4 June, 2015
Complex commercial agreements frequently seek to incorporate extraneous documents within their terms. These documents may include:
- schedules dealing with specific commercial aspects that add detail to general legal terms and conditions;
- previously executed agreements between the parties that are to be “merged” into the head agreement; and/or
- supplemental terms and conditions to be agreed at a later point between the parties or their affiliates (e.g. purchase orders).
Given that the specific personnel dealing with, and timing of agreeing, these documents frequently differ from those related to the head agreement, priority clauses – which set out which parts of an agreement will prevail where there are conflicts – are an essential aspect of complex commercial agreements.
A recent English High Court case, having a corresponding basis in Hong Kong law, has reiterated that, notwithstanding a priority clause, it will seek to construe "conflicting" clauses as consistent with each other to the extent possible, unless there is unequivocal discrepancy between them. Careful drafting is therefore required to ensure that each party's commercial objectives are achieved.
Contracts In Question
In the case of Alexander (As Representative of Property 118 Action Group) v. West Bromwich Mortgage Co Ltd  EWHC 135, the claimant ("Mr Alexander") was granted a mortgage by the defendant (West Bromwich Mortgage Company Limited – the "Bank"). The mortgage was granted on the terms of:
- an "Offer Letter" from the Bank; and
- the Bank’s standard Mortgage Conditions (the "Conditions"), which incorporated the terms of the Offer Letter by reference.
The relevant terms in question are as follows:
- The Offer Letter stated that the loan’s variable interest rate was the Bank of England Base Rate plus a premium of 1.99%.
- "Clause 5" of the Conditions stated a variety of circumstances where the Bank can change the variable interest rate.
- The Conditions also contained a "Priority Clause", stipulating that the terms in the Offer Letter will prevail over the Conditions in the event of inconsistencies.
The Bank relied on Clause 5 to increase the loan’s variable rate to the Bank of England Base Rate plus 3.99%. Mr Alexander argued that the Priority Clause operated so that the Offer Letter overrode such Clause 5, preventing the Bank from making such increase.
The Court held that there was no conflict between the Offer Letter and Clause 5, as: • there were no terms in the Offer Letter to prevent the Bank from relying on Clause 5;
- effect could be given to both the Offer Letter and Clause 5, if the latter was interpreted to qualify the Offer Letter;
- on this basis, the Offer Letter was interpreted as stating the rate that would apply unless qualified by Clause 5; and
- there was no irreconcilable conflict between the two clauses in question, and therefore the Priority Clause did not apply.
The Bank therefore had the right to make their proposed increase to the loan’s variable rate.
The Court reinforced the following principles in its decision, as previously set out in Pagnan SpA v. Tradax Ocean Transportation  2 Lloyd's Rep. 342:
- one clause may qualify another without being in conflict with it;
- there must be clear and irreconcilable discrepancy before the Court will rely on a conflicts clause’s agreed order of precedence; and
- it is necessary for the Court to consider all of the contractual terms as a whole and give sensible effect to each of them, which can be done by regarding one as modifying or qualifying the other where possible.
Pagnan SpA case remains good law in Hong Kong, having previously been applied by Hong Kong courts in commercial contract (Xu Yi Hong v. Chen Ming Han (HCA 1109/2005)) and employment contract (Ko Hon Yue v. Chiu Pik Yuk (2012) 15 HKCFAR 72) contexts.
This case is a reminder for lawyers drafting a commercial agreement that:
- all provisions “incorporated” into an agreement must work together, as a court will first attempt to read the terms together before relying on a priority clause, and will generally be reluctant to hold that contract documents are inconsistent;
- priority clauses therefore are only applied where there are “clear and irreconcilable” conflicts, and do not relieve draftspersons from their responsibility to carefully integrate extraneous documents with general terms and conditions; and
- where the parties have agreed clear interpretation rules for an agreement, these should be set out within the agreement.
For further information, please contact:
Jamie Barr, Partner, Hogan Lovells
Tim Fletcher, Partner, Hogan Lovells
Terence Lau, Partner, Hogan Lovells
Mark Parsons, Partner, Hogan Lovells
Nelson Tang, Partner, Hogan Lovells
Thomas Tarala, Partner, Hogan Lovells
Steven Tran, Partner, Hogan Lovells