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Principles of Contract Construction
It is almost inevitable. A contract, whether commercial or consumer in nature, is bound to have a word, phrase, provision, part or section which is not entirely clear and gives rise to more than one reasonable interpretation.
This is where most disputes between parties will occur.
In such circumstances, you can expect each party to adopt and contend for that interpretation which best serves their commercial interests. The parties are then likely to either perform their obligations in a manner inconsistent with the true requirements of the contract or simply refuse to fulfil their obligations at all until there is consensus as to what is required to be done.
This can cause delays and have devastating consequences for the parties.
As disputes over contract construction are so common, the Courts have developed (and continued to develop, since the dawn of our legal system), a body of principles directed at assisting the parties, or the Courts, to determine the linguistic meaning and legal effect of ambiguous words, phrases or provisions used in a contract.
The parties will either, acting sensibly, agree to adopt an interpretation in accordance with established principles of contract construction, or the Courts will step in and impose their own interpretation on what certain words or phrases were intended to mean or how certain provisions were intended to operate under the contract.
This article explores some principles of construction used to resolve issues of interpretation in commercial contracts.
What is the relevance of the parties' intention to contract construction?
The primary objective of contract construction is to determine and give effect to the common or presumed intention of the parties.
Intention may be actual, expressed or implied. Actual intention is the intention subjectively (i.e. actually) held by the parties. Expressed intention is the intention expressly stated by the parties in the contract. Implied intention is the intention which is imputed or attributed to the parties in relation to matters in respect of which no intention has been expressed.
Intention, in the context of contract construction, is assessed objectively by reference to the words used in the contract. That is, the Court will strive to give effect to the express intention of the parties. To put it another way, the Court will ask itself, in the construction exercise: “What is the meaning of what the parties have said”, and not “What did the parties mean to say”.
Where no intention is expressed, the Court will impute an intention to the parties in light of the contract as a whole.
What are the principles or rules of contract construction in the context of commercial contracts?
In the modern approach to construction of commercial contracts, the Courts will strive to give effect to the following principles:
- a commercial approach to construction must be taken (for example, if detailed semantic and syntactical analysis of words or an expression in a commercial contract is going to lead to a conclusion that flouts business commonsense, it must be made to yield to business commonsense);
- giving a commercial contract a businesslike interpretation (by understanding the genesis and background of the transaction, the language used by the parties, the circumstances addressed by the contract and the commercial objects it is intended to secure);
- a preference for construction which is reasonable or sensible and not unreasonable, absurd or inconvenient (although, the Court has no jurisdiction to reject an interpretation, clearly intended by the parties, merely because it is in its view unreasonable or because it produces unreasonable results);
- having proper regard to the context of the contract, by recognising the factual and legal matrix of the contract in determining meaning to resolve ambiguity;
- the Courts must receive evidence of the circumstances surrounding the contract, including the aim, the object or commercial purpose of the contract, on the basis that it forms part of the factual matrix against which the parties contracted;
- however, the Court has been cautious to warn that the words or expression at issue must first be susceptible of more than one meaning in order to justify the use of surrounding factual circumstances (meaning, the factual matrix cannot be used to contradict a document the meaning of which is clear); and
- the parole evidence rule, which restricts the use of extrinsic evidence:
- as an aid to interpretation of the contract; or
- to prove the existence of additional terms of the contract, which is otherwise presumed to be a complete statement of the contract.
These principles of construction apply irrespective of the form or nature of the commercial contract (i.e. it does not matter whether the contract is for the sale of goods or the provision of services etc).
What is the parole evidence rule?
The parole evidence rule restricts the use of extrinsic evidence.
The parole evidence rule is generally thought of as comprising three (3) separate rules:
- the first rule holds that where a document exists (e.g. a written deed or contract), other evidence of the terms of the document are inadmissible;
- the second rule prohibits evidence of other terms not included expressly or by reference in the deed or contract; and
- the third rule excludes evidence of its writer’s intended meaning.
In terms of the third rule, there are generally three (3) categories of extrinsic evidence that may not be used as an aid to interpretation of the contract:
- direct evidence of the actual (i.e. subjective) intention of the parties;
- evidence of the parties’ prior negotiations; and
- evidence of the parties’ subsequent conduct.
What are the exceptions to the parole evidence rule?
The parole evidence rule only applies if a party seeks to adduce extrinsic evidence of the meaning or legal effect of the words or expressions used in a contract.
Thus the parole evidence rule does not operate to prohibit a party adducing extrinsic evidence where the issue does not concern the construction of the contract but rather concerns other issues, such as a breach and remedies available under the contract or issues concerning lack of capacity, misrepresentation, mistake, illegality, estoppel, validity and enforceability of the contract.
However, as an exception to the parole evidence rule, a party will be permitted to adduce extrinsic evidence as an aid to interpretation of the contract in the following circumstances:
- to identify the subject matter of the contract, where the description of the subject matter of a contract is uncertain or ambiguous;
- to resolve any patent ambiguity (clearly apparent on the face of the document) or latent ambiguity (words or expressions which provide superficial certainty) in the contract;
- to imply a term in the contract whether as a matter of fact or law (as a Court may have regard to extrinsic evidence for the purpose of supporting or rebutting a presumption that the term should be so implied);
- to resolve an ambiguity or imply a term by reference to custom, usage and course of dealing between the parties;
- to identify the consideration (i.e. value) to be given under the contract;
- to identify the parties to the contract or the capacity in which a party contracted (where the document does not make this clear);
- to rectify a contract (where extrinsic evidence of the parties’ intention, including direct evidence of intention, is admissible to rectify the document so that it expresses that intention).
Unless the ambiguity is resolved by the application of the construction principles, the word, expression or clause in question will be void for uncertainty.
If you need legal advice or assistance with the preparation of a contract or representation in respect of a contractual dispute, please contact ADVIILAW today to speak to one of our experienced commercial or commercial litigation lawyers.
Contact us on 07 3088 7937 or email us at [email protected].
This commentary is of a general nature only, containing some general information for the reader.
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