £143,138) had been paid in full.

iv)

Nevertheless, under the then - existing guarantee signed on 25^th September 1998 Static Control had security against Mr Egan for the first £75,000 of that debt.

v)

The terms agreed with Mr Jones at the meeting on 2^nd September1999 were such that both companies intended and contemplated that the debt referable to goods supplied after that date could not exceed about £72,000. The ceiling on stock to be supplied was £12,000 per week and the period of credit was to be reduced to about 6 weeks (45 days).

vi)

An undoubted effect of the guarantee signed on 2^nd September 1999 (indeed its only difference from the previous one) is to increase the ceiling of liability from £75,000 to £150,000.

Informed by that background, any reasonable person would, in my view, reason as follows.

I agree with Mr Lander that there is a tension between the words “you may supply” in the first limb and the reference to “the whole debt” in the second. But viewed in this way, “something must have gone wrong with the language”. Any reasonable person would consider that paragraph 1 as a whole was intended to extend, and did extend, to both the existing and the further future debt.

Mr Lander submitted that if a guarantee in these terms was signed at the start of a trading relationship there would no pre-existing debt. Accordingly the words “shall be in respect of the whole debt” could not refer to a pre-existing debt and could only be referable to, and explicable by, the subrogation point. I agree, of course, that at the start of a trading relationship there would be no pre-existing debt and so in such a case the wording may relate only to the subrogation point. But the argument misses the point that the words are capable of more than one meaning or purpose. The factual matrix of this case and this guarantee is that there had been previous trading; there were previous guarantees; and there was a pre-existing debt.

Mr Lander submitted that to adopt the construction that I have would be “creative” or involve “rewriting” the guarantee, and would fail to respect the approach of construing a guarantee strictly. I cannot accept the submission. There has been no creativity and no rewriting; but simply ascertainment of the meaning of the document by the objective approach described by the House of Lords. That being the task, it may be that the concept that a guarantee should be “strictly construed” now adds nothing.

For these reasons I consider that the recorder was right to give judgment for the full amount (not exceeding £150,000) still due from TBS to Static Control and I would dismiss this appeal.

Since preparing this judgment I have read in draft the judgment of my Lady, Arden LJ, with which I agree.

I agree. I gratefully adopt Holman J’s statement of the facts and use his abbreviations.

This case raises some important points of principle on the interpretation of documents generally, and in particular guarantees, in the light of their factual background. Mr Richard Lander, for the appellant, submits as his primary submission that the meaning of the guarantee dated 2 September 1999 is plain. He submits that Mr Paul Egan, the guarantor, promised to be responsible only “for the price of all Trade Goods that you may supply to the trader”. The words “that you may supply to the trader” are, he submits, plainly goods to be supplied after the date of the guarantee. He accepts that the factual background to the execution of the guarantee is admissible, but, on his submission, it cannot be used to alter or qualify the plain meaning of the guarantee on its face.

The short answer to the last part of this submission is that it is contrary to the decision of the House of Lords in Prenn v Simmonds [1971] 1 WLR 1381, and other cases. It is necessary to explain, in more detail, why that is so. Prenn v Simmonds made it clear that, in the construction of documents, “the factual background, known to both parties at or before the time of the contract, including evidence of the “genesis” and objectively the “aim” of the transaction” is receivable in evidence (page 1385). Moreover, in that case, at page 1384, Lord Wilberforce, with whom the other members of the House agreed, accepted the effect of such evidence might be, in the words of Cardozo J in Utica City National Bank v Gunn (1918) 118 N.E. 607 at 608, to “stamp upon a contract a popular or looser meaning” than the strict legal meaning, certainly when to follow the latter would make the transaction futile.

The facts of Prenn v Simmonds illustrate the role of the factual background on questions of construction. The contract in question conferred on Dr Simmonds an option to purchase shares in the company if the “profits” of the company available for dividend on its ordinary stock in a particular four year period were £300,000 or more. The company’s own profits in the relevant period were below £300,000, but the condition was met if the reference to the profits of the company was construed as a reference to the consolidated profits of the company and its subsidiaries. The purpose of the agreement was to secure the services of Dr Simmonds. In return he was to be able to acquire an equity interest in the company if he remained with the company and the company earned sufficient profits to enable it to redeem preference stock held by its former holding company. For this purpose, a payment of £294,716 had to be made out of the company’s own profits. The company was not a trading company, but held the shares in a number of subsidiary companies. If the reference to “profits” of the company was only to its profits, the other contracting party, Mr Prenn, being the majority shareholder in the company, could always effectively prevent the company from procuring its subsidiaries to pay any dividends to it. The House of Lords held that the reference to “profits” was to be construed as a reference to the consolidated profits of the company and its subsidiaries so as to achieve the aim of the transaction and to make the agreement accord with commercial sense. In addition, Lord Wilberforce added that the linguistic arguments pointed the same way.

The principle enunciated in Prenn v Simmonds was developed by Lord Hoffmann in two more recent cases and applied to the situation where the interpretation of an instrument in the light of its factual background differed from its purely linguistic construction. In the first case, Mannai Investment Ltd v Eagle Star Life Assurance Co Ltd [1997] AC 749, the House of Lords held that a notice to determine a lease could be construed with the benefit of knowledge of the terms of the lease. Even though it gave the wrong date, the notice would have been reasonably clear to a reasonable recipient with knowledge of the terms of the lease and thus it should be construed as referring to the correct date. At 779F, Lord Hoffmann said:-

“In the case of commercial contracts, the restriction on the use of background has been quietly dropped. There are certain kinds of evidence, such as previous negotiations, expressed declarations of intent which for practical reasons which it is unnecessary to analyse, are inadmissible in aid of construction. They can be used only in an action for rectification. But apart from these exceptions, commercial contracts are construed in the light of all the background which could reasonably have been expected to have been available to the parties in order to understand what would objectively have been understood to be their intention: Prenn v Simmonds [1971] 1 WLR 1381, 1383. The facts that the words are capable of a literal interpretation is no obstacle to evidence which demonstrates what a reasonable person with knowledge of the background would have understood the parties to mean, even if this compels one to say that they used the wrong words. In this area we no longer confuse the meaning of words with the question of what meaning the use of the words was intended to convey.”

This approach was elaborated by Lord Hoffmann in the ICS case, particularly in the passage which Holman J has already set out. Lord Hoffmann’s principle (1) in that passage makes it clear that there are not two possible constructions in any given situation, namely a purely linguistic one and one in the light of the factual background, but only one, the true interpretation. This is because the object of interpretation is to discover the meaning of the provision in question in its context. Those points are also made clear in the final sentence of the passage I have cited above from the Mannai Investment and also in Lord Hoffmann’s proposition (4) in the ICS case. Thus, in principle, all contracts must be construed in the light of their factual background, that background being ascertained on an objective basis. Accordingly, the fact that a document appears to have a clear meaning on the face of it does not prevent, or indeed excuse, the court from looking at the background. For these reasons, I would reject the appellant’s primary submission and hold that the Recorder was correct in looking at the background to the signing of the guarantee.

Lord Hoffmann’s principles (4) and (5) in the ICS case, set out in the judgment of Holman J, also make the point that the effect of construing a document in the light of the relevant factual background may be that it becomes clear, in the exceptional case, that the parties have made a mistake in the way in which they have expressed themselves. This is particularly understandable in the case of a commercial contract made under pressure of time by business people. True, in the present case, they were using the precedent of the earlier guarantee dated 25 September 1998, which was apparently drafted by Static Control’s solicitors. (It was Static Control who adapted it, and it probably did so without any legal input.) When the court interprets a document, it is not bound to make the unreal assumption that the parties expressed themselves with accuracy or precision. The court looks to the parties’ common aim or intention in reducing an agreement in writing and the evidence as to the background information may lead to the conclusion that the parties have failed to express themselves accurately.

When the principles in the ICS case were first enunciated, there were fears that the courts would on simple questions of the construction of deeds and documents be inundated with background material. Lord Hoffmann recognised this risk by emphasising in BCCI v Ali [2002] 1 AC 251 at 269 that his reference to “absolutely anything” in his second proposition was to anything that a reasonable man would have regarded as relevant. Speaking for myself, I am not aware that the fears expressed as to the opening of floodgates have been realised. The powers of case management in the Civil Procedure Rules could obviously be used to keep evidence within its proper bounds. The important point is that the principles in the ICS case lead to a more principled and fairer result by focussing on the meaning which the relevant background objectively assessed indicates that the parties intended. Lord Hoffmann prefaced his propositions in the ICS case by saying that the result of the approach in Prenn v Simmonds and the later case of Reardon Smith Line Ltd v Yngvar Hanson-Tangen [1976] 1 WLR 989:-

“has been, subject to one important exception, to assimilate the way in which such documents are interpreted by judges to the common sense principles by which any serious utterance would be interpreted in ordinary life. Almost all the old intellectual baggage of ‘legal’ interpretation has been discarded.” (page 912).

The important exception is set out in Lord Hoffmann’s principle (3).

In the present case, the principal elements of the background are summarised in paragraph 15 of the judgment of Holman J. As he states elsewhere in his judgment, there had also been a meeting on the 2 September 1999 between representatives of the respondent and Mr Jones, a representative of the appellant. At this meeting the parties agreed that Static Control would continue to supply product to TBS on terms that the existing guarantee for £75,000 given by Mr Egan would be increased to £150,000, and that the existing debt would be repaid by agreed instalments. The credit limit was to be kept below £150,000 by the appellant taking stock of no more than £12,000 per week commencing from 6 September 1999.

The judge also found that Mr Egan, who was not present at the meeting, also knew that the guarantee was to be increased, not simply substituted by a guarantee for future supplies only. However, I proceed on the basis that that particular fact would not have been known to a reasonable person in possession of all the information available to the parties at or before the time that the guarantee was signed (Lord Hoffmann’s principle (1)). He would not necessarily know what Mr Jones had told Mr Egan. However, for the purpose of Lord Hoffmann’s principle (1) he would in my judgment make the assumption that Mr Jones would have correctly informed Mr Egan of what was agreed at that meeting.

The reasonable person for the purpose of Lord Hoffmann’s principle (1) would also know was that there was an outstanding debt of £143,000 odd, then either immediately due or about to become immediately due, and that the limitation in the guarantee of £150,000 made no commercial sense except in the context of both the outstanding and future debt. He would also know that it was not the communicated or common intention of the parties that a guarantee should be given in substitution for the existing guarantee. That would effectively leave Static Control without any security for the existing debt. The agreement between the two companies was that the guarantee would have to be increased.

The reasonable person for the purpose of Lord Hoffmann’s principle (1) would, therefore, approach the interpretation of the document with all that information in mind. The reasonable person is not required to have any specialist experience, and so (in the absence of evidence that the parties themselves jointly addressed this point) in my judgment, he is not to be taken to know that the purpose of the words “so that my liability to you should be in respect of the whole debt” was so as to prevent the guarantor from sharing in any right of proof of the creditor in a liquidation of TBS until Static Control had been repaid in full. However, the reasonable person would see that the words “the whole debt” were unqualified. They are not limited to the debt in respect of the supply of future goods, though if there had been no pre-existing debt the words would naturally be so limited. The reasonable person would also know that the form of guarantee presented to Mr Egan for signature was the same as the guarantee previously executed by him and limited to £75,000, with the figure of £75,000 removed and substituted by the figure of £150,000. He would draw the conclusion that the previous guarantee might have been used simply because it was a convenient precedent.

The reasonable person for the purpose of Lord Hoffmann’s principle (1) would also know that, if the appellant’s construction were right, it would have been sufficient if the guarantee were limited to £72,000 since that was the maximum amount that would be outstanding under the new terms of business. Mr Richard Lander seeks to meet this point by submitting that the parties may have inserted the figure of £150,000 to give a margin in case matters should slide or there was a change in the limit. In my judgment, this is not a credible explanation. It would involve doubling the expected amount that would be outstanding at any one time for goods delivered after 2 September 1999.

Mr Lander submits that the terms offered at the meeting on 2 September 1999 constitute matters of negotiation which are not relevant to interpretation of the guarantee. I would reject this submission since the terms were accepted by TBS and therefore were removed from the realm of mere negotiation into a concluded agreement between TBS and Static Control. Their agreement is part of the relevant background.

Given the unqualified reference to “the whole debt” and the limitation to the figure of £150,000, which only made sense in the context of both the existing and future debt, the reasonable person for the purpose of Lord Hoffmann’s principle (1) would, in my judgment, conclude that something had gone wrong with the wording of the first part of clause 1 of the guarantee. He would conclude that the words “that you may supply to the trader” meant not only goods that Static Control might supply to TBS after the date of the guarantee but also any goods that it had already supplied to TBS. Accordingly, even though the words “goods that you may supply to the trader” on their literal interpretation, without reference to the background mean and mean only goods supplied to TBS after the date of the guarantee, in my judgment, on their true construction they clearly include also the goods that had already been supplied to the trader. The contrary construction would reduce Static Control’s security for the unpaid indebtedness (not increase it as agreed), and this result would make no business sense. The parties have, like Mrs Malaprop, made an obvious mistake. In summary, this case is therefore an illustration of Lord Hoffman’s principle (5) in the ICS case.

At the start of his submissions, Mr Lander made a submission which I ought to mention that the guarantee in this case should be construed contra proferentem, that is against Static Control who produced it for Mr Egan to sign. That canon of construction can only apply if a document, properly interpreted, admits of doubt. Moreover, the issue here is not whether Static Control has put forward a form of guarantee which removes by unclear language incidents of a guarantee to which a guarantor would be entitled by operation of law. Nor is the provision in question one as to which there is no relevant background evidence. In this case, the issue is as to the scope of the guarantee. That issue can be resolved by referring to the relevant background evidence. Accordingly, this is a situation where, in my judgment, the rule of contra proferentem has no place and should be discarded. There is no reason of public policy why guarantees should not in general be construed in accordance with the principles of interpretation enunciated in Prenn v Simmonds and the ICS case.

In the circumstances, I too would dismiss this appeal.