All questions

Contract interpretation

i Interpretation of commercial contracts

Australian courts adopt a common-sense approach to the interpretation of commercial contracts. The terms of a contract will be construed objectively to determine what a reasonable business person would have understood the words to mean, having regard to the language used by the parties and their context, including the surrounding circumstances known to them and the commercial purpose or objects to be secured by the contract.9 The courts undertake the task of contractual interpretation pragmatically on the basis that the parties intended to produce a commercial result and will, therefore, construe a contract's terms to avoid a commercially nonsensical or inconvenient interpretation.10

To appreciate the commercial purpose of a contract, Australian courts look to understand the origin and background of the transaction as well as the context and market in which the parties operate.11 The context of a contract is derived from its entire text as well as any contract, document or statutory provision referred to in the contract.12 These factors are not considered to be 'extrinsic' to the contract and may be taken into account without offending common law or the statutory rules of evidence discussed below.

ii Admissibility of extrinsic evidence in contractual interpretation

Where a contract has been reduced to writing, extrinsic material, such as evidence of the parties' prior negotiations, is generally inadmissible for the purpose of contradicting the plain meaning of a contractual provision.13 In those circumstances, Australian courts will determine the meaning of what the parties recorded in the written agreement, not what the parties contend they intended to say.14

Apart from affording contracting parties consistency in interpretation, and therefore a greater measure of commercial certainty, there is also a pragmatic underpinning of this rule of evidence, as observed by the Court of Appeal of Western Australia:

Difficulties and expense may arise not only from disputed oral communications, but also from the parties inviting the court to parse and construe the (often significant) volume of pre-contractual emails and the like, which themselves may be redolent with equivocation (deliberate or otherwise) and ambiguity.15

There are a number of exceptions to the general prohibition against the admissibility of extrinsic evidence. Extrinsic evidence may be admissible when used for limited purposes, such as assisting the court to identify the commercial purpose or objects of the contract,16 particularly where that task of contractual interpretation is facilitated by an understanding of the origin and background to the contract, its context and the market in which the parties operate.17 Extrinsic evidence may also be admissible to assist in the interpretation of a contract where the language is ambiguous18 or in determining the proper construction of a contractual term where there exists a 'constructional choice' (a choice between two interpretations that are reasonably open on the plain wording of the contract).19