I
One of the core skills of the practising barrister is the interpretation of legal instruments.
When the instrument is a private contract, the task may seem deceptively simple:
“Most practising lawyers like to think that they can give reliable advice as to the true interpretation of contracts crossing their desks simply by pondering the words in question and, if need be, by consulting their dictionaries. They reside in ‘that lawyer’s Paradise…where, if the writer has been careful, a lawyer, having a document referred to him, may sit in his chair, inspect the text, and answer all questions without raising his eyes.”1
The difficulty with this approach, however, is that virtually all words take their meaning from the context in which they are used.
Consider the language used in what has been described as “the shortest will ever drafted”. In Thorn v Dickens [1906] WN 54, the will simply provided:
“All for Mother”.
The meaning of the will would seem to be plain — all the testator’s property was bequeathed to his mother. But this was not the meaning accepted by the court. The court heard that the practice of the testator was to refer to his wife — the mother of their children — as “Mother”. Accordingly, it was the testator’s wife — and not his mother – who was found to have benefitted under the will.
The key point is that:
“…few, if any, English words are unambiguous or not susceptible of more than one meaning or have a plain meaning. Until a word, phrase or sentence is understood in the light of the surrounding circumstances, it is rarely possible to know what it means.”2
To resolve any contest between possible meanings of a contractual instrument, a set of interpretative principles has been developed by the common law.
In essence, there are five core principles:3
“First, the objective principle. The courts are concerned usually with the expressed intentions of a person, not his or her actual intentions. The standpoint adopted is that of a reasonable recipient of the communication or utterance.
Secondly, the aim of the courts in interpreting a document or utterance is loyalty. Loyalty to the contractual language, and accordingly loyalty to the apparent intention of those who subscribed to the document or made the utterance.
Thirdly, the holistic approach. Courts are not excessively focused upon a particular word, phrase, sentence or clause. Rather the concentration is on the document or utterance as a whole. This is the first half of the modern concern with context.
Fourthly, the contextual dimension. Modern judges are prepared to look beyond the four corners of a document, or the bare words of an utterance. They have regard to the relevant surrounding factual (and legal) circumstances which constitute the context in which the document was drafted or the utterance was made. This is the second and broader aspect of the modern concern with context.
Fifthly, the purposive approach. The courts have regard to the overall purpose of the parties with respect to a particular transaction, or more narrowly with respect to a particular term, or the reason why a particular obligation was undertaken.
It must be acknowledged straight away that these principles to some extent overlap in practice. There is no rigid hierarchy between the five. However it is submitted that the first two are foundational. They answer the questions: what is the purpose of the technique of interpretation? or what is it we are seeking to ascertain? The next two deal with the question: which materials should the judge have regard to carrying out the technique? The last principle… is necessarily a subsidiary principle which cannot be deployed until the judge has sufficiently oriented himself by addressing the first four imperatives.”
It was once thought that there were extensive constraints upon the use of the fourth of these principles — the principle which permits reference to the “surrounding circumstances” or “factual matrix”.
First, it was thought that this was only possible where there was real ambiguity in the language of the contract4 – but this limitation has now been rejected.5
Secondly, it was thought that the “surrounding circumstances” were confined to truly objective facts (eg the physical characteristics of property being sold) and excluded reference to the various matters which the parties may have communicated to each other in the course of negotiations (eg earlier drafts of the agreement, statements by one of the parties about their intentions or understanding)6 — but this limitation has also been softened.7
Thirdly, it was also thought that the “surrounding circumstances” were confined to facts within the actual knowledge of all contracting parties.8 Whilst this approach has been tentatively reaffirmed by the NSW Court of Appeal,9 a wider view finds some support in the authorities.10
The demise of these constraints has serious practical implications for the interpretation of instruments and for the conduct of litigation.
As Lord Hoffmann explained, the potential width of the “factual matrix” in any given case may be great :11
“ The background was famously referred to by Lord Wilberforce as the ‘matrix of fact’, but this phrase is, if anything, an understated description of what the background may include. Subject to the requirement that it should have been reasonably available to the parties and to the exception to be mentioned next, it 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 many cases, however, this substantial broadening of the factual enquiry is of little or no practical use.
The warning to parties — and their lawyers – about the need to exercise careful judgment before venturing into a costly examination of the factual matrix has been clearly sounded:
[34] …..[Counsel] asked us to enter into a full consideration of the surrounding circumstances. These surrounding circumstances that we were asked to look at included three periods: (a) before the bids were submitted; (b) the negotiation between the parties at about the time the bids were submitted; and (c) negotiations between the parties after the bids were submitted.
[35] Barrett J was invited to do the same exercise. This meant that there were seven days of oral evidence before his Honour, most witnesses being in the box for the whole day and one unfortunate for two days. In addition, there were 2,524 pieces of paper placed before his Honour, not only including the substantial agreements and various drafts of them, but almost every piece of paper that passed between the parties. All this to work out the meaning of the word “successful”.
[36] Under what Lord Hoffmann would doubtless call the “old rules of legal interpretation”, almost none of this material would have been tendered and the case would doubtless be over in half a day. That is because 50 years ago courts paid great respect to the rule that if parties had put down their contract in a written document, one construed their writing and the parol evidence rule was applied to exclude extraneous material. That may have been too draconian an approach. However, the reverse approach which permits every piece of paper to be put before the court is causing tremendous expense in commercial litigation. That expense might be justified in a case such as the present where something like $4.5 million might be at stake. However, it is not at all uncommon for the same approach to be used in small commercial disputes involving amounts not greater than the District Court ceiling….
[53] In view of what the High Court said and did in the Royal Botanic Gardens case, trial judges are virtually precluded from excluding this evidence. However, it may well be that after the case is over, special orders should be made as to costs where a party has unduly extended the time of hearing by long cross examination as to surrounding circumstances or by tendering a bulk of papers which are either of no actual assistance in the long run, or alternatively, stray too much into the field of negotiations as to the parties proposing and amending drafts as opposed to negotiations which show the underlying concept of the contract and the background to it. In the state of the law it is probably only by making such orders for costs as will dissuade people from unduly extending the length of cases that will bring this sort of commercial litigation back into some realistic scope. [emphasis added]
In these circumstances, two main questions arise.
First, as the law presently stands, how far beyond the four corners of the contract is it permissible to go to outline the factual matrix of an agreement? Does the factual matrix extend to the negotiations of the parties? To the draft agreements which they exchanged? To the objects and purposes which they communicated to each other? To any discussions about the meanings which they attributed to the proposed terms?
Secondly, even if the law permits an excursion into the factual matrix, how does one decide when to embark upon such an excursion and how far to extend it?
II
The answer to both questions can be found by seeking to identify those categories of case where the factual matrix has provided real assistance in the resolution of disputed interpretations.
Three categories of case are readily identified. In each of these categories, the existence of the fact is linked, by a direct logical connexion, to principled reasoning which tends to support one of the disputed interpretations.
The first category of case is the conventional one – where the known objective facts relating to the transaction are relied upon as part of the factual matrix. The objective facts may include matters such as the physical characteristics of the subject matter of the contract, the way in which the subject matter can be legally or practically used, or the pre-existing contractual framework within which the new contract was made. Facts of this kind will provide a relevant factual matrix if, from the viewpoint of a reasonable person, they make one of the disputed constructions of the contract more likely (eg. because it is consistent with the commercial purpose of the agreement12 ).
This category of case may be illustrated by Environmental Systems Pty Ltd v. Peerless Holdings Pty Ltd (2008) 19 VR 358 (Vic CA). That case concerned the proper construction of an agreement to supply an emission control system to a factory. The question was whether the agreement warranted performance only in relation to certain specified kinds of emissions — or whether performance was warranted in relation to the different kinds of emissions actually produced by the factory. In deciding between these interpretations, the Court of Appeal was assisted by the evidence that the contract had been negotiated with both parties possessing actual knowledge of the emissions which the factory actually produced.13 Accordingly, this fact was relevant to a purposive approach to interpretation — and favoured the second of the two possible constructions, which gave the term a rational, commercial purpose.
The second category of case is more controversial.14 It concerns a situation where, in the course of negotiations, there was an explicit discussion between the parties of the meaning or purpose of the provisions being negotiated. As a general rule, the course of negotiations between the parties has been excluded from the factual matrix as a matter of policy.15 That is because negotiations generally contain a series of stances, ripostes and compromises from which it is difficult to extract any meaningful understanding of the common intention embodied in the final contract. However, where consensus is actually reached between the parties about what a particular word was intended to mean or about the purpose for including a provision in the contract, then recent authorities suggest that it is admissible as part of the factual matrix.
This category of case is illustrated by the recent decision of the Queensland Court of Appeal in Australian Medical Insurance Ltd v. CGU Insurance Ltd (2010) 271 ALR 142. The question in that case was whether an insurance policy covered a particular risk. During the course of negotiations, the parties had explicitly discussed and reached a common understanding in relation to this matter. Indeed, the common understanding involved actual agreement. As the Court observed, however:
“[62] The English cases, in particular Karen Oltmann , suggest that where the parties in negotiation have concurred on a meaning as to a word or phrase and share a mutual intention with respect to it, evidence of the concurrence and the intention is admissible, on the question of what the word or phrase means.”
In applying this principle, however, it is important to distinguish between the cases where there is true concurrence and those where merely one parties’ understanding or belief is communicated .16
The third category of case also concerns a form of concurrence— where, in the course of negotiations, one party proposes a particular term (eg in a draft agreement) and that proposal is explicitly rejected by the other party as unacceptable and so excluded from the terms of the ultimate contract. What if one of the parties later contends that other terms of the contract are to be construed as having the same effect as the rejected term? Can the circumstances of rejection be relied upon as a surrounding circumstance suggesting a consensus to exclude that right or obligation from the contract? Whilst this question remains controversial, an emerging body of authority suggests that the fact that an explicit provision was rejected in the course of negotiation may lead a reasonable reader to conclude that neither party intended the remaining provisions to have that effect.17
Beyond these three categories of case, however, the position is even less certain.
In 1998, Lord Hoffmann observed that the “boundaries” of the permissible use of negotiations were somewhat unclear.18
In 2010, similar observations continue to be made by Australian appellate courts.19
The trend, however, appears to favour a principled approach to this issue, rather than a blanket rejection of all communications made in the course of negotiations :20
“[4] …. We agree with Gyles AJA that the documentary background material and the drafts are not helpful in the determination of the issue at hand, being the objective construction of the mortgages in question. We would reserve making any comment on the admissibility of this material. The line in any given body of circumstances between impermissible recourse (in the process of construction and interpretation) to negotiations to understand the actual intentions of the parties…and the legitimate scope of the identification of the “position of the parties” by reference to which the reasonable person would be taken to make the enquiry as to the meaning of the words used… may be difficult to identify.
[5] The possible subtlety of the distinction can be seen in Lord Wilberforce’s reasons in Prenn v Simmonds [1971] 1 WLR 1381 at 1384—1485, and the recognition that the objective commercial aim may, possibly, be ascertained from some aspect of what has passed between the parties. The distinction can also be seen in what Mason J said in Codelfa at 352 about prior negotiations and their legitimate use “to establish objective background facts which were known to both parties and the subject matter of the contract”, and their inadmissibility “in so far as they consist of statements and actions of the parties which are reflective of their actual intentions or expectations”. See also in this respect , Bank of Scotland v Dunedin Property Investment Co Ltd 1998 SC 657 at 665 per the Lord President; and see generally Pacific Carriers Ltd v BNP Paribas 218 CLR 451 ; [2004] HCA 35 at 461—2; Royal Botanic Gardens and Domain Trust v South Sydney City Council 76 ALJR 436 ; [2002] HCA 5 at 438—9 [9]—[11]; Gardiner v Agricultural and Rural Finance Pty Ltd [2007] NSWCA 235 at [7]—[13] and Spigelman CJ “From Text to Context: Contemporary Contractual Interpretation” (2007) 81 ALJ 322.
[6] Here, the background material is unhelpful and no further discussion of it is necessary.”
A recent illustration of this principled approach in Queensland courts can be found in Mac Developments (Gold Coast) Pty Ltd v Rams Financial Group Pty Ltd [2010] QSC 477. That case concerned the construction of a settlement deed between a franchisor and a franchisee who were in an ongoing franchise relationship. At the time of the deed, the franchisor was conducting the franchise using practices which the franchisee asserted to be wrongful. The deed contained a general release of the franchisee’s claims. The question was whether the deed released only the franchisee’s rights in relation to past breaches — or whether it released the franchisee’s rights to complain about breaches which were said to be still continuously occurring. In resolving this dispute, the court found assistance in the circumstances surrounding the negotiation of the deed. In these negotiations, the franchisor made it plain that it did not intend to change its practices. In the particular circumstances of that case, this intention was itself held to be a fact which, viewed objectively, made it unlikely that the parties were agreeing only to a release of the claims up to the date of settlement.
III
What do these developments mean for the practising barrister?
First, they suggest the need for caution in seeking to interpret any instrument without regard to its proper factual and legal context. Even where the language is apparently unambiguous, the context may affect the meaning of the words used. It is a matter which calls for some enquiry.
Secondly, on the other hand, it would be a mistake to believe that the courts are encouraging parties, in the conduct of trials, to engage in indiscriminate investigations into the factual matrix. Most negotiated agreements arise from dealings which are lengthy and complex — with numerous drafts and proposals exchanged between the parties and their solicitors. Often, however, this material will reveal nothing more than the subjective views and intentions of the respective parties which have no logical relevance to the point in dispute. On conventional principles of interpretation, this material is simply irrelevant.
Thirdly, these developments stress the need for a rigorously logical and principled approach. For any background fact to be relevant, it must be one which would lead a reasonable reader — applying the conventional principles of interpretation — to regard one relevant interpretation as representing the common intention of the parties. Mutually known, objective facts may have this effect. Conventions adopted by the parties as to the purpose or meaning of an agreement — or matters which it should not provide for — may also have this effect. But if the relevant event reveals only the subjective intentions or understanding of one party, it is usually logically irrelevant to the construction process and is of no assistance.
J.D. McKenna S.C.
Footnotes
1. D.McLaughlan “Contract Interpretation: What is It About?” (2009) 31 Syd LR 5 at 14.
2. Manufacturers’ Mutual Insurance Limited v Withers (1988) 5 ANZ Ins Cas 60-853 quoted with approval in Geroff v CAPD Enterprises Pty Ltd [2003] QCA 187 at [41] (per Muir J with whom McPherson and Jerrard JJA agreed).
3. G.McMeel “Prior Negotiations and Subsequent Conduct — The Next Step Forward for Contractual Interpretation” (2003) 119 LQR 272 at 277.
4. Codelfa Constructions Pty Ltd v. State Rail Authority (NSW) (1982) 149 CLR 337, 352 (per Mason J).
5. Franklins Pty Ltd v. Metcash Trading Ltd (2009) 264 ALR 15 (NSW CA) at [14]-[18], [42]-[43] and [239]-305].
6. Codelfa Constructions Pty Ltd v. State Rail Authority (NSW) (1982) 149 CLR 337, 352 (per Mason J); Investors Compensation Scheme Ltd v. West Bromwich Building Society [1998] 1 WLR 896 at 912-913 (per Lord Hoffmann).
7. See discussion below.
8. Reardon Smith Line v. Hansen-Tangen [1976] 1 WLR 989 at 996-997; Codelfa Constructions Pty Ltd v. State Rail Authority (NSW) (1982) 149 CLR 337, 352 (per Mason J).
9. Movie Network Channels Pty Ltd v Optus Vision Pty Ltd [2010] NSWCA 111; QBE Insurance Australia Ltd v. Vasic [2010] NSWCA 166 .
10. Investors Compensation Scheme Ltd v. West Bromwich Building Society [1998] 1 WLR 896 at 912-913.
11. Investors Compensation Scheme Ltd v. West Bromwich Building Society [1998] 1 WLR 896 at 912-913.
12. Eg Allen’s Asphalt Pty Ltd v. SPM Group Pty Ltd [2010] 1 Qd R 202 (Qld CA) at [51]
13. At [22]-[32].
14. See the discussion of competing authorities in D.McLaughlan “Contract Interpretation: What is It About?” (2009) 31 Syd LR 5.
15. Investors Compensation Scheme Ltd v. West Bromwich Building Society [1998] 1 WLR 896 at 912-913
16. Phoenix Commercial Enterprises Pty Ltd v. City of Canada Bay Council [2010] NSWCA 64 at [29]-[30]; [139].
17. Codelfa Constructions Pty Ltd v. State Rail Authority (NSW) (1982) 149 CLR 337, 352; Centrepoint Custodians Pty Ltd v Lidgerwood Investments Pty Ltd [1990] VR 411 at 421-424, per Ormiston J; Burger King Corporation v Hungry Jack’s Pty Ltd [2001] NSWCA 187 at [137]-[139], per Sheller, Beazley and Stein JJA; 260 Oxford Street Pty Ltd v Premetis [2006] NSWCA 96 at [132]-[134], per Young CJ in Eq; A Goninan & Co Ltd v Direct Engineering Services Pty Ltd [No 2] [2008] WASCA 112 at [37]-[40], per Buss JA, with whom Martin CJ and McLure JA agreed; PT Krakatau Stell v Felix Resources Ltd [2010] SASC 170 at [107]-[112].
18. Investors Compensation Scheme Ltd v. West Bromwich Building Society [1998] 1 WLR 896 at 912-913
19. Phoenix Commercial Enterprises Pty Ltd v. City of Canada Bay Council [2010] NSWCA 64; Franklins Pty Ltd v. Metcash Trading Ltd (2009) 264 ALR 15 (NSW CA) at [24].
20. Kimberley Securities Ltd v. Esber (2008) 14 BPR 26,121 at [4]-[5] (per Allsop P and Macfarlan JA).
