Australia: This Contract makes no sense! Avoiding contractual disputes

Last Updated: 27 February 2012
Article by Robert Toth

Commercial agreements set out the parties rights and obligations and essentially allocate risk. It is that risk that lawyers can identify and assist a client to accept or reject, as well as ensure the parties intentions are accurately reflected in their agreement.

Disputes often arise as to whether the agreement as drawn makes "commercial sense" or truly reflects the parties intentions. This often arises where parties have drawn agreements that are unclear or do not reflect their intentions.

Agreements can not cover every event, however industry knowledge can assist a lawyer to identify and ensure they cover likely events for their clients. Wisewould Mahony corporate have specialised industry knowledge in a number of highly regulated industries such as Franchising, Licensing and Distribution, Liquor Licensing and Gaming, Transport, Pharmacy and New Energy.

The devil is in the detail and ensuring the parties intentions are properly reflected takes time and skill. The process of entering into a Memorandum of Understanding or Heads of Agreement can assist the parties to document the important issues and obligations. Involving your lawyer at that early stage of the negotiations can assist to ensure major risks and legal considerations are covered which can then be properly reflected in the formal agreement.

How do Courts construct and agreement which is unclear, makes no commercial sense or does not reflect the parties intentions?

A case on point which highlights the principles applied by the Courts is Battery World Pty Limited v Heavenly Bound Pty Limited & Ors [2009] NSWSC 1309.

In this case the franchisee's legal team argued that as the agreement simply expired at the end of its term, that "expiry" did not mean "termination". Therefore a number of clauses that were to operate only upon "termination" of the Franchise Agreement could not apply for the benefit of the franchisor as the agreement expired.

The termination provisions in the agreement enabled the franchisor to continue to operate the franchise and therefore the business assets, such as customer information, permits and other approvals and premises.

The Franchisee argued that the rights of the franchisor to retain the business asset and lease were dependent on clause 11, which set out circumstances for termination other than through the effluxion of time ("expiry"), for example where the Franchisee was in default in failing to remedy a breach.

The Court disagreed with the defendant (franchisees) argument. The effect being that even though there was no termination (as the agreement simply ended) the franchisor was able to exercise its rights to retain ownership of the customer information, permits and the lease.

Principles of Construction

The Court applied the following principles to interpreting a commercial agreement:

  1. To ascertain and give effect to the intention of the contracting parties;
  2. To construe commercial contracts with a view to making commercial sense of them;
  3. To ascertain the meaning of a document by reference to the reasonable business person having regard to all the background knowledge reasonably available to them;
  4. To avoid narrow, technical or artificial interpretations of commercial contracts; taking into account the reasonableness and commerciality of the outcome or a particular outcome; and
  5. A semantic syntactical analysis of a word in a commercial contract...must yield to business commonsense, reasonableness and avoid absurdity.

The Franchisors Argument

The Franchisor (Plaintiffs) position was that the ordinary English meaning of the word "termination" should be applied which could include and was intended to include expiry of the term of the Franchise Agreement.

The Court held that there was no rational commercial reason why the parties would take the course suggested by the franchisee which involved uncertainty, delay and additional cost.

Is the Word "Terminate" Ambiguous?

The franchisee relied on the case of Orrong Strategies Pty Ltd v Village Roadshow Ltd (Habersberger J, Supreme Court of Victoria, 25 January 2007, unreported). In that case, the Judge relied on various cases that recognised that the word "terminate" by itself was ambiguous.

The Judge in Battery World stated that the Judge in Orrong Strategies Pty Ltd v Village Roadshow Ltd took the conventional approach however it is often in the words of the document that the factual context between the parties, common purpose and object between the parties is revealed.

The Outcome

The franchisees sought to argue against accepted principles of interpretation and construction of commercial contracts and failed. The Court in Battery World applied the following principle:

"That narrow, technical or artificial interpretations of commercial contracts are to be avoided and it is necessary for the Court to take into account the reasonableness and commerciality of the outcome of a particular construction; the more unreasonable the result, the more unlikely it is that the parties intended it".

This case highlights that a party may not be able to rely on an error or ambiguity in an agreement that may not have been intended by the parties and which may not make commercial sense.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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