Since a court will not consider what the parties to a contract actually meant, a contract should be carefully and clearly worded.

There's a surprising belief among business and even some lawyers that when interpreting a contract, the clear words of the contract can be displaced by evidence of a party's actual (subjective) intention. This belief can lead them to be less than rigorous when drafting a contract, because they assume that their subjective intent will trump (or at the least serve to clarify) the words of the contract. It is also a belief that can lead to expensive court battles.

The importance of getting the clear words of a contract right has been underscored by the High Court in Byrnes v Kendle [2011] HCA 26, which confirmed that the parties subjective intent is generally irrelevant to the interpretation of a contract. The Court also considered when the surrounding circumstances of a contract can be examined. Unfortunately, it didn't take the opportunity to clarify whether surrounding circumstances can be examined where the language of the contract has a plain meaning.

Subjective intention of the parties is generally not relevant

When a court is asked to interpret a contract, it uses a two-step process:

  • first, what are the terms of the contract?
  • secondly, what do they mean objectively?

The purpose is to give effect to the intentions of the parties as expressed in the contract, objectively assessed.

The interpretation of a contract does not depend upon the subjective intention or mental state which parties may have had but did not express, except in limited circumstances.

Justices Gummow and Hayne make it clear in their joint judgment that the fundamental question when interpreting contracts is "What is the meaning of what the parties have said?", and not "What did the parties mean to say?".

When will parties' subjective intentions matter?

The High Court confirmed that there are limited exceptions where the subjective intention will be relevant, which includes a challenge, claim or allegation involving:

  • mistake or misrepresentation or undue influence or unconscionable dealing or other equitable fraud;
  • non est factum or duress defences;
  • estoppel;
  • illegality;
  • a sham;
  • a condition not been satisfied; or
  • rectification.

There is the additional exception mentioned in Codelfa Construction Pty Ltd v State Rail Authority of New South Wales (1982) 149 CLR 337: evidence of subjective intention is admissible when both parties reject an inference to be drawn from the surrounding circumstances of a contract. This depends, however, on whether the language of the contract is clear to begin with.

Looking at the surrounding circumstances of a contract when the language is unclear

The relevant (objective) intention is determined only as revealed in the words used by the parties, amplified by the facts known to both parties. But what do we mean by "the facts known to both parties", sometimes described as the "factual matrix" or "surrounding circumstances"? And when are they relevant?

Where the language used in a contract is unclear, the court is left to determine the meaning from the surrounding circumstances and the subjective intention of the parties will still be irrelevant.

An examination of the surrounding circumstances does not permit examination of the pre-contractual negotiations when used for the purpose of drawing inferences about what the contract meant, unless it demonstrates knowledge of the surrounding circumstances.

Looking at the surrounding circumstances of a contract when the language is clear

There has been some uncertainty as to when the surrounding circumstances can be considered if the language is not ambiguous. This stems from the English case of Investors Compensation Scheme Ltd v West Bromwich Building Society [1998] 1 WLR 896 – does it use a different rule to that in Codelfa? If so, which should prevail?

Justices Heydon and Crennan referred to the High Court's decision in Royal Botanic Gardens and Domain Trust v South Sydney City Council, which said that until such as time as the High Court decided on whether there were differences between Investors Compensation and Codelfa, the latter case should prevail in Australia.

Codelfa may be seen to limit the use of extrinsic material: "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".

Lessons for drafting a contract

As noted above, it's surprising how many people think that what they actually meant by the words in a contract will be relevant if there is a dispute about what the words mean. The High Court has yet again sought to disabuse them of this belief.

Since subjective intent will generally not be considered, a contract should be carefully worded. If there may be ambiguity, you should not only attempt to clarify the actual words of the contract, but also express the intended meaning of those contractual clauses to the other party in writing prior to execution.