Supreme Court adds tenth 'without prejudice' exception

In order to encourage companies to settle disputes without going to court they can try to reach agreement through negotiations that are 'without prejudice' to any position they adopt later in court should those negotiations fail.

Admissions made in without prejudice communications cannot be brought up in court. This is intended to allow full and frank negotiation in which companies can make concessions without fearing that they might be bound by them in later court cases.

Shipping company TMT argued that some of the 'without prejudice' material in question would help to clarify what an agreement it came to with Oceanbulk actually meant. It is this clarifying material that acts as an interpretation aid that it wanted admitted to Court.

The Supreme Court has agreed.

Material leading up to the formation of a contract cannot be heard as evidence in a court because the contract itself is the legally binding agreement and courts have ruled in the past that its integrity would be undermined by drawing inferences from the negotiations leading up to it.

That does not apply to factual material, such as material which demonstrated that one party to the contract knew certain information at a certain time. As long as it is not without prejudice, that material can be heard.

"It is not in dispute that, where negotiations which culminate in an agreement are not without prejudice, the exclusionary rule applies to the correct approach to the construction of the agreement," said Lord Clarke, giving the judgement of the Supreme Court. "Nor is it in dispute that in those circumstances evidence of the factual matrix is admissible as an aid to interpretation even where the evidence formed part of the negotiations."

The Supreme Court ruled that material which was factual and would be admitted if it were not without prejudice should be admitted when it was without prejudice.

Lord Clarke accepted that it was sometimes difficult for trial judges to determine what material was factual and what was not, but said that the same rules should be used in that process whether the material was without prejudice or not.

"I see no reason why the ordinary principles governing the interpretation of a settlement agreement should be any different regardless of whether the negotiations which led to it were without prejudice," he said. "The language should be construed in the same way and the question ... should be the same, namely what a reasonable person having all the background knowledge which would have been available to the parties would have understood them to be using the language in the contract to mean."

"That background knowledge may well include objective facts communicated by one party to the other in the course of the negotiations," he said. "As I see it, the process of interpretation should in principle be the same, whether the negotiations were without prejudice or not. In both cases the evidence is admitted in order to enable the court to make an objective assessment of the parties' intentions."

"I would not accept the submission that to hold that the process of interpretation should be the same in both cases would be to offend against the principle underlying the without prejudice rule," said Lord Clarke. "The underlying principle, whether based in public policy or contract, is to encourage parties to speak frankly and thus to promote settlement. As I see it, the application in both cases of the same principle, namely to admit evidence of objective facts, albeit based on what was said in the course of negotiations, is likely to engender settlement and not the reverse."

"I would accept the submission made on behalf of TMT that, if a party to negotiations knows that, in the event of a dispute about what a settlement contract means, objective facts which emerge during negotiations will be admitted in order to assist the court to interpret the agreement in accordance with the parties' true intentions, settlement is likely to be encouraged not discouraged. Moreover this approach is the only way in which the modern principles of construction of contracts can properly be respected," he said.

The companies had disputed the meaning of an agreement between them about the settlement of a $40 million bet on the costs of shipping, costs which veered wildly between the start and end of 2008, when the deal was made.

The two companies disputed what a part of the contract meant, and to support its view TMT wanted to introduce evidence of what it was told by Oceanbulk in the run up to the signing of the disputed contract.

Courts had previously allowed the admittance of without prejudice material to help decide if a contract should be rectified, or corrected. If that was right then it was right to admit the material in this case too, said Lord Clarke.

"I have already expressed the view that the rectification exception is correctly accepted because no sensible line can be drawn between admitting without prejudice communications in order to resolve the issue whether they have resulted in a concluded compromise agreement, which was the first exception identified by Robert Walker LJ in Unilever, and admitting them in order to resolve the issue what that agreement was. There is also no sensible basis on which a line can be drawn between the rectification case and this type of case," he said.

Lord Clarke said that the interpretation exception should be added to the nine others already identified because "justice clearly demands it".

"In doing so I would however stress that I am not seeking either to underplay the importance of the without prejudice rule or to extend the exception beyond evidence which is admissible in order to explain the factual matrix or surrounding circumstances to the court whose responsibility it is to construe the agreement in accordance with the principles identified in ICS and Chartbrook. In particular nothing in this judgment is intended otherwise to encourage the admission of evidence of pre-contractual negotiations," he said.

The ruling agrees with the High Court's conclusion in the same case last year. John MacKenzie, a litigation expert at Pinsent Masons, the law firm behind OUT-LAW.COM, said at that time that the creation of this new exception was unlikely to undermine the without prejudice rule.

"At first glance it might seem that the court has weakened the protection of the without prejudice rule, but in fact the judgment just applies the existing rule to a new set of circumstances," he said.

"Most without prejudice communications will retain their secrecy and they won't be subjected to courtroom scrutiny," said MacKenzie. "Information that resolves an ambiguity in a settlement agreement might be admitted, but the stuff that's most important in the majority of settlement talks – the evidence that reveals your true bargaining position – that remains off limits."