The hazard of the unused definition.

12 September 2012

In this case the judge followed the approach set out in Chartbrook Ltd v Persimmon Homes Ltd2 by the Court Appeal where it was held that the correct practice is to determine what a reasonable person would have understood the parties to have meant in a way consistent with the purpose of the contract. Rayford Homes ('R') borrowed money from two lenders: its trustee shareholder ('T') and the Bank of Scotland ('BoS'/'the Bank'). Both lenders were granted security over the company's assets. The parties then entered into an inter-creditor agreement in the Bank's standard form, intended to regulate the rights of the creditors amongst themselves. A schedule to the agreement included a definition of "BoS Priority", which was defined as meaning "BoS Debt not exceeding £ [ ] together with interest … ". The amount was left blank when the agreement was signed, and the term "BoS Priority" was not used in the agreement. After signing the agreement the Bank agreed to make further advances to R; following this the Bank requested that T sign a document acknowledging that the "BoS Priority" figure was increased to the maximum amount that the Bank had now agreed to advance and that this figure would be inserted into the definition of "BoS Priority". In accordance with the Bank's request, T signed the document; however, because the definition was still not used in the agreement, this did not seem to have any effect. R then entered into administration and became unable to repay its debts and administrative receivers were appointed. The matter in dispute was whether the definition "BoS Priority" had any meaning, i.e. whether it limited the amount to which the Bank's charge had as against that of T. The Bank argued that the definition had no meaning and was merely descriptive of the amount of the loan facility at the time that the change was initialled. The Bank argued this in order to enable them to rely on the other provisions of the agreement and other security documents. In contrast T argued that the definition imposed specific financial limits on the extent of the Bank's priority. The judge held in favour of T. He said that there was no single commercially sensible construction for the effect of the addition to the definition of "BoS Priority" in the inter-creditor agreement. Both unlimited priority for the Bank and a limited priority were entirely plausible, and in his view this case was one of the many in which commercial plausibility was of no real assistance in constructing the parties' agreements. Using the Chartbrook principles for construction of an agreement, the Judge rejected the argument that the purpose of the insertion was simply to state the facility limit as at the date of the initialling. The clear construction of the inter-creditor agreement was that, without the insertion, the priority was unlimited. The purpose of the definition was by its terms to limit the Bank's priority. The initial reaction to the existence of an unused definition might be that such a definition would be of no effect and serve no relevance on the interpretation of the contract. However, this case highlights the danger of using such definitions, the consequences being that it may become difficult to predict the effect of such definitions and they may work against you. This especially could be the case where a change is subsequently made to the definition as were the circumstances in this case. For additional information please contact Justin Emerson of Gepp & Sons on 01245 228113. The above is not legal advice; it is intended to provide information of general interest about current legal issues. 1 [2011] EWHC 1948 (Ch) 2 [2009] 1 A.C. 1101