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Although businesses enter into commercial contracts on a regular basis it is often common for one party to claim that the contract does not adequately document the intention of the parties. The party in question may apply to court to have the contract rectified.

The case law around this subject varies, particularly as to whether the contract should be interpreted to reflect what the parties actually wanted and agreed (the subjective test) or what a hypothetical reasonable observer would have decided had been intended by the parties (the objective test).

The Court of Appeal clarified the position in FSHC Holdings Ltd v Flas Trust Corporation Ltd in which it was held that the subjective test was to be used unless there is a prior binding agreement between the parties.

In circumstances where there is no prior binding agreement the contract may be rectified. An example of this would be a situation whereby certain terms were agreed between the parties but the document executed contains terms to the contrary. The subjective test applies here in that ultimately the document should reflect what the parties had intended.

If however, there is an existing binding agreement in place, the objective test will apply ie. how a reasonable observer would have interpreted the terms based on what had previously been agreed. The reason being is that the objective test would create more certainty for an existing agreement and would prove difficult in other situations in proving the parties' common intentions.

The decision in this case certainly adds clarity to the law and makes it difficult to change formal agreements that have been entered into. It also prevents those parties that feel that they have entered into a bad bargain from going back on the agreement as they will need to prove that the agreement incorrectly reflects what the parties had intended rather that whether it is objectively wrong to enter into the terms of that agreement.

This case enforces the need to keep clear records in relation to contract negotiations showing the intention of the parties from the outset, particularly if the contract is challenged at a later date.

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