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15 February 2011
In Thomas Crema v Cenkos Securities plc(1) the Court of Appeal, while allowing an appeal on the facts, upheld the High Court's earlier finding that market practice is admissible as part of the factual matrix that may be considered in interpreting a contractual term.(2) The case also included an exploration of how and when a court will imply terms into a contract.
The English courts have set a high bar to implying a term into a contract on the basis of a particular trade's usage or custom. Chitty on Contracts(3) states that a term can be implied where the practice is "notorious, certain, reasonable" and not "contrary to law". The usage cannot be inconsistent with the express terms of the contract, which will otherwise prevail.
In interpreting contracts, the court will examine the intentions of the contracting parties, viewed objectively. This involves considering the ordinary meaning of the words used, in order to determine what a reasonable person, with knowledge of the full factual matrix available to the parties, would have understood the words to mean.
Cenkos was a stockbroker and corporate finance adviser based in London. In 2007-2008 it engaged Thomas Crema, who had worked as an investment banker in London for 20 years. Crema's role was to act as a sub-broker to find investors to finance a project for a venture capital company, Green Park Ventures (GPV).
There were two contracts concerning commission. The first was a contract between Cenkos and GPV; the second was a contract between Cenkos and Crema. It was not disputed that Crema's fee would be 70% of Cenkos's final commission payable by GPV, which was 7% of the total of £18 million raised for GPV. Crema's fee would be payable after GPV had received the total funds from investors; however, responsibility for paying the fee lay with Cenkos, not GPV.
The disputed point was whether Crema became entitled to be paid his commission only on GPV's fee being paid to Cenkos or whether he was entitled to payment even if Cenkos had not received payment. The problem arose because GPV refused to pay Cenkos's commission, although it had received all of the £18 million raised through Crema. It collapsed into insolvent administration in 2009.
Crema claimed a fee of £882,000, plus interest.
At first instance, expert evidence was heard from two witnesses on when a sub-broker would be paid commission by a broker on raising finance for the broker's client. Neither expert suggested that there was sufficient trade custom (in the sense described above) to imply a term into the contract. However, the first instance judge accepted that "there is a general market practice or understanding in [the City of London] that a sub-broker is not paid until the broker receives payment from the client". The judge found that payment in advance would be "regarded as an indulgence". He therefore held that a market practice existed. He also had to consider whether that fact was admissible. In deciding that it was, he stated that when construing a contract:
"the court is seeking to place itself in the position of the parties, and to do that it needs to have available to it all the background knowledge which would reasonably have been available to the parties in the situation in which they were at the time of the contract."
It was also held that contrary to the decision in Galaxy Energy International,(4) accord between experts as to market practice was not required. Therefore, he held that:
"it cannot be a prerequisite of admitting this evidence that both experts are agreed. It is for the court to decide whether a general market practice has been established... The evidence of one of them may be incredible or obviously wrong."
Despite coming to this conclusion, the judge felt able to ignore it for the purposes of his judgment. In his assessment, Crema and Cenkos had been "in it together". He stated that "any other arrangement would be rather uncommercial, placing the whole risk of non-payment by GPV on Cenkos". The judge found that the contract between Crema and Cenkos entitled Crema only to receive 70% of the brokerage actually received from GPV. Although the judge stated that he ignored market practice, he also said that it "strongly supported" his conclusion.
Lord Justice Aikens gave the leading judgment. He first considered the first instance finding that there was a term in the contract between Cenkos and Crema to the effect that the latter would take a 70% share of the 7% brokerage received from GPV, and that Crema had no independent right to payment of brokerage. He held that if such a term existed, it must be an implied term.
The judge considered the circumstances in which a term would be implied and referred to the principles in Attorney General of Belize v Belize Telecom Ltd:(5)
However, the judge went further than the Belize case in concluding that the principles must apply to any contract, whether in writing or oral. The Belize case was referred to as confirmation that market practice was admissible in the construction of a contract, stating that "[o]nly in that way can a court be put in the position of being what Lord Hoffmann calls the 'reasonable addressee'".
When giving their evidence, both experts accepted that they had never encountered a case in which a broker had not been paid, and so had to hypothesise on what would happen in that event. Their analysis had relied on the normal sequence of payments when arrangements went according to plan. The judge found the first instance finding on City practice to be "tentative and general", and that "the expert evidence did not drive [the first instance judge] to the conclusion that the parties to this contract" must have intended to operate the contract in line with the condition described above.
The judge asked:
"Is the only meaning of the contract,… consistent with its other provisions and taken against the relevant background,… that Crema is... entitled to his sub-commission [only] if Cenkos has been paid its commission?"
He concluded that this was not the meaning of the contract for the following reasons:
If there was to be an implied term, as found by at first instance, he found that:
"there had to be other implied terms in the contract. At a minimum (and as the judge found), these would impose duties on Cenkos to take reasonable steps to recover fees due from GPV and also not to do anything that would prevent payment of fees by GPV to Cenkos with the consequence that... Crema was deprived of his subcommission."
With many terms having to be implied to give the contract the meaning sought by Cenkos, it left the question: "Is that what the parties must have meant by the contract?" The conclusion was that it was not, and the appeal was allowed. The chancellor of the High Court agreed with the conclusion, but on slightly different grounds. Although he agreed that regard can be had to market practice - falling short of trade usage or custom - in interpreting a contract, he found that he did not have to consider the Belize case and the issue of when a court implies terms into a contract. Rather, on the documents correctly interpreted, he did not consider that they warranted the "gloss" - that is, the implied terms - "put on them by the [first instance] judge".
This judgment extends the bounds of the admissible factual matrix and provides a fresh avenue for parties to explore as an aid to contractual interpretation. It also serves as a reminder of how and when a court will imply terms to a contract, although there was disagreement among the judges as to whether that question was relevant to this case.
The case serves as a reminder that when drafting commercial contracts, parties must ensure that they are conscious of the environment in which they operate. If they intend to depart from common market practice - even practice that falls short of being "notorious, certain and reasonable" - they must do so explicitly. Otherwise, if it later falls to a court to construe the parties' agreement, they may find themselves held to a contract that they did not intend.
For further information on this topic please contact Geraldine Elliott at Reynolds Porter Chamberlain LLP by telephone (+44 20 3060 6000), fax (+44 20 3060 7000) or email (email@example.com).
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