Interpretation of contracts under Australian law

This guide summarises the key principles of contractual interpretation applied by Australian courts, including:

• interpretation of express terms;
• implying terms; and
• the extent to which the circumstances that surround the contract can be considered.

Express terms

General rules of interpretation

The overarching approach taken by Australian courts is that:

• when interpreting a contract, the court attempts to give effect to what the parties intended;
• what the parties intended is to be assessed objectively, not subjectively; and
• the meaning of the terms of a commercial contract are to be determined by what a reasonable business person would understand those terms to mean.

The starting point is the words actually used.¹ The court will give express terms their plain and ordinary meaning, unless doing so would result in manifest absurdity. In general, Australian dictionaries rather than English dictionaries should be used in determining the plain and ordinary meaning of words.² 

Where a term of a commercial contract is ambiguous or capable of more than one meaning, Australian courts attempt to give the contract a businesslike and commercial interpretation. The court proceeds on the assumption that the parties intended to achieve a commercial result, and seeks to construe the contract to avoid it making commercial nonsense or causing commercial inconvenience. In seeking to interpret a contract where a term is ambiguous, the court may have regard to the circumstances surrounding the contract, such as evidence of the background known to the parties at or before the contract, including evidence of the genesis and objective aim of the transaction, and pre-contractual negotiations.

There is currently debate in Australia as to whether such surrounding circumstances can only be considered where there is ambiguity on the face of the contract (ie there is a gateway requirement of ambiguity before surrounding circumstances can be considered), or whether surrounding circumstances can be considered in order to determine whether the terms of the contract in fact have a plain meaning. The traditional position is the former, ie that ambiguity is a gateway requirement, and evidence of surrounding circumstances is not admissible to contradict express terms where they have a plain meaning.³ However, passing comments in a recent High Court decision that surrounding circumstances and the commercial purpose of a contract were relevant to its interpretation⁴ have been interpreted by the NSW Court of Appeal⁵ and Full Federal Court⁶, and in first instance decisions of the Supreme Courts of Victoria⁷ and South Australia⁸, to mean there is no longer any “gateway requirement”.

The Western Australian Court of Appeal, on the other hand, has stated that ambiguity remained a gateway requirement, subject to narrow exceptions.⁹ 

The High Court in Mount Bruce Mining Pty Ltd v Wright Prospecting Pty Ltd¹⁰ acknowledged the controversy but did not consider that that case was a suitable occasion to resolve it.

Common terms and phrases

Some words and phrases which commonly appear in contracts, such as a requirement to use “all reasonable endeavours”, “best endeavours” and “reasonable endeavours” have been judicially considered and have obtained a legally accepted meaning as a result. It is beyond the scope of this guide to consider such words and phrases, although there are resources which provide a collection of them.¹¹ 

Words with special or technical meanings

There is an exception to the rule that evidence of surrounding circumstances is not admissible, where the words used in a contract have special or technical meanings. In such circumstances, the courts will have regard to extrinsic evidence which demonstrates that words have, for example, meanings which are specific to particular localities,¹² are trade, customary or technical,¹³ or which are specific to the parties.¹⁴ Where a special or technical term is used there is a rebuttable presumption that the parties have intended to use them according to their correct technical meaning.¹⁵ 

Can the court look beyond the terms of the contract?

The “parole evidence rule” means that evidence of prior negotiations is not admissible to the interpretation of contract terms,¹⁶ unless it provides evidence of the surrounding circumstances.¹⁷ Such evidence is admissible but not in aid of a subjective interpretation of the problem clause. The use of surrounding circumstances in contractual interpretation has been discussed above.

Implied terms 

Terms may be implied based on fact, law (common law or statute) or by dealing, custom or usage.

Terms implied by fact

There are only limited circumstances in which a term will be implied into a formal written contract; for a term to be implied it must:¹⁸ 

1. be reasonable and equitable;
2. be necessary to give business efficacy to the contract (so that no term will be implied if the contract is effective without it);
3. be so obvious that it goes without saying;
4. be capable of clear expression; and
5. not contradict an express term.

The test for informal contracts is less stringent: the term need only be “necessary for the reasonable or effective operation of a contract of that nature in the circumstances of the case”.¹⁹ 

Terms implied by law

Terms may be implied at common law where the term is necessary in the sense that, without it, the rights conferred by the contract may be rendered worthless (or, perhaps, seriously undermined), and where the term would not be unjust or unreasonable. In certain kinds of contracts, such as employment, consumer, and tenancy agreements, and contracts for the sale of goods, certain implied terms are well established. Examples include:

• in contracts for the provision of services, a term that the service provider (or employee) will exercise reasonable care and skill in the performance of duties;²⁰ 
• in contracts for the provision of professional services, that the service provider will exercise the degree of care reasonably expected of a person having or professing to have the special skill;²¹
• in employment contracts, a term that the employee serve with good faith and fidelity;²²
• in bailment contracts, that the bailee will exercise reasonable care in relation to the goods and not convert them;²³
• an obligation to co-operate in a certain way, for example the court has stated that “where in a written contract it appears that both parties have agreed that something shall be done, which cannot effectually be done unless both concur in doing it, the construction of the contract is that each agrees to do all that is necessary for the carrying out of that thing, though there may be no express words used”.²⁴ 

Terms implied by statute include:

• that goods will be of an acceptable quality²⁵
• and fit for any disclosed purpose;²⁶
• if goods are supplied by description, that the goods will correspond with their description;²⁷
• if goods are supplied by sample, demonstration or model, the goods will correspond with the sample, demonstration or model in terms of quality, state or condition;²⁸ and
• that due care and skill will be exercised in the performance of services.²⁹ 

Terms implied by dealing, custom or usage

In certain contracts, terms may be implied by virtue of trade custom or usage, or by an established course of dealing, although such implied terms are often difficult to prove. In Con-Stan Industries v Norwich Winterthur Insurance (Aust) Ltd, the High Court summarised the position in respect of implying a term by custom as follows:³⁰ 

1. the existence of a custom or usage that will justify the implication of a term into a contract is a question of fact;³¹
2. the custom or usage was so well known that it was “so notorious that everybody in the trade who enters into a contract with that usage as an implied term. It must be uniform as well as reasonable and it must have quite as much certainty as the written contract itself”³². However, it is not necessary that the custom be universally accepted;
3. a term cannot be implied by custom if it is contradicted by an express term of the contract;³³ and
4. a person may be bound by a custom, even if they had no knowledge of it.

Rectification

It is possible to challenge the plain language of a contract on the basis that the agreement reached by the parties has been incorrectly recorded in the document. A court can rectify the problem clause to make it accord with what the parties agreed. There is a heavy onus on a party attempting to persuade a court to rectify a contract.³⁴ 

ENDNOTES

1. Australian Broadcasting Commission v Australiasian Performing Right Association (1973) 129 CLR 99, 110.
2. See for example, Provincial Insurance Australia Pty Ltd v Consolidated Wood Products Pty Ltd (1991) 25 NSWLR 541, 553 and 561.
3. Codelfa Construction Pty Ltd v State Rail Authority of New South Wales (1982) 149 CLR 337, 352.
4. Electricity Generation Corporation t/a Verve Energy v Woodside Energy Ltd [2014] HCA 7 at [35], [53].
5. Mainteck Services Pty Ltd v Stein Heurtey SA [2014] NSWCA 184 at [71].
6. Stratton Finance Pty Ltd v Webb (2014) 314 ALR 166 at [36]-[41].
7. Fitzgerald v CBL Insurance Ltd [2014] VSC 493.
8. Essential Beauty Franchising (WA) Pty Ltd v Pilton Holdings Pty Ltd [2014] SASC 84.
9. Technomin Australia Pty Ltd v Xstrata Nickel Australasia Operations Pty Ltd [2014] WASCA 164
10. [2015] HCA 37.
11. For example, Lexis Nexis Encyclopaedic Legal Dictionary and Lexis Nexis Australia Legal Words and Phrases provide a comprehensive collection of judicially considered terms and phrases.
12. Smith v Wilson (1832) 110 ER 266.
13. Appleby v Pursell [1973] 2 NSWLR 879.
14. RW Cameron & Co v L Slutzkin Pty Ltd (1923) 32 CLR 81.
15. Cholmondeley v Clinton (1820) 2 Jac & W 1, 91.
16. Ibid.
17. Byrnes v Kendle (2011) 243 CLR 253, [98]‑[99].
18. BP Refinery (Westernport) Pty Ltd v Shire of Hastings (1978) 52 ALJR 20; Codelfa Constructions Pty Ltd v State Rail Authoity (NSW) (1982) 149 CLR 337.
19. Hawkins v Clayton (1988) 164 CLR 539, 573.
20. Often applied in both service and employment contracts, to the extent not regulated by or inconsistent with statutory requirements, for example; Aerial Advertising Co v Batchelors Peas Ltd (Manchester) [1938] 2 All ER 788; Greaves v Baynham Meikle [1975] 3 All ER 99;Breen v Williams (1996) 186 CLR 71; X v Commonwealth of Australia and Another [1999] HCA 0063, [31]; Wylie v the ANI Corp Ltd [2000] QCA 314, [10]-[13].
21. Rogers v Whittaker (1992) 175 CLR 479.
22. Robb v Green [1895] 2 QB 315 at 317; Charltons CJC Pty Ltd v Fitzgerald [2013] NSWSC 350 at [36].
23. Smith v Weldon (1922) 30 CLR 585.
24. Mackay v Dick (1881) 6 App Cas 251.
25. Competition and Consumer Act 2010 (Cth) sch 2 Australian Consumer Law s 54
26. Ibid,s 55.
27. Ibid,s 56.
28. Ibid,s 57
29. Ibid,s 60
30. Con-Stan Industries v Norwich Winterthur Insurance (Aust) Ltd (1986) 160 CLR 226, 236‑237.
31. With reference to Nelson v. Dahl (1879) 12 ChD 568, 575; approved in Thornley v. Tilley (1925) 36 CLR 1, 8.
32. Ibid.
33. With reference to Summers v Commonwealth, 148; Rosenhain v Commonwealth Bank of Australia (1922) 31 CLR 46, 53.
34. For further guidance see Seddon, N, Bigwood RADIUS and Ellinghaus, M, Cheshire & Fifoot Law of Contract (10 Aus ed) 12.30-12.40 and 12.53-12.54.