The Contextual Interpretation of Contracts and Priority Clauses in Current Case Law: Precedence in Reverse

Contractual inconsistency is a classic problem in the interpretation and construction of commercial contracts. As the parties are often aware of the difficulty of avoiding contradictions in a large body of contractual documentation, precedence clauses are often agreed to which seek to give priority to a single contractual term in the event of a conflict or, in the case of commercial contracts comprising several separate documents, to a particular set of terms.

However, two recent decisions of the English Court of Appeal serve as a reminder that the effect of priority clauses in the event of a potential conflict may be more limited than expected by the parties.

In Virgin Aviation TM Limited v Alaska Airlines Inc [2024] EWCA Civ 622, the Court of Appeal considered a trademark license agreement under which Virgin had granted its then-subsidiary Virgin America the right to use Virgin trademarks in return for the payment of revenue-based royalties. Due to a regulatory requirement of the US Department of Transportation, the license agreement gave Virgin America the option to operate without using the trademarks, in which case no royalties would be due (clause 3.7 of the agreement). At the same time, the parties agreed upon the payment of a minimum royalty of around USD 8 million per year in the event of revenue-based royalties falling short of this amount. In 2018, Alaska Airlines merged with Virgin America. As a result, Alaska stopped using the Virgin brand altogether and, citing clause 3.7, no longer wanted to pay any royalties. Virgin, on the other hand, argued that it was still entitled to the minimum royalty—which amounted to a whopping US$160 million over the remaining 20-year term of the license agreement.

The Court of Appeal ruled in Virgin's favor. The fact that clause 3.7 was to take precedence (‘Notwithstanding any other provision (…)’) was deemed irrelevant based on a contextual interpretation of this clause together with all other contractual clauses, in particular clause 3.6, which provided, though expressly ‘subject to clause 3.7,’ that the licensee should continue to use the Virgin trademarks and use reasonable efforts to promote its activities under those marks. As a result, the Court of Appeal held that clause 3.7 did not confer the right upon the licensee to cease the use of the licensed trademarks in their entirety and without payment of the minimum royalties.

Yieldpoint Stable Value Fund v Kimura Commodity Trade Finance [2024] EWCA Civ 639 on the other hand concerned a so-called sub-participation agreement pursuant to which Yieldpoint agreed in consideration for interest and other entitlements to pay US$5 million to participate in Kimura’s share of an existing loan facility extended to a Chilean mining company. The participation took place by means of an individual participation agreement that was being made pursuant to and expressly incorporated a master participation agreement in accordance with which Yieldpoint would not have recourse against Kimura in case of a default of the debtor and would accordingly expose its capital investment to this risk.

After the debtor defaulted and was finally declared bankrupt, Yieldpoint requested repayment of its investment from Kimura, arguing that the terms of the participation agreement (taking explicit precedence over the terms of the master agreement) contained a certain calendar date as the ‘Maturity Date of the Participation’ and had therefore effectively transformed the participation into a repayable fixed term loan that entitled Yieldpoint to repayment regardless of any default of the debtor. This view was rejected by the Court of Appeal. 

In both cases, the Court of Appeal has left no doubt as to the limited effect of priority clauses: Wording of precedence must be given effect, but only to the extent that there would (still) be an inconsistency or conflict after all the terms of the contract have been read together (apparently on an equal footing) ‘in order to arrive at a coherent interpretation of the whole contract which accords with commercial sense’ (Virgin v Alaska, para 28; Yieldpoint v Kimura, para 41).

Both judgments give rise to two fundamental questions that were not addressed by the Court of Appeal: First, is the apparent objective of achieving a consistent interpretation of the contract still in line with the precedent that it would be ‘wrong to approach the contract on the assumption that there is no inconsistency’ since ‘by including the inconsistency clause the parties have acknowledged that there may be one’ (Pagnan SpA v Tradax [1987] 3 All ER 565, 574h)? Secondly, and on a more fundamental level, the disregard of the priority wording in its entirety unless and until a contractual inconsistency has been positively established (rather than taking account of the intended priority already in the iterative process of interpreting the contract itself) raises the question of whether this approach can do justice to the express designation of a contractual provision as being of particular importance.

Be that as it may, both decisions have important lessons for the drafting of contractual terms: Relying on a priority clause alone may not be sufficient to ensure the unfettered enforcement of the substantive matter to which the clause relates. One possible remedy might be to make it explicit that the overriding nature of the priority clause must be duly taken into account in the process of interpretation itself, and not only afterwards. Surely it would be even better to try to avoid inconsistencies in the first place.

Patrick Ostendorf is a professor of commercial law at the HTW Berlin and of counsel at Orth Kluth Rechtsanwälte, Berlin.