Contract law update 2019

Interpretation of contracts

The starting point when interpreting a contract is to apply the literal meaning of the words used. The decision of the Western Australian Court of Appeal in Tokio Marine & Nichido Fire Insurance Co Ltd v Hans Bo Kristian Holgersson¹ illustrates the difficulties for a party in avoiding the literal meaning of a contract in the absence of ambiguity or absurdity.

The literal interpretation of a clause in a contract may be avoided, however, where that literal interpretation is inconsistent with another clause in the contract. In Greencapital Aust Pty Ltd v Pasminco Cockle Creek Smelter Pty Ltd (Subject to Deed of Company Arrangement)², the New South Wales Court of Appeal did not adopt a literal interpretation of a clause because of a commercial inconsistency between that clause and another clause in the contract.

In Greencapital, the failure of a condition precedent gave Pasminco a right to rescind the contract and Greencapital a 'step-in' right to fulfil the condition precedent. The trial judge held that Pasminco had validly rescinded the contract because it exercised its termination right before Pasminco exercised its step-in right.

The New South Wales Court of Appeal considered this to be an uncommercial result that deprived Greencapital of its valuable right to step-in. The court therefore held that Greencapital had a reasonable time to exercise its step-in right, notwithstanding the purported notice of decision from Pasminco. Assuming the final outcome was consistent with the parties' intention, it would, of course, have been better for the contract itself to have expressly dealt with the apparent inconsistency between the two clauses.

Many contracts contain clauses prohibiting one party from engaging in conduct (such as a change in control) without the other party's consent, such consent 'not to be unreasonably withheld'. In New Standard Energy PEL 570 Pty Ltd v Outback Energy Hunter Pty Ltd³ the Full Court of the Supreme Court of South Australia considered whether this obligation was promissory, or merely a proviso to the power to withhold consent. The difference is:

• if it is promissory, the other party can sue for damages for any loss caused by the failure to act reasonably and provide consent; but
• if it is a proviso, the other party cannot sue for damages, but may proceed to engage in the conduct (such as a change in control) without consent.

The trial judge had held that the phrase was promissory, but the Full Court disagreed and held that withholding consent unreasonably did not give the other party a right to seek damages.

The court's interpretation did, however, depend on the particular wording in the contract. It would be possible to draft such a clause in a manner giving a party a right to sue for damages if consent were unreasonably withheld.

The Full Court also made some interesting observations about the so-called 'implied duty to co-operate'. They confirmed earlier authorities that held the duty is 'confined to acts which are necessary to the performance by a party of fundamental obligations under the contract'.⁴ The court further held that, even if there were a promise not to withhold consent unreasonably, there was no proper basis for implying an obligation to co-operate in the process of obtaining consent. The court reached this conclusion applying the usual principles for implying terms into contracts – for example, it was not necessary to imply such a term to give business efficacy to the contract.