A Plea for Pragmatism

The use of extrinsic evidence in aid of construction: a plea for pragmatism[1]

By the Honourable Justice Bond 

Under the objective theory of contract the meaning of a contract is to be decided in accordance with what the terms of the contract would convey to a reasonable person in the position of the parties, rather than by reference to the subjective intentions of one, or even both, parties to the contract.[2]

The process of deciding the meaning of a written contractual term ordinarily involves objective consideration of — 

(a) the text of the contractual term;

(b) the context within which the term exists (namely, the entire text of the contract and any other contract, document or statutory provision referred to in the text); and

(c) the commercial purpose or objects evidently intended to be secured by the contract.[3]

This process ordinarily occurs by reference to the contract alone, namely to the contractual text and contextual matters to which it has referred. Notably, there is no ambiguity threshold which must be crossed before it is legitimate to look to context in this way.[4]

But, in the process of deciding the meaning of a contractual term, the question often arises whether a party should be permitted to refer to contextual matters which are extrinsic to the language of the parties’ agreement or what might be evident from it.

Traditionally the starting point to answering that question has been a statement of the operation of the parol evidence rule[5] and a consideration of the exceptions to it.[6] It is more common now simply to say that the ordinary course is that the process of construction occurs by reference to the contract alone (in the sense described above), but that sometimes recourse to events, circumstances and things external to the contract is necessary.

Of course, that begs the question as to how one can determine when recourse to events, circumstances and things external to the contract has become necessary. The famous Codelfa “true rule”,[7] suggests that an ambiguity threshold must first be passed. The first task essayed by this paper is the identification of the current state of Australian appellate authorities on this question. It will become apparent that the law is not yet in a satisfactory state and that there is still a division of approach between intermediate courts of appeal.

The second task essayed by this paper is a brief summary of the law concerning the use to which extrinsic evidence may be put once any ambiguity threshold is met (if there is one). Although the law seeks to draw a clear line between the legitimate and illegitimate uses of such evidence, it is readily apparent that the line is sometimes difficult to draw. And there are still some areas in which an approach is taken which seems anomalous.

In view of these difficulties, one might speculate whether the law is in need of reform.

Indeed, serious suggestions have been made that there should be no exclusionary rules at all. Rather the law should simply let everything in. For example, in a 2014 working paper entitled “A Draft Australian Law of Contract” prepared in response to the Commonwealth Attorney General’s discussion paper concerning reform to Australian contract law, Ellinghaus, Kelly and Wright recommended the abolition of the parol evidence rule. The learned authors would reform the law so that “[a]ll evidence that is relevant to identifying and interpreting the terms of a contract is admissible, including evidence of each party’s actual intention”.[8] The meaning of a contractual term would be that “intended by the parties, having regard to”, amongst other things, “the parties’ statements and other conduct before and after the contract was made”.[9] If a party intends a term to have a particular meaning, and the other party is or should reasonably be aware of that intention, that is its meaning.[10]

I recoil with horror from the breadth of these suggested reforms of the law and reject the notion that they reflect a proper policy setting for the law of contract in this country. The plea for pragmatism made in the title of this paper reflects a concern that the pursuit of theoretical purity can sometimes occur with insufficient attention to feasibility and practical consequences.

The third task essayed by this paper is the development of an explanation of why, in circumstances in which the parol evidence rule would have applied, the proper policy setting of the law must continue to be one in which admissibility in aid of construction of events, circumstances and things external to the contract is exceptional rather than usual.

My hypothesis is that one way or the other, and whether by developments in substantive or procedural law, or both, our system of justice must manage the question of admissibility of extrinsic evidence in aid of construction in such a way as will permit of its occurrence only where it is of real utility and must hold the evidence out if it is not.

The final task essayed by this paper is to suggest some procedural strategies which may improve the efficient management of the reception and use of such evidence in cases in which its use is proposed. I will leave the task of development of the substantive law to others.

The substantive law

Is there still an ambiguity threshold? 

The standard articulation of the objective theory of contract bears repetition. The meaning of a contract is to be decided in accordance with what the terms of the contract would convey to a reasonable person in the position of the parties, rather than by reference to the subjective intentions of one, or even both, parties to the contract.

Where the revealed contractual intention is that the whole of the parties’ agreement is contained in a written contract document, the parol evidence rule applies to exclude the use of extrinsic evidence in determining the meaning of the words used in the contract document.[11] Usually such an intention is sufficiently revealed by the production of a signed written instrument which appears on its face to be the final written expression of the full consensus of the parties.[12]

Of course, the Courts have long since recognised that there is more to the task of construction than simply working out the plain and ordinary meaning of the words used in the contractual text. The strict operation of the parol evidence rule has been the subject of a number of exceptions, the principal amongst which was Sir Anthony Mason’s famous statement in Codelfa Construction Pty Ltd v State Rail Authority (NSW)[13] of the true rule. He wrote:

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.

This statement of the rule had been widely regarded as authority for the proposition that “ambiguity” (in the sense that the language is ambiguous or susceptible of more than one meaning) was a threshold issue on which the admissibility of extrinsic evidence turned. (The threshold is fairly low: the Western Australian Court of Appeal has recently treated the concept as encompassing not only where a term is open to more than one meaning but also where it is merely difficult to understand; [14] and also any situation in which the scope or applicability of a contract to the circumstances concerned is doubtful and not merely cases involving lexical, grammatical or syntactical ambiguity. [15])

However, it was not too long after the articulation of the “true rule” that suggestions emerged that it was inappropriate to think of an “ambiguity threshold” to the admissibility of extrinsic evidence because language always needs to be interpreted in context. In Investors Compensation Scheme Ltd v West Bromwich Building Society,[16] Lord Hoffman famously summarised relevant principles in a way which rejected any notion of an ambiguity threshold, stating, amongst other things, that:

… Subject to the requirement that it should have been reasonably available to the parties and to the exception [that previous negotiations and declarations of subjective intent are excluded], [the background knowledge which the reasonable person is assumed to have had] includes absolutely anything which would have affected the way in which the language of the document would have been understood by a reasonable man.

In Bank of Credit and Commerce International SA v Ali,[17] Lord Hoffman clarified that in making that statement he was suggesting that there was “no conceptual limit to what can be regarded as background”.

In a paper delivered in 2009, Sir Anthony Mason himself retreated from the notion of an ambiguity threshold.[18] Relevantly:

(a) He thought that the favoured approach was that ambiguity should not be regarded as a necessary threshold. In this regard he observed (emphasis added):

It was that idea that I was endeavouring to express in Codelfa, albeit imperfectly, because I recognised that ambiguity may not be a sufficient gateway; the gateway should be wide enough to admit extrinsic material which is capable of influencing the meaning of the words of the contract. The modern point of criticism is that one should not have been thinking in terms of gateway. At the time, however, it was natural to do so because it stressed the importance of the natural and ordinary meaning of the words used by the parties in their written instrument and it respected the difference between interpretation and rectification.

(b) He generally supported Lord Hoffmann’s restatement of principles or guidelines and thought that the High Court of Australia had endorsed them in Pacific Carriers Ltd v BNP Paribas,[19] and in Toll (FGCT) Pty Ltd v Alphafarm Pty Ltd.[20]

(c) He did sound one word of caution, namely that he doubted that the Hoffmann restatement promoted cost-efficient litigation and thought it might lead to attempts to achieve rectification through interpretation.

Nevertheless, by early 2011 it seemed clear that it was a corollary of the objective theory of contract itself that identification of ambiguity in the terms of an agreement was not a necessary precursor to the examination of surrounding circumstances. This proposition had the support of multiple intermediate appellate courts:

(a) New South Wales:

(i) Franklins Pty Ltd v Metcash Trading Ltd;[21]

(ii) Synergy Protection Agency Pty Ltd v North Sydney Leagues’ Club Ltd;[22]

(iii) Masterton Homes Pty Ltd v Palm Assets Pty Ltd;[23] and

(iv) Movie Network Channels Pty Ltd v Optus Vision Pty Ltd.[24]

(b) Federal Court:

(i) Lion Nathan Australia Pty Ltd v Coopers Brewery Ltd;[25] and

(ii) Ralph v Diakyne Pty Ltd.[26]

(c) Victoria: MBF Investments Pty Ltd v Nolan.[27]

The judges in these cases had discerned in the High Court decisions which established the orthodoxy of the objective theory of contract[28] departure from the Codelfa rule which required ambiguity as a prerequisite for admissibility. They had noted that in stating the objective theory of contract, the High Court had done so in absolute terms and with no reference to any qualifications concerning the need to discern ambiguity. That proposition was certainly true and it was at least arguable that by so doing the High Court was favouring Lord Hoffman’s approach. Even Sir Anthony Mason thought that was the position. It suffices merely to refer to the following passage from Toll (FGCT) Pty Ltd v Alphapharm Pty Ltd (citations omitted, emphasis added):[29]

This Court, in Pacific Carriers Ltd v BNP Paribas, 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.

In 2011, however, the notion that intermediate courts of appeal had correctly identified that the High Court intended to depart from the Codelfa rule was the subject of trenchant criticism by the High Court. The following observations may be made:

(a) In Byrnes v Kendle,[30] Heydon and Crennan JJ emphasised that the observations in relevant intermediate courts of appeal which suggested a relaxation of the Codelfa approach must be read in the light of the fact that in Royal Botanic Gardens and Domain Trust v South Sydney City Council[31] a plurality comprising Gleeson CJ, Gaudron, McHugh, Gummow and Hayne JJ had said[32] that until the High Court had decided on whether there were differences between the arguably more liberal British approach and the approach authorised by Codelfa, and if so which should be preferred, Codelfa should be followed in Australia.

(b) Royal Botanic Gardens was a case in which the Court was construing a deed between the “Trustees of the Domain” called “the Lessors” and, on the other part, the Council of the City of Sydney called “the Lessee”, which governed the construction by the latter of the parking station beneath the Domain in Sydney. The Royal Botanic Gardens was the statutory successor of the Lessors. At issue was a clause concerning the determination of rent and whether the Lessors were bound by the words “in making any such determination the Trustees may have regard to additional costs and expenses which they may incur in regard to the surface of the Domain above or in the vicinity of the parking station” to take into account only such additional costs or could take wider considerations into account. Gleeson CJ, Gaudron, McHugh, Gummow and Hayne JJ found —

(i) the relevant clause was ambiguous;

(ii) it was appropriate to take into account the following surrounding circumstances:

A. the parties to the transaction were two public authorities;

B. the primary purpose of the transaction was to provide a public facility, not a profit;

C. the lessee was responsible for the substantial cost of construction of the facility;

D. the facility was to be constructed under the lessors’ land and would not interfere with the continued public enjoyment of that land for its primary object, recreation;

E. the parties’ concern was to protect the lessor from financial disadvantage from the transaction; and

F. the only financial disadvantage to the lessor which the parties identified related to additional expense which it would or might incur immediately or in the future; and

(iii) the clause was to be interpreted as exhaustively stating the considerations which could be taken into account in making a rental determination.

(c) Given that the clause had been found to be ambiguous, the observation made about Codelfa was necessarily obiter, but it was made in a joint judgment of five High Court justices and then re-emphasised by two further High Court justices in Byrnes v Kendle. Without more, the two cases would be a powerful reminder to courts below to keep following Codelfa until the High Court said the contrary.

(d) The point was then re-made in robust observations made in a decision made on a special leave application by Gummow, Heydon and Bell JJ in Western Export Services Inc v Jireh International Pty Ltd.[33] Although decisions on special leave applications do not carry the weight of precedent, they may nevertheless be thought to be a strong indication of the approach of the High Court. Their Honours wrote:

[2] The primary judge had referred to what he described as “the summary of principles” in Franklins Pty Ltd v Metcash Trading Ltd. 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.

[3] 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 (NSW) by Mason J, with the concurrence of Stephen and Wilson JJ, 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.

[4] 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 Council and it should not have been necessary to reiterate the point here.

In light of that trilogy of High Court reminders that overruling Codelfa was a matter for the High Court, and not intermediate courts of appeal, one would have expected to find a degree of circumspection in subsequent cases in those Courts when dealing with the question whether the law required an ambiguity threshold to be met. It seemed that the High Court had deliberately pressed the brake on the developments which had been occurring in the Courts below.

To an extent, that is what happened and some decisions in intermediate courts of appeal appeared to retreat from the full flourish of the “ambiguity is unnecessary” proposition (or at least to treat the proposition with some reserve):

(a) In New South Wales: see Rinehart v Welker,[34] Cordon Investments Pty Ltd v Lesdor Properties Pty Ltd,[35] and Moorebank Recyclers Pty Ltd v Tanlane Pty Ltd.[36]

(b) In Victoria: see Reading Properties Pty Ltd v Mackie Group Pty Ltd,[37]and Retirement Services Australia (RSA) Pty Ltd v 3143 Victoria St Doncaster Pty Ltd.[38]

(c) In Queensland, the Court of Appeal seemed still to adhere to the [1] [2] [3] [4] [5]15] below. [6]16] and [47] to [48] below. [7]16] below. [8] [9] [10] [11] [12] [13] [14] [15] [16] [17] [18] [19] [20] [21] [22] [23] [24] [25] [26] [27] [28]2 above. [29] [30] [31] [32] [33] [34] [35] [36] [37] [38] [39] [40] [41] [42] [43] [44] [45] [46]