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Contract law update 2022

Contract law update 2022: construction of contracts

Different judges, different interpretations

The construction of contracts usually turns on the particular language chosen by the parties, sometimes informed by surrounding circumstances, and assisted by various rules or principles. When written contracts contain apparently contradictory clauses and various drafting errors, what rules will a court apply to determine the parties' (objectively ascertained) intention?

S&C Nicola Pty Ltd v Peter Holmes Investment Pty Ltd1 concerned an agreement that Justice Leeming described as 'poorly expressed … replete with syntactical or typographical errors'. He observed that this 'lack of care and precision and apparent lack of understanding of legal concepts … informs the task of construction in a number of ways'.2 These include:

  • a court should not place great weight on the precise wording used by the parties;
  • it may be that less weight should be given to the principle that operative provisions prevail over inconsistent recitals (although Justice Leeming didn't decide this point, which he noted would be contrary to some authorities); and
  • there may be threshold questions about the literal meaning of words actually used (and that may not bear their ordinary meaning).

Even with these guiding principles, different judges can interpret a contract in different ways: in this case, two of the three appellate judges preferred a different interpretation from the trial judge and the third appeal judge.

Sometimes the inconsistency within a contract is more commercial than literal. In those circumstances, it is difficult for a court to depart from the language used by the parties. An example of these difficulties is the decision of the Western Australian Court of Appeal in NTC Contracting Pty Ltd v Morton3, in which it declined to confine an insurance clause (which obliged one party to obtain insurance covering both parties) to circumstances covered by a separate indemnity clause. The appellant in that case relied on the decision of the NSW Court of Appeal in Erect Safe Scaffolding (Australia) Pty Ltd v Sutton4, where the court did confine the scope of an insurance clause by reference to the scope of an indemnity. The authority of Erect Safe is quite doubtful, however, given later judgments of the NSW Court of Appeal.5

S&C Nicola Pty Ltd v Peter Holmes Investment Pty Ltd [2022] NSWCA 72

Construction of partnership agreement with inconsistency between agreement's recitals and operative provisions, and how any such inconsistency is to be resolved.

In this case, the NSW Court of Appeal considered whether interest on funds provided to a partnership by one partner is to be treated as a partnership expense or as an independent debt to be paid by the other partner.

The court held that the interest entitlement due to the respondent is to be treated as an expense of the partnership, which is to be paid from the partnership assets before the division of profits and not from the appellant's share of the partnership profits.

This decision provides important guidance on the application of the rules of interpretation to poorly drafted contracts, particularly where there is no extrinsic contextual material.

Facts

The appellant, S&C Nicola Pty Ltd, and its related company, Manotik Pty Limited, acted in partnership with the respondent, Peter Holmes Investments Pty Ltd (PHI), in the acquisition and development of residential properties. Their practice was for PHI to fund the acquisition and development, S&C Nicola to find the property and coordinate the construction, and Manotik to carry out the building work.

PHI sought the taking of accounts in the Equity Division of the NSW Supreme Court regarding two of the partnership properties.

The appeal judgment concerned the construction of the partnership agreement between S&C Nicola and PHI, which the court variously described as 'poorly', 'casually' and 'carelessly' drafted.

Relevantly, Recitals D and E stated:

  1. In consideration of [PHI] entering into this Partnership [S&C Nicola] will [enter] into the Partnership agreement, support [PHI] in the Partnership and indemnify [PHI] from half of the costs of the development, plus pay [PHI] 5% interest per annum on all monies spent on the project by [PHI].
  2. After completion of the Development Project the units will be sold and the proceeds will be paid first towards return of the capital invested by [PHI], then toward 5% interest calculated per annum on a monthly basis on that Capital and finally distributed equally between the Partnership parties.

Clause 6(a)-(c) stated:

(a)  The parties must contribute the capital required to complete the project in the following proportions and will share in the profits and losses of the venture in the same proportions.

  (i)  Party 1 50%

  (ii)  Party 2 50%

(b)  If a Partner pays money on behalf of the Partnership, the other Partners must make a contribution as soon as practicable after being informed of the payment, to restore equality of contribution between them.

(c)  Despite (a) and (b) above Party 2 has agreed to fund the whole capital of the project on behalf of the parties until completion of the Partnership project and in consideration therefor Party 2 is entitled to be the sole owner of the properties and entitled to 5% interest on … all capital expenditure to be repaid before any profits are distributed. (emphasis added)

The issue for determination was whether, on the proper construction of the partnership agreement, the interest of 5% per annum on funds provided to the partnership was to be treated as a partnership expense (and borne equally by the partners), or was to be paid by S&C Nicola as a debt separate from the partnership expenses (in which case, S&C Nicola would be liable to pay the full 5%).

Judgment
 

Justices Macfarlan and Leeming determined that the interest payment was to be treated as a partnership expense. Justice White took the view that the partnership agreement treated the interest separately from other development costs and that S&C Nicola was obliged to pay it.

Justice Macfarlan had specific regard to the textual context in which the references to the interest payment are made. In each of Recital E and clause 6(c), the reference to the interest payment is 'wedged between' references to the return of PHI's capital contribution and division of the profits. His Honour considered that the placement of these references suggests, in the absence of any clear contractual indication otherwise, that the interest payment is intended to have a similar character to the repayment of capital, and is to be treated as a partnership expense to be deducted from the partnership assets before division of the partnership profits. His Honour did not consider that there was any inconsistency between the agreement's recitals and operative provisions to be resolved.

Justice Leeming agreed that the interest payment is to be treated as a partnership expense. His Honour noted the parties' decisions not to rely on any extrinsic material. The court was to 'give legal effect to the parties' words', which 'turns on an objective intention to be imputed to the parties, by reference to the contractual text construed in light of its context and purpose' (citing Electricity Generation Corporation v Woodside Energy Ltd (2014) 251 CLR 640; [2014] HCA 7 at [35]).

Justice Leeming identified three ways in which the 'lack of care and precision and apparent lack of understanding of legal concepts in the document informs the task of construction':

  • Where there are numerous errors and the drafter's approach to grammar and syntax is casual, it would be wrong to place great weight on the precise form of the clauses. In other words, legal meaning should not turn on 'semantic exactitude' where the parties have recorded their agreement in loose and ungrammatical language (citing Norton Property Group Pty Ltd v Ozzy States Pty Ltd (in liq) [2020] NSWCA 23 at [49]; Down Town Visuals Pty Ltd v Panorama Investments Pty Ltd [2018] VSC 427 at [94]).
  • Where an operative clause in a contract is clear and unambiguous, it cannot be controlled, qualified or modified by the recitals (citing Lord Halsbury’s speech in Mackenzie v The Duke of Devonshire [1896] AC 400 at 405-406). Importantly, his Honour did not indicate a willingness to stray from the authorities on this principle, despite some caselaw that does (see Tom Elvin Pty Ltd v Knell [2003] ACTSC 36 at [19]; Franklins Pty Ltd v Metcash Trading Ltd (2009) 76 NSWLR 603; [2009] NSWCA 407 at [381]). His Honour was also disinclined to accept (though did not offer a concluded view) S&C Nicola's submission that little weight should be given to the rule that where a recital and operative clause are in conflict, the latter prevails, despite the apparent unsophistication of the agreement, which may be cause to question whether the parties should be taken to know of the difference between a recital and operative provision. In any event, his Honour considered that neither Recital D or E is sufficient to diminish the effect of clause 6(c), given the direct inconsistency between them.
  • Sometimes the imprecision and ignorance of a drafter may lead to a threshold question about what the literal or grammatical meaning of the words used actually is.

Justice Leeming also considered the textual context within which the interest payment is referred to. His Honour observed that clause 6(c) treats the repayment of capital and the payment of interest in a 'rolled up way', which suggests the interest entitlement is a partnership expense that needs to be taken into account before the profit is determined. Further, if the liability to pay interest was a personal liability of S&C Nicola, there would be no need for the entitlement to be paid before profits are distributed.

Justice Leeming also referred to Recital E, which 'unequivocally speaks of the interest being paid from the same source as the return of capital' – each of the capital, interest and profits are to be paid from the proceeds of sale. This finding supports the view that the interest is a partnership expense.

Justice White reached a different conclusion from Justices Macfarlan and White, due to a stricter reading of the text of the agreement and a finding that the operative provisions are ambiguous. In particular, his Honour:

  • applied more weight to the wording of Recital D, which provides that S&C Nicola is to 'pay 5% interest per annum on all monies spent on the project by [PHI] [emphasis added]'. His Honour considered this to be expressed as a personal obligation;
  • contrary to Justice Leeming's view, considered that the source of the funds from which the interest is to be paid (as stipulated in Recital E) is not inconsistent with S&C Nicola having a personal obligation to pay it'
  • considered that the operative provisions in clause 6(a)–(c) were ambiguous and their interpretation was therefore able to be controlled by the recitals; and
  • contrary to the views of Justice Macfarlan and White, considered that the agreement treated the interest payment separately from the development costs, so the prima facie position that the interest would be borne equally by the partners (in accordance with s24 of the Partnership Act 1892 (NSW)) did not apply.

NTC Contracting Pty Ltd v Morton [2022] WASCA 160

Whether the scope of an indemnity clause confined the scope of an insurance clause.

In this case, the Supreme Court of Western Australia considered whether the scope of an indemnity clause in a building subcontract confined the scope of the insurance clause in that same contract.

The court held that the insurance clause in the subcontract was not confined by the separate indemnity clause in that contract. On that construction of the contract, NTC, as subcontractor, was obliged to procure public liability insurance for the principal (Bechtel) and the main contractor (ACTO) for any third party liability incurred.

This case highlights the importance of ensuring that different clauses in a contract operate together harmoniously

Facts

The case was an appeal from the District Court of Western Australia in relation to proceedings brought by Mr Morton, who had sued in negligence and for breach of statutory duty when he allegedly fell into a trench while working on a construction camp in the Pilbara.

Mr Morton's claims against Bechtel and ATCO were settled; however, third-party proceedings continued where Bechtel and ATCO argued that NTC was in breach of a term in the subcontract between NTC and ATCO, for failing to procure, for their benefit, an insurance policy covering Mr Morton's claim against them. The relevant clauses of the subcontract had the following effect:

Clause 15 – Indemnity clause: required NTC to indemnify ATCO and its respective employees and agents against any damage, liability and costs arising out of a direct negligent act or omission caused by NTC in carrying out the works.

Clause 17 – Insurance clause: required NTC to effect and maintain a public liability policy in the joint names of Bechtel, ATCO and NTC to cover the insured parties' rights and interests, as well as liabilities to third parties.

NTC argued that the obligation to insure was to be read in the context of, and was limited by, the indemnity clause. The judge at first instance found in favour of Bechtel and ATCO, and NTC appealed the decision.

Judgment

The court dismissed the appeal and NTC's argument that clause 17 should be read subject to the indemnity in clause 15.

The court held that, on its ordinary meaning, clause 17 did not convey a limitation as submitted by NTC. In addition, the 'architecture' of the subcontract did not support the argument that there was some link between the clauses – eg the clauses were not adjacent to each other, nor were the insurance and indemnity obligations combined into one provision.

The court also observed that it is not uncommon for a building contract to provide that one of the parties will take out an insurance policy indemnifying all of the parties involved in the work. In this case, the court found that clause 17 was 'of considerable elaboration and detail', which was consistent with the construction of that clause not being confined by the indemnity clause.

Footnotes

  1. [2022] NSWCA 72.

  2. At [29].

  3. [2022] WASCA 160.

  4. [2008] NSWCA 114; (2008) 72 NSWLR 1.

  5. Such as GIO General Limited v Centennial Newstan Pty Ltd [2014] NSWCA 13 and CSR Limited v Adecco (Australia) Pty Ltd [2017] NSWCA 121.