Interpreting contracts - implied terms and prior negotiations

Friday 16 July, 2021

When people enter into a contract, they usually try to make the terms of the contract as clear as possible and anticipate any issues that might arise when carrying out the contract. Unfortunately, sometimes they overlook issues which becomes a problem further down the track, or circumstances change in ways that they did not anticipate. This can lead to disputes between the parties about the meaning of the contract. When the courts resolve these disputes, they must consider what outside evidence they can use to determine the meaning and how far beyond the actual text they can go. Sometimes the contract does not cover the issue, so the courts have to decide if they should imply a new term into the contract.

There has been significant controversy about bringing external evidence into contractual interpretation, both in New Zealand and overseas. The Supreme Court has just released a long-awaited decision on evidence in contractual interpretation disputes and implied terms. The dispute in this case related to the timing of payments for the sale of coal mining rights and whether a royalty deed allowed the owner of the rights to stop mining operations. At issue was the interpretation of the Agreement for Sale and Purchase.

Approach to contractual interpretation

The Court affirmed that the correct approach to the interpretation of contracts was objective, asking what a reasonable person, with all relevant background knowledge, would think the contract meant. Words should generally be given their natural and ordinary meaning, unless it would lead to an outcome that was contrary to business common sense or unless the evidence showed that the parties to the contract had intended a different meaning. Under the Evidence Act 2006, evidence relating to the meaning of the contract is admissible, unless it is unfairly prejudicial or might prolong the proceedings unnecessarily.

Admissibility of prior negotiations or subsequent conduct

Some overseas courts do not allow evidence of prior negotiations, but in New Zealand it is allowed if it is relevant to finding the objective meaning of the contract. Undeclared negotiating positions or subjective intentions or beliefs are not relevant, unless the intention or belief was communicated to the other party and their response indicates a mutual understanding of the meaning of words in the contract. Subsequent conduct is likewise admissible if relevant to finding the objective meaning, but post dispute conduct is very unlikely to be relevant.

Implying terms into a contract

The Court restated and refined the law as to when it is acceptable for a court to imply a term into a contract. The Court summarised the approach to implied terms as follows:

• Courts can only imply a term if it is strictly necessary, which is a high threshold.
• The starting point is the text of the contract. If an eventuality is not provided for, the usual inference is that the parties did not provide for it.
• The court can only imply an unexpressed term if it would make the meaning of the contract clear, read against the relevant background to the contract.
• As with interpretation, the approach is objective.
• The court does not need proof of the parties’ actual intention nor should it speculate on what they would have wanted.
• The term must be capable of clear expression and must not contradict any express term of the contract.
• The conditions that the implied term be necessary to give business efficacy or entirely obvious are overlapping analytical tools, not cumulative.

Conclusion

This decision provides useful clarification on the approach to contractual interpretation in New Zealand, widening the scope of evidence that can potentially be admitted in contractual disputes. However, the overarching test remains whether the evidence is relevant to finding the objective interpretation of the contract and the Court’s insistence on the application of the provisions of the Evidence Act means that the courts are unlikely to be overwhelmed with unnecessary or subjective evidence in contractual disputes.

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