The Blue Paper and the Pink Paper: The Interpretation of Options

One
of the most frequently encountered issues in the practice of commercial law is
the construction of contractual notice requirements: a contract that confers on
one of the parties the right to do something (eg exercise an option or a break
clause) would ordinarily require that party to give notice to the other party. The
consequences of failing to understand exactly what the notice requires and
comply with it can be disastrous: for example, a tenant may lose the opportunity
to exit an expensive lease
in a falling market, an
option-holder the opportunity to buy valuable property in a rising market and
so on. The Court of Appeal has recently considered the principles governing the
construction of clauses of this kind in
Friends Life v Siemens.

The
leading authority in this field is the classic speech of Lord Hoffmann in
Mannai Investments.
The facts of that case were beguilingly simple. A tenant with a 10-year lease of
a property in Jermyn Street in London was allowed to exercise a break clause
provided he gave notice to this effect to ‘expire on the third anniversary
of the commencement date’ of the lease. The lease had been entered into on 13
January 1992. So the tenant should have given notice to expire on 13 January
1995. But it mistakenly gave notice to expire on 12 January 1995, confusing ‘first day of third year’ with ‘last day
of second year’. Though what the tenant meant was obvious to the landlord (who
was seeking to capitalise on the error), the judge and the Court of Appeal held
that the notice was defective, particularly against the background principle
that break clauses and notice requirements for options must be complied with
strictly. In the House of Lords, allowing the appeal, Lord Hoffmann explained
that the tenant had in fact complied
strictly with the notice requirement because one does not confuse the ‘inherent’
meaning of words (if any) with the meaning the
use of the words conveys
to a reasonable person possessed of all the
background knowledge the parties had.

Friends Life,
at first sight, was a remarkably similar case. The tenant had taken a 25 year
lease commencing in January 1999. It had one opportunity to exit this lease by
exercising a break clause. Clause 19.2 provided that the tenant could exercise
the break clause by:

giving
the Landlord not more than 12 months’ and not less than six months’ written
notice, which notice must be expressed to
be given
under section 24(2) of the Landlord and Tenant Act 1954.

On
28 September 2012, the tenant purported to exercise this break clause by
serving a notice in the following form:

…WE
HEREBY GIVE YOU NOTICE, for and on behalf of the Tenant, that the Tenant intends
to terminate the Lease 23 August 2013 in
accordance with clause 19 of the Lease
.

This
notice, as is evident, was ‘expressed to be given’ in accordance with clause 19
of the Lease, rather than (as clause 19 required) ‘under section 24(2) of the
Landlord and Tenant Act 1954’. It is obvious that the tenant’s intention is
plain, as it was in Mannai: the
landlord could not have understood the notice to mean anything other than that
the tenant was exercising the break clause.

In
these circumstances, a layman might be surprised to learn that there is even a
debate to be had about whether the notice is effective or not. The Court of
Appeal held, however, that the tenant had made a fatal mistake, and it is
submitted that that is clearly correct, and consistent with Mannai. In analysing cases of this kind,
it is important to distinguish between: (a)
a clause that requires the notice-giver to communicate a message bearing a
certain meaning to the recipient; and
(b) a clause that requires the
notice-giver to comply with some condition that is independent of the meaning of words. In
Mannai, Lord Hoffmann gave a well-known example
that illustrates the difference:

If
the clause had said that notice had to be on blue paper, it would have been no
good serving a notice on pink paper, however clear it might have been that the
tenant wanted to terminate the lease.

If
the clause falls under category (a), the notice-giver can comply with it
successfully even if it uses the ‘wrong’ words. In
Mannai,
the notice stated to expire on ‘January 13’ conveyed the meaning that it was to
expire on ‘January 12’ because no reasonable representee could have thought in
those circumstances that January 13 was the intended meaning. Notices of this
kind are successful not because they ‘substantially comply’ with the
contractual requirement: they comply with it fully and strictly. But this kind
of reasoning is simply irrelevant if the clause in question falls under (b):
the only way to comply with a requirement to send a notice on blue paper is to
use blue paper. It is no good using pink paper even if the landlord knows that
this was a mistake, and even if the message
written on the pink paper
was understood perfectly well by the landlord:
the problem is the paper, not the message.
Mannai
and the cases that apply it, therefore, do not decide that ‘substantial’
compliance is enough: they decide that complete and exact compliance has been
achieved even though the wrong words have been used.

In
Friends Life,
clause 19 required the tenant to give notice expressed to be under section 24(2) of the Landlord and Tenant Act
1954. This seems to be a clause under category (b) above: it does not relate to the meaning that the tenant must communicate to the landlord but to some
form of words that the notice must use. At first blush, the conclusion that the
notice is invalid seems obvious. But leading counsel for the tenant argued that
clause 19 should be taken to have been complied with if the reason for the insertion of clause 19 has
been complied with, that is, if the mischief clause 19 was intended to address
has not been defeated because of the tenant’s mistake. Lewison LJ correctly
rejects this argument in an instructive passage:

Attractively
as that argument was advanced I cannot accept it. I accept, of course, that the
purpose underlying a contractual provision may be highly relevant to what it means. But Mr Fancourt accepted that
what the clause meant was that the
notice had to say that it was being given under section 24 (2) of the Landlord
and Tenant Act 1954. He did not contend that clause 19.2 should be interpreted
in such a way that it meant no more than that the notice should satisfy the
substantive provisions of section 24 (2). But compliance with the substantive
provisions of section 24 (2) is not the same as complying with the formal
requirements of clause 19.2
. Moreover as Mr Wonnacott submitted since
clause 19.2 required that the notice be “expressed” to be given under section
24 (2) it would not be enough to conclude that it conveyed that message
implicitly. Here there was no compliance with the formal requirement of clause
19.2 that the notice be “expressed” in a particular way. There was quite simply
no reference in the notice to section 24 (2) at all.

In
other words, there is a difference between what
clause 19 means, and why clause 19
was inserted: it is no good complying with the latter without complying with
the former. The tenant’s obligation is to give notice in accordance with what
clause 19 means, not to give notice that fulfils the reason for including
clause 19 in the contract in the first place.

The
importance of this case for the general law is that it highlights the value of
a close analysis of whether a notice requirement relates to the meaning of
words (thus governed by the
Mannai rule) or to some
form of words or condition
independent of the meaning of words (thus governed by the pink paper example). Making
a mistake about this can result in expensive litigation. As Lewison LJ says:

I
do not accept that in the field of unilateral (or “if” contracts) there is any
room for the notion of substantial compliance. As Diplock LJ said in
United Dominions Trust the question is
whether the relevant event has occurred.
That question is to be answered
“Yes” or “No”. It cannot be answered “Almost”
. Either a purported exercise
of an option satisfies both the formal and substantive provisions of the
clause, or it does not. If it does not, then it is ineffective. In my judgment
ours is such a case. I appreciate that that is a harsh result, but hard cases
make bad law…The clear moral is: if you want to avoid expensive litigation, and
the possible loss of a valuable right to break, you must pay close attention to
all the requirements of the clause, including the formal requirements, and
follow them precisely.

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V. Niranjan

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