Court backs clawback clause
July 2018
The theme for this Legal Briefing is badly worded contracts and how courts can choose to deal with them.
Rating system (whole thing):
Reading time (1-10 minutes): 3
Sophistication level (1 (idiot) – 10 (expert)): 7
Entertainment value (1 (turgid) – 10 (side-splitting)): 5
Court backs clawback clause
Where a clause in a business contract is badly worded, judges will generally try to reach a decision as to what it intended to say. They would prefer to do this than to rule that the clause is meaningless and should be ignored completely. After all, presumably the parties to the contract meant it to mean something, otherwise they wouldn’t have put the clause in.
A recent case which went to the Court of Appeal on this subject related to a clause in a franchise agreement. It was a standard type of clause. Mr Forte was a financial advisor who entered into a franchise contract with Openwork Limited, which used its network of franchised advisors to sell Zurich Assurance Limited’s investment products. These are usually quite long term investments, and there is a risk that they might be withdrawn earlier than planned, so these contracts with the financial advisors invariably have some form of clause saying that if the financial advisor has made a big initial commission on a sale of an investment product which is withdrawn early then he has to hand some of it back. This is often called a ‘clawback’ clause.
This particular contract had a clause which said that if an investment was withdrawn within three years then Openwork could clawback a percentage of the initial commission it had paid Mr Forte. But it did not actually contain any formula for working out the amount of any clawback. All it said was that ‘the amount of initial commission clawed back relates to the amount invested, length of time invested and amount withdrawn’.
When two investors withdrew their investments within three years of buying them Openwork tried to claw back some of Mr Forte’s initial commissions. Mr Forte said they couldn’t because the so-called clawback clause had no clear formula and so was unenforceable.
Everyone agreed that the clause itself had no clear clawback formula. But both the initial court and then on appeal the Court of Appeal were keen to make the clause work as some form of clawback provision had clearly been intended by the contract. And so they were prepared to rule that a particular formula applied involving a straight line reducing percentage of the commission over time.
The Court of Appeal confirmed that there is a clear principle that courts will try to give some meaning to contractual clauses agreed by the parties if it is at all possible to do so. But rather than having the uncertainty and the waste of time and money in waiting for the courts to decide these things, it is of course better to make sure that your business contracts clearly say what you want them to say in the first place – ideally of course using specialist business lawyers to help prepare them or at least run their eyes over them before they are signed!
This is different from a case where the contract is clearly worded. The court can only use its powers of interpretation so far in its attempt to achieve what it thinks is fairness. I touched on this in my previous Legal Briefing when I talked about the recent attempt by some courts to impose a new implied duty of good faith into certain types of ‘relational’ contracts.
