Do your contracts mean what you think they mean? Steps to take to avoid business risk and costly disputes given recent controversy.

The key ideas in brief:

1. Australian contract law is currently in a state of uncertainty. It is not clear if, when a dispute arises about the proper interpretation of a commercial contract, the parties can put before the court the background and circumstances leading up to the transaction to assist the court arrive at the most appropriate interpretation of the contract.
2. This means there is some uncertainty about how your contracts are going to be interpreted if a dispute arises.
3. Until the issue is resolved by the High Court, if you are in business in Australia right now you should:
• review your important business contracts before they are signed (start with those that are high-value, high-risk, or important long-term deals) and enquire with your team about precisely how any important terms, commercial risk allocations you think have been struck in the deal or scenarios you think are accounted for, are actually drafted or catered for, clearly and unambiguously, in the contract.
• always engage a pragmatic law firm, to help you sensibly address this by using practical risk assessment and clear drafting of novel or important transaction features or terms in the contract for those transactions/engagements you consider warrant legal spend for increased certainty.
• for those transactions which do not warrant legal spend to improve the certainty of the deal (for example low value, or low risk deals), manage the risk in-house by reading the contract to satisfy yourself that important transaction features, scenarios and risk allocations you think exist are covered or catered for clearly and unambiguously.
4. In our opinion, this controversy has been over-stated by legal commentators. We expect the likely legal result will be that you must first demonstrate that a contract in dispute is ambiguous or susceptible of more than one meaning before a court will allow you to put evidence of the factual circumstances leading up to the transaction before the Court. However, practically, the test of ‘ambiguity/susceptibility of more than one meaning’ is likely a very low bar.
5. Despite our views, only the High Court of Australia can determine the answer to this controversy and the timing of when that might happen depends on a suitable case getting before the court that requires this question to be answered. In the meantime, the above strategy largely avoids the issue affecting your business adversely.

The detailed view:

If you are running a business in Australia right now, you would be forgiven for assuming our legal system must have a good handle on something as fundamental as how commercial contracts are interpreted. 

However, for a while now, there has been controversy in legal circles about a key question: when a dispute arises about the proper interpretation of a contract, are the parties permitted to put, in evidence before the court, the ‘surrounding circumstances’ and ‘commercial context’ which were known to both of them prior to their entry into the contract, so as to assist the judge arrive at the most appropriate business-like interpretation of the contract?

This controversy has arisen because courts in different States in Australia have interpreted recent decisions of the High Court of Australia on this issue differently. 

Our courts are presently confused.

Back in 1982, the High Court of Australia decided the case of Codelfa Construction Pty Ltd v State Rail Authority of NSW. 

In the case, the Court said the following:

“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.”

It seems straight-forward doesn’t it? If the contract has a plain meaning, no evidence of surrounding circumstances is permitted to be put before the court. Or, to put it another way, unless there is, initially, some ambiguity in the language used in the contract, or the disputed aspect of the contract is susceptible of more than one possible meaning, the court must not receive evidence of the surrounding circumstances leading up to the transaction, instead giving the contract its literal meaning (there are some limited exceptions regarding absurdity and other requirements such as reading the contract as a whole).

In 2002, the High Court of Australia made clear that the above ‘true rule’ in Codelfa still applied in Australia, when commenting on some UK decisions that took a different tack (allowing surrounding circumstances to always be admissible in evidence):

“the Australian courts, if they discern any inconsistency [with the UK decisions and] with Codelfa, should continue to follow Codelfa”

So, why are Australian courts and lawyers now confused?

Since the High Court stated the above, several High Court cases have seemingly gone about the process of interpreting commercial contracts before the court by automatically considering the surrounding circumstances and objects of the transaction/contract, without saying anything at all about first passing through the “true rule” in Codelfa to allow that to occur. For example (all underline is my emphasis):

Pacific Carriers Ltd v BNP Paribas (2004) 218 CLR 451: 

 “The construction of a commercial contract … requires consideration, not only of the text of the documents, but also the surrounding circumstances were known to the [parties], and the purpose and object of the transaction”.

Toll (FGCT) v Alphapharm Pty Ltd (2005) 219 CLR 165:

 “The meaning of the terms of a contractual document is to be determined by what a reasonable person would have understood them to mean. That, normally, requires consideration not only of the text, but also of the surrounding circumstances known to the parties, and the purpose and object of the transaction”.

International Air Transport Association v Ansett Australia Holdings Ltd (2008) 234 CLR 151: 

 “In giving a commercial contract a businesslike interpretation, it is necessary to consider the language used by the parties, the circumstances addressed by the contract, and the objects which it is intended to secure. An appreciation of the commercial purpose of a contract calls for an understanding of the genesis of the transaction, the background, and the market”.

In response, some of our State-based appeal courts have hung on these statements and declared them a departure from the “true rule” in Codelfa, or deemed them authority for the point that it is no longer necessary to demonstrate ambiguity before the court can consider the factual context in which the contract came into existence, when resolving the interpretation of a contract. The most emphatic of these cases was the NSW Court of Appeal decision of Franklins Pty Ltd v Metcash Trading Ltd [2009] NSWCA 407 which included the following statements in the judgment:

 “The state of the law in this respect is to be ascertained from a number of High Court cases: Maggbury Pty Limited v Hafele Australia Pty Limited; Pacific Carriers v BNP Paribas; …Toll (FGCT) v Alphapharm and International Air Transport Association v Ansett Australia Holdings Limited.

These cases are clear. The construction and interpretation of written contracts is to be undertaken by an examination of the text of the document in the context of the surrounding circumstances known to the parties, including the purpose and object of the transaction and by assessing how a reasonable person would have understood the language in that context.

 There is no place in that structure, so expressed, for a requirement to discern textual, or any other, ambiguity in the words of the document before any resort can be made to such evidence of surrounding circumstances. Further, intermediate appellate courts have been clear in their expression of view that these recent decisions of the High Court are to the effect that the identification of ambiguity is not a precondition to examining legitimate surrounding circumstances: Lion Nathan Australia Pty Ltd v Cooper Brewery Ltd; Ryledar Pty Ltd v Euphoric Pty Ltd…”

This decision caused considerable conjecture and debate in the legal industry.

In response, the High Court of Australia constituted by three judges in the decision of Western Export Services Inc v Jireh International Pty Ltd [2011] HCA 45 took the unusual step when refusing a party special leave to make an appeal to the High Court, of publishing reasons for that refusal which somewhat pointedly referred to the above NSW Court of Appeal decision and its associated controversy:

“The primary judge had referred to what he described as “the summary of principles” in Franklins Pty Ltd v Metcash Trading Ltd.5 The applicant in this court refers to that decision and to MBF Investments Pty Ltd v Nolan as authority rejecting the requirement that it is essential to identify ambiguity in the language of the contract before the court may have regard to the surrounding circumstances and object of the transaction. The applicant also refers to statements in England said to be to the same effect, including that by Lord Steyn in R (Westminster City Council) v National Asylum Support Service.

 Acceptance of the applicant’s submission, clearly would require reconsideration by this court of what was said in Codelfa Construction Pty Ltd v State Rail Authority of NSW8 by Mason J, with the concurrence of Stephen J and Wilson J, to be the “true rule” as to the admission of evidence of surrounding circumstances. Until this court embarks upon that exercise and disapproves or revises what was said in Codelfa, intermediate appellate courts are bound to follow that precedent. The same is true of primary judges, notwithstanding what may appear to have been said by intermediate appellate courts.

The position of Codelfa, as a binding authority, was made clear in the joint reasons of five Justices in Royal Botanic Gardens and Domain Trust v South Sydney City Council9 and it should not have been necessary to reiterate the point here.

 We do not read anything said in this court in Pacific Carriers Ltd v BNP Paribas;10 Toll (FGCT) Pty Ltd v Alphapharm Pty Ltd;11 Wilkie v Gordian Runoff Ltd12 and International Air Transport Association v Ansett Australia Holdings Ltd as operating inconsistently with what was said by Mason J in the passage in Codelfa to which we have referred.”

Since that slap-down, the High Court has not ‘revisited, disapproved or revised’ what was said in Codelfa but, despite this, the latest NSW Court of Appeal decision on the issue of Taouk v Assure (NSW) Pty Ltd [2017] NSWCA 227 seemingly persists with tacit approval of the position that the court can, and in fact must have regard to the surrounding circumstances of each contract by not distancing itself from the statement of principle made by the judge below that “words of a contract do not have a “natural” meaning that can be determined in isolation from the context in which they are used” Accordingly, a conclusion that language has a plain meaning reflects the outcome of a process of interpretation that has regard to context” and by again reciting prior High Court cases that referred to surrounding circumstances to determine the contractual interpretation in dispute without mentioning Codelfa or first making a finding of ambiguity.

On the contrary, over in Queensland, the courts have followed the reasoning that ambiguity must first be evident before evidence of the surrounding circumstances of the transaction/contract can be considered by a court in resolving that ambiguity, see for example: Hydrofibre Pty Ltd v Australian Prime Fibre Pty Ltd and Anor [2013] QSC 163.

To add more uncertainty, since the above High Court reasons in the case of Jireh were published, the High Court of Australia itself has confirmed in Mount Bruce Mining Pty Limited v Wright Prospecting Pty Limited [2015] HCA 37, that Jireh is not a judgment of the court and is therefore “not binding on anyone”.

Clearly, a collision course with the High Court, and possibly among judges sitting on that court, is looming on this issue, should the right case get before that court which squarely raises the issue for determination.

This is interesting for lawyers, but it is most unhelpful for businesses in Australia who want to know how their very important commercial contracts (often involving many millions of dollars changing hands, promises being made and transfer of liability and risk) are going to be interpreted (and therefore enforced) by Australian courts (and by reference to what evidence when resolving any issue).

So, what should businesses in Australia do until this issue is finally resolved?

1. First, do not assume you will always be permitted to tell the court about the circumstances leading up to any business transaction, purpose or object of it, if a subsequent contract dispute arises with your counterparty.
2. Second, review your important business contracts before they are signed (start with those that are high-value, high-risk, or important long-term deals) and enquire with your team about precisely how any important terms, commercial risk allocations you think have been struck in the deal or scenarios you  thinkare accounted for, are actually drafted or catered for, clearly and unambiguously, in the contract.
3. Third, engage a pragmatic law firm, to help you sensibly address item 2 above using practical risk assessment and clear drafting of novel or important transaction features or terms in the contract for those transactions/engagements you consider warrant legal spend to yield the benefit of increased certainty that the contract reliably and unambiguously reflects the deal characteristics as you understand it.
4. For those transactions which you do not consider warrant external legal expense to improve the certainty of the deal (for example because the deal is low value, or low risk), manage the risk in-house, cognisant of all of the above, by reading the contract to at least satisfy yourself that important transaction features, scenarios and risk allocations you think exist are covered or catered for clearly and unambiguously, or engage with your in-house legal talent in your business to practically verify how aspects of the deal that you consider are commercially important are actually documented in the contract.

By doing each of the above, you will minimize the business risk posed by the present uncertainty in the law and, regardless of the resolution of the issue, you will have adopted a sensible business practice.

So, what is the likely answer to the controversy?

For what it is worth, we think there is no genuine cause for the current controversy and that some courts, lawyers and industry commentators have misconstrued and over-analysed various decisions of the High Court, to the point of reading principles and conclusions into those decisions that were never arrived at by the High Court.

In our view, the reason the latest High Court cases adopted the approach of considering the surrounding circumstances of the contracts they were deciding the disputed interpretation of, and the reason why they did so without saying anything about the ‘Codeda true rule’, permitting this to occur because of ambiguity, was because it was plainly self-evident that there was ambiguity within the language in the contract put before the court, and because neither party asserted or put the Codelfa true rule issue before the court. 

This is hardly surprising.

When parties disagree about how a contract should be read, to the point that they end up before a court, and then end up before the highest court in Australia after multiple appeals, they are almost certainly disputing a document that is ambiguous or “susceptible of more than one meaning”. 

It would be a rare case indeed for a party (properly advised) to instigate costly litigation, arguing that a perfectly clear contract, which is not susceptible of more than one meaning, should be interpreted some other way.

It would be an even rarer case for such a dispute to somehow find its way to the High Court of Australia. 

The point is, most cases that reach our courts on a point of contractual interpretation and especially the High Court are going to involve contracts that are ambiguous. The English language is notoriously ambiguous. Lawyers exist partly for this reason. The Codelfa ‘ambiguity’/’susceptibility of more than one interpretation’ threshold is necessarily a low one.

It also must be remembered when reading any court decision, seeking to ascribe meaning to it, and certainly before making sweeping statements or conclusions of legal principle in reliance upon a tangential argument not expressly said by the court, that our courts are adversarial, impartial decision makers. Unlike some foreign courts, they are not inquisitive arbiters who inject themselves heavily into the fact finding and conduct a thorough inquisition of the parties. Parties before our courts are required to frame the issues in dispute through ‘pleadings’ and ‘submissions’ (a further reason why lawyers exist) and all lawyers/barristers who appear before the court have a primary duty to the administration of justice (which trumps the duty to their clients), this often involves assisting the court identify the relevant cases applicable to the issues they have framed in the dispute, making submissions on how they say the law should be applied and dealing with cases that are not supportive of their argument in those submissions by bringing them to the attention of the court. Given this important context, if the parties:

• did not raise as an issue in the court proceedings whether the “Codelfa true rule” was satisfactorily passed; and
• did not make submissions on that legal principle as applied to the case,’

the court cannot be expected to investigate and make a ruling on what was not raised as a contested issue. This is not unusual. For example, our courts do not, in every contract dispute, make rulings about whether there was sufficient offer, acceptance, consideration, certainty and intention necessary to create a binding legal contract in the first place, if the parties have not raised any of those issues as ‘issues in dispute.

In short, our view is:

1. The “threshold test” or gateway in Codelfa of ambiguity or susceptibility of more than one meaning is a low threshold – the English language is usually imprecise, it is not very difficult to establish some ambiguity or susceptibility of more than on possible interpretation unless the aspect of the contract being argued about is watertight in its drafting;
2. For the above reason, cases that make it to court, properly advised, will almost always pass the low threshold test;
3. If the parties do not cavil about whether the threshold test was in fact passed, the court does not need to specifically address what is obvious. Suggesting that the High Court’s absence of doing so in the cases cited somehow means the High Court has altered the Codelfa true rule reads into the Court’s judgements findings and conclusions that were not made by the Court;
4. The High Court decisions now being referred to by commentators and appellate courts to support their argument that the Codelfa true rule no longer applies were not cases about the admissibility of ‘surrounding circumstances’ or the Codelfa true rule, they were cases about the proper interpretation of a disputed contract which was already evidently susceptible of more than one possible interpretation.

If you are interested in reading more on this issue, have a read of the Supreme Court of Queensland decision of: Gladstone Area Water Board v AJ Lucas Operations Pty Ltd [2014] QSC 311, particularly paragraphs 153-168, which we prefer in place of the reasoning of the NSW Courts, and which eloquently summarises the difficulties with the NSW Court of Appeal’s reasoning.

Whilst we think the ultimate conclusion will be that the Codelfa true rule is alive and well, and ambiguity is first required before evidence of surrounding circumstances is admissible, presently, the reality is that the smartest legal minds in this country who sit as judges on appeal courts and trial courts can’t agree on this issue. Given that context, no one (including our firm) can unequivocally express a conclusion. The only party in a position to do this is the High Court of Australia, by express reference to the controversy.

Until then, commentary and debate on the issue is just that, hence our recommended pragmatic approach in the meantime to managing the risk this unfortunate situation poses to business/commercial certainty in Australia. Please reach out if we can assist.