Contractual interpretation and enforceability in commercial service level agreements

27th July 2017

Minimum acceptable performance level examples and key performance indicators (KPIs) have been held, by the Court of Appeal, to be contractually binding.  Commercial Dispute Resolution specialist Nick Lees discusses a case which will be of interest to all those who negotiate or operate commercial services or service level agreements.

Interpretation authority

Since the 2015 case of Arnold v Britton [1], Supreme Court authority on contractual interpretation has been clear.  In short:

• The starting point is the wording of the contract itself.
• Whilst consideration of commercial common sense can, in the right circumstances, be taken into account, it is not a criterion of contractual interpretation that should undermine the importance of the clear language of a clause.
• Similarly, whilst commercial common sense can be a consideration, it cannot be invoked ‘after the fact’ (it is only relevant to ascertaining how matters would or could have been perceived when the contract was made).
• Where necessary, an objective test – that of what the reasonable business person would understand the clause to mean – is applied to ascertain the parties’ intention at the time the contract was entered into.
• In a case where there are two or more tenable interpretations, the most commercially sensible option will be preferred.
• Crucially, it is not for the court to depart from clear contractual wording even where that represents a bad bargain for any party.

“Curious” case and Court of Appeal decision

In Sutton Housing Partnership Ltd v Rydon Maintenance Ltd [2] the parties entered into a 5 year contract pursuant to which Rydon would maintain and repair Sutton’s housing stock.  It was common ground between the parties that they had agreed that Sutton would be able to terminate the contract on notice if minimum acceptable performance levels (MAPs) were not met and that if the MAPs were exceeded, Rydon would receive bonuses.  When Sutton subsequently alleged that the MAPs had not been met and served notice to terminate the contract, it became clear that there were problems with the drafting of the relevant provisions.  The contract defined the MAPs by reference to a KPI framework , but the KPI framework contained MAPs figures which were referred to as “examples” only.  Rydon therefore argued that the contract did not specify MAPs – rather it only gave examples which were not contractually binding.  It fell to the Court of Appeal to construe the contract.

The Court of Appeal found for Sutton Housing, deciding that MAP “examples” were binding. The court was careful to note that it reached its decision with the Arnold v Britton authority in mind and it focused on the fact that it was clear that the parties’ intention was, and the intention of “any reasonable or indeed unreasonable person standing in the shoes of either party” would be, for the contract to specify MAPs.  In addition, whilst the contract was clear that the KPI framework included “examples”, Jackson LJ considered that wording within the KPI framework itself was clear that the figures were examples, but that the arithmetical consequences of the relevant provisions were specified.  The court referred to the drafting as “curious” and took into account commercial common sense when noting that, if the MAPs were not binding then, as well as Sutton’s termination option being precluded, Rydon’s bonus option would also be precluded.  It therefore stated that the conclusion that the MAPs were contractually binding was the only rational interpretation.

WM Comment

The use of KPIs, minimum performance standards and worked examples or illustrations is common in many commercial and service level agreements today. It is possible that drafting similarly loose or confusing to that in Sutton Housing v Rydon may have been applied in very many other cases, not least because it is common practice for minimum performance requirements, KPI schedules and the like to be put together by commercial or operations managers and then simply copied and pasted into contractual schedules, with little or no legal input, analysis or advice.

This case may be relied upon in future by those looking to the court to ‘fix’ confusing contractual provisions to ensure enforceability of performance standards. However, while the Court of Appeal reached what was clearly a common sense outcome on the particular facts of this case, it is easy to see that, as contractual wording is paramount to the contractual construction exercise, a different case could go a different way.

Practical advice

The best advice will therefore be for those businesses working with these types of contracts to ensure that all relevant provisions are drafted precisely and correctly in accordance with the parties’ intentions. Where contracts have already been completed, businesses should review very carefully the service level clauses, key performance calculations and any related definitions or other operative provisions to ensure that they actually bind both parties and work in the way that they were intended to do.

In the event of any dispute over the interpretation and operation of any such arrangements:

• Consider carefully the wording in the clause/contract itself. If there is real uncertainty, then commercial common sense can be taken into account and may assist.
• Also consider whether there is any scope for settlement? It is rare for any contractual interpretation dispute to be clear cut. In any such case there will be an element of ‘litigation risk’ for both parties, which can assist in negotiations to encourage a commercial compromise.
• In any event, it is good to talk. Interpretation disputes often arise by virtue of the fact that there is an ongoing contractual relationship between the parties. It can be in the interests of all concerned for the parties to behave in a reasonable and commercially sensible manner.
• Does the clause reflect the parties’ intentions at the time the contract was entered into? If it does not, is the contract capable of being rectified?
• Alternatively, was the clause entered into in reliance on any misrepresentations? If so, the contract could be set aside and financial compensation could be payable.
• Finally, consider whether you were properly advised when the contract was completed. It is possible that any losses could be recouped via a professional negligence claim.

Please do not hesitate to contact any member of Walker Morris’ Commercial Dispute Resolution team for further information or advice.

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[1] [2015] UKSC 36.  See our earlier briefing for further information and commentary.
[2] [2017] EWCA Civ 359