Construction of contracts – the admissibility of surrounding circumstances and the “true rule” in Codelfa

One of the cardinal principles of the construction of contract terms is that this is essentially carried out on an objective basis, in terms of what a reasonable person would have understood the words of a document to mean.  Accordingly, evidence as to the subjective intentions of the parties to the contract and other extraneous matters is generally irrelevant. 

The “true rule”

The objective theory of contract construction has been endorsed in several High Court cases.  In one of the most important of those cases, Codelfa Construction Pty Ltd v State Rail Authority of NSW (1982) 149 CLR 337 (Codelfa), Mason CJ said (at 352):

The true rule is that evidence of surrounding circumstances is admissible to assist in the interpretation of a contract if the language is ambiguous or susceptible to more than one meaning.

Mason CJ’s “ambiguity gateway” seems clear in its meaning, but the recent cases have not taken consistent approaches to the situations where evidence of surrounding circumstances will be admissible.  

Some of the High Court decisions delivered since Codelfa have been regarded as moving away from the true rule, with the result that evidence of surrounding circumstances will always be admissible when construing a contract, even when there is no ambiguity.

For example, in Lion Nathan Australia Pty Ltd v Coopers Brewery Ltd [2005] FCA 1812, Finn J said (at [78]) that it was clear from the more recent High Court cases that the “true rule” has been rejected, and on appeal his view was upheld unanimously by the full Federal Court.  Similarly, in Franklins Pty Ltd v Metcash Trading Ltd (2009) 76 NSWLR 603, New South Wales Court of Appeal unanimously held that there was no longer any requirement for ambiguity to be shown before surrounding circumstances could be admitted into evidence on construction questions.

Depending on the circumstances in a particular case, the question of whether extraneous circumstances can be considered at the outset, as opposed to only if there is ambiguity, could make a major difference to a court’s ultimate findings about the meaning of terms of a contract.

In Western Export Services Inc v Jireh International Pty Ltd [2011] HCA 45 (Western Exports), three members of the High Court, when refusing an application for special leave, published written reasons in which they stated in clear terms that Mason CJ’s “true rule” had not been abrogated or diminished by any of the following High Court decisions, so that the ambiguity gateway remained as a precondition to the admissibility of evidence of surrounding circumstances.

The most recent High Court decision dealing with the proper approach to the construction of commercial contracts was Electricity Generation Corporation t/as Verve Energy v Woodside Energy Ltd [2014] HCA 7 (Verve).  In that case, the High Court said (at 35):

Both Verve and the Sellers recognised that this Court has reaffirmed the objective approach to be adopted in determining the rights and liabilities of parties to a contract.  The meaning of the terms of a commercial contract is to be determined by what a reasonable businessperson would have understood those terms to mean.  That approach is not unfamiliar.  As reaffirmed, it will require consideration of the language used by the parties, the surrounding circumstances known to them and the commercial purpose or objects to be secured by the contract.  Appreciation of the commercial purpose or objects is facilitated by an understanding “of the genesis of the transaction, the background, the context [and] the market in which the parties are operating”. As Arden LJ observed in Re Golden Key Ltd, unless a contrary intention is indicated, a court is entitled to approach the task of giving a commercial contract a businesslike interpretation on the assumption “that the parties…intended to produce a commercial result”.  A commercial contract is to be construed so as to avoid it “making commercial nonsense or working commercial inconvenience”. (citations omitted)

The difficulty with the comments set out above is that on one view, the Court seems to be condoning the admission into evidence of extraneous evidence even where there is no ambiguity.

The question as to whether the High Court in Verve retreated from the position advanced in Western Exports was considered by the WA Court of Appeal in Technomin Australia Pty Ltd v Xstrata Nickel Australasia Operations Pty Ltd [2014] WASCA 164 (Technomin), and by the New South Wales Court of Appeal in Newey v Westpac Banking Corporation [2014] NSWCA 319 (Newey).

Technomin and Newey: the cases

The proceedings in Technomin arose out of a complex network of deeds of assignment and novation between various entities in relation to a set of valuable mining tenements.  In essence, Technomin Australia Pty Ltd claimed that it was entitled to royalties from additional mining tenements because of its contentions about the scope of the word “tenement”. 

At the heart of the case were questions of whether the contractual terms in question were sufficiently ambiguous to have regard to surrounding circumstances, in particular a contemporaneous letter agreement and evidence about various commercial disputes which had existed between the parties.  At trial, it was held that there was ambiguity or uncertainty surrounding the meaning of various contractual terms, so as to satisfy the “gateway” threshold of the true rule.

This finding (and others) were the subject of the appeal.

McLure P made the following observations:

[34] After careful consideration of multiple High Court decisions on the subject, a number of intermediate appellate courts in this country came to the view that evidence of surrounding circumstance was always admissible to assist in the construction of a contract, whether or not the contractual language was ambiguous or susceptible of more than one meaning.

[45] The aridity of this debate at the intermediate court level is manifest.  Until the High Court expressly states its position on the subject, I propose to continue to apply the ‘true rule’ as applied in Hancock Prospecting Pty Ltd v Wright Prospecting Pty Ltd (2012) 45 WAR 29.  In that case this court concluded that the true rule permits regard to be had to some surrounding circumstances for construction purposes without having to satisfy the gateway requirement.

[74] The fact that adversaries can formulate and advance materially different constructions of the language of a contract does not itself satisfy the gateway requirement.  Having regard to the language of the contract as a whole and what can be gleaned from that source as to the contractual purpose, competing constructions must be reasonably arguable. 

In Hancock Prospecting Pty Ltd v Wright Prospecting Pty Ltd (2012) 45 WAR 29 (Hancock Prospecting) McLure P allowed the admission into evidence of previous agreements between the parties that were expressly or impliedly referred to in the 1984 agreement which was the subject of the proceedings.  McLure P noted that 1984 agreement was part of “an inter-connected series of agreements which must be construed as a whole.”  Arguably, the approach in Hancock Prospecting was consistent with the “true rule”, as the earlier agreements were not extraneous to the 1984 agreement. 

In Technomin, Murphy JA came to much the same view as McLure P, and observed that the High Court in Verve should not be seen to have impliedly abrogated the “true rule”, and that for the time being the position remains as set out in Western Exports.  

The case in Newey also arose out of a set of deeds – this time between St.George Bank (St.George) and former employees who had lost their jobs prior to St.George’s integration into Westpac. The dispute concerned the construction and interpretation of restraint clauses in these deeds.

It was found at trial that there were ambiguities in the deeds in question, and that surrounding circumstances could be admitted into evidence as an aid to construction.  The appellants appealed from this decision.

Gleeson JA held that:

[89] Woodside endorses and requires a contextual approach to the construction of commercial contracts and “ambiguity” is to be evaluated having regard to surrounding circumstances and commercial purposes or objects.

[90] Nonetheless it is also important to bear in mind the extent to which context and legitimate surrounding circumstances can be used as an aid in the construction of a written agreement.

Lavan Legal comment

In summary therefore, the two authorities are in conflict in that:

  • The New South Wales Court of Appeal in Newey regarded the decision in Verve as reflecting a marked shift away from the “true rule”, so that ambiguity is not required as a precondition to the admissibility of surrounding circumstances.
  • The Western Australian Court of Appeal in Technomin has continued to apply the “gateway” threshold.

Faced with these inconsistent approaches, it would be useful for the High Court to review the question again, and to clarify, hopefully once and for all, whether the “true rule” enunciated by Mason CJ in Codelfa continues to apply.