Investors Compensation Scheme v. West Bromwich Building Society [1997] UKHL 28

Investors assigned compensation claims to the ICS, but a clause appeared to exclude valuable claims against the building society. The House of Lords, led by Lord Hoffmann, established modern principles of contractual interpretation, emphasising context over literalism to achieve commercial common sense.

Facts

Investors received negligent advice from financial intermediaries to enter into mortgage and investment schemes with West Bromwich Building Society (WBBS). The investors suffered financial loss and had potential claims against both WBBS and the intermediaries. The Investors Compensation Scheme (ICS) was established to provide compensation. In return for receiving compensation, each investor was required to sign a claim form which assigned their rights arising from the transaction to the ICS. The central dispute concerned the interpretation of an exclusion clause in this assignment contract, Section 3(b), which stated that the following claims were not assigned to the ICS:

“Any claim (whether sounding in rescission for undue influence or otherwise) that you have or may have against the said West Bromwich Building Society in which you claim an abatement of sums which you would otherwise have to repay to that Society in respect of sums borrowed by you from that Society in connection with the transaction and dealings giving rise to the claim (including interest on any such sums).”

A literal interpretation suggested that all claims against WBBS, including claims for damages, were retained by the investors. This would render the assignment commercially pointless for the ICS, as they would have paid compensation but acquired no valuable rights against WBBS in return, while the investors could potentially recover twice for the same loss.

Issues

The primary legal issue before the House of Lords was the proper construction of Section 3(b) of the assignment contract. The court had to determine whether the clause excluded all claims against WBBS, or only those claims specifically related to rescission (the right to have the mortgage contract set aside) and the abatement of the loan. This question engaged fundamental principles of contractual interpretation: should the court strictly adhere to the literal ‘natural and ordinary’ meaning of the words, or should it adopt a broader, purposive approach that considers the commercial context and purpose of the agreement?

Judgment

The House of Lords, by a 4-1 majority, allowed the appeal in favour of the ICS. Lord Hoffmann, delivering the leading judgment, moved away from traditional, literalist methods of interpretation and restated the principles of contractual construction in what has become a landmark speech.

Lord Hoffmann’s Principles of Interpretation

Lord Hoffmann summarised the modern approach to contractual interpretation in five principles:

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.’ 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 or adopted strange usages. But 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

Applying these principles, Lord Hoffmann concluded that the literal meaning of Section 3(b) produced a commercially absurd result. He argued that the ‘background’ revealed that the purpose of the assignment was for the ICS to acquire all valuable claims in order to ‘stand in the shoes’ of the investors it had compensated. The literal interpretation, where investors retained claims for damages, defeated this purpose entirely.

He determined that something had ‘gone wrong with the language’ and the drafter had made a mistake. The reasonable person, aware of the commercial context, would understand that the phrase ‘or otherwise’ in ‘sounding in rescission… or otherwise’ was intended to refer to claims similar in nature to rescission, not to all claims whatsoever. The court corrected the drafting’s effect by interpreting the clause to mean that only claims for rescission and the associated rights to reduce mortgage repayments were retained by the investors. All other claims, including those for damages, were successfully assigned to the ICS.

Lord Lloyd delivered a dissenting judgment, arguing for a more traditional and literal interpretation. He found the words of the clause to be unambiguous and believed the court was overstepping its role by effectively rewriting the contract for the parties.

Implications

The judgment in Investors Compensation Scheme v. West Bromwich Building Society is a watershed moment in the English law of contractual interpretation. It decisively shifted the judicial approach from a strict, literal method to a modern, contextual, and purposive one grounded in commercial common sense. Lord Hoffmann’s five principles became the leading authority for decades, empowering courts to look beyond the text to the ‘matrix of fact’ to ascertain the objective intentions of the parties and to correct apparent drafting errors to avoid absurd outcomes. While hugely influential, the decision has also sparked debate about the certainty of contractual language and the boundary between interpretation and rectification. Subsequent case law, such as Arnold v Britton, has sought to balance the Hoffmann approach by re-emphasising the primary importance of the natural meaning of the words used in the contract.

Verdict: The appeal was allowed.

Source: Investors Compensation Scheme v. West Bromwich Building Society [1997] UKHL 28