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Focus: The latest from the High Court on contractual interpretation

30 March 2017

In brief: There is an ongoing controversy as to whether, in construing a contract, the 'true rule' in Codelfa mandates that a contract be ambiguous (on its face) before a court may consider evidence of surrounding circumstances. The High Court this week had an opportunity to consider this issue. Although its decision did not expressly resolve the controversy, it may be seen as a (further) departure from the 'ambiguity gateway' approach. Partner, Malcolm Stephens (view CV) and Senior Associate, Jaime McKenzie report.

 
 

How does it affect you?

  • The Courts of Appeal in New South Wales, Western Australia and Victoria have taken very different approaches to this 'ambiguity gateway' question in recent cases.1 These difference were noted in our Contract Law Update 2016. This update included a summary of the Victorian Court of Appeal's decision in Gee Dee Nominees Pty Ltd v Ecosse Property Pty Ltd,2 and noted that the High Court had granted special leave to appeal against that decision.
  • The High Court delivered its judgment on 29 March 2017.3 The High Court's approach in Ecosse, although not definitively resolving the controversy, was more consistent with the approach recently taken in New South Wales (that evidence of surrounding circumstances may be taken into account even where a court has not first made a finding that the relevant clause is ambiguous).
  • In the context of this ongoing uncertainty as to the admissibility of surrounding circumstances, one option is to ensure that recitals (or other clauses) expressly state the commercial purpose of a contract. This will both minimise the risk of a court making incorrect inferences as to the commercial purpose, and will ensure that the court will have regard to the commercial purpose when construing the contract.

Background

The case concerned the proper construction of the terms of a 99-year lease. The parties had extensively amended a standard form 'farm lease' by striking out various parts, which remained legible in the executed document.

The key issue was whether the tenant was liable to pay the costs of rates, taxes, assessments and outgoings levied to the landlord. There were two clauses in the lease which pointed to different answers to this issue.

Clause 4 stated that the tenant (with deletions apparent on the face of the lease):

will pay all rates taxes assessments and outgoings whatsoever excepting land tax which during the said term shall be payable by the Landlord or tenant in respect of the said premises ...

 

The deletion of the words 'Landlord or" suggest an intention that the tenant would not be responsible for rates payable by the landlord.

On the other hand, clause 13 provided:

The parties acknowledge that it was the intention of the Lessor to sell and the Lessee to purchase the land and improvements hereby leased for the consideration of $70,000.00 and as a result thereof the parties have agreed to enter into this Lease for a term of ninety-nine years in respect of which the total rental thereof is the sum of $70,000.00 which sum is hereby acknowledged to have been paid in full.

 

This clause suggests an intention that the tenant would be liable for rates payable by the landlord.

Previous decisions

The trial judge decided that the tenant was liable for all such payments, including land tax. This was consistent with the purpose stated in clause 13.

The Victorian Court of Appeal gave greater weight to the apparent intention behind the deletions in clause 4. It therefore allowed the tenant's appeal and found that the tenant was only liable to pay rates, taxes, assessments and outgoings payable by the tenant.

Appeal decision

Justices Kiefel, Bell, Gordon (delivering the majority judgment) and Justice Gaegler (in a separate judgment) allowed the appeal. Justice Nettle, in dissent, agreed with the decision of the Court of Appeal.

The majority held that both:

  • the language of clause 13 of the lease; and
  • the surrounding facts and circumstances (that a reasonable businessperson in the position of the parties could be taken to have known)

pointed to the conclusion that the parties' intention was to achieve a position as close to a sale of the property as they could. On this basis, the majority held that the proper construction of the relevant payment clause was that it required the tenant to pay all rates, taxes and other outgoings over the term of the lease.

The relevant surrounding circumstances included that:

  • the leased land was intended to be sold by one party to the other (which was also apparent from clause 13);
  • the land could not be sold due to planning restrictions;
  • the lease was a mechanism to indirectly achieve the substance of the parties' agreement to sell; and
  • the agreed rent for the period ($70,000 paid in advance) was more or less equivalent to the market freehold value of the leased land.
With regard to the correct approach to contractual interpretation, the majority said that:

  • each of the parties' proposed constructions of the lease was plausible;
  • the terms of a commercial contract are to be understood objectively, by reference to what a reasonable businessperson would have understood them to mean, rather than by reference to the subjectively stated intentions of the parties to the contract;
  • in a practical sense, this process of interpretation requires that the reasonable businessperson be placed in the position of the parties. Importantly, the majority went on to say that:

    It is from that perspective that the court considers the circumstances surrounding the contract and the commercial purpose and objects to be achieved by it.

     

It was not necessary for the Court to determine the ambiguity gateway question to decide this case, because the parties did not dispute (before the Court of Appeal or before the High Court) that the clause was ambiguous. While the majority did not directly address the 'ambiguity gateway' question, their Honours' explanation of the context in which a court is to take into account evidence of surrounding circumstances (at the point of applying the 'reasonable businessperson' test) may be interpreted as support for the position taken in recent decisions of the New South Wales Court of Appeal. It is well established that the process of contractual interpretation is an objective one, to be undertaken by reference to the 'reasonable businessperson' test.4 That test is to be applied even if the words of a contract are clear and unambiguous. The statement by the majority, that surrounding circumstances are to be taken into account in the process of applying that test, suggests a further erosion of the view that the 'true rule' in Codelfa5 mandates that ambiguity in the language is required before a court may consider evidence of surrounding circumstances.

Justice Nettle, in dissent, preferred the approach of the Court of Appeal. In particular, Justice Nettle stated that the lease was poorly drafted and that, while poor drafting might justify a court being more willing to depart from the ordinary meaning of a clause, it did not give the court licence to change the meaning of a term that was otherwise clear and unambiguous.

Conclusion

The controversy surrounding the correct approach to the interpretation of contracts is likely to remain alive notwithstanding this latest judgment from the High Court. However, the decision appears to provide further support for the view that surrounding circumstances may be considered during the contract interpretation process, even where a contract appears, on its face, to be clear and unambiguous.

Footnotes
  1. See, for example, Mainteck Services Pty Ltd v Stein Heurtey SA [2014] NSWCA 184, WIN Corporation v Nine Network Australia [2016] NSWCA 297 and Zhang v ROC Services (NSW); NTI v Zhang [2016] NSWCA 370. For examples of the approach taken in Western Australia and Victoria, see Technomin Australia Pty Ltd v Xstrata Nickel Australasia Operations Pty Ltd [2014] WASCA 164 and Apple and Pear Australia v Pink Lady America [2016] VSCA 280.
  2. [2016] VSCA 23.
  3. Ecosse Property Holdings Pty Ltd v Gee Dee Nominees Pty Ltd [2017] HCA 12.
  4. See, for example, Electricity Generation Corporation v Woodside Energy Ltd [2014] HCA 7, at paragraph 35 per Chief Justice French and Justices Hayne, Crennan, and Kiefel).
  5. Codelfa Construction Pty Ltd v State Rail Authority (NSW) (1982) CLR 337.

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