Contractual interpretation revisited
6 Oct 2020
In what may turn out to be a landmark decision in Bathurst Resources Ltd v L&M Coal Holdings Ltd ( NZCA 113), the Court of Appeal has signalled a narrowing of the approach to contractual interpretation, reducing the relevance of evidence from outside a contract to determine its meaning.
Bathurst had acquired coal mining rights from L&M. Although 50,000 tonnes of coal had been mined by Bathurst, it argued that the performance payment obligation had not been triggered because the coal had not been "shipped". Two of the issues on appeal concerned the meaning of a sale agreement and its 2012 amendment, bringing issues of contractual interpretation to the forefront of the analysis.
While courts were traditionally reluctant to consider evidence from outside a contract to determine its meaning, the scope of what can relevantly be considered has been expanded over the past 25 years.
In Investors Compensation Scheme Ltd v West Bromwich Building Society ( 1 WLR 896 (HL)), Lord Hoffmann held that a court could use evidence from outside a contract to determine its meaning. However, the English courts declined to extend the evidence which could be considered in order to determine a contract's meaning to that of the parties' prior negotiations or subsequent conduct.
The NZ courts adopted a more flexible approach and extended the potential evidence beyond the limits imposed by the English courts in:
- Vector Gas Ltd v Bay of Plenty Energy Ltd ( NZSC 5), in which the Supreme Court ruled that evidence of prior negotiations was potentially admissible (for further details please see "Use of evidence of prior negotiations in contract interpretation"); and
- Wholesale Distributors Ltd v Gibbons Holdings Ltd ( NZSC 37), in which the Supreme Court held that evidence of post-contractual conduct was admissible in interpreting what the contract meant (for further details please see "Supreme Court on use of post-contractual conduct in contract interpretation").
While courts at every level have insisted that the written text should have primacy in interpretation, they have frequently considered surrounding context, including prior negotiations and subsequent conduct.
The leading NZ authority on contract interpretation is the Supreme Court decision Firm PI 1 Ltd v Zurich Australian Insurance Ltd ( NZSC 147). In this decision, the court emphasised three considerations:
- the objectivity of interpretation exercise;
- the primacy of the text; and
- the relevance of third parties to the scope of the interpretation exercise.
In New Zealand the aim of contract interpretation is to ascertain the meaning that the contract would convey to a reasonable person, having the background knowledge reasonably available to the parties in the situation that they were in at the time of making the contract.
The objectivity of contract interpretation is one of the distinguishing features of common law – distinguishing it from civil law which is more willing to delve into the common subjective intention of the contracting parties.
While the bystander or objective observer is presumptively reasonable, they will bear in mind:
- the contractual purpose;
- relative bargaining strengths;
- the character of the parties; and
- other context admissible for construction.
The objectivity principle is justified on a series of policy arguments:
- The reality of pursuing actual intended meaning will often be a futile exercise. No contract can provide for all potential eventualities.
- Disputes bring about distorted ex post facto thinking. What parties have to say with the benefit of hindsight about their contractual intentions is unlikely to be reliable or helpful.
- The objectivity principle is a rule of commercial efficiency. There must be a limit to the extent that it is gainful to dig into material beyond the confines of the contractitself.
- The objectivity principle may give way to actual contrary mutual intention in a case where the objective interpretation does not accord with actual common intent.
Primacy of text
In Firm PI 1 Ltd, the Supreme Court held that while context is a necessary element of interpretation, the text is of central importance:
If the language at issue, construed in the context of the contract as a whole, has an ordinary and natural meaning, that will be a powerful, albeit not conclusive, indicator of what the parties meant.
The textual primacy principle is itself an expression of the objectivity principle. The words used are the best objective evidence of what was intended.
Relevance of third parties
The Supreme Court observed that the language of complex commercial contracts will:
- result from a process of negotiation;
- attempt to record in a formal way the consensus reached; and
- have the important purpose of creating certainty for both the parties and third parties.
The fact that parties are aware that their contract might be relied on by a third party may justify a more restrictive approach to the use of background evidence.
It is a relevant contextual enquiry to ask to whom the contract was addressed or by whom it was to be relied on.
The wider the audience, the more restrictive should be the approach to the receipt of extrinsic evidence.
The first issue on appeal was whether a contractual reference to coal being "shipped" required the coal to be extracted and moved by Bathurst or whether it also required it to be transported by ship.
The High Court looked not only at the text but also at the overall commercial context to determine whether 'shipped' meant that the miner became liable only when the coal was transported by ship or if it became liable when the coal was transported from the mine by any means. In this case, the predominant destination of the coal was the export market, which supported the transported by ship interpretation.
However, contrary to such an interpretation was the miner's consistent acknowledgment in its financial statements for three years that the first performance payment had been triggered by production at the mine. There was also no distinction in the payment obligation between the coal which was exported and the coal sold domestically.
The court found that 'shipped' meant 'transported' and that if liability for performance payments were intended to depend on export tonnage, a more sophisticated formulation would have been necessary.
The Court of Appeal noted, in its conclusion on the meaning of 'shipped', that in Wholesale Distributors Ltd v Gibbons Holdings Ltd, the Supreme Court by majority had approved the admissibility of subsequent conduct evidence to ascertain meaning. Nonetheless, it found the evidence of Bathurst's post-contract conduct in its financial statements to be of limited value, noting that it was unilateral conduct of one party only and was equally consistent with a unilateral mistaken understanding. Subsequent conduct by a party in support of one interpretation:
may be indicative of a merely mistaken perspective of obligation. Such a perspective ought not to bind and the actor ought to be able to renounce it, unless their conduct creates an estoppel by convention, apart from the contract itself.
As the post-contract conduct evidence was held to be of little assistance, it was set aside.
L&M Coal Holdings argued for the inclusion of evidence of pre-contractual negotiations in interpreting the contract; that evidence had been held to be admissible in the High Court.
In contrast, the Court of Appeal ruled that evidence of pre-contractual conduct was inadmissible:
The contract is the governing instrument and must be made to yield a solution. Notably that solution is not reached by looking at prior negotiations – perhaps the best evidence of intention, yet inadmissible to interpretation.
The Court of Appeal referred neither to the Supreme Court's decision in Vector on this point nor to any other NZ case in which evidence of prior negotiations was considered to determine the meaning of a contract.
Ultimately, the Court of Appeal rejected the use of evidence of prior negotiations entirely and adopted a confined role for subsequent conduct evidence in interpreting a contract.
Throughout its decision, the Court of Appeal emphasised the objective approach to interpretation of contract at common law where "the aim of contract interpretation is to ascertain the meaning the contract would convey to a reasonable person, having the background knowledge reasonably available to the parties in the situation they
were in at the time of the contract".
The judgment also set out a number of key contract interpretation principles:
- Text is pre-eminent in interpretation, being an expression of the objective approach in that it is the best objective evidence of what was intended.
- Evidence of subsequent conduct in reliance on the text is more readily received than that of prior negotiations.
- However, subsequent conduct may merely be evidence of mistaken interpretation of the contract.
- The reasonable observer will bear in mind:
* the contractual purpose;
* relative bargaining strengths;
* the character of the parties; and
* other admissible context.
- Interpretation is only one of the three principal elements of contract construction – the others being implication and rectification.
- Only in rectification is the subjective intention of the parties relevant.
- Rectification ensures that parties are not held to an objectively ascertained bargain that they did not intend.
- Disputes bring about distorted ex post facto thinking – what parties have to say with the benefit of hindsight about their contractual intentions is unlikely to be reliable or helpful.
- The objectivity principle recognises that there must be a limit to the extent to which it is gainful to dig into material beyond the confines of the contract to ascertain its meaning.
The court concluded that the sale agreement in this case provided for performance payment to be made by Bathurst to L&M when Bathurst shipped 25,000 tonnes from the permit area. In answering the first issue, the court found that this was unequivocally triggered once that tonnage had been transported from the permit area by road. It did not need to be exported by ship.
This decision indicated a material shift in the presumptive relevance of subsequent actions and prior negotiations to the interpretation of a contract.
However, on 27 July 2020 the Supreme Court granted leave to appeal based on the following notes:
- The principles of contractual interpretation have been set out by the Supreme Court in Firm PI 1 Ltd v Zurich Australian Insurance Ltd (Zurich) and the court will not revisit those principles in the appeal.
- The decision did not deal with the admissibility or otherwise of evidence of prior negotiations or subsequent conduct. The court will hear argument on those issues.
- The court is also prepared to hear argument on the distinction between 'interpretation' and 'implication' and the appropriate test for the latter.(1)
As the Supreme Court has undertaken to reconsider the application of established principles to certain types of evidence, it remains to be seen whether it will uphold an approach to contractual interpretation consistent with the Court of Appeal in Bathurst or whether it will favour the approach taken in Vector Gas and Gibbons.
For further information on this topic please contact Victoria Rea at Wilson Harle by telephone (+64 9 915 5700) or email (firstname.lastname@example.org). The Wilson Harle website can be accessed at www.wilsonharle.com.
(1) Bathurst Resources Limited v L&M Coal Holdings Limited  NZSC 73.