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Sending a Strong Message on Contractual Interpretation.

10 November, 2011

 

In brief: 

 

Three High Court judges have stated, in a special leave decision, that extrinsic evidence of surrounding circumstances cannot be used to interpret a contract where the contract is not ambiguous on its face. This article will discuss an unusual, but very important, High Court decision handed down last week.

 

How does it affect you?

 

  • The decision of the High Court will be of immediate interest to those involved in disputes concerning the correct interpretation of contracts as it limits the circumstances in which a court may depart from the literal interpretation of a contract.

 

 

  • The decision is also important for those involved in drafting and negotiating contracts. It is an important reminder that, in the event of a dispute, the actual words used in a contract will often be more important than the apparent intention of the parties.

 

‚ÄčThe legal context

 

Contract litigation frequently involves a contest between two interpretations of a contract: one of which is better suited to the literal meaning of the words used in the contract; the other which (arguably) better reflects the intention of the parties and the commercial purpose of the contract.

 

In litigation of this type, the party advocating a 'commercial' interpretation of the contract will seek to support its argument by putting forward evidence of surrounding circumstances known to the parties at the time the contract was entered into. A common issue is whether these surrounding circumstances can be used to interpret words in a manner different from their ordinary (or 'plain') meaning.

 

In recent years, many Australian courts have held that it is permissible to look at the surrounding circumstances, known to the parties, before deciding whether a word may have a meaning other than its 'plain' meaning.  Three High Court judges have now expressed a strong view that these decisions are inconsistent with High Court authority and are therefore wrong.

 

The factual background

 

Jireh International Pty Ltd and Western Export Services Inc (WES) entered into an agreement by which WES agreed to assist Jireh to become Gloria Jean's master franchisee. The first sentence of clause 3 of the agreement noted the intention of the parties to establish Jireh 'or an associated entity' as a supplier to Gloria Jean's. The second sentence stated that Jireh (with no reference to associated entities) would pay WES a commission of 5 per cent of the price of coffees, teas and other products sold by Jireh to Gloria Jean's stores.

 

A dispute arose between the parties as to whether commission was only payable on sales by Jireh itself or also on sales by an associated entity of Jireh.

 

The trial judge adopted a 'commercial and business like' interpretation of clause 3 and held that, although the phrase 'Jireh International Pty Ltd' was not itself ambiguous (there being only one entity with that name), a reasonable person in the position of the parties would have understood the phrase 'sales by Jireh International Pty Ltd to GJCC stores' to encompass sales by Jireh's associated entities.

 

The NSW Court of Appeal overturned the trial judge's decision. Justice Macfarlan, who delivered the leading judgment, held that because there was no ambiguity in the words 'Jireh International Pty Ltd', there was no justification in departing from the plain meaning of the contract unless the words actually used by the parties would give the contract an absurd operation (which, in this case, they didn't). However, Justice Macfarlan accepted that, before determining whether the language was unambiguous, the court was required to look at both the contract as a whole and the surrounding or background circumstances known to both parties.

 

WES sought special leave to appeal to the High Court.

 

The High Court's decision

 

The High Court (Justices Gummow, Heydon and Bell) refused special leave. Unusually, the court provided detailed reasons for refusing special leave. Even more unusually, the reasons have now been published separately.*

 

In refusing special leave, the High Court went out of its way to make statements concerning the circumstances in which evidence of surrounding circumstances may be considered in contract interpretation.

 

Until recent years, the leading decision on this issue was that of Justice Mason in Codelfa Construction Pty Ltd v State Rail Authority of NSW.** In that case, Justice Mason stated that evidence of surrounding circumstances is only admissible to interpret a contract where the language is ambiguous or susceptible of more than one meaning. It was implicit in this decision that a judge should decide whether there is an ambiguity before, rather than after, having regard to the surrounding circumstances known to the parties.

 

However, in recent times, the Federal Court and the NSW and Victorian Courts of Appeal have held that Justice Mason's approach in Codelfa has been undercut by later High Court authority and that evidence of surrounding circumstances known to both parties may be considered without the trigger of ambiguous contractual language.***

 

In its reasons refusing special leave, the High Court strongly reaffirmed the statement of five justices in Royal Botanic Gardens and Domain Trust v South Sydney City Council**** that until the High Court reconsiders the Codelfa decision, intermediate appellate courts and trial judges are bound to follow Justice Mason's approach. A similar statement was recently made by Justices Heydon and Crennan in Byrnes v Kendle.*****

 

Comment

 

The High Court's decision leaves trial judges in a difficult position. The general view is that the reasons provided by the High Court when refusing special leave create no precedent, and are merely persuasive dicta.****** Despite the High Court's statement that trial judges are bound to follow the decision in Codelfa, a number of cases suggest that a trial judge must follow the decision of an intermediate appellate court in the same hierarchy, even if inconsistent with a prior decision of the ultimate appellate court.******* On this view, because the High Court's reasons are merely persuasive, a trial judge in NSW might still follow the NSW Court of Appeal decisions holding that ambiguity is not a prerequisite for the consideration of evidence of surrounding circumstances.

 

Consequently, it is not easy to predict how trial judges will deal with the High Court's decision. It does, however, seem likely that whatever approach is taken by a trial judge, an intermediate appellate court will hold that evidence of surrounding circumstances will only be admissible if the contract is ambiguous on its face.

 

The consequences for contract litigation are therefore likely to be a renewed emphasis on arguments as to whether the language in a contract is ambiguous and, perhaps, more claims for rectification of contracts that are alleged not to reflect the common intention of the parties.

 

Footnotes

 

*[2011] HCA 45.

**(1982) 149 CLR 337 at 352.

***See, eg, Lion Nathan Australia Pty Ltd v Coopers Brewery Ltd (2006) 156 FCR 1; Franklins Pty Ltd v Metcash Trading Pty Ltd (2009) 76 NSWLR 603; MBF Investments Pty Ltd v Nolan [2011] VSCA 114.

****(2002) 240 CLR 45 at 62-63 [39].

*****[2011] HCA 26 at [99].

******Ex parte Zietsch; Re Craig (1944) 44 SR (NSW) 360; North Ganalanja Aboriginal Corp v Queensland (1996) 185 CLR 595 at 643; Algama v Minister for Immigration & Multicultural Affairs (2001) 115 FCR 253 at [62].  See also Mason A, 'The Use and Abuse of Precedent' (1988) 4 ABR 93 at 97.

*******Miliangos v George Frank (Textiles) Ltd [1976] AC 443 at 478-479; Attorney-General (UK) v Heinemann Publishers Australia Pty Ltd [No 2] (1987) 10 NSWLR 86 at 189; Huntingdale Village Pty Ltd (recs & mgrs apptd) v Corrs Chambers Westgarth [2011] WASC 44 at [24] and [26].

 

 

For further information, please contact:

 

Malcolm Stephens, Allens Arthur Robinson

[email protected]

 

Tom Prince, Allens Arthur Robinson

[email protected]

 

 

 

 

 

 

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