Contract Construction in the High Court of Australia

US Supreme Court Justice Oliver Wendell Holmes Jr once famously said that words are but ‘the skin of a living thought’Towne v Eisner (1918) 245 US 418, 425. When it comes to construing contracts, it is the thoughts themselves (regarded objectively) that courts must ascertain and apply.

The vast majority of cases involving the construction of contracts are determined by orthodox principles of interpretation, which for the most part, focus far more on the internal content of a contract than the external context.

Yet most judicial, practitioner and academic debate focusses on the extent to which recourse may be had to evidence of surrounding circumstances in construing contracts, even though most real life cases do not often hinge on the distinction between ambiguous and plain language.

The High Court of Australia has delivered 9 decisions expressly dealing with the interpretation of contracts since the year 2000 (listed below), yet reconciling their reasoning is no easy task.

Therefore a must read for commercial lawyers is NSW Supreme Court Justice Robert McDougall's recent paper "Construction of Contracts - the High Court's Approach" (26 June 2015).

Justice McDougall observes that "the question of whether – or more accurately, 'to what extent' – evidence of surrounding circumstances is admissible as an aid to the construction of contracts is a still a live issue".

It is clear enough that one starts with the 'true rule'  laid down by Mason J (with whom Stephen and Wilson JJ agreed) in Codelfa Construction Pty Ltd v State Rail Authority of New South Wales (1982) 149 CLR 337, 352:

"The true rule is that 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 when it has a plain meaning."

Carefully reconciling those 9 decisions, Justice McDougall explains that an open view - and in his opinion, the best view - of Codelfa is that it prescribes three distinct purposes for which extrinsic evidence can be “admitted”, and two prohibited purposes for which it cannot be “used”. Although his Honour concedes this is not the only possible reading of Codelfa, or even necessarily the best reading of Codelfa from a policy perspective, "it appears to be the reading that most convincingly harmonises these otherwise disparate authorities".

His Honour identifies the permitted purposes as (1) where there is ambiguity in the language of the contract; (2) to identify the meaning of a descriptive term, and (3) to explain the genesis or aim of a transaction. He then observes that Codelfa expressly prohibits the use of extrinsic evidence: (1) To contradict the language of the contract when it has a plain meaning; or (2) To establish subjective intentions of the parties, even where shared by both parties.

In adopting his framework, McDougall J effectively splits the ‘true rule’ in half, treating the existence of ambiguity as a basis for admissibility, and the existence of a plain meaning as a bar against the use of extrinsic evidence to contradict it.

Thus Codelfa shows that extrinsic evidence is always admissible in the evidentiary sense. The ‘true rule’ is directed at the probative purpose of the evidence (that is, whether or not it can shine light on the meaning of words) rather than, by its terms, the reception of evidence; it is clear that ‘admissibility’ in the true rule means ‘admissible... in some particular reasoning process’, or synonymously, ‘useable’ or ‘applicable’.

Dated: 23 July 2015

Dominique Hogan-Doran is an Australian commercial barrister based in Sydney. 

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