UK: Court Of Appeal's Paradigm Shift On Rectification For Common Mistake: FSHC v. GLAS

Last Updated: 22 August 2019
Article by Bryan Johnston and Oliver Saunders

The Court of Appeal has recently reversed a controversial line of case law on the rectification of contracts where both parties are mistaken as to the contract's legal effect.

In FSHC Group Holdings Limited v. GLAS Trust Corporation Limited [2019] EWCA Civ 1361, the defendant appealed the lower court's order for rectification of two deeds that did not reflect the parties' subjective common intentions. The defendant argued that – objectively speaking – there was no evidence of a common intention and as such the deeds should not be rectified. However, in a shift from previous authority, the Court of Appeal agreed that it is the subjective common intention of the parties, as evidenced at the time of the contract, that is relevant to the question of rectification.

The facts

The background to the dispute was a corporate acquisition in 2012, by which a private equity investment fund acquired a controlling interest in FSHC Group Holdings (the holding company of Four Seasons Health Care Group). The acquisition was funded through a complex set of arrangements that were governed by an intercreditor agreement. Barclays Bank plc was the security agent in the intercreditor agreement (and the original defendant). GLAS stepped into Barclays' shoes as the security agent and the defendant later (after the lower court's judgment had already been handed down).

The issue arose because the intercreditor agreement required FSHC Group to assign to Barclays, by way of security, the benefit of a shareholder loan (worth £220 million). By an oversight, that assignment never took place when the acquisition completed in 2012.

The oversight came to light when FSHC Group's solicitors were instructed in 2016 to advise on a debt restructuring. The intercreditor agreement required any default identified by a party to be remedied within 30 business days of becoming aware. To remedy the default, FSHC Group's lawyers advised it to accede, by deed, to two other security documents that formed part of the financing arrangement. It was found as a fact that the parties had not realised that, by FSHC entering the accession deeds, it would not only be assigning the missing security, but would also be taking on additional onerous obligations that went significantly beyond the commercial deal struck in 2012.

FSHC's lawyers explained to Barclays prior to executing the accession deeds that their purpose was merely to ensure compliance with the intercreditor agreement. FSHC wanted to do no more than avoid defaulting on the intercreditor agreement. Barclays were content with the proposal and the deeds were entered into.

When the effect of the accession deeds became clear, FSHC approached Barclays to rectify the accession deeds so as to remove the additional obligations. Barclays refused, arguing that FSHC had taken a deliberate decision to enter into the accession deeds and be bound by the additional onerous obligations in order to plug the gap in the security quickly and reduce the risk of the issue coming to the attention of creditors in the debt restructuring. 

Objective and subjective common intention

The court considered the historic case law on rectification leading up to the most recent leading authority, Chartbrook Ltd v. Persimmon Homes (in 2009). In that case, a development agreement between a developer and a landowner contained a provision for a payment to be calculated using a defined formula. A dispute emerged as to which formula applied – on Chartbrook's case, the amount payable was £4.4 million; on Persimmon's, it was only £900,000. Persimmon succeeded on its primary case based on interpretation of the contract. However, its alternative case (which was therefore "academic") was that the agreement should be rectified. The parties' pre-contractual correspondence evidenced an agreement about the formula. However, it was found as a fact that Chartbrook's directors had understood the formula agreed in correspondence to mean something different. Lord Hoffman's judgment (which would later be quoted and applied) was that it did not matter what Chartbrook's directors thought (subjectively), only what could actually be shown to have been agreed objectively (i.e. the pre-contractual correspondence).

What makes things more interesting is that pre-Chartbrook case law casts rectification in a different light, where the subjective intention of parties was held to be relevant. Some uncertainty therefore lingered as to whether Chartbrook was in fact the correct approach. The distinction between objective and subjective common intention is evidently an important one – leading to potentially millions of pounds of difference in outcome for litigating parties, depending upon which approach the court has applied. 

In this case the question of whether objective or subjective intention should be relevant to the question of rectification would mean the difference between: (1) looking objectively at the correspondence between FSHC and Barclays to determine what was agreed (i.e. to enter into the accession deeds), and (2) looking at what the actual subjective intentions were of the two parties which was to do no more than what was necessary to provide the missing security and no more.

The decision

The Court of Appeal upheld the lower court's order for rectification. Rectification – so the court clarified – can be ordered in one of two situations:

  1. where the contract in question does not reflect the terms of a previously concluded agreement; and
  2. where the contract in question does not reflect the actual subjective common intentions of the parties at the time it is executed.

The analysis for the first situation must be objective because an agreement designed to reflect a previous agreement must (necessarily) reflect only that previous agreement. Whereas in the second situation, it is the subjective intentions of the two parties that is critical as there is (by definition) no objective agreement to draw from. However, not only must their subjective intentions be the same, but there must also be an "outward expression of accord" – so it is not the case that the second situation is a purely subjective test.

FSHC's case was of course a situation where an agreement (on FSHC's case) did not reflect the actual subjective common intentions of both parties. FSHC's lawyers had not read the IRSAs and when communicating their client's intentions to Barclays they made it plain that the accession deeds were designed simply to provide the missing security. Barclays argued that objectively speaking FSHC had failed to specifically exclude the additional obligations. In other words, a bystander aware only of the matters communicated between the parties would not be aware that the parties had no appreciation for the actual legal effect of the accession deeds. There was no express wording to the effect that FSCH wanted to "do no more" than provide the security. 

The court nevertheless concluded that rectification should be ordered based on several decisive factors. The first was the contextual background to the deeds and the communications preceding their execution: here the parties were not negotiating a new deal – the negotiations had taken place in 2012 and the agreement here was designed to complete "one missing brick in the edifice" of the intercreditor agreement. Correspondence between the parties began with simply checking whether the assignment existed. Once it transpired that it did not, the correspondence discussed the accession deeds. The "obvious inference" according to the court was that the deeds must have been intended to replace the missing security and not fulfil any other or additional purpose. The commercial absurdity of the deeds and the absence of a discussion about such a fundamental change to the deal were further factors that weighed decisively in favour of rectification.

Commentary

The case represents a sensible clarification of the law on rectification for common mistake. Parties which have entered into a contract that takes effect from a previous document may seek rectification on the objective basis. Where the parties have subjectively agreed on the meaning of a contract which it does not in fact reflect, then the court will be able to consider the evidence of the parties' mindset at the time of executing that contract. It perhaps remains to be seen whether the additional requirement for an "outward expression of accord" causes difficulties for parties where their intention can only be inferred subjectively. Indeed, in this case, this factor did not appear to play a significant role in the decision-making.

What is most helpful from the court's analysis is the decisive weight that was attached to the commercial background. The fact that the acquisition took place in 2012 meant that the deeds could have had only one purpose – to complete the promised security pursuant to the 2012 deal. The court attached weight to the commercial absurdity of not rectifying the agreement and the fact that a significant change in the contract could not have been intended without a formal discussion about the additional obligations. This pragmatism will certainly be welcomed by practitioners and clients alike.

Dentons is the world's first polycentric global law firm. A top 20 firm on the Acritas 2015 Global Elite Brand Index, the Firm is committed to challenging the status quo in delivering consistent and uncompromising quality and value in new and inventive ways. Driven to provide clients a competitive edge, and connected to the communities where its clients want to do business, Dentons knows that understanding local cultures is crucial to successfully completing a deal, resolving a dispute or solving a business challenge. Now the world's largest law firm, Dentons' global team builds agile, tailored solutions to meet the local, national and global needs of private and public clients of any size in more than 125 locations serving 50-plus countries. www.dentons.com.

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