Negotiation and the law of contract – multivalency or incoherence?

Negotiation features in Contract Law in numerous guises. (1) Courts recognise that negotiation may precede agreement (2) Courts will enforce agreements made after a negotiation process where parties intended to enter into legally binding arrangements (3) Courts decline to construe the contract by interrogation of the negotiations which led up to the point of agreement (4) A Court may create imaginary negotiation evidence, gleaning this from a Court simulated negotiation between hypothetical parties to the actual agreement (5) In the event of a breach of contract, a party may establish that the breaching party had actual knowledge of a state of affairs that might be a not improbable result of that breach. That actual knowledge will almost certainly have been created or transferred during negotiations. In this note, I argue that the principles of construction at 3 and 5 above are manifestly mutually incompatible. The logic of my argument is that reconsideration of the exclusionary rule is merited, particularly in the light of multiple exceptions and given the fact that Judges routinely deal with evidence of negotiations. As the actual knowledge rule is unexceptionable and the exclusionary rule highly questionable, coherence can be brought to the law relatively easily.


Introduction
Negotiation features in Contract Law in numerous guises. In summary: 1. Courts recognise that negotiation may precede agreement. 1 Less plausibly, Judges occasionally infer that they understand the commercial negotiation process, tending to believe that the only participants worth a mention are lawyers. 2 It is not always the lawyers who negotiate; indeed, lawyers are, in many cases, backroom advisers. 3 2. Courts will enforce agreements made after a negotiation process where the parties have intended to enter into legally binding arrangements and have reached a consensus on the key matters. 3. A Court may create imaginary negotiation evidence, gleaning this from a Court simulated negotiation between hypothetical parties to the actual agreement, where a breach of contract means that 'The claimant has in substance been deprived of a valuable asset' 4 . In such cases, the Court will establish a 'hypothetical release fee' to be used in the assessment of damages, although the actuality is 'regrettably vague'. 5 4. Courts will decline to construe the contract by interrogation of the negotiations which led up to the point of agreement, even where such interrogation might make the intention of the parties 'crystal clear'. 6 This is often referred to as the 'exclusionary rule' and I use that term. 7 5. In the event of a breach of contract, a party may establish that the breaching party had actual knowledge of a state of affairs that might be a not improbable result of that breach. That knowledge may signify that such a state of affairs was in the 'reasonable contemplation' 8 of the breaching party and will, in all likelihood, vary the assessment of damages to be awarded. 9 That actual knowledge will almost certainly have been created or transferred during negotiations.
In this article, I argue that the principles of construction at 4 and 5 above are manifestly mutually incompatible. The logic of my argument is that reconsideration of the exclusionary rule is merited, particularly in the light of multiple exceptions and given the fact that Judges routinely deal with evidence of negotiations. As the actual knowledge rule is unexceptionable and the exclusionary rule highly questionable, coherence can be brought to the law relatively easily.

The exclusionary rule
In a landmark decision, Chartbrook Ltd v Persimmon Homes Ltd 10 (Chartbrook), the key Judgment being that of Lord Hoffmann (his last in the House of Lords), which may have settled this issue for thirty years according to Sir Richard Buxton, 11 the House of Lords reiterated that to all intents and purposes 'evidence of what was said or done during the course of negotiating the agreement' may not be used 'for the purpose of drawing inferences about what the contract meant'. 12 Lord Rodger, however, did not rule out a reconsideration of the rule but observed that 'if there is to be a change, it should be on the basis of a fully informed debate in a forum where the competing policies can be properly investigated and evaluated'. 13 The context was a dispute between a developer and a landowner as to the price to be paid to the landowner once the development was complete and all units sold. The developer wished to rely on evidence of an agreement reached during negotiations. The hapless draftsman, much criticised in the High Court and in the House of Lords, had rendered a tolerably clear agreement made during negotiations into a somewhat convoluted provision, Lord Rodger describing it as 'obviously defective' in disagreeing with both Rimer LJ aand Tuckey LJ who had described the provision as unambiguous. 14 Lord Hoffmann, however, based his Judgment on the idea that this was an exceptional case in which the drafting had been careless, that no 'rational' party would have agreed to such a provision, and rested his argument on the proposition that interpretation using 'ordinary rules of syntax makes no commercial sense', where 'something had gone wrong with the language'. 15 In the High Court, Briggs J described the issue:  [81]. The italics are mine.
A clause providing for payment of '23.4% of the price achieved for each Residential Unit in excess of the Minimum Guaranteed Residential Unit Value less the Costs and Incentives' meant 'the amount by which 23.4% of the price achieved for each Residential Unit (less the costs and incentives) is in excess of the Minimum Guaranteed Residential Unit Value' 17 Lord Hoffmann took a fairly extreme position in Chartbrook when he said that even where the rule may mean that 'parties are sometimes held bound by a contract in terms which, upon a full investigation of the course of negotiations, a reasonable observer would not have taken them to have intended': a system which sometimes allows this to happen may be justified in the more general interest of economy and predictability in obtaining advice and adjudicating disputes 18 Lady Hale observed of the record of the negotiations, seen by nine Judges, that on 'any objective view, that made the matter crystal clear' 19 perhaps as a minor rebuke to Lord Hoffmann who had referred, generically, to negotiation evidence as being 'drenched in subjectivity'. 20 Catherine Mitchell says of Chartbrook that 'the application of formal norms of interpretation would almost certainly have led to the wrong interpretation being placed on the contract' and that 'policy considerations' appeared to trump evidence of objective intention. 21 It is hard to disagree with this analysis.
In total six Judges out of nine agreed with the interpretation of the developer, Catherine Mitchell irresistibly arguing that this makes it hard to maintain a claim that admitting negotiation evidence would create uncertainty. 22 Lawrence Collins LJ observed that 'every contemporary document…, and every piece of paper which throws light on the commercial purpose of the provision, supports Persimmon's case'. 23 In an earlier case, Lord Hoffmann explained that evidence of negotiations is admissible in rectification actions but not otherwise for reasons of practical policy', 24 Sir Richard Buxton disagreeing, citing Lord Nicholls, 25 saying that the fear that Courts would be 'overwhelmed by masses of irrelevant evidence never seemed a convincing reason' 26 for the exclusionary rule. Judges routinely read negotiation evidence (Lord Nicholls describing this as 'page after page of turgid pre-contract correspondence' 27 ) to determine whether a contract has been agreed, or whether it should or should not be rectified, and then go on to consider what it means. Indeed the Supreme Court itself considered the negotiations leading up to the contract in Cavendish  Given that Judges tend to be provided with negotiation evidence as part of the disclosure exercise 29 and disclosure is not limited to admissible documents, 30 it seems to me to be difficult to argue that Judges cannot differentiate between (objective) negotiation evidence which makes the position 'crystal clear' and that which Lord Wilberforce might view as 'unhelpful', 31 or in Popham CJ's evocative seventeenth century phrase the 'uncertain testimony of slippery memory'. 32 It should go without saying that any change to the exclusionary rule must not imperil the objective character of interpretation and that only evidence drenched in objectivity, or at least with subjective elements wrung out, should be admissible. In Chartbrook, for example, the key objective text turned up in disclosure of Chartbrook's documents; perhaps illustrating the robust nature of our litigation rules, or, at least, that the rules were rigorously adhered to.
In one recent example, negotiation evidence formed part of the background to a complex Sale and Purchase Agreement; O'Farrell J said that 'There is strong evidence that the above interpretation was shared by the parties at the time of the SPA'. 33 One eccentric exception to the rule is that where parties have, in negotiation, agreed to exclude one possible meaning of a provision, that evidence may be admissible. Applying this idea to Chartbrook, for example, it seems that had the parties expressly rejected Chartbrook's interpretation that rejection would have been admissible. But an unexpressed rejection, clear from the documentation which pointed to Persimmon's interpretation, was inadmissible. Commenting on the key Australian case, in which Mason J ruled that 'It is possible that evidence of mutual intention, if amounting to concurrence, is receivable so as to negative an inference sought to be drawn from surrounding circumstances', 34 Donald Nicholls (Lord Nicholls), writing extra-judicially, says that this 'destroys the rationale for an absolute rule'. 35 It defies logic and common sense that evidence of the negotiated rejection of a particular meaning is admissible in interpretation but had the parties agreed rather than rejected such interpretation in negotiation, the evidence would be inadmissible.
I don't argue that the evaluation of negotiations is easy. Melvin Eisenberg's recognisable description of negotiations resonates: A relatively norm-free process centred on the transmutation of underlying bargaining strength into agreement by the exercise of power, horse-trading, threat and bluff 36 One lesson which should be drawn from it is that it is likely to be difficult to locate a point in time, prior to full agreement, where a commitment intended by both parties to be binding has been made. That does not mean that it is impossible; just that it is not easy.

Actual knowledge of special circumstances
The classic formulation of what damages may be recovered by the innocent party to a breach of contract was delivered by Lord Reid in Koufos v C Czarnikow Ltd: 'The crucial question is whether, on the information available to the defendant when the contract was made, he should, or the reasonable man in his position would, have realised that such loss was sufficiently likely to result from the breach of contract to make it proper to hold that the loss flowed naturally from the breach or that loss of that kind should have been within his contemplation. 37 When that reasonable [person] is in possession, at the time the contract is made, 38 of actual knowledge of facts which might lead them to realise that certain damage would be not unlikely to flow from a breach of contract that damage may well be recoverable. Most commentators regard the remoteness rules as agreement based, although Andrew Robertson describes them as 'gap-filling'. 39 Citing Andrew Robertson, however, Lord Hoffmann asserted in The Achilleas that: [T]he implication of a term as a matter of construction of the contract as a whole in its commercial context and the implication of the limits of damages liability seem to me to involve the application of essentially the same techniques of interpretation. 40 Subsequent case law appears to confirm that this is the orthodox approach, Toulson LJ noting in Supershield Ltd v Siemens Building Technologies FE Ltd that 'the question is not simply one of probability, but of what the contracting parties must be taken to have had in mind, having regard to the nature and object of their business transaction'. 41 However, even if the determination of whether loss or damage was a natural or direct result of a breach can be characterised as either a question of causation or of gap-filling, that is not true of the analysis of what actual knowledge a party possessed. That, it seems to me, is a classic matter of construction, involving an enquiry into the matrix to determine what the contract means, what the parties have accepted, in terms of liability for breach.
In discussing the issue of actual knowledge, it is worth bearing in mind that there is a relative dearth of cases on the point, probably because the Courts readily impute knowledge, as McGregor notes the 'reasons for imputing knowledge might be good reasons for an inference of actual knowledge'. 42 McGregor provides a nice example -'the defendant will be taken to have known that the claimant might have been, say a furniture dealer, when the defendant purchases a large quantity of furniture, and might therefore lose business profits by a failure or delay in delivery' 43 .As Lord Walker observed in The Achilleas: Businessmen who are entering into a commercial contract generally know a fair amount about each other's business 44 That knowledge might be background but will often be created or transmitted in the course of negotiations. In the same case, Lord Rodger said that: the parties, who were both engaged in the business of shipping, would have known that market rates for tonnage go up and down, sometimes quite rapidly 45 In Simpson v London & North Western Railway Co, each of the three Judgments makes it clear that notice given to the railway company's agent of the object of the transaction allowed, unusually for a contract of carriage, the imposition of liability for loss of profit. The case seems to hinge on both a course of dealing and on actual notice. 46 In Hammond v Bussey, Lord Esher found as a matter of fact that, consequent upon a history of dealing between the parties: … when the defendant sold the coal, he knew that the plaintiffs were buying the coal in order to sell it again to the owners of steamers calling at Dover to be used as steam-coal … ; and he therefore knew that the plaintiffs would enter into contracts with others similar to the contract he himself had made with the plaintiffs 47 It seems impossible that the knowledge was gained other than during discussions or negotiations about the contract. In Trans Trust SPRL v Danubian Trading Co McNair J, at first instance, found, having reviewed the negotiations which preceded the contract, that, as Somervell LJ agreed, 'it was also established that both the plaintiffs and the defendants knew that neither of them were in a position to put up the necessary Belgian francs to satisfy their purchase obligations, unless the American buyers made the money available through their letter of credit'. In the same case in the Court of Appeal Denning LJ said that the 'buyer knew that the sellers could not obtain the goods at all unless the credit was provided'. 48  had not been 'shown in evidence that the defendants knew what his occupation was or that he intended to carry out a conversion of the premises.' 49 It is also clear from the Judgment of Devlin J in Biggin and Co Ltd v Permanite Ltd that the actual knowledge of the resale by the plaintiff of the defective adhesive to the Dutch Government arose during negotiations. 50 In a case involving a breach of warranty in a share sale agreement, O'Farrell J interrogated the negotiations to find that certain contracts should have been defined as material for the purpose of valuing the transaction. 51 More recently in Wellesley Partners LLP v Withers LLP, the first instance Judge found that Withers knew that Wellesley was contemplating expansion in the US and Floyd LJ in the Court of Appeal took this into account in the assessment of damages that arose from a third-party bank exercising a negligently drafted option to withdraw some of its capital, with the consequence that Withers was unable to take advantage of a particular US opportunity. 52 In one unusual case, Duncan v Underwood, actual knowledge gained pre-contract, during negotiations, operated to reduce the damages that might otherwise have been awarded. Estate agents had advised on individual prices and knew that the claimant's intention was to sell the properties individually, so, whereas a sale as an estate would have realised a higher price, the right measure was that which would have been realised by individual sales. 53 Judges do, then, review evidence arising from negotiations to determine liability issues. 54 It is difficult to imagine a different valid source of such evidence given that knowledge must be acquired in a way that justifies the imposition of liability. 55 An overheard conversation in my local pub was enough to create a breakthrough in the first case in which DNA evidence convicted someone of murder but a similar acquisition of commercial knowledge would likely not support an assumption of contractual liability. 56 Even in the somewhat fanciful hypothetical of the taxi driver informed by a passenger that failure to get them to their destination on time would cause a huge loss to the passenger, Ivan Sin, correctly in my view, says, albeit without emphasising that the information must be given before the driver accepted the fare, that 'in order to render the taxi driver liable, there would have to be clear and unequivocal communication to the effect that the passenger should tell the driver that if he could not arrive on time, he would truly hold the latter responsible. 57 In actual knowledge cases, Andrew Robertson's claim that remoteness rules operate as a 'gap filling device' 58 cannot be right and in these cases, the rule is clearly a rule of construction.  59 and circumventable', noting the power of the Courts to control evidence and Rules that ensure that evidence can be limited. 60 He is right that exceptions to the rule are numerous. 61 They include rectification, 62 duress, 63 misrepresentation, 64 breach of warranty (perhaps analogously to actual knowledge issues), 65 estoppel, 'sham' contracts 66 as well as the somewhat eccentric exception of deleted items.
Rectification, not so much an exception to the 'overly blunt' 67 exclusionary rule as a necessary result of or corollary to it (Robert Stevens noting that jurisdictions missing the exclusionary rule also miss out on the remedy of rectification 68 ), is available where it can be shown that 'the parties were in complete agreement on the terms of their contract, but by an error wrote them down wrongly'. 69 In cases such as duress, undue influence, misrepresentation, consent is in issue. If a contract is entered into under duress the threatened party may avoid it. Threats that have this effect include threats to the person, the person's property (including threats to seize goods), and, sometimes, wrongful or illegitimate threats to their economic interests. 70 Undue influence is a doctrine permitting the setting aside of contracts in cases in which a transaction between two parties, usually in a relationship of trust and confidence, may be set aside if the transaction is the result of an abuse of the relationship. 71 The doctrine has no clear boundaries, Lord Chelmsford LC making the point that 'courts have always been careful not to fetter this useful jurisdiction by defining the exact limits of its exercise'. 72 Misrepresentation's essence is that a false statement of fact has induced one party to enter into a contract. 73 From the above precis, one can see that such cases are 'identical to the kinds of mistake or other vitiating factor that can set aside contracts generally'. 74 'Snapping Up' may be another case in point, although it may fit more neatly as an estoppel, also an exception, but reflecting the law's occasional reluctance to allow parties to take unfair advantage. 75 Where the Courts are analysing the effect of actual knowledge in relation to the liability of a breaching party, there is no question of adulteration of the language being in issue as in rectification cases, nor is there any question of analysing consent to determine whether or not it was specious as in duress, undue influence or misrepresentation. These exceptions are different in class. Actual knowledge forms part of the matrix, the background, and is used in the construction of a valid agreement.

Discussion
The 'suspect' 76 exclusionary rule has been upheld in Scotland, 77 New Zealand 78 and Australia, the High Court going so far as suggesting that a search for what the parties actually meant would be 'revolutionary'. 79 This reflects the generic common law Judge claim that their approach is 'objective'. 80 David McLauchlan describes it as incongruous on the one hand to describe the judicial task as to 'ascertain and give effect to the intention of the parties' while on the other claiming it to be 'revolutionary to suggest that the search is for what the parties meant'. 81 Businesspeople would be, it is suggested, astonished, even insulted, to find their actual (evidenced) intentions, forged in the heat of the commercial process, apparently dismissed as 'subjective', connoting, I suggest, to a reasonable businessperson, bias or emotion, the Judges meanwhile asserting that their opinion, formed in the comfortable and synthetic amphitheatre of a Courtroom, is 'objective', connoting scientific.
Like the exclusionary rule, the actual knowledge rule is a central canon of contract construction and the two are manifestly incompatible. A Judge cannot apply one without disapplying the other. There may be hope. Andrew Burrows has expressed discomfort with the traditional rule writing: To allow in previous negotiations or declarations of intention … is consistent with an objective approach in that one is still ascertaining a party's intentions through objective evidence … an objective approach would not permit evidence of undeclared intention or of what a party thought the previous negotiations meant 82 It is wider than the argument made by Lord Nicholls that admitting reliable evidence from the parties' pre-contract exchanges of the meaning they intended the words in dispute to bear 'would not be a departure from the objective approach. Rather, this would enable the notional reasonable person to be more fully informed of the background context 83 There are clear similarities to the suggestion of Lady Hale in Chartbrook that perhaps rectification might proceed on the basis of evidence of an objective pre contract consensus improperly reflected in the eventual contract during negotiations. 84 All three approaches seem possible, and, given the similar 'forensic purpose' 85 of construction and rectification, appear to me to be practical and each would add clarity. Only Andrew Burrows's formulation, however, has breadth sufficient to obviate the tension between the exclusionary rule and the actual knowledge rules, unless you stretch the word 'consensus' to include the transmission of actual knowledge. Adjustment of the exclusionary rule along with those lines would, in my opinion, provide greater coherence to our Law of Contract, maintain its objective nature and avoid the risk that Judges are persuaded by negotiation evidence but, unable to say so, give reasons which are not true reasons.