The modern approach to contract interpretation

Author: Khaled Metlej

Publish Date: Aug 31, 2011

The decision of the House of Lords ICS Ltd v West Bromwich Building Society [1998] 1 WLR 896 (“ICS”) heralded a new approach to contract interpretation. No longer were Courts bound to uphold interpretations of contracts which the parties could not have intended. Instead, Courts were tasked to ascertain the meaning a “document would convey to a reasonable person having all the background knowledge which would reasonably have been available to the parties …” (ICS at 912). The High Court of Australia has since adopted the ICS approach to contract interpretation: Pacific Carriers Ltd v BNP Paribas [2004] HCA 35 and Toll (FGCT) Pty Ltd v Alphapharm Pty Ltd [2004] HCA 52 at [40].
 
As is evident from the New South Wales Court of Appeal’s decision in Jireh International Pty Ltd v Western Export Services [2011] NSWCA 137 (per Macfarlan JA, Young JA, and Tobias AJA), Australian Courts have had some difficulty in applying leaving behind the “old intellectual baggage of “legal” interpretation” leading to confusion in the basic approach to contract interpretation in Australia.  Jireh concerned the interpretation of a “Letter Agreement” which provided, inter alia, that WES should receive a commission of 5% for products sold by Jireh International to Gloria Jeans Stores in Australia (Clause 3).
 
With the effect of circumventing its arrangements with WES, Jireh International contracted with a related Australian entity, JIWD, to sell the products it imported into Australia to Gloria Jeans Stores. WES contended that the clause 3 of the Letter Agreement applied so as to make Jireh International liable to pay the commission on products sold by JIWD to Gloria Jeans Stores. Jireh International contended that the Letter Agreement applied only to sales made by it to the Gloria Jeans stores.
 
At first instance, it was found by the trial judge that, on the question of construction of clause 3, “on the plain English meaning of the words, there is no ambiguity and no warrant to read in the words ‘or an associated entity’ in cl 3 where they do not appear.” It was also held that JIWD did not sell as agent for Jireh International. On appeal, the New South Wales Court of Appeal held that the operation of clause 3, on its plain and unambiguous meaning, gave an “unbusinesslike operation”, although not an absurd operation(Macfarlan JA at [64]). Macfarlan  JA (with whom the Court agreed) held that, in the absence of ambiguity in the language, an unbusinesslike interpretation (which was not an absurd interpretation) was required to be upheld (Macfarlan  JA at [64]).
 
At least since the House of Lord’s decision in ICS, the law of contract does not require a Court to uphold a meaning of a contract which the parties did not intend. Objectively ascertained, the parties could not have intended that clause 3 operate in an unbusinesslike manner. That the Court of Appeal would not depart from an “unbusinesslike” literal interpretation in the absence of an ambiguity in the contract is inconsistent with the principles in ICS and prior NSW Court of Appeal authority.
 
Since Lord Hoffmann’s restatement of the approach to commercial interpretation in ICS, Australian Courts have accepted that ambiguity is not required before a Court can resort to background materials to discern the meaning that parties to a contract intended.  In Franklins Pty Ltd v Metcash Trading Ltd [2009] NSWCA 407, in referring to the decision in ICS, Giles JA (with whom Campbell JA agreed at [305]), stated (at [49]) that: “I agree that, as the law has developed, it is not necessary to find ambiguity in the words of a written contract before going to context and purpose in the construction of a contract.”
 
In the present instance, the Letter Agreement between Jireh International and WES recorded the terms of an arrangement with some informality. Particularly in cases where an agreement has been recorded informally, a Court should avoid seeking to apply a plain meaning rule to the construction of an agreement. The observations of Moore Bick LJ in Ravennavi SpA v New Century Shipbuilding Co Ltd [2007] 2 Lloyds Rep 24 at [12] are pertinent:
 
“Unless the dispute concerns a detailed document of a complex nature that can properly be assumed to have been carefully drafted…detailed linguistic analysis is unlikely to yield a reliable answer. It is far preferable, in my view, to read the words in question fairly as a whole in the context of the document as a while and in light of the commercial and factual background known to both parties in order to ascertain what they were intending to achieve.”
 In consideration of the relevant circumstances known to both parties at the time the contract was made, WES would be instrumental in the development of the Gloria Jeans franchise in Australia. As found by trial judge at first instance (as quoted by Macfarlan JA at [299]), it is not conceivable that the parties could have intended that Jireh was free to circumvent its arrangements with WES by importing products for JIWD instead of supplying directly to franchisees.
 
 Once the intention of the parties, objectively ascertained, is indentified, “there is not, so to speak, a limit on the amount of red ink or verbal rearrangement or correction which the court is allowed. All that is required is that it should be clear that something has gone wrong with the language and that it should be clear what a reasonable person would have understood the parties to have meant…” (Chartbrook Ltd v Persimmon Homes [2009] 1 AC 1101 at p1113-1114).
 
As the Court of Appeal accepted that the plain meaning of clause 3 produced an “unbusinesslike operation”, there is a strong argument that the NSW Court of Appeal did not apply the modern approach to contract interpretation in upholding a contract which was inconsistent with the objective intention of the parties.
 
Interpreting contracts can now no longer be confined to looking at the meaning of words. As was made plain by Lord Hoffmann in Manni Investment Co. Ltd v Eagle Star Life Assurance Co. Ltd. [1997] AC 749 (at 775), the Court must:
“distinguish between the meanings of words and the question of what would be understood as the meaning of a person who uses the words… It is that background the enables us, not only to choose the intended meanings when a words has more than one dictionary meaning but also…to understand a speaker’s meaning, often without ambiguity, when he has used the wrong words.”
Parties to a contract may have “used the wrong words” but may have communicated their meaning tolerably clearly. The modern approach to contract interpretation requires Courts to uphold the meaning the parties intended (objectively ascertained), and not the meaning of words.
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