Rainy Sky S. A. and others v Kookmin Bank

Contractual interpretation is a unitary and objective exercise. The court identifies what a reasonable person, possessing the background knowledge reasonably available to the parties, would understand the language to mean.

Where the language is unambiguous, the court must apply it even if the result appears commercially improbable. Where a term is genuinely capable of more than one interpretation, the court may prefer the construction most consistent with business common sense and the agreement’s commercial purpose. The alternative need not produce an absurd, irrational or extreme result before commercial consequences become relevant. This approach permits a choice between meanings which the language can bear; it does not permit the court to rewrite the parties’ bargain.

The appellants were buyers under six shipbuilding contracts. The respondent bank issued materially identical advance payment bonds securing sums payable by the builder. After the builder entered a debt workout procedure, the buyers demanded repayment of pre-delivery instalments under an insolvency provision in the contracts and then demanded payment under the bonds.

The Commercial Court gave summary judgment for the assignee of the bonds. A majority of the Court of Appeal allowed the bank’s appeal in [2010] EWCA Civ 582, holding that the bonds did not cover refunds arising under the insolvency provision. Sir Simon Tuckey dissented.

The issue was whether paragraph 3 of the bonds, construed in its contractual and commercial context, covered refunds due under article XII.3 of the shipbuilding contracts.

1. Appeal allowed unanimously. Lord Clarke delivered the judgment, with which Lord Phillips, Lord Mance, Lord Kerr and Lord Wilson agreed. The Commercial Court’s order was restored.
2. Contractual construction is a unitary exercise. The court asks what a reasonable person, equipped with the background knowledge reasonably available to the parties at the time, would understand the language to mean. The language and all relevant surrounding circumstances must be considered together.
3. Where contractual language is unambiguous, the court must apply it. Business common sense does not authorise rewriting the words used. Where, however, a provision is capable of two meanings, the court may prefer the meaning most consistent with business common sense and reject the less commercial meaning. The disfavoured interpretation need not be so extreme, absurd or irrational as to show that it was unintended.
4. Paragraph 3 of the bonds was capable of both proposed meanings. Although paragraph 2 gave some support to the bank’s narrower construction, it did not accurately or exhaustively define the obligations secured. The shipbuilding contracts did not prescribe the bonds’ final scope, and their guarantee provision did not confine cover to refund obligations arising under articles X.5 and X.6.
5. The buyers’ construction accorded with the bonds’ commercial purpose. Insolvency was the event in which security for advance payments was most likely to be needed. No credible commercial reason explained why that refund obligation alone should have been excluded while other repayment obligations were secured. The words “all such sums due to you under the Contract” therefore covered pre-delivery instalments repayable under article XII.3 following an insolvency event.

1. United Kingdom Supreme Court: Allowed the appeal unanimously and restored the Commercial Court’s order.
2. Court of Appeal: By a majority, allowed the bank’s appeal and gave summary judgment for the bank: [2010] EWCA Civ 582 . Sir Simon Tuckey dissented. Permission to appeal was refused.
3. Commercial Court: Rejected the bank’s construction and gave summary judgment for the assignee. It had earlier rejected the bank’s separate contention that payment was not due pending resolution of the underlying dispute: [2009] EWHC Civ 2624 (Comm).