Investors Compensation Scheme Ltd v West Bromwich Building Society [1998] 1 WLR 896

Investors who suffered losses from Home Income Plans claimed compensation from the Investors Compensation Scheme, which then sought to recover from building societies as assignees. The House of Lords clarified principles of contractual interpretation, holding that documents must be construed by reference to background knowledge available to parties, not merely literal word meanings.

Facts

The Investors Compensation Scheme Ltd (ICS) was established under section 54 of the Financial Services Act 1986 to compensate investors with unsatisfied claims against authorised investment advisers. Numerous elderly homeowners suffered losses after being advised by financial intermediaries to enter into Home Income Plans, which involved mortgaging their homes to invest in equity-linked bonds. When markets fell, investors suffered severe losses.

Investors signed Claim Forms assigning their rights against financial advisers and third parties to ICS upon receiving compensation. Section 3(b) of the Claim Form contained a reservation purporting to exclude certain claims against building societies from the assignment. The dispute concerned whether this reservation covered only claims for rescission or all claims against the building society.

Issues

Primary Issue

The central question was the proper construction of section 3(b) of the Claim Form, specifically whether investors retained all claims against the building society or only claims sounding in rescission.

Secondary Issue

Whether, if the assignment purported to split remedies in respect of a single cause of action, such assignment was legally valid.

Judgment

The House of Lords (Lord Goff, Lord Hoffmann, Lord Hope and Lord Clyde; Lord Lloyd dissenting on construction) allowed the appeal. Lord Hoffmann delivered the leading judgment setting out fundamental principles of contractual interpretation.

Principles of Interpretation

Lord Hoffmann articulated five principles that have become authoritative on contractual construction:

“(1) Interpretation is the ascertainment of the meaning which the document would convey to a reasonable person having 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.”

“(2) The background was famously referred to by Lord Wilberforce as the ‘matrix of fact,’ but this phrase is, if anything, an understated description of what the background may include. Subject to the requirement that it should have been reasonably available to the parties and to the exception to be mentioned next, it includes absolutely anything which would have affected the way in which the language of the document would have been understood by a reasonable man.”

“(3) The law excludes from the admissible background the previous negotiations of the parties and their declarations of subjective intent.”

“(4) The meaning which a document (or any other utterance) would convey to a reasonable man is not the same thing as the meaning of its words. The meaning of words is a matter of dictionaries and grammars; the meaning of the document is what the parties using those words against the relevant background would reasonably have been understood to mean.”

“(5) The ‘rule’ that words should be given their ‘natural and ordinary meaning’ reflects the common sense proposition that we do not easily accept that people have made linguistic mistakes, particularly in formal documents. On the other hand, if one would nevertheless conclude from the background that something must have gone wrong with the language, the law does not require judges to attribute to the parties an intention which they plainly could not have had.”

Application to the Facts

Lord Hoffmann concluded that section 3(b) reserved only the right to claim rescission and any consequent abatement of the mortgage debt, not claims for damages. The commercial background indicated that ICS would have intended to take over claims against solvent building societies. The right to rescission was not a chose in action assignable separately from the property itself.

Lord Lloyd, dissenting on construction, considered the investors’ interpretation (reserving all claims against the building society) was the plain meaning of the words and could not be displaced by purposive construction.

Implications

This case is of fundamental importance in English contract law for establishing the modern approach to contractual interpretation. Lord Hoffmann’s five principles represented a significant shift towards purposive interpretation, emphasising that courts should ascertain what reasonable parties would have understood by the words used against the relevant background, rather than applying rigid literal construction.

The judgment confirmed that where language appears to have gone wrong, courts may conclude parties used incorrect words or syntax, without requiring formal rectification. However, this approach has limits – courts cannot rewrite contracts or substitute meanings that are not available from the words used.

The case also clarified the distinction between choses in action (assignable rights to money) and other rights of action such as rescission (which attach to property ownership and are not separately assignable).

Verdict: Appeal allowed. Upon the true construction of the ICS Claim Form, all claims for damages and compensation were validly assigned to ICS. The investors retained only the right to claim rescission of their mortgages upon such terms as the court may consider just.

Source: Investors Compensation Scheme Ltd v West Bromwich Building Society [1998] 1 WLR 896