Australia: Interpretation of contracts: the search for the meaning of words

In brief - Two different courts can apply the same rules and produce different results

Successive courts which examine a commercial contract can come to different conclusions about how it is to be interpreted and whether or not the circumstances surrounding it should be taken into account.

What is the "true meaning" of a contract?

The courts have been filled with a plethora of cases which deal the construction of contracts. In 2013, the NSW Court of Appeal pragmatically articulated the process as follows: "In the context of litigation over the meaning of words, the true meaning is the choice made from the competing meanings by the last court that has authority on the matter".

But, how does a court reach the "true meaning"? And, more importantly, almost 21 years on, does the true rule as stated by Justice Mason in Codelfa Construction Pty Ltd v State Rail Authority of NSW (1982) 149 CLR 337 still apply? The answer: a resounding yes.

The Australian approach to the interpretation of contracts

Australian law takes an objective approach to the construction of contracts. This means that words are to be understood by determining what a reasonable person would understand them to mean.

The first step in understanding the meaning of a contract is to look at the words themselves. If the words are unambiguous, a court must give effect to that meaning. The court will look at the whole contract.

The process also involves looking at the surrounding circumstances that are known to the parties, the purpose of the transaction and the objects which it was intended to secure.

These rules must be applied on the conditions set down in Codelfa.

The "true rule": when can surrounding circumstances be looked at?

The true rule is essentially that evidence of surrounding circumstances is admissible to assist in the interpretation of a contract if the language is ambiguous or it is susceptible to more than one interpretation.

There have been numerous attempts in recent times to argue that ambiguity is no longer required. These arguments are based on cases like Franklins Pty Ltd v Metcash Trading Ltd. In Franklins, the NSW Court of Appeal made the following comments on the interpretation of commercial contracts.

  • Commercial agreements should be given a businesslike interpretation.
  • The nature and extent of the commercial aims and purposes of the agreement or parts thereof are part of the essential background circumstances.

Without the clear proviso intended by Codelfa, these statements have formed the basis of arguments and submissions that a court can look at the circumstances surrounding a commercial contract without first identifying that there is some ambiguity.

This submission was made in Western Export Services Inc v Jireh International Pty Limited [2011] HCA 45. It was swiftly rejected by the High Court. The submission did not conform to Codelfa and its acceptance would require a reconsideration of Codelfa and its principles. The High Court added that until the court embarks on the exercise of reviewing Codelfa and disapproves or revises what was said, intermediate appellate courts are bound to follow it.

Interpretation in practice: Onesteel v Bluescope

The decision in OneSteel Manufacturing Pty Limited v BlueScope Steel (AIS) Pty Limited [2011] NSWSC 1450; [2013] NSWCA 27 shows an application of these rules working in practice and, more importantly, how the application of substantially the same rules can create a different result.

The Court of Appeal overturned the primary judge's finding. While the primary judge's interpretation was available and arguable, it was not the preferable and true meaning of the contractual provisions in question.

Interestingly, the Court of Appeal did not mention Jireh and the strong view taken by the High Court in that case.

OneSteel sues Bluescope for refusing to accept shipments of iron ore

OneSteel and BlueScope had entered an agreement for the purchase of iron ore by BlueScope from OneSteel.

The agreement involved the scheduling of shipments over a number of years. At some stage during the arrangement, the agreement was amended in relation to four specific shipments.

BlueScope wrote to OneSteel, requesting that four scheduled shipments not be loaded, relying of clause 4.1(d) of the agreement. OneSteel rejected the request and sued BlueScope for loss and damages caused as a result of BlueScope's alleged wrongful refusal to accept the shipments.

The issue that is the focus of this article centres on clause 4.1(d) and its meaning: did it allow BlueScope to refuse to take a shipment?

The relevant parts of clause 4.1(d) read:

If the Seller (being OneSteel) has scheduled DEQ Port Kembla Shipments of Iron Ore to the Buyer (being BlueScope) and the Buyer requests the Seller for any reason (other than pursuant to Clause 6.4) to either not load the Vessel at all or not load the Vessel to the full Practical Loaded Capacity of the Vessel, then the Buyer shall:...

There are three points that clearly illustrate the different approaches to applying the principles of interpretation to the issue.

  1. The words of clause 4.1(d)

At first instance, the primary judge looked at the words of the clause and concluded that the words were clear and unambiguous, and there was no difficulty in giving the clause "its plain meaning". In addition, there was no room to read in a requirement that OneSteel had to accept BlueScope's request not to load before the request had any effect, as OneSteel had argued.

In addition, the primary judge held that the phrase "for any reason (other than pursuant to clause 6.4)" would have no purpose if OneSteel had the power to approve or decline BlueScope's request.

The Court of Appeal, however, read this clause in light of the surrounding circumstances and commercial context of the agreement. This included the variability of the price of iron ore. If BlueScope could use clause 4.1(d) to reject a shipment, it would be free to go to market whenever it wanted to get a cheaper price.

This approach seems to verge on the approach rejected by the High Court in Jireh. Perhaps the fact that the two parties had a different interpretation of the clause was enough to establish ambiguity within the sense of the "true rule".

  1. BlueScope's obligation to purchase

Clause 4.1(a) of the agreement read:

For each Contract Year of the Term (part Contract Years pro rata), the Seller may supply to the Buyer up to the Maximum Tonnage of Iron Ore on a DEQ Port Kembla basis in reasonably evenly spaced Shipments and any Iron Ore so offered for supply must be purchased by the Buyer subject to and upon the terms of this Deed.

For the primary judge, the words "subject to and upon the terms of this Deed" were clear and made BlueScope's obligations to purchase steel conditional.

On appeal, the court held that a broad reading of clause 4.1(d) would be inconsistent with BlueScope's obligation to purchase.

But what of the words "subject to and upon the terms of this Deed"? If it was logically correct to understand this sentence to mean that clause 4.1(a) must be read in the context of the rest of the agreement, including clause 4.1(d), to do so would remove all "force and sense" from the balance of the paragraph and render it somewhat unnecessary. The result would be that the words "must be purchased" would have the meaning "may be purchased".

  1. The rest of the contract

OneSteel put forward an argument that, if clause 4.1(d) gave BlueScope the right to refuse a shipment, clause 4.1(d) would be inconsistent with a number of other clauses in the agreement.

Justice Hammerschlag at first instance did not agree. The agreement did include other clauses that envisaged the reduction of supply or the reduction of shipments, however he held that their words made it clear that they applied in different contexts and had different commercial consequences.

Again, the Court of Appeal did not agree and said that interpretation of clause 4.1(d) was inconsistent with the other clauses in the agreement. The result was that clause 4.1(d) was read down significantly. The court found that its construction still left clause 4.1(d) with a purpose: it required dead freight to be paid and it granted BlueScope a valuable right to have OneSteel consider the secondary request and not withhold consent unreasonably.

The court's reading of the clause brings with it a separate question: if clause 4.1(d) had to be read in conjunction with, and consistently with, clauses which envisaged the reduction of shipments, when could clause 4.1(d) be used? The parties included a clause for a reason and its reading down has made it somewhat redundant. This was not really dealt with by the Court of Appeal.

No certainty of outcome in a court's interpretation of contracts

Despite comments to the contrary, the position has not changed. Jireh reminds us that there has been no change in the principles, including Codelfa, that apply to the interpretation of contracts.

However, there is clearly still much room to debate what Codelfa means in practice and what the most appropriate method for interpreting a contract is. This was pointed out in the recent case of Schwartz v Hadid, where Justice of Appeal Macfarlan recognised the conflict between the High Court's decision in Jireh and the NSW Court of Appeal's decision in Franklins.

The outcome of each case will depend on the facts, the words in question and the interpretation of the judge.

In the words of Lewis Carroll:

"The question is," said Alice, "whether you can make words mean so many different things."
"The question is," said Humpty Dumpty, "which is to be master - that's all."

Grazia Altieri
Key Contacts:
David Kennedy Leanne Walker
Commercial litigation
CBP Lawyers

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