1. Start (and end) with what the contract says

The words in the document are the starting point, and commonly the end point, for questions of interpretation.

In Bank of Credit and Commerce International SA (in compulsory liquidation) v Ali [2001] UKHL 8 the court considered whether the defendant employees who had been made compulsorily redundant by the plaintiff bank had validly released the bank from potential claims under a settlement agreement. The court held that there were no special rules of interpretation applicable to a general release, which was to be construed in the same way as any other contract, the question being the intention of the parties ascertained objectively in the context of the circumstances in which the release had been entered into. In clarifying his earlier judgment that any factual background should be taken into account when interpreting a contract Lord Hoffmann said that:

"The primary source for understanding what the parties meant is their language interpreted in accordance with conventional usage."

The senior courts have issued a series of warnings to judges, not to disregard or override the literal wording of the contract in pursuit of commercial common sense. In Arnold v Britton [2015] UKSC 36, Lord Neuberger said:

“the reliance placed in some cases on commercial common sense and surrounding circumstances … should not be invoked to undervalue the importance of the language of the provision … the clearer the natural meaning the more difficult it is to justify departing from it.”

2. Parties' intention assessed objectively

An objective test is used for ascertaining the intention of the parties to the contract. Their actual or subjective intentions are irrelevant. The standpoint of a reasonable businessperson is adopted. Where the contract is in writing, what the parties have written, rather than what they intended to write, constitutes the agreement.

It follows that the parties' declarations of subjective intent are not relevant or admissible on a question of contract interpretation. (They are admissible in a claim for rectification.)

3. Business common sense

The language should be read in accordance with common sense, and not in a pedantic or literal way.

In Antaios Compania SA v Salen AB (The Antaios) [1985] AC 191 heard an appeal against an arbitration award where one of the principal issues had been whether owners were entitled to withdraw a vessel on discovering that the charterers had issued incorrect bills of lading. The owners relied on what they said was 'the literal meaning of the words in the clause' (which stated that the owners can withdraw the charter party in the case of "any other breach of this charter party"). The tribunal rejected this interpretation and ruled that a repudiatory breach was meant: “We would say that if necessary, in a situation such as this, a purposive construction should be given to the clause so as not to defeat the commercial purpose of the contract.” The court confirmed the award and stated that:

"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".

In Rainy Sky SA and others v Kookmin Bank [2011] UKSC 50 a shipbuilder entered into six contracts with purchasers to build and sell vessels. The purchases paid instalments on account of the purchase price and the shipbuilder arranged bank refund guarantees for the purchasers relating to the instalments. The shipbuilder went insolvent and refused to repay the instalments and so did the bank arguing that the guarantee did not extend to an insolvency event. The judge in the Commercial Court held that the construction of paragraph 3 of the bonds had two possible meanings (one covering the insolvency and one not) but that the construction contended for by the bank would have an uncommercial result and gave summary judgment for the claimants. The bank appealed but conceded that the two different interpretations of paragraph 3 advanced by the bank and by the claimants were both arguable. The Court of Appeal held, by a majority, that the construction contended for by the bank would not produce an absurd or irrational result and that it was not sufficient to say that no credible commercial reason had been advanced for the limited scope of the bonds as that would put the court in danger of substituting its own judgment of the commerciality of the transaction for that of the parties. Accordingly, the Court of Appeal allowed the appeal and gave summary judgment for the bank.

The Supreme Court held, allowing the appeal, that if there were two possible constructions the court was entitled to prefer the construction which was consistent with business common sense and to reject the other; that it was not necessary to conclude that a particular construction would have an absurd or irrational result before having regard to the commercial purpose of the agreement; that since the two possible interpretations of paragraph 3 contended for by the claimants and by the bank were both arguable, it was appropriate for the court to have regard to considerations of commercial common sense in resolving the question as to what a reasonable person would have understood the parties to have meant; that an appellate court was also entitled to take account of the fact that an experienced judge of the Commercial Court had concluded that the bank's construction would have an uncommercial result; that of the two arguable constructions of paragraph 3 the claimants' construction was to be preferred because it was consistent with the commercial purpose of the bonds in a way that the bank's construction was not; and that, accordingly, the judge's order would be restored.

However, this does not mean that courts should disregard the literal meaning of a clause, even if it seems badly drafted or unreasonable. Lord Neuberger said in Arnold v Britton:

“… while commercial common sense is a very important factor to take into account when interpreting a contract, a court should be very slow to reject the natural meaning of a provision as correct simply because it appears to be a very imprudent term for one of the parties to have agreed, even ignoring the benefit of wisdom of hindsight. The purpose of interpretation is to identify what the parties have agreed, not what the court thinks that they should have agreed. Experience shows that it is by no means unknown for people to enter into arrangements which are ill-advised, even ignoring the benefit of wisdom of hindsight, and it is not the function of a court when interpreting an agreement to relieve a party from the consequences of his imprudence or poor advice. Accordingly, when interpreting a contract a judge should avoid re-writing it in an attempt to assist an unwise party or to penalise an astute party.”

In Trust Risk Group Spa v Amtrust Europe Ltd [2015] EWCA Civ 437 an insurance broker appealed against a decision that the respondent insurer had a good arguable case that the English courts had jurisdiction over disputes arising out of a "terms of business (ToB) agreement" between them. The contractual arrangements between the broker and the insurer comprised a framework agreement to which was appended an earlier ToB agreement. The ToB agreement was a standard London-form brokering agreement with an English law and jurisdiction clause. The framework agreement provided for an exclusive relationship between the parties regarding medical malpractice insurance in Italy. It contained an Italian law and jurisdiction clause. A dispute arose between the parties under the ToB agreement. In determining which court had jurisdiction, the question was whether the two agreements were freestanding and had equal weight, or whether they comprised a composite agreement in which the ToB agreement was subordinate.

The court held that where the court was faced with two possible constructions, it was entitled to prefer that which was more consistent with commercial common sense, though that was not to be elevated to an overriding criterion of construction. Beatson LJ has suggested that business common sense is not much help when there are reasonable arguments both ways as to interpretation. He repeated the warning of the other senior judges that commercial common sense should not be "elevated to an overriding criterion of construction ... still less should the issue of construction be determined by what seems like commercial common sense from the point of view of one of the parties to the contract".

The Court of Appeal gave a similar message, while invoking the literal meaning of a particularly badly drafted clause to reverse the interpretation reached by the judge at first instance: Wood v Sureterm Direct Ltd [2015] EWCA Civ 839.