This article has been written by Dipali Patil pursuing the Diploma in Advanced Contract Drafting, Negotiation and Dispute Resolution from LawSikho. This article has been edited by Ruchika Mohapatra (Associate, Lawsikho) and Dipshi Swara (Senior Associate, Lawsikho).
A contract is a legally binding agreement between two or more parties. This agreement creates mutual rights and obligations between the parties and governs the relationship between the parties to the agreement. It specifies detailed terms of the contract and what should be done in case of a breach of any terms of the contract. The contract may be oral or written but written contracts are more legally binding and easy to enforce. However, there are some contracts that are mandatory to be in written form. It is very essential and important to correctly include the terms in the contract to avoid the scope of misinterpretation’s main cause of disputes are conflicting or ambiguous wording of the contracts. Thus, contract interpretation is very much essential where there is a dispute over the terms of the contract or the definitions of language used in a contract.
Background of European contract law
The European contract law is a bunch of rules that are framed by Ole Lando (Lando Commission. Principles of European Contract Law were prepared by the European Contract Law Commission edited by Ole Lando and Hugh Beale. Members from each country of the European Union are included in the commission of European Contract Law. The Lando commission tried to create European Contract Law on the basis of the concept of “uniform contract law”. There are various purposes behind the formation of principles of European contract law (PECL):-
- It states the common core of European contract law.
- It contributes towards the future association of European contract law.
- It provides codification of a set of rules that can be applied as a law and the very important thing is that the commission has provided a common European language for discussion on contract law. The aim of the commission behind the formation of PECL is that it should be used as widely as possible.
PECL was written in a very elegant style and the commission made every effort to draft the law and the general rules in simple, short and easy to understand language not only by law scholars but also by laymen. PECL was published in the English language and soon after the publication of the English version, the first part of the French translation was published. Law has been drafted in a very flexible manner so that there is a huge scope for future development. The structure of PECL is very straightforward and it consists of 131 Articles divided into 9 chapters which are subdivided into two or more sections and the basic purpose of contract law is to resolve conflicts between the parties to the contract and the system of contract law has to balance these conflicting interests.
Unlike most of the civil codes in Europe, the PECL contains the article relating to “freedom of contract” i.e. parties are free to enter into the contract. The focus of PECL is on Good Faith and Fairness in Dealing while applying the principles of the law. PECL is inspired by various European cultures and the commission had no intention to hide the fact; rather it claims that contract law has been inspired by various European legal cultures and this law has been created for the betterment of economic and social conditions subsisting in the country.
General provisions of European contract law
- Chapter 1 deals with General Provisions and Section 1 consists of the application of principles and rules of contract law on European communities. Chapter 1, Section 2 is regarding general duties and each party owes the duty to obey these duties while;
- Chapter 2 consists of the formation of contracts, managing the process of contract formation mostly through exchanging the declarations of will i.e. offer and acceptance. Once the acceptance is made, the contract becomes effective and parties are bound by the terms of the contract. Section 1 of Chapter 2 deals with Principles of European Contract Law dedicated to the general provisions of contract formation and Section 2 is regarding the formation of contract through offer and acceptance. Section 3 is related to liability for negotiations and confidentiality of information provided during the process of negotiation.
- Chapter 3 governs the authority of an agent or other person binds principally with the third party in relation to a contract and its sections 2 and 3 deal with “Direct Representation” and “Indirect Representation”.
- Chapter 4 covers the validity of the contracts and this chapter and does not deal with invalidity due to lack of capacity, illegality and immorality.
- Chapter 5 consists of general rules of interpretation of the contract.
- Chapter 6 relates to contents and their effects, the statements giving rise to contractual obligations.
- Chapter 7 talks about the performance of the contract which includes the time of performance, order of performance, performance by the third party, etc.
- Chapter 8 consists of the Non-Performance of the contract and the remedies available in general.
- Chapter 9 talks about the detailed particular remedies available for non-performance of a contract.
- Chapter 10 explains the plurality of parties and the plurality of debtors and creditors.
- Chapter 11 deals with the assignment of claims under the existing contract by agreement.
- Chapter 12 contains general rules relating to the transfer of contract, substitution of new debtors.
- Chapter 13 describes detailed provisions relating to set off.
- Chapter 14 talks about general provisions of prescription and period of prescription and its commencement.
- Chapter 15 talks about illegality of contracts that are in contravention of fundamental principles.
- Chapter 16 deals with conditions and contracts which depend on certain events for their performance.
- Chapter 17 focuses on the capitalization of interest.
Meaning of interpretation
Interpretation of contract means the determination of the contents of the contract and meaning of the terms which are unclear, ambiguous. Contract interpretation is a must when a dispute arises over the terms and conditions of the contract. The main purpose of interpretation of the contract is to find out what is the intention of the parties behind entering into the contract. The court always interprets the contracts with the aim of finding the intention of the parties. Contract interpretation becomes necessary when mistakes have been made or ambiguities have been felt by parties during performing the terms of the contract.
Process of interpretation of contracts
- The whole contract is to be considered: Look at the whole Agreement and read the nature and purpose of the whole contract. The interpretation should be based on the whole Agreement. Read all the clauses carefully to get a clear picture of what the contract is all about and to draw a clear interpretation of the contract.
- Determine Intentions of the Parties: The first step to follow while interpreting a contract is to find out the intention of the parties. While interpreting contracts, the court always first attempts to determine the indentation behind the draft of terms of the contract. The primacy of contract language, the governing principle and text used are considered as the intention of parties concluding the contract.
- Ordinary Meaning: In order to find out if the language used in the contract is clear, the court generally relies on the ordinary meaning of the words/terms which are in question. In interpreting contracts, ordinary words are interpreted according to ordinary meanings and technical or trade terms are interpreted according to trade or technical meaning.
- External documents: When the terms of the contract are the cause of dispute then the court decides to disregard the contract and use some external documents to interpret the contract.
Lord Hoffman’s five principles for interpretation of contracts
Lord Hoffman laid down five principles for interpretation of contracts in Investors Compensation Scheme Ltd vs. West Bromwich Building Society, –
- the right meaning is what the document conveys to a reasonable person;
- this includes everything in the “matrix of fact”, or relevant background circumstances;
- prior negotiations are excluded from this (a point which has been much criticized since);
- the meaning of words is not a literal meaning, but the one reasonably understood from the context, and
- the meaning should not contradict a common-sense view of what a contract requires.
The first article of chapter 5 of the Principles of European contract law states the following:
- While interpreting a contract, paramount importance is to be given to the intention of the parties. The same shall be taken into consideration even if it differs from the literal meaning of the words specified in the contract.
- If one party is able to establish that it intended the meaning of the contract in a particular way and the other party could not have been unaware of such an intention at the time of concluding the contract, the contract will be interpreted as per the intention of the first party.
- However, if the intention of the parties cannot be established, the contract will be interpreted as per the intention of a reasonable man if he was placed in the same position as the parties.
After getting a brief idea of the general rules of interpretation in a contract, it is important to see how the basic clauses of a contract should be interpreted.
Interpretation of contents of contract
- Title of the Contract: Every contract must contain a “title”, which gives a general idea about what the contract is all about by just reading it, the intent of parties behind entering into the contract. E.g. Transfer, rent or lease, or for granting something.
- Introduction of Parties: It is very important to give a description of who the parties to the contract are. To get general information about the background of the parties, it is mandatory to provide the correct name, address, and identification numbers.
- Recital: Recital explains the purpose and object of the parties to the contract. Basically, a recital contains an introduction of the contract; it is considered as a preamble of the contract.
- Definitions: Definitions in the contract give the meaning of the terms which are repeatedly used, it is good practice to define these words to avoid ambiguity in the contract.
- Subject Matter of the contract: The Subject Matter of the contract is (the Product or Service) for which the parties entered into the contract. The subject matter of the contract should be described in detail so that the prudent person could reasonably understand contract details. If the contract is regarding granting the right to use something then specify that in the contract if it is an exclusive right. It is also appropriate to specify the geographical area covered by the contract.
- Place and Date: If the contract is Regarding Products and Services it is very important to specify Delivery Dates.
- Other Terms And Conditions: There must be a clause in every contract regarding the Obligations of the parties and the power and responsibilities given to the parties under the contract should be described clearly and precisely, everything important to the parties to perform in the contract should be mention in detail all the terms and conditions should be fulfilled.
- Payment: There must be details given in every contract regarding Payment. When and how payment should be made, after performance of duties or in advance? In arrears (current account basis) or all at once. What will be the consequences for non-payment or delay in payment? Everything should be clearly specified in the contract to avoid future disputes.
- Term and Termination of Contract: It is very important to mention how long a contract remains in force, e.g. from the date on which the contract has been signed by the parties for a specified period. It also needs to be covered when the contract can be terminated.
- Disputes: In case of dispute, it is advised to try to solve it through Agreement because settling a dispute through arbitration or through the court of law will be a long and expensive process. But parties can also resolve their dispute through other ways of dispute settlement process in contract e.g. Mediation, conciliation or other alternative forms.
Clauses regarding any dispute which are to be settled by arbitrators are required to mention primarily in the contracts between businesses. Arbitration is a very expensive process, but faster than normal court procedures’ if the parties do not agree in the contract on the method of dispute settlement then the dispute will be settled in any general court.
Chapter 6 of principles of European contract law is on content and effects it clarifies the element in the contract there is potential for dispute.
- Statements that form a part of the contract
- implied obligations
- How price, quantity, quality and ending the contract are dealt with if not included in the actual contract terms.
Both the parties are expected to behave reasonably while dealing with issues where there is any confusion or doubt.
- Signatures: Specify the Date and Place on which the contract is to be signed by the parties.
This article provides basic rules related to the interpretation of contracts of European contract law. Interpretation of contracts becomes relevant at three stages of contract at the time of formation, at the time of performance, and at the time of settlement of the dispute. The goal of contract interpretation is to clarify the original intent of the parties. In order to avoid disputes and contact interpretation, it is required that both parties should ensure everyone understands the terms of the contract and both parties are on the same page.
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