Construction of contractual terms

CONSTRUCTION OF CONTRACTUAL TERMS

‘There’s a sign on the wall. But she wants to be sure

’Cause you know sometimes words have two meanings’.

- Led Zeppelin, Stairway to Heaven

(from the LP Led Zeppelin IV, 1971)
‘Words are chameleons, which reflect

the color of their environment.’

Learned Hand J,

Commissioner v National Carbide Corp, 167 F 2d 304, 306 (1948)


INTRODUCTION
This paper will examine the principles used by courts in interpreting the words used in a contract. This is usually referred to as the construction of terms of the contract. The principles of construction involve two things: (i) the meaning of the terms of the contract; and (ii) the legal effects or significance of the document’s terms.¹
This paper will examine the principles of construction of terms of a contract in relation to the meaning of the terms of a contract. The importance of this topic cannot be overstated. A large proportion of cases in contract law have as a component - often the major component - the construction of the terms of the contract. The conclusion reached by the court on the construction issue usually has significant consequences in relation to the outcome of the case before the court. It can be noted at this stage that the principles of construction of contractual terms apply with equal force to contracts with governments and² deeds.³ They also apply to trust documents,⁴ one of the reasons for this being that ‘[t]he contractual relationship provides one of the most common bases for the establishment or implication and for the definition of a trust’.⁵
In determining the meaning of the words used in a contract, a significant source of the problems faced by the courts is the richness of the English language. This point was well made by Lord Simon of Glaisdale in Stock v Frank Jones (Tipton) Ltd⁶ where his Lordship said:
Words and phrases of the English language have an extraordinary range of meaning. This has been a rich resource in English poetry (which makes fruitful use of the resonances, overtones and ambiguities) but it has a concomitant disadvantage in English law (which seeks unambiguous precision, with the aim that every citizen shall know as exactly as possible, where he stands under the law).
CONSTRUCTION OF TERMS IN PRACTICE
Justice Kenneth Martin,⁷ based upon his experiences as a Supreme Court judge offers the following reflections that are relevant to the issue of construction of contract:
As a trial judge running a busy commercial list which includes many contractual interpretation cases, I have to say that I sometimes detect a rather clear felling approach by advisers who, in embarking on pre-trial discovery quests, seek supposedly helpful documents relating to surrounding circumstances. These pre-trial quests are usually pursued on the basis that a hopeful rummage through every employee’s corporate email box, or in metadata repositories, may possibly bring to light a document revealing a mutually known circumstance prior to contracting that may, somehow, howsoever slightly, advance the construction argument they are seeking to run over the disputed meaning of words in a document.
Frequently that interlocutory searcher, like Christopher Columbus, seems not to know what they hope to find, how they will get there, or indeed what they have found when they find it. But a trawling exercise, however long, costly or burdensome, must, it is put, always be undertaken. At the end of the day, someone is paying for all this and a real question arises as to whether such expense is warranted.
After the dust of a search has settled in the wake of these expensive quests there is, I humbly suggest, an essential need for the party who wants to argue there is a significant mutually known surrounding fact(s) or circumstance(s) that existed at the time of contracting, to do at least two things. First, it should explicitly plead out the fact to openly identify it. It needs to do this so the opposition can be both:

1. 
   apprised of what that alleged fact or circumstance is before trial;
   
2. 
   have a fair opportunity to indicate whether or not it accepts the existence of the fact or circumstance.
   

Identification can avoid diverting excursions into side issues over facts which, at the end of the day, may either be uncontested or even accepted.

The second requirement is for the party advancing a supposedly relevant surrounding fact or circumstance, having identified it, to then go on to clearly explain at some point in the trial process how and why the fact or circumstance assists in advancing its construction position.
In my experience, the second requirement, which I call the ‘causative impact’ of the supposedly helpful surrounding fact or circumstance, is usually either globally glossed over, or just ignored. A typical glossing scenario as to causative impact is like an overflowing potpourri of multiple diverse alleged surrounding facts and circumstances. These are then addressed in a closing submission delivered in a style akin to the advocacy of shabby solicitor Dennis Denuto during his desperate, now infamous invocation of ‘the Vibe’ in the movie The Castle.
Each different surrounding fact may indeed carry some unique causative impact in the interpolation process that should be explained. But I would humbly both suggest and request that the causative impact of each background fact relied on be clearly spelled out.
THE IMPORTANCE OF INTENTION
In ascertaining the meaning of the terms of a contract the court is primarily concerned with objectively determining the intention of the parties.⁸ This fundamental point was reaffirmed in Byrnes v Kendle⁹ where Heydon and Crennan JJ said:
Contractual construction depends on finding the meaning of the language of the contract – the intention which the parties expressed, not the subjective intentions which they may have had, but did not express. A contract means what a reasonable person having all the background knowledge of the ‘surrounding circumstances’ available to the parties would have understood them to be using the language in the contract to mean.
The basic approach in determining the intention of the parties was set out in Chartbrook Ltd v Persimmon Homes Ltd¹⁰ where Lord Hoffmann said:
When the language used in an instrument gives rise to difficulties of construction, the process of interpretation does not require one to formulate some alternative form of words which approximates as closely as possible to that of the parties. It is to decide what a reasonable person would have understood the parties to have meant by using the language which they did. The fact that the court might have to express that meaning in language quite different from that used by the parties … is no reason for not giving effect to what they appear to have meant.
Thus, as was stated by Jonathan Sumption QC in submissions in Wasa International Insurance Co Ltd v Lexington Insurance Co,¹¹ ‘[a]ny judicial interpretation of a contract involves retrospectively attaching to it a meaning which hypothetical persons in the position of the parties are assumed to have intended at the time when it was made, but which may have been unclear or unknown to those particular parties’.
In this process of construction it is not the role of the court to improve the contract. Thus, in Arnold v Britton¹² Lord Hodge said:
The [court] is not there to re-write the parties' agreement because it was unwise to gamble on future economic circumstances in a long term contract or because subsequent events have shown that the natural meaning of the words has produced a bad bargain for one side. The question for the court is not whether a reasonable and properly informed [party] would enter into such an undertaking. That would involve the possibility of re-writing the parties' bargain in the name of commercial good sense.
In relation to words used in a document same word more than once in a carefully drafted document, a rebuttable presumption arises to the effect that they intended that the word to mean the same thing throughout the entire document.¹³ Thus, it may be that the same words have different meanings, even if in the same document.¹⁴
When construing terms of a contract, a court must have regard to all its words used to ensure the congruent operation of its various components as a whole.¹⁵ Thus, in Chapmans Ltd v Australian Stock Exchange Ltd¹⁶ Lockhart and Hill JJ said:
It is an elementary proposition that a contract will be read as a whole giving weight to all clauses of it, where possible, in an endeavour to give effect to the intention of the parties as reflected in the language which they have used. A court will strain against interpreting a contract so that a particular clause in it is nugatory or ineffective, particularly if a meaning can be given to it consonant with other provisions in a contract. Likewise where there are general provisions in a contract and specific provisions, both will be given effect, the specific provisions being applicable to the circumstances which fall within them.
To similar effect, in Re Strand Music Hall Co Ltd,¹⁷ Lord Romilly said:
The proper mode of construing any written instrument is, to give effect to every part of it, if this be possible, and not to strike out or nullify one clause in a deed, unless it be impossible to reconcile it with another and more express clause in the same deed.
Furthermore, in construing contractual terms, a court will seek to adopt a construction that will preserve the validity of the contract and in that regard will strive to avoid holding agreements, in particular commercial agreements, void for uncertainty.¹⁸ Thus, a court should construe a commercial contract ‘fairly and broadly, without being too astute or subtle in finding defects’.¹⁹
In the process of construction it is clear that no hard and fast rules apply. The ‘construction [of contractual terms] is a composite exercise, neither uncompromisingly literal nor unswervingly purposive’,²⁰ although in more recent times there has been a move away from literal methods of construction towards a more commercial approach.²¹
Where technical words or phrases are incorporated into a contract there is a rebuttable presumption that they are used with that technical meaning in mind.²² This presumption is not easily displaced.²³ In relation to the presumption, in Phoenix Commercial Enterprises Pty Ltd v City of Canada Bay Council²⁴ Campbell JA said the following:
There has long been a principle of construction concerning words or phrases that have a specialised or technical meaning in the law whereby: ‘[w]hen technical words or phrases are made use of, the strong presumption is, that the party intended to use them according to their correct technical meaning’ ... In Sydall v Castings Ltd²⁵ Diplock LJ explained the principle:
Documents which are intended to give rise to legally enforceable rights and duties contemplate enforcement by due process of law, which involves their being interpreted by courts composed of judges, each one of whom has his personal idiosyncracies of sentiment and upbringing, not to speak of age. Such documents would fail in their object if the rights and duties which could be enforced depended on the personal idiosyncracies of the individual judge or judges on whom the task of construing them chanced to fall. It is to avoid this that lawyers, whose profession it is to draft and to construe such documents, have been compelled to evolve an English language, of which the constituent words and phrases are more precise in their meaning than they are in the language of Shakespeare or of any of the passengers on the Clapham omnibus this morning. These words and phrases to which a more precise meaning is so ascribed are called by lawyers ‘terms of art’, but are in popular parlance known as ‘legal jargon’. We lawyers must not allow this denigratory description to obscure the social justification for the use of ‘terms of art’ in legal documents. It is essential to the effective operation of the rule of law. The phrase ‘legal jargon’, however, does contain a reminder that non-lawyers are unfamiliar with the meanings which lawyers attach to particular ‘terms of art’, and that where a word or phrase which is a ‘term of art’ is used by an author who is not a lawyer, particularly in a document which he does not anticipate may have to be construed by a lawyer, he may have meant by it something different from its meaning when used by a lawyer as a term of art ....
If the document in question is drawn by a lawyer, is manifestly intended to effect a legal transaction, and uses an expression that is not an expression in common use but that has a meaning in an area of legal discourse that is relevant to the document in question, that in itself provides a basis for the reasonable reader concluding that that expression is used in its special legal sense, unless there are other factors present that show it is not used in that special legal sense. So understood, the presumption is consistent with the current approach to construction.
Finally, it can be noted that the impact of the contract upon third parties is relevant to determining the objective intention of the parties. In Kidd v The State of Western Australia²⁶ Beech J observed:
That is not to say that any consequences, or potential consequences, for third parties, of a particular construction are to be ignored. To the extent that they may be an indication of the objective common intention of the parties to the contract, such consequences are among the matters to be considered in the construction process. Similarly, the nature and effect of a particular provision is to be borne in mind in its proper construction. These matters are part of what informs the proper construction of any contract.
THE OBJECTIVE DETERMINATION OF INTENTION
As a matter of policy, the law has always required the interpretation of a contract to be determined on an objective basis. This point has been repeatedly stressed by the High Court.²⁷ The justification for this objective approach was explained by Tipping J in Vector Gas Limited v Bay of Plenty Energy Limited²⁸ as follows:
The objective approach is regarded as having two principal advantages. These are greater certainty and the saving of time and cost: greater certainty, because the subjective approach is apt to undermine the security of the written words by means of which the parties recorded their consensus; and saving time and cost, because a subjective approach is generally thought to require a fuller search for and examination of extrinsic evidence. A lesser, but still significant, perceived advantage is avoiding the effect a subjective approach might have on third parties who may have relied on what the words of the document appeared objectively to mean. But, despite its eschewing a subjective approach, the common law does not require the court, through the objective method, to ascribe to the parties an intention that a properly informed and reasonable person would not ascribe to them when aware of all the circumstances in which the contract was made.
In the United Kingdom, the leading formulation of the objective test of interpretation is set out in Lord Hoffmann’s speech in Investors Compensation Scheme Ltd v West Bromwich Building Society²⁹ where his Lordship said that the interpretation of a written contract involved:
… the ascertainment of the meaning which the document would convey to a reasonable person having all the background knowledge which would reasonably have been available to the parties in the situation in which they were at the time of the contract.
Significantly, in his statement of principle, Lord Hoffmann did not restrict a court from referring to the surrounding circumstances to cases where contractual terms are written in ambiguous language. In the light of considerable debate over the impact of this case, in Chartbrook Ltd v Persimmon Homes Ltd³⁰ Lord Hoffmann made the following comment:
The only points [Investors Compensation Scheme Ltd v West Bromwich Building Society³¹] decided that might have been thought in the least controversial were, first, that it was not necessary to find an ‘ambiguity’ before one could have any regard to background and, secondly, that the meaning which the parties would reasonably be taken to have intended could be given effect despite the fact that it was not, according to conventional usage, an ‘available’ meaning of the words or syntax which they had actually used.
On the other hand, in the leading Australian High Court decision on construction of contracts of Codelfa Construction Pty Limited v State Rail Authority of New South Wales³² Mason J said:
The true rule is that evidence of surrounding circumstances is admissible to assist in the interpretation of the contract if the language is ambiguous or susceptible of more than one meaning. But it is not admissible to contradict the language of the contract when it has a plain meaning.
In the wake of these two statements of principle considerable debate was generated as to whether there was a difference of approach between them and if so which was binding on Australian courts. What was seen by many as the essential difference between the two approach was that the Mason J’s statement meant that evidence of surrounding circumstances could only be used as an aid to the construction of a term if it was ambiguous or susceptible to more than one meaning. On the other hand, Lord Hoffman’s approach meant that such evidence could be used, whether or not there was any ambiguity in the term.
In 2002, in Royal Botanic Gardens and Domain Trust v South Sydney Council,³³ the High Court, left open for a future time the question as to whether Lord Hoffmann’s approach was broader or preferable to that of Mason J,³⁴ and demanded that, in the meantime, other Australian courts should construed contractual terms in accordance with Mason J’s statement of principle in Codelfa Construction Pty Limited v State Rail Authority of New South Wales.³⁵ The binding nature of Mason J’s statement of principle has been subsequently reaffirmed by the High Court on a number of occasions.³⁶ Thus, in Mount Bruce Mining Pty Limited v Wright Prospecting Pty Limited³⁷ French CJ, Nettle and Gordon JJ echoed the views of Mason J when they said:
Ordinarily, this process of construction is possible by reference to the contract alone. Indeed, if an expression in a contract is unambiguous or susceptible of only one meaning, evidence of surrounding circumstances (events, circumstances and things external to the contract) cannot be adduced to contradict its plain meaning.
To the same effect, Kiefel and Keane JJ³⁸ said:
[I]t is essential to identify ambiguity in the language of the contract before the court may have regard to the surrounding circumstances and the object of the transaction.
On the basis that evidence of surrounding circumstances can only be admitted where, in the words of Mason J in Codelfa Construction Pty Ltd v State Rail Authority of New South Wales,³⁹ the ‘language used is ambiguous or susceptible of more than one meaning’, the following two questions arise:

1. 
   When is language ‘ambiguous or susceptible of more than one meaning’?
   
2. 
   What is meant by ‘evidence of surrounding circumstances’?
   

Ambiguity
The meaning of language that is, in the words of Mason J, ‘ambiguous or susceptible of more than one meaning’, has drawn a number of comments by later Australian courts. Thus, in Ritter v Keatley Real Estate Pty Ltd Trading as Mt Gambier First National⁴⁰ Stanley J said:
The concept of ambiguity referred to by Mason J … is not without its difficulties. The disjunctive reference to language which is ambiguous or susceptible to more than one meaning suggests that the concept of ambiguity is broader than the concept of a word or phrase susceptible of more than one meaning. This may reflect an intention to include concepts of patent, latent and inherent ambiguity. The dictionary definition of ‘ambiguous’ includes the following meanings: ‘open to various interpretations’, ‘equivocal’, ‘doubtful’, ‘uncertain’, ‘having a double meaning’, ‘obscure’, ‘indistinct’, and ‘lacking clarity’. In Gardiner v Agricultural and Rural Finance Pty Ltd,⁴¹ Spigelman CJ said that ambiguity ‘extend[s] to any situation in which the scope and applicability of the formulation [is], for whatever reason, doubtful’. In my view, the Mason J formulation … is directed to circumstances in which an exclusively textual analysis of the language of a contract produces uncertainty as to the meaning of the contractual provision.

In Bisognin v Hera Project Pty Ltd⁴² Sloss J said that, at the very least ambiguity ‘extends at least to the situation where a textual analysis of the language used in the contract reveals or gives rise to uncertainty as to the meaning of a provision, or apprehension that the wording of the contract might not reflect the presumed intention of the parties’. His Honour⁴³ went on the express his support for a broader view of ambiguity, exemplified in the following three decisions from the Supreme Court of Western Australia. First, in McCourt v Cranston⁴⁴ Pullin JA said:

Usually, the meaning of ‘ambiguous’ is taken to include ‘open to various interpretations’ … but by using the phrase ‘ambiguous or susceptible of more than one meaning’ perhaps Mason J wished to emphasise that not only a contract open to more than one meaning would allow in evidence of surrounding circumstances but also one where the contract is merely ‘difficult to understand’.
Second, in Acorn Consolidated Pty Ltd v Hawkslade Investments Pty Ltd⁴⁵ Owen J said:
I think the proper approach is to look first to the instrument itself to see whether there is some reasonable basis for the apprehension that the wording of the contract might not necessarily reflect the presumed intention of the parties. The English language being what it is, such a reasonable apprehension will generally be apparent ‘in many, if not most, cases’.⁴⁶ It may come from a patent and obvious confusion in the words themselves. But it may also come from a reading of the instrument as a whole. The law has long recognised that ambiguity can be latent, as well as patent.
Third, in Technomin Australia Pty Ltd v Xstrata Nickel Australasia Operations Pty Ltd⁴⁷ McClure P said:
For the purposes of the gateway requirement ‘ambiguity’ means any situation in which the scope or applicability of a contract is, for whatever reason, doubtful. It is not confined to lexical, grammatical or syntactical ambiguity. The fact that adversaries can formulate and advance materially different constructions of the language of a contract does not itself satisfy the gateway requirement. Having regard to the language of the contract as a whole and what can be gleaned from that source as to the contractual purpose, competing constructions must be reasonably arguable.
In Manufacturers Mutual Insurance Ltd v Withers⁴⁸ McHugh JA said:
[F]ew, if any, English words are unambiguous or not susceptible of more than one meaning or have a plain meaning. Until a word, phrase or sentence is understood in the light of the surrounding circumstances, it is rarely possible to know what it means.
This approach was endorsed by the Court of Appeal in Mainteck Services Pty Ltd v Stein Heurtey SA⁴⁹ where Leeming JA said:
[T]o say that a legal text is ‘clear’ reflects the outcome of that process of interpretation. It means that there is nothing in the context which detracts from the ordinary literal meaning … [W]hether contractual language has a ‘plain meaning’ is (a) a conclusion and (b) a conclusion which cannot be reached until one has had regard to the context … Mason J was indicating that there are very real limits to the extent to which grammatical meaning can be displaced by contextual considerations. However, in order to determine whether more than one meaning is available, it may be necessary first to turn to the context.
In coming to this conclusion, Leeming JA referred to and relied upon the High Court decision in Electricity Generation Corporation v Woodside Energy Ltd⁵⁰ where French CJ, Hayne, Crennan and Kiefel JJ, said:
The meaning of the terms of a commercial contract is to be determined by what a reasonable businessperson would have understood those terms to mean. That approach is not unfamiliar … [I]t will require consideration of the language used by the parties, the surrounding circumstances known to them and the commercial purpose or objects to be secured by the contract. Appreciation of the commercial purpose or objects is facilitated by an understanding ‘of the genesis of the transaction, the background, the context [and] the market in which the parties are operating’⁵¹ … A commercial contract is to be construed so as to avoid it ‘making commercial nonsense or working commercial inconvenience’.⁵²
Leeming JA⁵³ then concluded as follows:
To the extent that what was said in Jireh⁵⁴ supports a proposition that ‘ambiguity’ can be evaluated without regard to surrounding circumstances and commercial purpose or objects, it is clear that it is inconsistent with what was said in Woodside.⁵⁵ The judgment confirms that not only will the language used ‘require consideration’ but so too will the surrounding circumstances and the commercial purpose or objects.
The views of Leeming JA were echoed in WIN Corporation Pty Ltd v Nine Network Australia Pty Ltd⁵⁶ where Barrett AJA, speaking for a unanimous Court of Appeal, said:
A potential tension that inheres in this proposition is that to recognise words as bearing a ‘plain meaning’ is merely to state a conclusion arrived at by some process of interpretation which cannot, as a matter of logic, exclude context. As Leeming JA noted in Mainteck Services Pty Ltd v Stein Heurtey SA,⁵⁷ to state that a legal text is ‘clear’ does no more than recognise that ‘there is nothing in the context which detracts from the ordinary literal meaning’. It therefore becomes clear that the notion that it may first be necessary to consider context when construing a contract is not inconsistent with Mason J’s ‘true rule’. On this footing, it does not follow that the task of assessing whether a phrase or expression is ambiguous or susceptible of more than one meaning must be undertaken without regard to evidence of surrounding circumstances. This position corresponds with the approach of the High Court in Victoria v Tatts Group Ltd⁵⁸ where the relevant contract was construed by reference to its text, context and purpose without any anterior finding of ambiguity as a precondition to a consideration of surrounding circumstances as an aid to discovering or elucidating context and purpose.
Similarly, in Todd v Alterra at Lloyd’s Ltd⁵⁹ Beach J, in referring with approval to the views of Leeming JA, said:
[G]enerally, textual analysis is to be given primacy. Nevertheless, words cannot be construed in a vacuum. The meaning of words cannot be divorced from their context. To proceed by only analysing the text with the aid of dictionary meanings is sterile and productive of error. One does not need the assistance of modern philosophy including Ludwig Wittgenstein’s model of language games to recognise as much. Words and their use must be construed in context. Moreover, uncertainty or ambiguity in the words used may only be ascertainable once context is first appreciated. Extra-textual context may reveal uncertainty or ambiguity that is not otherwise apparent from the text. Mount Bruce Mining Pty Ltd v Wright Prospecting Pty Ltd⁶⁰ recognises, at least implicitly, that the approach of Mason J (as he then was) in Codelfa Construction Pty Ltd v State Rail Authority of New South⁶¹ may not rule out an approach which first uses context to ascertain otherwise latent textual uncertainty or ambiguity. Mason J’s approach is not inconsistent with the notion that it may first be necessary to consider context. Mason J stated that:
The true rule is that evidence of surrounding circumstances is admissible to assist in the interpretation of the contract if the language is ambiguous or susceptible of more than one meaning. But it is not admissible to contradict the language of the contract when it has a plain meaning. (My emphasis.)
But ‘plain meaning’ is a conclusion. How is such a conclusion to be reached? Mason J’s approach would not deny the proposition that before reaching such a conclusion you can consider context. By first considering context, you may conclude that there is no one plain meaning. Context can therefore be used to perform two functions. It can enable you to assess whether there is a plain meaning. And if one concludes that there is no plain meaning, it can assist in resolving the latent textual imprecision.
The significance of the decision in Mainteck Services Pty Ltd v Stein Heurtey SA⁶² is that it appears to adopt an approach to interpretation that is consistent with the approach of Lord Hoffmann in Investors Compensation Scheme Ltd v West Bromwich Building Society.⁶³ In this respect, it was endorsed in Stratton Finance Pty Limited v Webb⁶⁴ where the Full Court of the Federal Court said:
Recently, in Mainteck Services Pty Ltd v Stein Heurtey SA⁶⁵ the New South Wales Court of Appeal … expressed the view that … Woodside⁶⁶ was inconsistent with Jireh. We agree with that conclusion.
However, in Gladstone Area Water Board v A J Lucas Operations Pty Ltd⁶⁷ Jackson J came to the conclusion that Woodside⁶⁸ was not inconsistent with Jireh⁶⁹ and that the Court of Appeal in Mainteck Services Pty Ltd v Stein Heurtey SA⁷⁰ was wrong to conclude that Woodside⁷¹ had impliedly overruled Jireh.⁷² Similar sentiments were expressed by the Court of Appeal in Western Australia in Technomin Australia Pty Ltd v Xstrata Nickel Australasia Operations Pty Ltd.⁷³ In Apple and Pear Australia Ltd v Pink Lady America LLC⁷⁴ the Court of Appeal in Victoria, after a lengthy analysis of the cases, concluded as follows:
[T]here has been controversy, reflected in the judgments of many intermediate appellate courts, about when, and in what manner, surrounding circumstances can be relied upon in the construction of commercial contracts, the questions surrounding the extent to which surrounding circumstances can be relied upon in the construction of commercial contracts raise large issues and their fate remains to be resolved by the High Court on another day.