Contract law update 2023: Contract interpretation

Contract law update 2023

When a court may have regard to surrounding circumstances when interpreting a contract has been a constant theme in our Contract law updates. It is well accepted, at least in New South Wales, that a court should have regard to the surrounding circumstances when interpreting a commercial contract, and there is no need first to show an ambiguity in the contract. The orthodox principle, as stated (for example) by the New South Wales Court of Appeal in Ulladulla Creative Images Pty Limited v Tibbles¹, is that a court may have regard to objective surrounding circumstances known to the parties at the time of entering into the contract, but will not have regard to the parties' statements as to their actual intentions and expectations.

The decision of the New South Wales Court of Appeal in Altius Pty Ltd v Abignano Nominees Pty Ltd² is an example of the court having regard to surrounding circumstances in interpreting a contract in a manner different from the most obvious, literal interpretation. In considering competing interpretations, the court examined the financial consequences of the parties' respective interpretations. The leading judgment of Justice Adamson stated [at 111]:

These calculations indicate that the construction for which the Abignano entities contended is highly uncommercial, viewed from the point of view of both parties in the context of the circumstances which applied at the time, because it delivered an unwarranted windfall to the Abignano entities and imposes an unwarranted penalty on the Peterkin entities. A construction which 'makes commercial nonsense or is shown to be commercially inconvenient' is to be avoided …

The court arguably extended the traditional limitations on the use of surrounding circumstances by having regard to the parties' stated intentions in pre-contractual correspondence. It may be, however, that not too much should be read into this, as no point appears to have been taken that such correspondence should only be admissible in so far as it evidences objective matters known to both parties.

The New South Wales Court of Appeal adopted a more orthodox approach to the use of surrounding circumstances in The J&P Marlow (No 2) Pty Ltd v Joseph Hayes & Andrew McCabe in their capacity as joint and several liquidators of [various entities]³. In that case, the court noted that:

ordinarily, the process of contractual construction is possible by reference to the terms of the contract alone [at 75];
a commercial purpose or object to be secured by the contract … is to be discerned objectively, with the contract itself supplying the best source for the ascertainment of that objective and determined purpose [at 75];
one must also be cautious in attributing a particular commercial intent or understanding of commercial common sense to parties to a commercial agreement [at 76];
attributing commercial purpose will not be used by a Court to give to the words of a contract a meaning that they cannot reasonably bear [at 79];
whilst the construction urged by the respondent and adopted by the primary judge may not reflect the subjective intention of the parties, it cannot be said to be absurd or so inconsistent to the parties' objectively determined intention that words should be read into the critical definition [at 112].

The use of expert evidence to construe a contract

There are occasions when a court will look beyond both the terms of a contract and the circumstances known to the parties for the purpose of construing the contract. For example, expert evidence may be allowed, to show that a particular word or phrase has a well-established meaning by 'custom and usage'. In Quasar Resources Pty Ltd v APG Aus No 3 Pty Ltd⁴, the Western Australian Court of Appeal held that expert evidence might be used to assist in the construction of contracts even if a particular 'custom or usage' had not been established. The court referred to cases where such evidence had been admitted, although noting that 'it must be acknowledged that it is not always easy to identify the principles being applied in a particular case by a Court in having regard to evidence of this kind'⁵. The court referred to a suggestion by Professor Carter that evidence of technical or other instances of words used within a particular industry may be led as contextual evidence, independently of the rules on 'custom and usage'⁶, and, apparently on that basis, admitted the expert evidence.

The obligation to carry on business in business sale agreements

Our 2021 Contract law update considered a decision of the New South Wales Court of Appeal on whether a hotel vendor complied with an obligation to carry on the Business in the usual and ordinary course … '. The issue arose because the hotel's usual operations were affected by Covid regulations. The High Court heard an appeal from that judgment in Laundy Hotels (Quarry) Pty Limited v Dyco Hotels Pty Limited⁷. The court, disagreeing with the majority in the New South Wales Court of Appeal, held that the vendor was not in default of this obligation, in so far as its usual operations were restricted by Covid regulations. The High Court held that an obligation to carry on a business in the ordinary course 'incorporated an inherent requirement to do so in accordance with law' [at 28].

Precontractual negotiations - parol evidence rule

In this case, the New South Wales Court of Appeal took a broad approach to construing an ambiguous clause within a contract. Usually when a contract is in writing, the court cannot take into account pre-contractual statements. However, the court found that the clause was sufficiently ambiguous that it was necessary to consider pre-contractual negotiations when construing it.

This case shows that the court will go beyond the written contract when necessary. It may take into account context, purpose and negotiations where contracts are sufficiently ambiguous. The case also serves as a reminder of the importance of clear contractual drafting.

The case concerned a joint venture between two property developers, Mr Peterkin and Mr Abignano, to develop a property on Pittwater Road. For that purpose, they created a unit trust (which had Altius Pty Ltd as the trustee). Both developers had various legal entities associated with them and that were involved in the joint venture.

After development approval for the Pittwater Road property was refused, Mr Abignano sold his units in the unit trust to Mr Peterkin.

A dispute arose about whether that sale discharged loans made to Altius by Mr Abignano during the joint venture.

The broader context of that sale included:

discussions in October 2015, where the solicitor for Mr Peterkin made an offer of $2.3 million for Mr Abignano's units in the unit trust;
discussions between Mr Peterkin and Mr Abignano in November 2015, where they had agreed the purchase price for the units would be $2.6 million; and
a buy-out agreement signed on 17 November 2015 that provided for a purchase price of $2.6 million and agreed that it would be adjusted for 'holding costs.'

Eventually, the parties signed an option agreement on 14 March 2016 (the option agreement), which contained a clause that said the price of $2.6 million would be adjusted for the 'holding cost contribution'. The 'holding cost contribution' was defined as 'the sum of all liabilities for all outstanding contributions payable in respect of holding costs of the Property … by any or all of [the Abignano entities] pursuant to any or all of the Joint Venture Agreement' (the disputed clause).

On 13 May 2016, Mr Abignano sent a letter of demand to Altius for repayment of a loan. After Altius failed to repay, he sued it for repayment. Altius said in its defence that the loans, including one made by NAB, were discharged by Mr Abignano's sale of his units.

At first instance, the primary judge held that none of the loans fell within the definition of 'holding costs contribution' in the disputed clause because none of them was made 'pursuant to' the joint venture agreement. This meant Altius was liable to repay the loans.

Whether or not Altius was liable depended on whether the loans were a 'holding costs contribution' within the meaning of the disputed clause. The appeal court construed the disputed clause so that the loans were a holding costs contribution. As a result, Altius was not liable for repayment.

When construing the clause, the court went beyond the words of the option agreement. When construing the clause, it considered the commercial relationship between the parties, pre-contractual negotiations and the context of the option agreement.

Justice Adamson (Justices Leeming and Stern agreeing) reasoned that:

The loans were made 'pursuant to' the joint venture agreement under the disputed clause. The words 'pursuant to' meant 'consequent on' or 'in conformity with', and included the loans because of both the natural meaning of the words and the broader context of the option agreement. This included that the sole purpose of the joint venture was to develop the property, and the loans were the only way the joint venture was to be funded. The October 2015 pre-contractual negotiations indicated 'a common intention that the Abignano entities' share of Altius' liabilities' would be discharged and this context indicated that 'contributions' included loans. A collateral agreement was formed between the parties in these negotiations, which was consideration for and consistent with the option agreement.
Not including the loans as a holding cost contribution would lead to a wholly uncommercial construction of the option agreement, where the Abignano entities would benefit significantly more than the Peterkin entities. This was 'commercial nonsense'.
The purpose of the option agreement was to end the relationship between Mr Peterkin and Mr Abignano (and associated entities) as to the property. It was not consistent with that purpose for Altius to remain liable to the Abignano entities for the loans.

Usually, a court cannot go beyond the written agreement between the parties (in accordance with the parol evidence rule, that a written document is intended to be the entire agreement between them). However, Justice Adamson considered an inference could be drawn that the parties did not intend the agreements to be their entire agreement. Her Honour reasoned that there were several collateral contracts in addition to the main agreement, which allowed the court to take the other agreements into account when construing the disputed clause.

In a separate judgment, Justice Leeming reached the same conclusion that the loans were a holding costs contribution. His Honour emphasised that while the result might involve 'some straining of the language' of the agreement, this was needed because of the ambiguity of the contract – it was necessary to have regard to textual, contextual and purposive considerations.

Proper construction of 'sale price of the Property' in hotel management agreements; use of surrounding circumstances to interpret contract

In this case, the New South Wales Court of Appeal considered the proper construction of the words 'sale price of the Property' in four materially identical hotel management agreements. The court held that, on a literal and contextual construction of the hotel management agreements, the 'sale price of the Property' did not encompass the price of the hotel business being operated on the land or the gaming machine entitlements sold together with the land.

This case outlines the relevant legal principles to be applied in construing the meaning of the words of a contract. It highlights the importance of considering the meaning in light of the text, context and purpose sought by the parties.

The case concerned the construction of four materially identical hotel management agreements (the agreements). The four hotels were located on land owned by four separate companies, being the second to fifth respondents (the landowners). The landowners held (as trustees of unit trusts) the land on which the hotel was situated and the gaming machine entitlements (GMEs) used at the hotel. The hotels were operated by four separate companies (the operating entities), under leases with the landowners. All four hotels were managed by the first and second appellants (the Marlow group).

In 2022, the land on which each of the hotels was located was sold, together with the respective hotel businesses being operated by the operating entities.

Under the agreements, in exchange for providing hotel management services to the operating entities, the Marlow group was entitled to certain fees, including a capital gains bonus fee (CGBF) upon the sale of the hotels. The agreements provided that the property and the hotels would be sold as 'one package and as a going concern'. The CGBF was to be calculated as 15% of the 'Net Sales Price', less the 'Purchase Price' and 'Net Capital Expenditure'. The agreements separately defined the 'Property' (being the property 'located at' the named address), the 'Hotel' (being the hotel operated at the named address) and the 'Business' (being the management of the hotel). 'Net Sales Price' was defined by reference to:

the sale price of the Property under a contract signed by the Landowner as the seller (which may include the Company as the seller of the Business), less any adjustments, taxes, fees, legal costs and agents’ commissions payable by the Company and the Landowner in connection with its sale or disposition of the Property and otherwise in connection with the operation of the Business.

The landowners went into liquidation. In the winding up, the Marlow group claimed to be entitled to a CGBF under the agreements, calculated on the basis that the 'sale price of the Property' encompassed the sale price of both the land and the hotel businesses. The first respondent (the liquidators) sought declarations that this was the proper construction of the CGBF formula to justify those payments to the Marlow group.

The primary judge declined to make the declarations sought by the liquidators, instead holding that the 'sale price of the Property' meant the sale price of the land, including the hotel building constructed on that land, but did not include the sale price of the hotel business operated on that land, or the GMEs used at each of the hotels. The Marlow group appealed.

The Court of Appeal unanimously dismissed the appeal – Justices Meagher and Kirk in a joint judgment and Chief Justice Bell in a separate judgment. The key grounds for the decision were:

The natural construction of the text of the agreements did not support one whereby the lease held by the operating entities was within the definition of 'Property'. The agreements referred to the property 'located at' an address. One has a leasehold interest 'in' a property, not 'at' the property. Further, there were separate definitions of 'Hotel', 'Business' and 'Lease' in the agreements that were not consistent with subsuming the business and leasehold interest within the definition of the 'Property'.
The clause that provided that the property and hotel would be sold as a single package did not support the submission that the Net Sales Price included the property price and hotel price. Rather, it supported the concept that the agreement made a distinction between the property and the hotel. A single package sale could be achieved through separate agreements with separate sale prices (or the sale price could otherwise be apportioned).
The definition of Net Sales Price referred to 'the Landowner in connection with its sale or disposition of the Property'. Only the land (and not the leasehold) was the landowner's to sell.
'Property' in the definition of Net Sales Price should be construed in the context of the agreements as a whole and should not be given a different meaning in that clause.

The court (in particular, Justices Meagher and Kirk) acknowledged that there was strength in the Marlow group's submission that this construction undermined the purpose of the CGBF, which it said was to reward the Marlow group for services as hotel manager that contributed to an increase in the overall value of the hotel business. However, the court held that the subjective intention of the parties was not sufficient to displace the plain and ordinary meaning of the text of the agreements, which did not lead to an outcome that was commercially absurd. This was not a case where two alternative constructions of an ambiguous clause were available – regardless of the parties' subjective intentions, the construction put forward by the Marlow group was simply not objectively open on the text of the agreements.

Meaning of 'refining' in agreement for sale of mining tenements - use of expert evidence to establish meaning of contractual terms by reference to industry understanding

In this case, the Western Australian Court of Appeal considered the meaning of the word 'refining' in an agreement for the sale of mining tenements, specifically in relation to a clause requiring the payment of a royalty. The meaning of 'refining' was relevant to determining the costs and charges that could be deducted by the appellant in calculating the royalty that it was required to pay the defendant.

The court dismissed the appeal, and held there was no error in the primary judge's finding that the respondent's narrow construction of the word 'refining' was preferred to the appellant's broad construction, thereby limiting the scope of deductible costs and charges for the royalty.

This case reaffirms that expert evidence may be used as an aid in the construction of contractual terms by reference to industry understandings of the technical meaning of a term. It also demonstrates that expert evidence may be admitted for this purpose without having to meet the stringent requirements that would apply if establishing a term's meaning by reference to a particular custom and usage.

The appellant and the respondent were successors to an agreement for the sale of mining tenements. As part of the consideration, the appellant was required to pay the respondent a royalty that was described as a 'net smelter royalty' .

The agreement contemplated a wide range of mineral products being produced under the tenements for which the royalty would be payable. The appellants were mining uranium using an in-situ leaching mining process and various hydrometallurgical processes to produce yellowcake.

Although the royalty was described as a 'net smelter royalty', there was a formula that governed how it would be calculated. That formula calculated the royalty as the gross amounts received for the sale of (relevantly) yellowcake minus any 'Allocable Charges'. The term 'Allocable Charges' contained costs and charges including those associated with smelting, refining and marketing particular metal products.

At the core of the dispute was whether any of the hydro-metallurgical processes used on site as part of the in-situ leaching process and production of yellowcake constituted 'refining'.

The respondent at trial argued a narrow interpretation that 'refining' meant the final processing of a metal bearing product, where impurities were removed to form a pure, or near-pure, final product.

The appellant argued that the term 'refining' should not be given the respondents' narrow interpretation, which, it asserted, was associated with the production of base metals or gold. The appellant asserted that, given the breadth of the mineral products covered by the royalty, the word 'refining' should be given its ordinary and broad meaning, which would cover a variety of processes for a variety of mineral products (not just gold and base metals). It asserted that, in this context, refining meant 'purifying and upgrading a commodity by the removal of impurities'.

The trial judge agreed with the respondent, and found that the parties to the agreement (being participants in the Australian mining industry) objectively knew that 'refining' was understood to have a technical meaning in the mining industry that was consistent with the narrow version propounded by the respondent. In determining how the word 'refining' was in fact understood in the mining industry, the trial judge adopted the meaning advanced in testimony from expert witnesses called by the respondent.

The essence of the appellant's complaint on appeal was that the trial judge erred in finding that the word 'refining' was to be understood in a narrow, technical sense, and not in a broad, ordinary sense.

The issues for the Court of Appeal to consider were:

whether the trial judge's factual findings as to the meaning of 'refining' could be overturned on appeal;
if so, whether the word 'refining' had an ordinary or technical meaning when used in the relevant agreement; and
whether regard could be had to extrinsic evidence (in the form of expert witness testimony) to determine the technical meaning.

On the first issue, the court held that because the trial judge's factual findings as to the meaning of 'refining' were based on an assessment of the reliability of expert witnesses, the appellant's challenge to the factual findings was not permitted, in accordance with the principle of appellate restraint. As noted by the court, this principle prevents an appellate court from interfering with the findings of a trial judge to the extent they are based substantially on an assessment of the reliability of witnesses, including expert witnesses, unless those findings are clearly wrong or improbable.

On the second issue, the court agreed with the trial judge that 'refining' was to be understood as having a technical meaning, rather than an ordinary meaning. It held that the meaning of 'refining' varies according to the context in which it is used, and in the context of the Australian mining industry, the meaning is a narrow, technical one. The court also held that ascribing a technical meaning to 'refining' was consistent with the terms of the agreement (including the royalty payment clause) and the parties' objective intentions, as well as the agreement's context and background. Additionally, Justice Lundberg held in a separate judgment to the majority (with whom his Honour agreed) that the technical meaning was more likely to further the agreement's commercial purpose than would any ordinary meaning.

As to the third issue, the court held that extrinsic evidence (here in the form of expert witness testimony) was admissible to ascertain the technical meaning of 'refining' as understood in the Australian mining industry. Relevantly, it determined that extrinsic evidence is permissible where one party contends that a word bears a particular or technical meaning, rather than its ordinary meaning. In addition, the majority held that expert evidence can be heard to establish an industry understanding of a contractual term without that evidence having to meet requirements that otherwise apply to establish a meaning by custom or usage – that is, where the custom or usage must be so 'notorious, uniform and certain' that a party can be presumed to have known of it and intended for it to inform the meaning of the relevant term.

'Usual and ordinary course of business' during COVID-19 pandemic - business sale agreement

This case concerned the construction of a contract for the sale of the property and assets of a hotel business. The High Court considered whether a vendor's obligation to carry on the business in the 'usual and ordinary course' was breached in circumstances where the business was operating on a restricted basis in accordance with a public health order in response to the COVID-19 pandemic. The court unanimously held that the vendor did carry on the business in the usual and ordinary course, even though the law unexpectedly changed that usual course.

This case demonstrates that the meaning of 'ordinary course of business' in a business sale agreement is a flexible concept, which extends and retracts depending on the legal context. Commercial contracts must account for, and clearly explain, how changes in the legal environment may affect a transaction.

On 31 January 2020, Laundy Hotels (Quarry) Pty Limited (the vendor), entered into a contract with Dyco Hotels Pty Limited (the purchaser) for the sale of the freehold hotel property of the Quarryman's Hotel. The contract included a hotel licence, and other business assets such as electronic gaming machines, gaming machine entitlements and goodwill. The date for completion was 30 or 31 March 2020.

Clause 50.1 of the contract required the vendor to carry on the business in the usual and ordinary course with regard to its nature, scope and manner, from the date of the contract until the date of completion. Clause 51.7 provided that if completion did not occur on the completion date, a party that was ready, willing and able to complete and not in default could serve on the other party a notice to complete.

On 23 March, the New South Wales Health Minister made a public health direction that required hotels to be closed to the public and their business restricted to selling takeaway food and alcohol. A failure to comply with the direction was a criminal offence. In response, the Quarryman's Hotel was closed on 23 March and had reopened by 26 March for takeaway sales only.

On 25 and 27 March, the purchaser informed the vendor that it would not complete the contract because:

The vendor was not 'ready, willing and able' to complete, including due to a breach of clause 50.1.
The contract had been frustrated.
The vendor could issue a notice to complete with which it could not comply, entitling the purchaser to terminate the contract and sue for damages.

The vendor responded that it was ready, willing and able to perform its contractual obligations, including clause 50.1, and called upon the purchaser to complete.

Completion did not occur and the vendor ultimately served a notice to complete and, subsequently, a notice of termination. The purchaser commenced proceedings, seeking declaratory relief that the contract was frustrated, or the vendor was not entitled to issue a notice to complete and its notice of termination was a repudiation, which the purchaser accepted.

The decision at first instance

In the Supreme Court of New South Wales, Justice Darke held that the contract was not frustrated and that the vendor was not in breach of clause 50.1 – which required it to carry on the business in the 'usual and ordinary course' only so far as was possible in accordance with law. Therefore, the vendor was entitled to serve the notice to complete, the notice of termination was effective and the vendor was entitled to sue for damages for loss of bargain (ie damages to recover the contractual benefits it would have received had the contract been performed).

The decision on appeal

In appealing the decision, the purchaser alleged that the primary judge misconstrued clause 50.1 because the vendor was not 'ready, willing and able' to complete the contract from the date of the Minister's public health direction. The purchaser did not appeal the primary judge's findings on frustration. A majority of the Court of Appeal (Chief Justice Bathurst and Justice Brereton) allowed the appeal. Justice Basten dissented, essentially agreeing with the primary judge's reasoning. The majority was not willing to read into the clause a limitation that it was only required to be complied with to the extent permitted by law. Chief Justice Bathurst considered that the public health direction was a supervening event that had made compliance with clause 50.1 illegal, so that the vendor could not comply with it. Justice Brereton also held that the vendor was in breach of clause 50.1. On those bases, the majority held that the vendor had not been entitled to issue the notice to complete, so that the notice of termination was invalid. The purchaser was entitled to have its deposit back and was not required to proceed with the acquisition.

The High Court's decision

The vendor appealed to the High Court, which restored the decision of the primary judge. The court found that the vendor was 'ready, willing and able' to complete the sale, and was not in default of its contractual obligations at the time it served its notice to complete on the purchaser.

The court considered that the subject matter of the contract was the business, and that the contract recognised the business was subject to a dynamic regulatory environment. That was not within the control of the vendor, which did not warrant that the value of the business would not change before completion. Until completion, the vendor bore the risk of reduced revenue from any change in law. From the completion date, the purchaser bore that risk. From the perspective of a reasonable businessperson, the court found that the proper construction of clause 50.1 was that it required the vendor to carry on the business in accordance with law. The lawfulness of the operation of the business was objectively essential and a commercial necessity for the parties, as without the hotel licence and associated gaming machine entitlements, there would be no 'business'.

Although the public health direction meant that the vendor was unable to carry on the business in the same way that it had at the time of the contract, this did not mean that it was in breach of clause 50.1. Accordingly, the vendor was 'ready, willing and able' to complete at the time it served the notice to complete on the purchaser. As time was of the essence, the purchaser was in breach of the contract, entitling the vendor to terminate it, keep the deposit and sue for damages.

Footnotes

[2021] NSWCA 289: as summarised in our 2021 Contract law update.
[2023] NSWCA 177.
[2023] NSWCA 117.
[2023] WASCA 171.
[at 50].
[at 59].
[2023] HCA 6.

Contract interpretation

Having regard to surrounding circumstances

The use of expert evidence to construe a contract

The obligation to carry on business in business sale agreements

Altius Pty Ltd v Abignano Nominees Pty Ltd [2023] NSWCA 177

The J & P Marlow (No 2) Pty Ltd v Joseph Hayes & Andrew McCabe in their capacity as joint and several liquidators of Peak Invest Pty Ltd (in liq), Five Islands Invest Pty Ltd (in liq), Surry Hills Pub Invest Pty Ltd (in liquidation) and Four By Four Investments Pty Ltd (in liq) [2023] NSWCA 117

Quasar Resources Pty Ltd v APG Aus No 3 Pty Ltd [2023] WASCA 171

Laundy Hotels (Quarry) Pty Limited v Dyco Hotels Pty Limited [2023] HCA 6

Footnotes