Adjusting to changing circumstances: only when frustrated

The UK Supreme Court pronounced on 23 January 2013 in the much discussed case of Lloyds TSB Foundation for Scotland v Lloyds Banking Group plc [2013] UKSC 3, reversing the First Division and reinstating Lord Glennie's decision in the Outer House, in favour of the Bank and against the Foundation. 

The unanimous (although Lords Hope and Clarke clearly had doubts before reading Lord Mance's leading judgment) decision is based on grounds different from Lord Glennie's, however: fundamentally an approach to the interpretation of the controverted contract based upon how the reasonable person would have understood the agreement at its creation in 1997 against the background of the factual matrix of the time, rather than the "deletion" of words which read awkwardly in the light of changed legal and factual circumstances.  Although in the light of this approach it was not necessary to discuss the extent of Scots law's recognition of a doctrine of "equitable adjustment" of contracts in the light of changed circumstances, Lord Hope does say that outside frustration of contract, there is no such doctrine in the law; it may be, however, that in frustration cases the law's response is not limited to applying unjustified enrichment rules.

The decision will no doubt be much discussed on other blogs, and I do not go into further detail here as a result.  I am grateful however to be allowed to reproduce the comments made to me by my Scottish Law Commission colleague Charles Garland, who happens to be working on trust law as well as being a member of my contract law team.  This is what Charles says:

"On a fairly quick read this strikes me as a rather disappointing decision (well, a disappointing series of decisions as there is little by way of continuous thread through the three court pronouncements).  The SC justices have taken a purely interpretative approach but some of them seem to have swithered rather heavily as to what the result should be.  What we’re left with is a difference of opinion over the fundamental question of how the reasonable person would have interpreted the covenant when it was signed.  The IH said (at [12] (with emphasis added):

The relevant reasonable person addressing what the parties meant on entering the 1997 Deed would not have known that in 2002 a European Regulation would come into force which would require negative goodwill to be brought into account as a positive figure in the drawing up of the respondent's consolidated income statement (or consolidated profit and loss account). He would, however, have known (as was accepted on behalf of the respondent) that it was possible that the accounting rules which had to be applied in drawing up such a statement or account might change.

And Lord Hope seems to have reached the opposite view (at [34]) (again with emphasis added):

[…] I have been persuaded by Lord Mance’s judgment that these words must be read in the light of what a reasonable person would have taken them to mean, having regard to what was known in 1997 when the idea of introducing negative goodwill into the profit and loss account was unthinkable. Read in that context, the words do not have the weight that the Dean’s argument would give to them. That would be to give them a meaning which no reasonable person would have dreamed of at that time. The words used are capable of meaning realised profit or loss before taxation, and of excluding elements which would not have been contemplated as having anything to do with the computation of profit or loss when the Deed was executed. On that reading I am left in no doubt that the argument for Lloyds Bank, which accords with the landscape at the time when the words were written, must prevail over that for the Foundation.

This hugely divergent pair of results [Charles continues] seems to me to cast some doubt on the utility of the “reasonable person” test in cases such as this.  It’s not an example of poor drafting or of parties not applying their minds properly to their agreement.  It’s much more a situation of unexpected circumstances arriving somewhat out of the blue.  Drafters surely cannot be expected to provide a scheme which will work even if the world is turned upside down and inside out.  That would be an unreasonable demand.  Some form of equitable adjustment, or some judicial discretion, would seem to be appropriate (though that idea was considered and rejected).  Just as a speculation: what if the Foundation had in fact been successful and had gained a lottery-scale windfall?  As a charity, it could have decided to seek assistance from the court by way of cy-près, rather like the situation in RS Macdonald Charitable Trust [2008] CSOH 116 (where Lord Drummond Young said, in setting out the basic facts: “The result is that the Trustees now control very substantial assets; it is averred that these are greatly in excess of what the Truster could have contemplated when he set up the Trust in 1978.”).  That way of dealing with the unexpected seems to me to make much more sense."

What this makes me wonder (as Professor rather than as Commissioner MacQueen) is whether if trust law can provide for change of circumstances in this way, why not the law of contract?  The starting point should be, of course, that contracting parties (as distinct from the parties to a trust) are free to change their contract by agreement; but suppose, as in the Lloyds case, they cannot agree?  Would it not be better than long and expensively contested litigation through three tiers of the court system to have some sort of contractual equivalent to the courts' cy-près jurisdiction in trusts?  This need not necessarily be the same as the PECL, DCFR and proposed CESL schemes to which reference was made in the Inner House (although of these the DCFR seems best to me because it does not impose any duty on parties to negotiate before resorting to the courts for a decision).  But something along those lines would bring us rather more into line with other jurisdictions in the European Union (if that remains any sort of material consideration after Mr Cameron's speech on the same day as the Supreme Court judgment).

Lord Hope's possible opening of the door to using approaches other than unjustified enrichment in response to the frustration of contract, at least to the extent of a tiny chink (see [43] -"Adaptability has a part to play in any civilised system of law") is to be welcomed (see MacQueen & Thomson, Contract Law in Scotland (3rd edn, 2012) paras 4.85, 4.88 with further references), but how it may be developed is left opaque.  Some more work for the comparative lawyers amongst us, perhaps?