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Court of Appeal guidance on incorporation of terms and limits of the factual matrix

It is comparatively rare that TCC decisions make their way up to the Court of Appeal, so, when they do, the judgments usually contain something of note for the construction practitioner.

The judgment in Northrop Grumman Missions Systems Europe Ltd v BAE Systems (Al Diriyah C4I) Ltd is no exception. Although the court itself appeared keen to emphasise that the case turned “on what is ultimately a short point of construction, raising no issues of principle”, two aspects of the decision are worthy of further comment.

Northrop v BAE: the issue

Despite the somewhat exotic subject matter of the underlying contracts (computer software for a missile command and control system being provided to the Saudi Arabian government), the facts were straightforward. The dispute concerned the relationship between two contracts:

  • The “enabling agreement”, a framework agreement concluded between the claimant and the defendant’s sister company. The enabling agreement contained many of the various boilerplate clauses often found in commercial contracts, including a “termination for convenience” clause.
  • The “licence agreement”, by which the claimant agreed to provide a number of software licences to the defendant over an extended period. The licence agreement provided that it was to be “governed by” the terms of the enabling agreement.

The defendant purported to terminate the licence agreement pursuant to the termination for convenience clause contained in the enabling agreement. The sole issue was whether it had been entitled to do so.

At first instance, in a detailed and precise judgment, Ramsey J concluded that the defendant had indeed been entitled to terminate the licence agreement pursuant to the termination clause contained in the enabling agreement. The Court of Appeal agreed and upheld that decision in full.

Incorporation by reference

The first aspect of the judgment worthy of note concerns the proper approach to the incorporation of provisions into a contract by reference to provisions contained in another contract.

Those principles are of considerable practical importance. They frequently arise in relation to construction contracts, perhaps most often as a result of clauses in sub-contracts seeking to incorporate all of the terms of the main contract, but also (as here) as a result of a contractual structure that utilises an over-arching framework agreement and then further contracts for particular orders or portions of work.

The Court of Appeal in Northrop v BAE reiterated that determining the meaning and effect of clauses that are either incorporated from one contract into (or are otherwise said to “govern”) another contract was a matter of carefully construing the terms of that second contract. Indeed, the court even went so far as to suggest that the various authorities on the proper approach to issues of incorporation by reference amounted to nothing more than “the application of well-understood principles of construction” to that particular context.

Significantly, the court was not deterred from deciding that the termination for convenience clause did apply to the licence agreement by the fact that such a conclusion required “modification” or “manipulation” of the contractual wording as it appeared in the enabling agreement. If manipulation was necessary to give effect to the parties’ intentions, then so be it.

The limits of the “matrix of fact”

The second aspect of the judgment that warrants attention concerns the boundary between admissible evidence constituting part of the background “matrix of fact” on the one hand, and, on the other, inadmissible evidence of the parties’ positions in negotiating a contract.

In an approach often adopted by parties when an issue as to the proper construction of a contract arises, the claimant sought to buttress its interpretation of the relevant contracts by reference to evidence of their factual context or background. It pointed to emails exchanged during the contract negotiations that showed that both parties understood that the claimant was only prepared to supply the licences at a reduced price if the defendant agreed to purchase the full quantity of licences on offer. It submitted that termination for convenience, with the defendant having only bought some but not all of the available licences, was inconsistent with that “background fact”.

The Court of Appeal gave that argument short shrift. It accepted Ramsey J’s concise summary of the relevant principle:

“Evidence of pre-contractual negotiations is not generally admissible to interpret a concluded written agreement. But evidence of pre-contractual negotiations is admissible to establish that a fact was known to both parties and to elucidate the general objective of the contract.”

It then had little hesitation in deciding that the “fact” relied upon was not part of the relevant matrix of fact, nor was evidence of the parties’ negotiations admissible to prove it:

“…a ‘fact… known to both parties’ means some objective part of the background matrix of fact other than a mere negotiating position taken by one of the parties, however vigorously expressed… the ‘fact’ which [the claimant] seeks to establish is precisely such a negotiating position.”

The message from the Court of Appeal was clear. This was precisely the sort of argument that the rule excluding pre-contract negotiations, affirmed in Chartbrook v Persimmon Homes, is intended to prevent.

Conclusion

In providing useful guidance in relation to the two particular issues identified above, the judgment in Northrop v BAE also contains a reminder as to the courts’ approach to the construction of contract documents that is useful in a more general sense:

  • The court will not shy away from “appropriate manipulation” of the particular words or phrases used if that is necessary to give effect to the parties’ intentions.
  • When it comes to the construction of contract documents, the court is more concerned with the overall scheme and internal logic of the parties’ agreement than it is with the particular factual background to it.
Keating Chambers Tom Coulson

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