KNOWLEDGE

Contract: Recitals or Operative Clauses, who would win in a fight?

MortonFraser_Simon Roudh
Author
Simon Roudh
Trainee Solicitor
PUBLISHED:
18 February 2020
Audience:
Business
category:
Blog

And the answer is, operative clauses, which a recent ruling (27 January 2020) handed down in the Admiralty Court, Queen's Bench Division, helpfully reminds us of.

The case, Qatar National Bank v Owner of the Yacht Force India, involved a yacht. Qatar National Bank, benefited from a mortgage over the yacht. In addition to the mortgage, a deed of covenant was entered into, as is customary in shipping transactions.

As a legalistic aside, the ships mortgage is typically a document where limited information can be included due to the format of the mortgage itself, usually a form, with boxes to include information and/or drop down information to choose from. The deed of covenant is where the parties will include a lot more detail in terms of the parties obligations and in relation to the ship/yacht itself, for example in relation to the use of the yacht, where it can sail, insurance provisions and the like. The mortgage and the deed of covenant really go hand in hand in terms of taking security over a ship.

So, back to the case: Well, things went sour: the loan was not repaid as per the agreement between the parties and Qatar National Bank sought to enforce the mortgage over the yacht. Ultimately, the court ordered the sale of a luxury yacht and its proceeds to be used to pay back Qatar National Bank.

One of the discussions within the judgment, which ultimately assisted the Admiralty Court in arriving to its conclusion related to the obvious inconsistency between the provisions of the recitals within the mortgage and the operative provisions of the security documentation as a whole in the deed of covenant. The inconsistency was in relation to the limitation of liability amount (€5,000,000) and what it actually covered, as follows:

  • The recital terms in the mortgage placed the €5 million limit "on all sums…owing to the Mortgagee by the Borrower under the Facility Documents whether by way of principal and interest or otherwise as well as other money whatsoever now or any time hereafter owed or to be owed to the Mortgagee". Consideration of the words "as well as" was given by the court that they arguably place that limit on "other money whatsoever…owed or to be owed to the Mortgagee".
  • In contrast, clauses 2.1 and 3.1 of the deed of covenant placed the €5 million limit onlyon the principal amount guaranteed: "The owner's liability under this covenant is limited to a principal amount of €5,000,000 together with interest, costs and expenses of collection." The courts centred their attention on "together with" and deduced that "interest, costs and expenses of collection" are not subject to that limit.

In deciding how to address this inconsistency, the court looked to the well-established principle that in the case of an inconsistency between the recitals and the operative part of a contract, the operative part prevails. As such the proper construction of the deed of covenant and mortgage read together was therefore that the €5 million limit was only to apply to the principal sum due under the loan facility and the interest, costs and expenses of collection guaranteed by the deed of covenant were not limited.

Moreover, the court looked beyond these two documents and considered the background to which the parties' agreement was against and must be construed to support this construction, notably, the court looked to a side letter which provided "The Yacht Mortgage shall now be restricted to a principal amount of €5,000,000". This represents a further indication of the parties' intentions for the limit only to apply to the principal sum and not to the sum or costs and expenses of collection.

Comments

It is often the case in contracts, loan documents or security documents that recitals precede the operative provisions. They tend not to automatically form part of the operative legally binding agreement between the parties but can be considered helpful by a third party (such as a court) in ascertaining the true intention of the parties, such as in this case. But it is important to consider all documents and circumstances as a whole, as the court did, to get the most accurate picture of the parties' intentions.

So what can we learn here?

Whilst this is an English High Court judgement and the approach taken in this case can be used for persuasive purposes here in Scotland, the main focus of this case is worthy of consideration as a reminder when drafting contracts, loan documents and the like:

  • ensure consistency of terms throughout the contract and ancillary documentation incorporated into the contract in question. This will avoid any ambiguity as to their interpretation or the true intentions of the parties;
  • be clear in the contract if you want to give legally binding effect to the recitals by explicitly incorporating the recitals in the definitions or interpretation section; otherwise, draft the recitals with 'scene-setting' in mind and do not include contractual obligations; and
  • if the parties' intentions change over the period of the performance of the contract and they wish to amend their agreement, they should do so in writing, bearing in the mind any other documentation in force between the parties.

 

Disclaimer

The content of this webpage is for information only and is not intended to be construed as legal advice and should not be treated as a substitute for specific advice. Morton Fraser LLP accepts no responsibility for the content of any third party website to which this webpage refers.  Morton Fraser LLP is authorised and regulated by the Financial Conduct Authority.