Construction of terms

Overview

Once terms are established it is necessary to interpret them.

As a general rule, a contract (and its terms) should be given the meaning intended by the parties (determined objectively by reference to what a reasonable person would have thought parties intended).

Where this is not obvious the court will do its best to ascertain and give effect to that intention.

A number of rules have emerged to aid the court in that regard.

Basic rule: intention of the parties

The basic rule of construction in contract is that the terms should be construed so as to give them the meaning intended by the parties. Intention, in this respect, is (subject to limited exceptions) determined objectively; what would a reasonable person think was intended by the term?

Objective approach

Consistent with other contract law principles, intention of the parties is determined objectively, not by reference to actual subjective intent.

In Toll (FGCT) Pty Ltd v Alphapharm Pty Ltd [2004] HCA 52; 219 CLR 165 (para 40) the Court observed:

This Court ... has recently reaffirmed the principle of objectivity by which the rights and liabilities of the parties to a contract are determined. It is not the subjective beliefs or understandings of the parties about their rights and liabilities that govern their contractual relations. What matters is what each party by words and conduct would have led a reasonable person in the position of the other party to believe. References to the common intention of the parties to a contract are to be understood as referring to what a reasonable person would understand by the language in which the parties have expressed their agreement. 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. [footnote omitted]

We do not take into account the actual intentions of the parties and for the very good reason that an investigation of those matters would not only be time consuming but it would also be unrewarding as it would tend to give too much weight to these factors at the expense of the actual language of the written contract.

Ambiguity

The issue of determining objective intent by reference to surrounding circumstances and the purpose or object of the transaction will only arise in the event that there is ambiguity; if the term has clear meaning there is no need to resort to this evidence. In relation to contracts that have been reduced to writing, the parol evidence rule (see also terms) addresses when and how extrinsic evidence (evidence outside the written document) may be used to assist in determining the meaning of terms.

In Codelfa Construction Pty Ltd v State Rail Authority of NSW [1982] HCA 24; (1982) 149 CLR 337 at 352, Mason J discussed the parol evidence rule on the use of extrinsic evidence to aid construction in the following way:

[11] The broad purpose of the parol evidence rule is to exclude extrinsic evidence (except as to surrounding circumstances), including direct statements of intention (except in cases of latent ambiguity) and antecedent negotiations, to subtract from, add to, vary or contradict the language of a written instrument .... Although the traditional expositions of the rule did not in terms deny resort to extrinsic evidence for the purpose of interpreting the written instrument, it has often been regarded as prohibiting the use of extrinsic evidence for this purpose. No doubt this was due to the theory which came to prevail in English legal thinking in the first half of this century that the words of a contract are ordinarily to be given their plain and ordinary meaning. Recourse to extrinsic evidence is then superfluous. At best it confirms what has been definitely established by other means; at worst it tends ineffectively to modify what has been so established....

[12] On the other hand, it has frequently been acknowledged that there is more to the construction of the words of written instruments than merely assigning to them their plain and ordinary meaning ... . This has led to a recognition that evidence of surrounding circumstances is admissible in aid of the construction of a contract. So Lord Wilberforce ... was able to state the broad thrust of the rule in this way:
"The general rule is that extrinsic evidence is not admissible for the construction of a written contract; the parties' intentions must be ascertained, on legal principles of construction, from the words they have used. It is one and the same principle which excludes evidence of statements, or actions, during negotiations, at the time of the contract, or subsequent to the contract, any of which to the lay mind might at first sight seem to be proper to receive."
...
[13] However,... the English rule forbidding recourse to extrinsic evidence is not as strict as some have thought. ... [In the case of Prenn v Simmonds (1971) 1 WLR 1381 it] was held that, although evidence of prior negotiations and of the parties' intentions, and a fortiori the intentions of one of the parties, ought not to be received, evidence restricted to the factual background known to the parties at or before the date of the contract, including evidence of the "genesis" and objectively of the "aim" of the transaction, was admissible. ...
[21] In DTR Nominees Pty Ltd v Mona Homes Pty Ltd [1978] HCA 12; (1978) 138 CLR 423, at p 429, Stephen and Jacobs JJ and I ... in a joint judgment said:
"A court may admit evidence of surrounding circumstances in the form of 'mutually known facts' 'to identify the meaning of a descriptive term' and it may admit evidence of the 'genesis' and objectively the 'aim' of a transaction to show that the attribution of a strict legal meaning would 'make the transaction futile' . . . "
[22] 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. Generally speaking facts existing when the contract was made will not be receivable as part of the surrounding circumstances as an aid to construction, unless they were known to both parties, although, as we have seen, if the facts are notorious knowledge of them will be presumed. ...
[23] It is here that a difficulty arises with respect to the evidence of prior negotiations. Obviously the prior negotiations will tend to establish objective background facts which were known to both parties and the subject matter of the contract. To the extent to which they have this tendency they are admissible. But in so far as they consist of statements and actions of the parties which are reflective of their actual intentions and expectations they are not receivable. The point is that such statements and actions reveal the terms of the contract which the parties intended or hoped to make. They are superseded by, and merged in, the contract itself. The object of the parol evidence rule is to exclude them, the prior oral agreement of the parties being inadmissible in aid of construction, though admissible in an action for rectification.
[24] Consequently when the issue is which of two or more possible meanings is to be given to a contractual provision we look, not to the actual intentions, aspirations or expectations of the parties before or at the time of the contract, except in so far as they are expressed in the contract, but to the objective framework of facts within which the contract came into existence, and to the parties' presumed intention in this setting. We do not take into account the actual intentions of the parties and for the very good reason that an investigation of those matters would not only be time consuming but it would also be unrewarding as it would tend to give too much weight to these factors at the expense of the actual language of the written contract.
[emphasis added]

Parol evidence rule and exceptions

We have considered the parol evidence rule as it relates to ambiguity. The parol evidence rule also operates to exclude evidence of other possible terms when it is first established that the written document was intended to contain all of the contractual terms. See, eg, State Rail Authority of New South Wales v Health Outdoor Pty Ltd (1986) 7 NSWLR 170 at 191.

President Allsop (as he then was) in the NSW Court of Appeal set out the following principles for deciding whether an agreement is wholly in writing or partly written and partly oral ([Masterton Homes Pty Ltd v Palm Assets Pty Ltd [2009] NSWCA 234 at [90] (footnotes omitted)]

(1) When there is a document that on its face appears to be a complete contract, that provides an evidentiary basis for inferring that the document contains the whole of the express contractual terms that bind the parties ...
(2) It is open to a party to prove that, even though there is a document that on its face appears to be a complete contract, the parties have agreed orally on terms additional to those contained in the writing ...
(3) The parol evidence rule applies only to contracts that are wholly in writing, and thus has no scope to operate until it has first been ascertained that the contract is wholly in writing ...
(4) Where a contract is partly written and partly oral, the terms of the contract are to be ascertained from the whole of the circumstances as a matter of fact ...
(5) In determining what are the terms of a contract that is partly written and partly oral, surrounding circumstances may be used as an aid to finding what the terms of the contract are ...
(6) A quite separate type of contractual arrangement to a contract that is partly written and partly oral is where there is a contract wholly in writing and an oral collateral contract ...

Aids to construction

Some of the aids to construction courts use when interpreting a contract include:

Ordinary meaning
The courts will assume the parties intended words they used to have their ordinary meaning (subject, for example, to a 'defined' terms section in the contract that defined them in a different way or evidence of customary meaning when used in the context of the subject matter of the contract). To ascertain ordinary meaning courts might have regard to dictionaries.

Promotion of validity of contract
In cases of ambiguity courts will favour a meaning that promotes validity of the contract, it being presumed that the parties would have not have intended a meaning that invalidated the contract.

Consideration of context
Words will be considered in the context of the rest of the clause and document in which they appear.

Contra proferentum rule
In cases of ambiguity terms should be construed against the party drafting the clause.

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Last updated: 18 October 2019