Extrinsic Material and the Interpretation of Commercial ContractsThe Hon J J Spigelman AC QC*1

The scope of extrinsic material to which reference has come to be given for purposes of

contractual interpretation threatens to undermine commercial certainty. English law has

gone further than Australian law in this respect. In Australia the parol evidence rule has

been reaffirmed and there are indications that the High Court is reasserting the centrality

of the text.

Drafters of contracts are no less prone than parliamentary draftsmen to express

exasperation about how their carefully crafted words are misunderstood by others, not

least by judges. All lawyers who draft texts attempt to be as clear and comprehensive as

they can. We try to anticipate the kinds of issues that may arise, to which the verbal

formulae we devise have to be stretched. As Sir James Fitzjames Stephen put it:

“It is not enough to attain to a degree of precision which a person

reading in good faith can understand. It is necessary to attain, if

possible, to a degree of precision which a person reading in bad

faith cannot misunderstand. It is all the better if he cannot pretend

to misunderstand it.”2

This objective is never capable of complete achievement. Hence disputes and litigation

about what words mean. In this process the principles of contractual interpretation

constitute a distinct body of law reflecting, in large measure, a general body of principles

applicable to the interpretation of all legal texts, albeit with numerous principles

specifically applicable to contracts or to particular kinds of contracts.

Over the course of our legal history, incorporating in that concept over half a millennium

of English legal history before the foundation of Australia, there have been fluctuations in

the prevalent style of interpretation of legal texts. The law after all is, in many respects, a

fashion industry. The emphasis given to the words used in a text, as distinct from

purpose, motive or the circumstances in which the text came into existence, has often

varied.

Over recent decades there has been a clear oscillation of the pendulum away from

literalism—with its focus on the ordinary meaning of particular words — towards a

purposive or contextual approach to interpretation. This oscillation has been apparent in

constitutional, statutory and contractual interpretation. I have described it as a movement

“from text to context”.3

1 *The Honourable James Spigelman was Chief Justice of New South Wales1998-2011.2 Re Castioni (1891) 1 QB 149 at 167-168 per Stephen J3 See J.J. Spigelman, “From Text to Context: Contemporary Contractual Interpretation” (2007) 81 ALJ 322.

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I am concerned that the movement away from a focus on the text may have gone too far

in other jurisdictions, albeit not yet in Australia. The swing of the pendulum, particularly in

the extension of the materials to which the courts have regard for purposes of interpreting

a contract is such as to invite those judges, who may be so inclined to re-write the

bargain of the parties in the light of the events that have happened, so that the judge can

reach a just result.4 In my opinion, this development threatens to undermine the

predictability of legal disputation and, thereby, to undermine the certainty which contract

law must deliver for commercial relationships.

Although it is useful to distinguish between textualists and contextualists, in order to

identify alternative basic approaches to contractual interpretation, it must be remembered

that what is involved is a spectrum, not a simple duality. There is a range of legitimate

opinion in terms of the approach that should be adopted, either as a general rule, or in a

particular class of cases, or in a specific case. Judges can and will vary amongst

themselves as to where on this spectrum she or he is placed. In this article I am

principally concerned with long term shifts in approach which affect the judiciary as a

whole.

The centrality of certainty

The starting point for the interpretation of any text must be the nature of the document.

Many of the principles which have developed with respect to specific kinds of documents

cannot be transposed to the interpretation of other documents. The interpretation of

different texts is subject to different kinds of restraints and requirements.

Accordingly, a national Constitution must be interpreted as an instrument of government,

a document intended by its framers to adapt to changing social conditions.

Similarly, many principles, often referred to as presumptions, which are applicable to the

interpretation of a statute derive from the nature of the political system. That is why a

statute must be interpreted in accordance with the public values of the system of

government, such as the presumptions appropriately grouped under the principle of

legality.5 This principle encompasses a range of rebuttal presumptions that Parliament

did not, in the absence of a clear statement of intention, intend to affect fundamental

rights and freedoms, or restrict access to the courts, or abrogate legal professional

privilege, or the privilege against self-incrimination, or to interfere with vested property

rights.6 Such principles turn on the nature of the statute as a product of a democratic

Parliament.

4 For some American examples see “Daniel v Barnhizer Context as Power: Defining the Field of Battle for Advantage in Contractual Interactions” (2010) 45 Wake Forrest Law Rev 607.5 See J J Spigelman, “The Principle of Legality and the Clear Statement Principle” (2005) 79 ALJ 769 especially at 774–5;JJ Spigelman, Statutory Interpretation and Human Rights; the McPherson Lectures, Vol 3, University of Queensland Press, Brisbane, 2008 especially at pp 22–9.6 See generally J J Spigelman “The Principle of Legality and the Clear Statement Principles” (2005) 79 ALJ 769 at 774ff.

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A written commercial contract must be interpreted so as to provide as much commercial

certainty as the words permit.7 Although the principles of interpretation applicable to

statutes do not currently apply to commercial contracts, if the corporate social

responsibility idea gathers momentum, it may well be that something similar develops in

the context of commercial arrangements.

Like many other aspects of contract law, interpretation requires the resolution of a tension

between certainty or efficiency on the one hand and accuracy or fairness on the other.

There exists a broad spectrum of permissible opinion as to where the balance between

these often conflicting considerations should be drawn.

“Certainty” in this context refers to the proposition that the extent to which lawyers giving

advice on contractual obligations, and practitioners, arbitrators and judges involved in

dispute resolution refer to matters beyond the document constituting the contractual

arrangement between the parties, the certainty of advice or of the outcome of the dispute

resolution process, is lessened. Furthermore, the length and cost of the process is

increased. “Accuracy” or “fairness” in this context refers to the central significance of

determining what the actual intention of the parties was with respect to the meaning of

particular words used in a written agreement. Justice requires that they be held to the

bargain upon which they truly agreed. This has been called “a more principled and fairer

result”8 or one that will meet “the reasonable expectations of the parties”9 or supported on

the basis that “fairness should trump convenience”.10

A restrictive approach to evidence for purposes of interpretation may sometimes mean

that “justice” is not done.11 However, as Chief Justice Gleeson forcefully pointed out, the

“holy grail of individualised justice” is frequently in conflict with the need for predictability

and certainty in areas of the law, including commercial transactions.12

As is so often the case, reasonable people can differ about where the balance between

practical considerations and principle should be drawn. Practical considerations which are

concerned with commercial certainty and the cost of contract writing, advice and

adjudication, are regarded by some as an unprincipled constraint upon the true object of

contract law and by others as a valid factor entitled to weight in the balance.

Furthermore, in terms of the justice of the situation, distinct issues arise in that significant

range of commercial relationships in which third party interests become involved on the

basis of the contractual text. Insofar as the true intentions of the parties is to be

7 Spigelman,above n2.8 Static Control Components (Europe) Ltd v Egan [2004] EWCA Civ 392; [2004] 2 Lloyd”s Rep 429 at [29] per Arden LJ.9 See J Steyn “Contract Law: Fulfilling the Reasonable Expectations of Honest Men” (1997) 113 Law Quarterly Review 433 esp at 441-442.10 V K Rajah “Redrawing the Boundaries of Contractual Interpretation” (2010) 22 Singapore Academy of Law Journal 513 at 538.11 D J Nicholls “My Kingdom for a Horse: The Meaning of Words” (2005) 121 Law Quarterly Review 577 at 586.12 A M Gleeson “Individualised Justice – The Holy Grail” (1995) 69 Australian Law Journal 421 at 431-432; applied in this context in J J Spigelman “From Text to Context” supra at pp 333-334.

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determined by extrinsic materials, they invoke matters of which such third parties have no

knowledge.

Certainty does not just refer to predicting the results of litigation. Primarily, I am speaking

about the ability of commercial parties, perhaps with legal advice, to determine their rights

and assess their risks as soon as a dispute arises. The greater the scope of materials

relevant to an issue of interpretation that can be taken into account, the greater the scope

for difference between legal advisors in terms of the advice they give the contending

parties and, therefore, the greater the scope for uncertainty as to the outcome of any

dispute, whether in commercial arbitration or in litigation. Furthermore, the length and

cost of the process of seeking legal advice and of determining the dispute is significantly

increased.

One thing that all parties would agree upon at the outset is that their written contract

should be sufficiently clear to minimise the possibility of differences of legal opinion.

Commercial parties are well aware that litigation is never a desirable commercial outcome

— indeed, more often than not, it is a commercial disaster. Except of course for the

lawyers. When a dispute arises, self interest means that this original, mutual

understanding is forgotten. Judges should not also forget it.

The scope for divergent interpretations

There are a range of legitimate interpretive tasks which arise in the process of contractual

interpretation. These include:

Deciding whether to read down general words;

Deciding whether to imply terms;

Deciding whether to depart from the natural and ordinary meaning of words;

Deciding whether or not the contractual definition of a particular word does in fact

apply to its use in a particular clause;

Deciding whether or not to give qualificatory words ambulatory meaning.

A considerable degree of flexibility necessarily exists in any process of interpretation.

There is always some scope for divergence when expressing an opinion or formulating a

judgment about the meaning of words.13 That is one reason why, particularly in a

commercial context, it is important that legal principle and procedure should not add to

the problem.

13 See my observations in JJ Spigelman, “Words,Words,Words” (2007) 81 ALJ 601 esp at 601–2.

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Of course, the ultimate source of this flexibility is the wonderful flexibility of our language.

Lord Simon of Glaisdale — a master of statutory interpretation, an officer of the Simplified

Spelling Society and a Scrabble tragic — put it well:

“Words and phrases of the English language have an

extraordinary range of meaning. This has been a rich resource in

English poetry (which makes fruitful use of the resonances,

overtones and ambiguities); but it has a concomitant

disadvantage in English law which seeks unambiguous precision,

with the aim that every citizen shall know as exactly as possible,

where he stands under the law”14

Nevertheless, in a legal text, it is usually the case that one can clearly identify which of

the range of meanings is intended. However, over recent decades the shift in

jurisprudential fashion to which I have referred has called into question the resort to what

has traditionally been called the “plain meaning” or the “natural and ordinary meaning” of

words. As Lord Hoffmann once put it:

“I think in some cases the notion of words having a natural

meaning is not a very helpful one. Because the meaning of words

is so sensitive to syntax and context, the natural meaning of

words in one sentence may be quite unnatural in another. Thus

the statement that words have a particular meaning may mean

no more than that in many contexts they will have that meaning.

In other contexts their meaning will be different but no less

natural.”

Lord Hoffmann has been responsible for a significant turn in the approach to contractual

interpretation which, in large measure, reflects in this sphere of legal discourse, the

movement from text to context that I have identified.

A good example of the possibility of divergence is whether to read down general words.

This arises frequently in the context of commercial contracts, including insurance

contracts. Numerous examples can be given of this process at work in the interpretation

of insurance contracts. A classic case is the fire policy which was subject to an exclusion

if “gasoline (was) stored or kept in the building”. The House of Lords read down the

reference so as not to apply in a case when only one pint of gasoline 15 was held for

cooking purposes. What the parties had in mind, their Lordships held, was a significant

quantity, not such a small amount for use for domestic purposes.14 Similarly, an

exclusion expressed in terms of “exposure to obvious risk of injury” was held not to

extend to apply to a person crossing the street.16 Such examples could be multiplied.

14 Stock v Frank Jones (Tipton) Ltd [1978] 1 All ER 948; [1978] 1 WLR 231; [1978] IRLR 87 at 23b.15 16

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Surrounding Circumstances

The words of a written agreement are the primary focus of attention in the sense that,

subject to collateral doctrines such as rectification and estoppel, it is those words that fall

to be interpreted. However, the surrounding circumstances in which a text was drafted

can be of assistance in its interpretation and that fact may not have received sufficient

emphasis until recently.

Words never stand by themselves. They do not exist in limbo. Justice Learned Hand put

the proposition well when he said:

“Of course it is true that the words used, even in their literal

sense, are the primary, and ordinarily the most reliable, source of

interpreting the meaning of any writing; be it a statute, a contract,

or anything else. But it is one of the surest indexes of a mature

and developed jurisprudence not to make a fortress out of the

dictionary; but to remember that statutes always have some

purpose or object to accomplish, whose sympathetic and

imaginative discovery is the surest guide to their meaning.”17

The same, of course, is true of the commercial purposes of a contractual relationship. No-

one doubts the importance of surrounding circumstances or the “factual matrix”, as it is

often called, for purposes of interpretation. However, reasonable minds can differ about

how readily and how far such background should be taken into account for that purpose.

Questions of fact and degree are involved.

In common law nations the practice of modifying the parol evidence rule by taking

account of surrounding circumstances and the commercial purpose of contract

accelerated in the 1970”s and has continued to expand. In England this movement from

text to context commenced under the influence of Lord Wilberforce, who in 1971, with the

agreement of other members of the House of Lords, re-emphasised the relevance to

interpretation of the factual matrix known to both contracting parties, including the genesis

and the aim or commercial purpose of the transaction.18

I do not believe that Lord Wilberforce intended any dramatic change from past practice.

The “factual matrix” which he had in mind encompassed a limited range of basically

uncontested commercial factors understood by both parties, even in a context where,

almost by definition, their interests were in conflict.

Lord Wilberforce could not have anticipated the explosion in the scope of available

documentation. As a barrister his commercial briefs came wrapped in pink ribbon and, as

a judge, he witnessed the arrival of briefs in one or two spring back folders. He could not

have anticipated word processing, emails, the internet or twitter, the latter at least having

17 Cabell v Markham 148 F2d 737 at 739 (1945).18 17 See Prenn v Simmonds [1971] 1 WLR 1381 at 1385; Reardon Smith Line Ltd v Yngvar Hansen-Tangen [1976] 1 WLR 989 at 987

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the benefit of brevity. These technological developments have transformed litigation into

one, two or more trolley cases and then, into detachable hard drives. The cost

consequences of access to multiple drafts and of conversations replaced by emails —

accessible even after deletion by interrogating hard drives — have become

unsustainable.

I have, on a number of occasions, expressed my reservations about the significant

expansion of the scope and nature of evidence now available for the purposes of

interpreting a written contract.19 What started out as the perfectly acceptable principle that

the words of a written contract must be understood in their commercial context, has

turned into a mechanism for creating a high level of uncertainty in commercial

relationships. This was not intended by Lord Wilberforce.

There remains a real tension between the principle that surrounding circumstances be

taken into account for purposes of interpretation, on the one hand, and the certainty

sought by a written text, on the other hand. It is necessary, in my opinion, to be robust in

asserting the fundamental principle that interpretation must be based on the express

words. The contemporary approach to interpretation is best described as “literal in total

context” However context cannot be used to distort the language. As Felix Frankfurter

once put it:

“While courts are no longer confined to the language, they are

still confined by it. Violence must not be done to the words

chosen.”20

It is not the task of the courts to make the contract for the parties that they ought to have

made. An issue of judicial legitimacy is involved here. The courts must determine what

the parties meant by the words they used. It is not a proper function for the courts to

determine what the parties intended to say. No doubt such an approach will, on

occasions, lead to results that some people would not regard as “fair”. Life is like that

sometimes, even, judicial life.

Questions of fact and degree arise. The balance between commercial certainty and the

accurate reflection of the parties intentions will not always be drawn in the same way.

However, contracts between commercial parties must be interpreted on the basis that

both parties sought certainty, even at the expense of faithfully reflecting their “true”

intentions.

This perspective leads to an approach to contractual interpretation which may differ from

the approach to interpretation of other texts. Specifically, it leads to a consideration of the

circumstances, short of litigation, in which commercial parties will be required to make

decisions, perhaps with legal advice, as to the meaning of the text in order to determine

their conduct, including conduct which must be undertaken without delay. The 19 See most recently JJ Spigelman, “Contractual Interpretation; a Comparative Perspective” (2011) 85 ALJ 41220 See F. Frankfurter, “Some Reflections on the Reading of Statutes” (1947)47 Columbia LR 527 at 543

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commercial certainty sought by a text must be, and must be known to be, respected by

the courts.

As I will indicate below, Lord Hoffmann has been the principal progenitor of an expansion

in the scope of relevant background to be taken into account. His Lordship, with his

customary insight, has stated the alternative view with precision. He said:

“There is certainly a view in the profession that the less one has

resort to any form of background in aid of interpretation, the

better . . . These opinions . . . reflect[s] what may be a sound

practical intuition that the law of contract is an institution designed

to enforce promises with a high degree of predictability and that

the more one allows conventional meanings or syntax to be

displaced by inferences drawn from background, the less

predictable the outcome is likely to be.”21

As Lord Hoffmann suggested, it is very revealing that those who resist the expansion of

the use of extrinsic material for purposes of interpretation tend to be active practitioners

with a keen understanding of the implications for both advice and litigation of this

extension.22 In contrast there is a strong contingent of academic legal writing, indeed

near unanimity, in favour of the admissibility of pre-contractual negotiations.23

Traditional Restraints

The scope of surrounding circumstances to which regard may be had has traditionally

been confined by two legal principles: the parol evidence rule and the requirement to

identify ambiguity in the language of a contract.

The parol evidence rule has been stated in different ways, but the core principle is that,

when parties have reduced their contract to writing, a court should only look to the writing

to determine any issue of interpretation. The rule excluded extrinsic evidence for the

purpose of interpretation. However, the rule applied only if the parties had, as a matter of

fact, determined that the whole of their contract would be in writing. Extrinsic material

could be considered to determine whether that was or was not the case.

United States observers distinguish between jurisdictions which apply a “hard parol

evidence rule” and those which apply a “soft parole evidence rule”. In the former, there is

a strong presumption that a contract which appears to be final and complete on its face

should be accepted as such. In the latter, the presumption is more readily overridden by

extrinsic evidence.

21 See Chartbrook Ltd v Persimmon Homes Ltd [2009] UKHL 38; [2009] 1 AC 1101; [2009] 4 All ER 677; [2009] 3 WLR 267 at [36]–[37].22 See, eg, A Berg, “Thrashing through the Undergrowth” (2006) 122 LQR 354; R Calnan,”Construction of Commercial Contracts; a Practitioners Perspective” in A Burrows and E Peel (Eds), Contract Terms, Oxford University Press, Oxford, 2007, p17.23 I set out the references in my article, aboven9.

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Australian case law contains statements of both kinds. Older cases emphasise that the

presumption is “strong”.24 More recent cases, manifesting the drift from text to context,

suggest the text is little more than evidence.25 The High Court has emphatically

confirmed that the parol evidence rule remains part of our law.26 The position is not so

clear in England where the Law Commission, many text writers and some judges, treat

the rule as a historical footnote of little practical significance in view of developments

commencing with Lord Wilberforce's "factual matrix" formulation.

Matters of fact and degree arise on the spectrum between a “hard” parol evidence rule

approach and a “soft” or “non-existent” parol evidence rule approach. One matter on

which the line can still be held is the effect given to entire agreement clauses.

For major contractual relationships a detailed document is usually prepared. It is rare to

find one that does not include an entire agreement clause. Where the parties have

expressly stated that the written document represents the whole of their agreement then,

short of rectification or the application of some other collateral doctrine, that clause

should, in my opinion, be given full and clear effect. If reference to extrinsic evidence is

admissible in some circumstances to determine the true agreement between the parties,

surely the assertion that the true agreement is contained entirely in the document is

entitled to at least substantial, and usually determinative, weight in this very respect. In

any event, such a clause resolves the preliminary question for the application of the parol

evidence rule. This is a contract wholly in writing.

The second traditional restraint is the requirement to identify ambiguity in the text before

relying on surrounding circumstances. This requirement has been attenuated, like the

parol evidence rule to which it is closely related, by the movement from text to context.

The identification of an “ambiguity” is of particular significance in the case of insurance

contracts, eg, in the application of the contra proferentem principle.

A conclusion of “ambiguity” does not involve a simple yes or no answer derived from a

clear pattern of logical reasoning. There are degrees of ambiguity. It does not simply

matter that more than one meaning is open, but also how seriously the less literal

meaning should be regarded as open. By reason of the wonderful flexibility of the English

language, to which I have referred, a conclusion that more than one interpretation of

ordinary words is possible is actually very common. Differences of approach will

determine how “open” a particular meaning will be taken to be.

There are numerous statements in the case law that, where the words are sufficiently

clear, it is not the role of the courts to make a better bargain, or even a reasonable,

24 See, eg, Major v Bretherton (1928) 41 CLR62 at 67; [1928] ALR 281; (1928) 2 ALJR 73; BC2800017; Gordon v McGregor (1909) 8 CLR 316 at 323;15 ALR 274; [1909] HCA 26; BC0900046; L G Thorne & Co Pty Ltd v Thomas v Barthwick & Spas Ltd (1956) 56SR (NSW) 81 at 88.25 See, eg, State Rail Authority of NSW v Heath Outdoor Pty Ltd (1986) 7 NSWLR 170 at 191; Masterton Homes Pty Ltd v Palm Assets Pty Ltd (2009) 261 ALR 382; [2009] NSWCA 234; BC200907137 at [90].26 Equuscorp Pty Ltd v Glengallan Investments Pty Ltd (2004) 218 CLR 471 especially at [33]-[36]

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bargain for the parties.27 Clarity of language is, on its face, an objective test, so is

“beauty” which, notoriously, lies in the eye of the beholder.

What keeps the scope for divergence within acceptable limits is the professionalism and

collegiality of the judiciary and appellate supervision. My concern is that such processes

have, over recent decades, given inadequate weight to the central significance of

certainty in interpreting commercial texts.

Commercial purpose

Perhaps the most frequently cited proposition, with respect to the interpretation of

commercial contracts, is that they must be given a “business like” interpretation or that

they must be interpreted in order to serve the “commercial purpose” of the contract. There

is nothing particularly new about giving commercial contracts a “business like”

interpretation.

In 1893 the Lord Chancellor said: “A business sense will be given to business

documents.”28

Further, in 1927 one Law Lord said: “Commercial contracts are to be interpreted with

regard to the circumstances of commerce with which they deal, the language used by

those who are parties to them, and the objects which they are intended to secure.”29

More recently the following formulation of Lord Diplock has been frequently cited: “If

detailed semantic and syntactical analysis at words in a commercial contract is going to

lead to a conclusion that flouts business common sense, it must be made to yield to

business common sense”30

However, as a joint judgment of the High Court put it: „Business common sense‟ is

something on which reasonable minds may differ and in respect of which an imputed

consensus of an objective character is simply impossible. 31

The “business like” approach is a worthy, albeit somewhat vague, instruction which does

not, in my opinion, take into account the fact that commercial contracts are not all of the

same character.

“A businesslike” or “business common sense” test applies flexible terminology giving rise

to questions of fact and degree about which it is considerably less likely that the

hypothetical reasonable observer will come to only one conclusion. Once a significant

subjective element is introduced into the interpretive process, the result will vary from one

interpreter to another.

27 See, eg, George & Goldsmiths & General Burglar Insurance Association [1899] 1QB595 at 609; Trickett v Queensland Insurance Co Ltd [1932] NZLR 1727 at 173228 Glynn v Margetson & Co [1893] AC 351 at 359; [1891-4] All ER Rep 693;(1863) 62 LJQB 466.29 Lake v Simmons [1927] AC 487 at 509 per Viscount Sumner; [1927] All ER Rep 49; (1927) 96 LJKB 621; (1927)137 LT 233.30 See The Antaios [1985] AC 191 at 201; [1984] 3 All ER 229; [1984] 3 WLR 592; [1984] 2 Lloyd”s Rep 23531 See Maggbury Pty Ltd v Hafele Australia Pty Ltd (2001) 210 CLR 181; 185 ALR 152; [2001] HCA 70; BC200107781 at [11].

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However, taking the well established principle at face value, it remains necessary to give

substantial weight to the requirements of commercial certainty, which is the principal

objective of reducing commercial arrangements to an agreed text. This objective is

emphasised in many cases by the adoption of an entire agreement clause, to which full

force and effect should be known will be given.

It must be accepted that by the time a court or an arbitrator comes to interpret a contract,

this essential commercial purpose has failed in the instant case. However, it remains

pertinent, not least as a precedent, to approach the task of interpretation on the basis that

a significant commercial purpose of the written agreement was to state the obligations of

the parties with sufficient certainty to avoid the very dispute that has eventuated. The

further one travels beyond the text the less likely it is, that, that commercial purpose will

be served.

Numerous cases state that a result that can be appropriately characterised as “absurd”,

or which provides benefits under a contract that are “illusory”, will lead to an interpretation

that avoids such a result.32 Such a test is consistent with certainty. It involves a high level

of objectivity, which minimises the scope for divergence of views. It can safely be

presumed that commercial parties did not intend an “absurd” or “illusory” result.

However, there is a range of judicial formulations which allow greater scope for

subjectivity and which could permit a judge to achieve what s/he may regard, in the

commercial circumstance of a particular case, to be a fair and reasonable result. What do

we do with such formulations that appear in the case law as:

The “more reasonable” interpretation or the more reasonable construction.33

“Unreasonable, commercially inconvenient or highly detrimental to one side”.34

“Commercially inconvenient”.35

“The contract would operate in a commercial and realistic way”.

“An unrealistic result . . . promote a sensible commercial result”.36

“Commercially sensible construction”.37

“Construed to make commercial sense”.38

32 Biotechnology Australia Pty Ltd v Pace (1988) 15 NSWLR 13033 Hide & Skin Trading Pty Ltd v Oceanic Meat Traders Ltd (1990) 20 NSWLR 310 at 313–14.34 Pegela Pty Ltd v National Mutual Life Association of Australasia Ltd (2007) 14 ANZ Ins Cas 90-131; [2006] VSC 507; BC20061121635 Hide & Skin Trading Pty Ltd v Oceanic Meat Traders Ltd (1990) 20 NSWLR 310 at 313–14.36 Consolidated Bathurst Exports Ltd v Mutual Boiler & Machinery Insurance Co (1980) 1 SCR 888 at 901–2; Non Marine Underwriters, Lloyds o fLondon v Scalera (2000) SSC 24; (2000) 1 SCR 551 at [72].37 Society of Lloyds v Robinson [1999] 1 WLR 756; [1999] 1 All ER (Comm) 545.38 Strzelecki Holdings Pty Ltd v Cable Sands Pty Ltd [2010] WASCA 222; BC201008728 at [77].

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It is difficult not to conclude that these various formulations are not in fact the application

of a test, but the statement of a conclusion that, for not fully articulated reasons, the

relevant result is too unreasonable. Many of the cases are a long way from a test of

absurdity or of an “illusory” obligation. As the NSW Court of Appeal said recently, when

affirming that, in the absence of ambiguity, only a finding of absurdity will permit a court to

fail to give effect to the language:

A finding of absurdity of operation is different in principle from a finding that a contract

would have an uncommercial or unbusinesslike meaning if given a particular meaning.39

In the context of contractual interpretation, the word “reasonable” must be deployed with

circumspection. What does it mean in a context where the interests of the parties conflict?

The word requires the application of some kind of value judgment about the issues

involved, in the context of the circumstances that in fact have arisen. By maximising the

scope for divergent interpretation, such language undermines the objective of certainty. A

test of absurdity or “illusory” or of “no commercial sense” does not.40

I accept that questions of fact and degree often arise in determining the scope of matters

that have been included in an insuring clause or which fall within the scope of an

exception or limitation clause. The greater the scope of the “background” or “surrounding

circumstances” that are able to be produced in evidence, the greater the degree of

discretion available to a judge seeking to reach a fair and reasonable result with the

benefit of hindsight, although no one ever says that is what is happening.

Divergence between Australia and England

A clear difference has emerged between Australian and English approaches to

contractual interpretation. The English approach has been followed in most other

common law jurisdictions. I doubt that Australian law will develop in the same way. In this,

as in some other respects, Australia is emerging as an outpost of common law and equity

orthodoxy. The extent of the divergence will be determined by the High Court in the

future.

There is, of course, much common ground between the Australian and English positions.

Specifically, the starting point, in contrast with that of civil law jurisdictions, is an objective

theory of contract; the process of interpretation is the ascertainment of the meaning by a

reasonable independent observer.

The High Court has often reaffirmed that the orthodox approach to interpretation is

objective.41 The purpose is to ascertain the intentions of the parties in an objective sense. 39 Jireh International Pty Ltd v Western Export Services Inc [2011] NSWCA 137; BC201103717 at [64].40 McGrath v Sturestens [2011] NSWCA 315; BC201107717 at [18].41 See Pacific Carriers Limited v BNP Paribas (2004) 218 CLR 451 and Toll (FGCR) Pty Ltd v Alphapharm Pty Ltd (2004) 219 CLR 165. 41 See Moneypenny v Moneypenny (1861) 9 HLC 114; 11 ER 671 at 684; Rickman v Carstairs (1833) 5 B & Ad 651; 110 ER 931; Smith v Lucas (1881) 18 Ch D 531 at 543; Drughorn v Moore [1924] AC 53 at 57; Joseph M Perillo “The Origins of the Objective Theory of Contract Formation and Interpretation” (2000) 69 Fordham L Rev 427 42 Life Insurance Company of Australia Ltd v Phillips (1925) 36 CLR 60 at 76 43 See Nolan v Clifford (1904) 1 CLR 429 at 449; R v Bolton; Ex parte Beane (1987) 162 CLR 514 at 518; Byrne v Australian Airlines Ltd (1995) 185 CLR 410 at 459; Wik Peoples v Queensland (1996) 187

13

It is not to determine the subjective intention of the parties. This is a longstanding

principle in contractual interpretation.42 As long ago as 1925, Justice Isaacs described it

in the following words “Few principles are more firmly entrenched in the law”.43

In this regard, the law of statutory interpretation and that of contractual interpretation are

the same. Accordingly, if a Minister in a Second Reading speech has expressed the

intention of the legislation that is not determinative. The task of the courts in statutory

interpretation is to determine what Parliament meant by the words it used. The courts do

not determine what Parliament intended to say.44

The same is true for contractual interpretation. The subjective intentions of the parties are

not admissible but, even if admitted on some other basis, e.g. as revealing the “factual

matrix” or commercial purpose or as relevant to a case based on misrepresentation,

estoppel or rectification, the courts will not have regard to any such subjective statements

on an issue of interpretation.

Notwithstanding the new influence of European law on the common law of England, Lord

Hoffmann retains the traditional objective approach to determining the intention of parties

to a contract. Nevertheless, he noted in his proposition (3) in Investors Compensation

Scheme that the exclusion of any declaration of subjective intent was an exception to the

basic rule and that “the boundaries of this exception are in some respects unclear”.45

Lord Bingham of Cornwall in re-expressing Lord Hoffmann”s judgment in Investors

Compensation Scheme appeared to indicate a firm view that the necessity of ascertaining

the party”s intentions is an objective one and did not suggest any change was likely. 46 In

this respect Australian authority is quite emphatic.47

It is easy to elide the relevant principles by using the language of “intention” of the parties.

It is always necessary, at least in Australia, to bear in mind that the concept of “intention”

in this sphere of discourse has no relationship to the subjective intention of the parties,

nor are we, unlike England affected by the European civil law with its subjective theory of

contract.48

As the High Court has expressed it:

References to the common intention of the parties to a contract

are to be understood as referring to what a reasonable person

would understand by the language in which the parties have

expressed their agreement. The meaning of the terms of a

CLR 1 at 168-168; Dossett v TKJ Nominees Pty Ltd (2003) 218 CLR 1 at [10] and see the authorities discussed in R v Young (1999) 46 NSWLR 681 at [5].42 43 44 45 For an analysis of the distinction between subjective and objective purposes in different jurisdictions see Aharon Barak Purposive Interpretation in Law, Princeton Uni Press, Princeton NJ (2005) at 336ff. 46 See Bank of Credit & Commerce International SA v Ali [2002] 1 AC 251 at [8]47 See, e.g. Codelfa supra at 351-352 and 406; Pacific Carriers supra at 461, and Alphapharm supra at 17948 Except in the context of the international sale of goods

14

contractual document is to be determined by what a reasonable

person would have understood them to mean. That, normally,

requires consideration not only of the text, but also of the

surrounding circumstances known to the parties, and the purpose

and object of the transaction.49

This much remains common to both jurisdictions. There are, however, some significant

differences. At present Australian law remains that stated by Justice Mason in Codelfa.50

The court accepted that evidence of surrounding circumstances, or the “factual matrix”,

can be taken into account, but limited its use in the following passage:

Evidence of surrounding circumstances is admissible to assist in

the interpretation of the contract if the language is ambiguous or

susceptible of more than one meaning, but it is not admissible to

contradict the language of the contract where it has a plain

meaning. Generally speaking facts existing when the contract

was made will not be receivable as part of the surrounding

circumstances as an aid to construction, unless they were known

to both parties, although if the facts are notorious knowledge of

them will be presumed.

His Honour went on to note that evidence of prior negotiations is only admissible if it

tends to establish “objective background facts which were known to both parties”.

Otherwise, not.

There are three matters that should be emphasised in this passage. First, is his Honour’s

use of the formulation “ambiguous or susceptible of more than one meaning”. Second, is

his Honour’s extension beyond what was “known to both parties” only to “notorious” facts,

and not to facts which either party ought to have known. Third, is the express statement

that surrounding circumstances are not admissible if the contractual language has “a

plain meaning”. This is a reaffirmation of the traditional parol evidence rule. I will return to

the significance of these features below.

The English law of contractual interpretation now finds its origins in a different set of

principles. I refer to Lord Hoffmann”s five point restatement of the principles of Investors

Compensation Scheme case,51 as subsequently affirmed and applied by the House of

Lords in Chartbrook,52 as follows:

49 See the joint judgment in Toll (FGCT)Pty Ltd v Alphapharm Pty Ltd (2004) 219 CLR 165; 211 ALR 342; [2004] HCA 52; BC200407463 at [40].50 Codelfa Construction Pty Ltd v State Rail Authority (NSW) (1982) 149 CLR 337; 41 ALR 367; [1982] HCA 24; BC8200083.51 Investors Compensation Scheme Ltd v West Bromwich Building Society [1998] 1 WLR 896 at 912–13; [1997] CLC 1243; [1998] 1 All ER 98. The parentheses indicate Lord Hoffmann”s qualification of the original formulation in Bank of Credit and Commerce International SA v Ali [2001] UKHL 8; [2002] AC 251 at 36.52 Chartbrook Ltd v Persimmon Homes Ltd [2009] UKHL 38; [2009] 1 AC 1101; [2009] 4 All ER 677; [2009] 3 WLR 267.

15

1. Interpretation is the ascertainment of the meaning which the document would

convey to a reasonable person having all the background knowledge which

would reasonably have been available to the parties in the situation in which they

were at the time of the contract.

2. The background was famously referred to by Lord Wilber force as the “matrix of

fact‟, but this phrase is, if anything, an understated description of what the

background may include. Subject to the requirement that it should have been

reasonably available to the parties and to the exception to be mentioned next, it

includes absolutely anything which would have [been regarded as relevant by,

and therefore] affected the way in which the language of the document would

have been understood by, a reasonable man.

3. The law excludes from the admissible background the previous negotiations of

the parties and their declarations of subjective intent. They are admissible only in

an action for rectification. The law makes this distinction for reasons of practical

policy and, in this respect only, legal interpretation differs from the way we would

interpret utterances in ordinary life. The boundaries of this exception are in some

respects unclear. But this is not the occasion on which to explore them.

4. The meaning which a document (or any other utterance) would convey to a

reasonable man is not the same thing as the meaning of its words. The meaning

of words is a matter of dictionaries and grammar, the meaning of the document is

what the parties using those words against the relevant background would

reasonably have been understood to mean. The background may not merely

enable the reasonable man to choose between the possible meanings of words

which are ambiguous but even (as occasionally happens in ordinary life) to

conclude that the parties must for whatever reason, have used the wrong words

of syntax…

5. The “rule‟ that words should be given their “natural and ordinary meaning‟

reflects the common sense proposition that we do not readily accept that people

have made linguistic mistakes, particularly in formal documents. On the other

hand, if one would nevertheless conclude from the background that something

must have gone wrong with the language, the law does not require judges to

attribute to the parties an intention which they plainly could not have had.

Notwithstanding his general approach, Lord Hoffmann accepted, albeit without

enthusiasm, that it was too late for English courts to change the principle of English law

that pre-contractual negotiations were not admissible for the purpose of interpreting a

contract, save in the case of ambiguity or insofar as the negotiations demonstrated

knowledge of the relevant factual matrix. Accordingly, this remains the position in

16

England,53 as it is in Australia,54 Hong Kong55 and India.56 The position appears to be

different in Singapore.57 The position in New Zealand is not clear.58

Differences in Principle and Emphasis

Significant differences of principle, and of emphasis, emerge when comparing the

Hoffmann principles with Codelfa. Specifically:

The independent reasonable person is said to have “all the background knowledge which

would reasonably have been available to the parties”. The Australian position is that

relevant background must be known to both parties and not simply be “reasonably

available”.

This “background” is to be taken into account whether or not the text gives rise to an

ambiguity. This is probably not the position in Australia.

This “background” extends to “absolutely anything” which such a reasonable observer

would have regarded as “relevant” and therefore, could affect the way in which the

language is to be understood. No Australian authority has accepted so broad, indeed

unrestricted, a conception of relevant background. The traditional parol evidence rule has

not been attenuated, or become “soft”, in Australia.

With respect to the first difference, the position was affirmed by the NSW Court of Appeal

in an insurance case: QBE Insurance v Vasic.59

This was a coverage dispute. On this occasion it was QBE that sought to have regard to

material extrinsic to the policy wording. This included a statement by an insurance broker

as to the aim of the QBE policy and also a proposal and policy wording of a similar

insurance taken out by the insured at an earlier time with a different insurer. The Court of

Appeal affirmed that the principle in Australia is that material must be actually known to

the parties and not be “merely reasonably available to them”.60 The passage in Lord

Hoffmann”s principles referring to “background knowledge which would reasonably have

been available to the parties” was expressly rejected as inconsistent with Codelfa.61

53 Investors Compensation Scheme Ltd v West Bromwich Building Society [1997] CLC 1243; [1998] 1 All ER 98; [1998] 1 WLR 896 at 913; Chartbrook Ltd v Persimmon Homes Ltd [2009] UKHL 38; [2009] 1 AC 1101; [2009] 4 All ER 677; [2009] 3 WLR 267 at [28]–[42].54 Codelfa Construction Pty Ltd v State Rail Authority (NSW) (1982) 149 CLR 337 at 352; 41 ALR 367; [1982] HCA 24; BC82000083.55 Marble Holdings Ltd v Yatin [2008] HKCFA 29 at [21]–[22].56 See RG Padia (Ed), Pollock & Mulla”s Indian Contract and Specific Reliefs Act, 13thed, LexisNexis Butterworths, 2006, Vol1, p277.57 Zurich Insurance (Singapore) PTE Ltd v B-Gold Interior Design and Construction PTE Ltd (2008) 3 SLR 1029 at [81]. This is affirmed in extra judicial writing of one of the judges in the case. See VK Rajah, “Redrawing the boundaries of contractual interpretation; from text to context to pre-text and beyond” (2010)22 Singapore Academy of LJ 513 at [20] and subsequent analysis.58 See Vector Gas Ltd v Bay of Plenty Energy Ltd (2010) 2 NZLR 444 and the analysis of this case in Spigelman, above n8, at 423.59 QBE Insurance Australia Ltd v Vasic [2010] NSWCA 166; BC20100492360 Ibid at [20],[25]–[27] and see Movie Network Channels Pty Ltd v Optus Vision Pty Ltd [2010] NSWCA 111; BC201003145 at [97]–[100].61 See QBE Insurance v Vasic [2010] NSWCA 166; BC201004923 at [31]–[35].

17

With respect to the second difference, in England the Hoffmann principle has the

consequence that it is not necessary to identity any “ambiguity” before reference is

permitted to the background as broadly defined.62 In this respect the Australian law of

contractual interpretation probably diverges, at least at present, from the Australian law of

statutory interpretation, where a finding of ambiguity is not necessary before reference is

made to extrinsic materials.63 However, there are indications that the High Court is

changing its approach to the use of extrinsic material in statutory interpretation.64

It is not entirely clear whether, in Australia, a finding of ambiguity is still required. This

may turn on what Justice Mason meant by the addition of words beyond the reference to

“ambiguous” in Codelfa, ie, “if the language is ambiguous or susceptible of more than one

meaning”. I have expressed the view that what Justice Mason had in mind with these

additional words was to extend the word “ambiguity” to encompass situations in which the

scope or applicability of a particular verbal formation is doubtful,65 as he had done in the

case of statutory interpretation.66 On this view, Justice Mason was deploying the word

“ambiguity” in its more usual meaning of a verbal or grammatical ambiguity.

Some recent High Court decisions have stated the relevant principles without expressly

reasserting the necessity for ambiguity. Indeed, in one case, a majority joint judgment of

the High Court quoted, without comment, Lord Hoffmann”s reference to “background

knowledge which would reasonably have been available for the parties”.67 Some

intermediate Court of Appeal judgments have taken the view that the ambiguity

requirement has been dispensed with.68

Codelfa has never been over ruled by the High Court. The High Court has sometimes

refrained from formally overruling prior decisions, allowing them to be simply superseded

62 61 See also Westminster City Council v National Asylum Support Services [2002] UKHL 38; [2002] 4 All ER 654; [2002] 1 WLR 2956 at [5]; affirmed in Oceanbuilt Shipping and Trading SA v TMT Asia Ltd [2010] UKSC 44; [2011] 1 AC 662; [2010] 4 All ER 1011; [2010] 3 WLR 1424 at [36]. But cf Multilink Leisure Developments Ltd v North Lanarskshire Council [2010] UKSC 47; [2011] 1 All ER 175 at [11].This is also the position in other common law jurisdictions: Ansley v Prospectus Nominees Ltd [2004] 2 NZLR 590; (2004) 5 NZ ConvC 193,914; (2004) 10 TCLR 952 at [63]; Zurich Insurance (Singapore) Pte Ltd v P-Gola Interior Design Construction Pty Ltd (2008) 3 SLR 1029 at [62].63 See, eg, the analysis of the caselaw Spigelman, above n2, at 324–5.64 See JJ Spigelman, “The Intolerable Wrestle: Developments Statutory Interpretation”(2010) 84 ALJ 822; Wicks v State Rail Authority (NSW) (2010) 241 CLR 60; 267 ALR 23; [2010] HCA 22; BC201004005; Westport Insurance Corporation v Gordian Runoff (2011) 281 ALR 593; [2011] HCA 37; BC201107579.65 See South Sydney Council v Royal Botanic Gardens (1999) 10 BPR 18, 961; [1999] NSWCA 478; BC9908533 at [35].66 Commencing in K & S Lakes City Freighters Pty Ltd v Gordon & Gotch Ltd (1985) 157 CLR 309 at 315; 60 ALR 509; [1985] HCA 48; BC8501100, as subsequently approved by majority joint judgments, eg, CIC Insurance Ltd v Bankstown Football Club Ltd (1997) 187 CLR 384 at 408; 141 ALR 618; [1997] HCA 2; BC9700046; Project Blue Sky Inc v Australian Broadcasting Authority (1998) 194 CLR 355; 153 ALR 490; [1998] HCA 28; BC9801389 at [69].67 Maggbury Pty Ltd v Hafele Australia Pty Ltd (2001) 210 CLR 181;185 ALR 152; [2001] HCA 70; BC200107781 at [11]; See also Toll (FGCT) Pty Ltd v Alphapharm P/L (2004) 219 CLR 165; 211 ALR 342; [2004] HCA 52; BC200407463 at [40]; IATA v Ansett Australia Holdings Ltd (2008) 234 CLR 151; 242 ALR 47; [2008] HCA 3; BC200800357 at [53].68 See Masterton Homes Pty Ltd v Palm Assets Pty Ltd (2009) 261 ALR 382; [2009] NSWCA 234; BC200907137 at [112]–[113]; Franklins Pty Ltd v Metcash Trading Ltd (2009) 76 NSWLR 603; 264 ALR 15; [2009] NSWCA 407; BC200911627 at [14]–[18], [239]–[305]; Coopers Brewery Ltd v Lion Nathan Australian Pty Ltd (2006) 156 FCR 1; 236 ALR 561; [2006] FCAFC 144; BC200608232 at [45]-[52], [98], [101], [254] and on appeal (2006) 156 FCR 1; 236 ALR 561; [2006] FCAFC 144; BC200608232 at [45]–[52], [98], [100] and [254]; Home Building Society Ltd v Pourzand [2005] WASCA 242; BC200511240 at [25]–[32]; McGrath v Sturestens [2011] NSWCA 315; BC201107717 at [17]; MBF Investments Pty Ltd v Nolan [2011] VSCA114; BC201102273 at [197]–[202].

18

by subsequent formulations that cover the same field. However, the court has expressly

warned intermediate Courts of Appeal not to follow English decisions which appear to be

inconsistent with Codelfa.69 In the Royal Botanic Gardens case, the High Court expressly

stated that, in case there was a difference, lower courts should continue to follow Codelfa:

“It is unnecessary to determine whether their Lordships there

took a broader view of the admissible “background‟ than was

taken in Codelfa or, if so, whether those views should be

preferred to those of this Court. Until that determination is made

by this Court, other Australian courts, if they discern any

inconsistency with Codelfa, should continue to follow Codelfa.”70

In a recent judgment, two judges of the High Court noted that the decisions of

intermediate Courts of Appeal that proceeded on the basis that subsequent authority had

qualified Codelfa “must be read in the light” of this warning.71 Subsequently, a three

judge bench, when rejecting a special leave application on other grounds, dealt with a

submission that ambiguity was not required before surrounding circumstances could be

taken into account. Their Honours indicated that this proposition would require

reconsideration of Codelfa and rejected the proposition that subsequent High Court cases

had qualified Codelfa in this respect. Their Honours did not, however, address the

additional words in Justice Mason”s reasons in Codelfa.72

With respect to the third difference — the “absolutely anything” test — this is, inconsistent

with the reaffirmation by the High Court of the parol evidence rule. In Australia the parol

evidence rule remains in full force and effect.73 One of the reasons, forcefully, advanced

in the contemporary High Court case which reaffirmed the rule, is that the effect of

permitting oral evidence is to allow “difficult, time consuming, expensive and problematic”

disputation.74 Practical considerations of cost and delay in litigation, which undermine

commercial certainty, are amongst the reasons why pre-contractual negotiations remain

inadmissible.75

The somewhat anomalous maintenance in England of the exclusion of pre-contractual

negotiations is the last, albeit significant, remnant in England of the traditional parole

evidence rule.76

69 See Royal Botanic Gardens and Domain Trust v South Sydney Council (2002) 240 CLR 45; 186 ALR 289; [2002] HCA 5.70 See Royal Botanic Gardens & Domain Trust v South Sydney Council (2002) at 76 ALJR 436 at [39]71 Byrnes v Kendle (2011) 279 ALR 212; 85 ALJR 798; [2011] HCA 26; BC201105711 at n 135.72 Western Export Services Inc v Jireh International Pty Ltd [2011] HCA Trans 297 (28 October 2011).73 Spigelman, above n 8, at 415–1674 Equuscorp Pty Ltd v Glengallan Investments Pty Ltd [2004] 218 CLR 471; 211 ALR 101; [2004] HCA 55; BC200407555 at [35]; Ratfland Pty Ltd v Commissioner of Taxation (2008) 238 CLR 516; 246 ALR 406; [2008] HCA 21; BC200803682 at [33]; Royal Botanic Gardens & Domain Trust v South Sydney City Council (2002) 240 CLR 45; 186 ALR 289; [2002] HCA 5; BC200200231 at [99]–[103].75 Hope v RCA Photone of Australia Pty Ltd (1937) 59 CLR 348 at 357; 11 ALJR 357; [1937] HCA 9076 See Law Commission, Law of Contract: the Parol Evidence Rule, HMSO, London, 1986; and references set out in Spigelman, above n 8, at 414–15

19

Australian law still insists on a focus on the text and it is the departure from the text that

constitutes the exception.

The position in England is that, subject to certain exceptions, subsequent conduct is not

admissible.77 As it was put: “it is not legitimate to use as an aid in the construction of the

contract anything which the parties said or did after it was made”.78

These decisions have not, or at least not yet, been revisited since Lord Hoffmann’s

restatement. The principle that subsequent conduct is not available as an aid to

interpretation has been affirmed in Australia.79 However, the reaffirmation did not involve

detailed consideration of the various issues that arise in this respect.80

This position has also been affirmed in Hong Kong81 and in Malaysia.82 However, in

Singapore, subsequent conduct is probably admissible. It was placed in the same

position as precontractual negotiations, as discussed above.83

In India, evidence of subsequent conduct is admissible in certain circumstances for

purposes of construing a written agreement. There must, however, be some ambiguity in

the contract and particular weight appears to be given to conduct done shortly after the

date of a contract.84

In Gibbons Holdings, a majority of judges in the Supreme Court of New Zealand accepted

that subsequent conduct can be referred to for purposes of interpretation. However, the

doctrinal basis of this acceptance is unclear. Two of the judges would limit such evidence

to a situation in which the conduct was engaged in by both parties, another judge said

that even unilateral conduct was admissible, a further judge accepted that subsequent

conduct could be admissible, without adverting to this distinction and the fifth judge

reserved upon the admissibility of all subsequent conduct.85

I am generally critical of the expanded use of extrinsic material for purposes of

interpretation. However, the adverse commercial effects which concern me are unlikely to

arise if reference to conduct is limited along the lines adopted by the Indian courts. Where

there is ambiguity in the written contract, conduct shortly after it came into effect can be

revealing.

77 James Miller & Partners Ltd v Whitworth Street Estates (Manchester) Ltd [1970] AC 538 at 603, 606, 611 and 614-615; and, L Schuler AG v Wickman Machine Tool Sales Ltd [1974] AC 235 at 252, 260, 265-70, and 272-3.78 James Miller supra at 60379 Agricultural & Rural Finance Pty Ltd v Gardiner [2008] HCA 57; (2008) 238 CLR 570 at [35].80 See, eg, the range of authorities referred to in Hide & Skin Trading Pty Ltd v Oceanic Meat Traders Ltd (1990) 20 NSWLR 310 at 315-316; FAI Insurance Co Ltd v Savoy Plaza Pty Ltd [1993] 2 VR 343 at 346-351.81 Marble Holding supra at [21]-[22].82 Petroleum Nasional Bhd v Kerajaan Negeri Terengann [2004] 1 MLJ 8 at [31]-[33].83 See Zurich Insurance supra at [132(d)]; V K Rajah “Redrawing the Boundaries of Contractual Interpretation” (2010) 22 Singapore Academy of Law Journal 513 at [48].84 See Abdulla Ahmeda v Animerndra Kissen Mitter All India Rep (1950) SC 15 at [23]; R G Padia (ed) supra at 267-278 and Mark Beeley, “A Rose by Any Other Name? A Comparative Examination of the English and Indian Approaches to Contractual Interpretation” (2005) 6 Business Law International 630 at 137-138.85 Wholesale Distributors v Gibbons [2007] NZSC 37; [2008] 1 NZLR at [52]-[53], [73] and cf [134]-[136], see also [7] and [27].

20

The involvement of third parties The law of contractual interpretation focuses almost

exclusively, as does the law on contract, on the parties to the contract. Contract law has

not given effective consideration to the significance of contracts to others. It is where one

party to a contract wishes to deal with its interest in the contract that this issue becomes

critical. That is so, in my opinion, whether both parties are aware of the intention to so

deal at the outset or not.

One of the propositions advanced most forcibly by those, like myself, who are critical of

the expansion of materials available for the purpose of interpreting the words of a written

contract concerns the implications of this expansion upon the reasonable expectations of

third parties who are, and were known at the time of contracting to be, or likely to be,

interested in the performance of obligations under the contract. In most cases such third

parties will not know anything about the pre-contractual negotiations. This is a

consideration that nevertheless is of fundamental significance, not least to ensure

certainty in commercial transactions.

The underlying principle was well expressed by Lord Devlin when he said:

The development of the English law of contract has favoured the

pragmatic rather than the moral. This is not, I think, because the

English were less influenced by moral considerations than other

nations, but because at the time when the common law was

growing they were more interested than others in commerce and

so the common law of contract was designed mainly to serve

commerce. If a man minded only about keeping faith, the spirit of

the contract would be more important than the letter. But in the

service of commerce the letter is in many ways the more

significant. This is because in most commercial contracts many

more than the original parties are concerned. The contract is

embodied in a document which may pass from hand to hand

when the goods it represents are sold over and over again to a

string of buyers, or when money is borrowed on it, or insurances

arranged . . . For the common law, the sanctity of the contract

means the sanctity of the written word in the form in which it is

ultimately enshrined. Normally, evidence is not admissible of

conversations and correspondence leading up to the contract;

they cannot be used to amplify or modify the final document. The

document must speak for itself. For the common law has its eye

fixed as closely on the third man as on the original parties; and

the final document is the only thing that can speak to the third

man.86

86 Lord P Devlin, The Enforcement of Morals, Oxford University Press, Oxford, 1965, p 44.

21

In subsequent judgments, Lord Hoffmann elaborated on his original statement of the

principles of interpretation by outlining what I think was a key assumption that underlies

his five point scheme, namely that: Ordinarily… a contract is treated as addressed to the

parties.87

There are a number of judgments, including those of Lord Hoffmann, in which it has been

accepted the contractual documents were not addressed only to the parties to a contract,

eg, a bill of lading,88 the statutory contract constituted by the Memorandum

85

87

and Articles of Association of a company,89 or an interest in land recorded on a public

register.90

It has always been the case that third parties have dealt with one or other of the parties to

a contract with respect to their contractual rights and obligations under commercial

contracts. More often than not in large commercial transactions, loan agreements are

interrelated with an underlying basic contract between parties in a direct commercial

relationship. The financier is never far removed, usually to the knowledge of both parties

to a contract. However, in contemporary circumstances, most parties would assume that

there was a financier involved for many transactions. More significantly, it would also be

assumed that a financier may become involved after the contract has been executed.

Similarly, there have always been forms of dealing with contractual rights and obligations.

One thinks of dealings with book debts by way of factoring and the like. However, in

contemporary circumstances, virtually anything seems to be able to be securitised and

subsequently made the subject of derivatives of a character only a mathematician can

understand.

Such contemporary developments strongly suggest that third party involvement in

commercial transactions is now of a considerably different order to the past. This

challenges the general idea that a contract of commercial significance consists only of a

relationship between two parties.

I disagree with Lord Hoffmann”s statement that a contract is “ordinarily” addressed to the

parties alone.91 In my opinion, third party reliance on written contracts is common.

Accordingly, the parol evidence rule should be strictly applied in any case in which a third 87 86 Chartbrook Ltd v Persimmon Homes Ltd [2009] UKHL 38 at [80]; [2009]1AC1101at [38]; [2009] 4 All ER 677; [2009] 3 WLR 267. See also Homburg Houtimport B V v Agrosin Private Ltd [2003] UKHL 12; [2004] 1 AC 715; [2003] 2 All ER 785; [2003] 2 WLR 711 at [73].88 Homburg Houtimport BV v Agrosin Private Ltd [2003] UKHL 12; [2004] 1 AC 715; [2003] 2 All ER 785; [2003] 2 WLR 711 at [74]–[77].89 See cases set out in Spigelman, above n 1, at 336.90 See, eg, Westfield Management Ltdv Perpetual Trustee Co Ltd (2007) 233 CLR 528; 239 ALR 75; [2007] HCA 45; BC200708402 at [37]–[38], [40].

22

party will (or perhaps even might) rely on the terms of the written contract. A rigorous

application of the ambiguity requirement is also appropriate in any such context.

Alternatively the interests of third parties can be accommodated in Lord

88

89

90

Hoffmann”s scheme, by an express exclusion of the same character as his Lordship

accepted for pre-contractual negotiations. For similar reasons, although not yet explicitly

recognised, as a principle standard form contracts should always be given the same

meaning, subject to the application of doctrines such as estoppel or misrepresentation in

specific cases.92

The interests of third parties can be accommodated in Lord Hoffmann”s scheme. Either or

both parties to a contract may know that third parties will, or will probably, or may become

involved and that they would know little or nothing about the factual matrix or the

surrounding circumstances, let alone about the subjective intention of the parties.

However, it is, in my opinion, a significant defect in Lord Hoffmann”s schema that no

express provision is made in this regard.

The scope of contemporary involvement by third parties with one or other of the parties to

a contract, on the basis of the performance by the other party of its obligations, at least in

commercial contracts of any size or longevity, is such that it should now be assumed that

both parties are aware that the other party to the contract will, or may, (the test is yet to

be determined) deal with its contractual rights with third parties, whether as lenders or as

assignees or in some other capacity.

On that basis both parties should be aware that any such a third party would rely on, and

usually rely only on, the text of the agreement. Where a text purports or appears to be

comprehensive in such a context, resort to the factual matrix could well be restricted and

any suggestion of an expansion in the scope of “surrounding circumstance” in the

direction of “absolutely everything” should be resisted.

Conclusion

I do not doubt that surrounding circumstances, in the sense of the commercial context of

a contractual relationship, are relevant to the task of interpretation. However, the

91 Chartbrook Ltd v Persimmon Homes Ltd [2009] UKHL 38; [2009] 1AC 1101; [2009] 4 All ER 677; [2009] 3 WLR 267 at [38]; Spigelman, above n 8, at 432–3. The scope of third party involvement was also emphasised in argument in the recent special leave application which reaffirmed the requirement of ambiguity, see Western Export Services Inc v Jireh International Pty Ltd [2011] HCA Trans 297 at 4.92 See Agricultural & Rural Finance Pty Ltd v Gardiner (2008) 238 CLR 570; 251 ALR 322; [2008] HCA 57; BC200810883 at [38]; AIB Group (UK) Plc v Martin [2001] UKHL 63; [2002] 1 All ER 353; [2001] All ER (D) 177 (Dec); [2002] 1 WLR 94 at [7]; Dairy Containers Ltd v Tasman Orient Line CV [2004] UKPC 22; [2005] 1 NZLR 433; [2005] 1 WLR 215; [2004] 2 All ER (Comm) 667 at [12].

23

expansion of material now relied upon in this respect has gone too far. I identify a number

of desirable changes to recent practice in many jurisdictions.

(1) Affirm the parol evidence rule as a rule of interpretation and require clear

evidence that a written agreement, which appears complete on its face, was not.

(2) Prima facie, restrict the scope of admissible surrounding circumstances to

undisputed objective facts about the commercial context.

(3) Reaffirm the principle that ambiguity is required before other background facts,

known to both parties, are admissible.

(4) Apply a strict approach to the kind of latent ambiguity that is accepted for

purposes of (3).

(5) Affirm the principle that pre-contractual negotiations are not admissible.

(6) Restrict the admissibility of post-contractual conduct to a contract which is

ambiguous and to conduct engaged in shortly after the contract came into

operation.

(7) Establish a general exclusion to the admissibility of extrinsic evidence, including

post-contractual conduct, in any case in which a third party will (or even might)

rely on the written contract.

(8) Affirm the proposition that an entire agreement clause does restrict the use of

extrinsic material for purposes of interpretation, unless significant injustice would

arise from so doing.

(9) Restrict the right to discovery of documents and the right to subpoena third party

documents in litigation, so that each is available only with the leave of the court

after the identification of issues is dispute.

(10)Establish a principle that leave under (9) will only be given if it is established on

the balance of probabilities that documents of the character sought are both likely

to exist and likely to assist in the resolution of issues in dispute.

There is, I believe some evidence of a drift in Australian jurisprudence back towards a

greater focus on the text and away from reliance on extrinsic material. There is no

dramatic turning, just a gradual change in emphasis. A change in judicial approach of this

character will affect the degree to which a future High Court would be prepared to modify

Codelfa in the light of English developments.

I am not suggesting that literalism — often accompanied by words of derision like

“narrow” or “technical” — is back. However, there are indications of a change in judicial

style, a change which is and, if it continues, will be gradual and very important.