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Interpreting Contracts: More Art Than Science?

In litigation, the primary role of a judge is to interpret legal texts. In fact, it is estimated that interpreting legal texts comprises 90% of their work. There are many rules that are applicable to the interpretation of contracts, including:

  • Ejusdem generis: a rule for interpreting statutes and other writings by assuming that a general term describing a list of specific terms denotes other things that are like the specific elements.
  • Expressio unius est exclusio alterius: the express mention of one or more things of a particular class may be regarded as impliedly excluding others. Although the doctrine is useful in determining the extents of contracts, it is also an important principle in the interpretation of statutes.
  • Nocitur a sociis:  a doctrine or rule of interpretation: the meaning of an unclear or ambiguous word (as in a statute or contract) should be determined by considering the words with which it is associated in the context.
  • Contra proferentum: an ambiguous term of a contract will be interpreted against the party which proposed or drafted the contract or clause.

However, in the final analysis, legal interpretation does not generally depend on application of rules. It is an artful process, which requires intuition and consideration of factors that lie beyond the four corners of a contract.[1]

The Importance of Context

First and foremost, it must be understood that interpreting contracts is all about language, and language can never be understood properly by divorcing it from its context. When considering the language, one must consider what the words would convey to a reasonable person circumstanced as the parties are. A failure to do so would result in significant injustice.

A judge will consider all the contextual material in order to determine:

  1. The different meanings that may be derived from the text; and
  2. What is the best interpretation among competing solutions.

In the context of business contracts, the commercial reality is that contracts are in many instances imperfectly drafted. Uncertainty commonly arises in the interpretation of contracts where there is/are:

  • Textual ambiguity; 
  • Inconsistency between terms;
  • Inconsistency between a term and the contractual purpose;
  • Apparent drafting defect;
  • Absurdity or arbitrariness in operation; and
  • Operation or practical effect which defies commercial common sense.

Given the fast-paced nature of commercial operations, poor draftsmanship is not unexpected. This is another reason why contextual considerations is so imperative; to provide clarity in such instances of ambiguity borne by drafting error.

The purpose of the interpretation of a contract is not to discover how parties understood the language of the text; the aim is to determine the meaning of the contract against its objective contextual scene.

Verve v Woodside Energy

Electricity Generation Corp (Verve) v Woodside Energy [2014] HCA 7 is a leading case on commercial contract interpretation in Australia. The High Court was required to clarify and reaffirm, amongst other things, the meaning of a “reasonable endeavours” term of a contract.

Facts

Woodside and Apache supplied gas in Western Australia, and Verve was the buyer. An explosion ripped through Apache’s gas plant in 2008, inhibiting its operations for an extended period of time.

Woodside had an agreement (original agreement) with Verve to supply a guaranteed amount of gas on a daily basis and to use “reasonable endeavours” to make extra gas available to Verve if it needed. 

Since Apache was off-line and available to supply, Verve needed extra gas. In response, Woodside was shrewd; it informed Verve that for extra gas, Verve it would have to sign under a new agreement under which Verve was required to pay a higher price for an interruptible supply. Verve entered the new agreement, albeit under protest. 

Issue

The central dispute in the case was whether this breached Woodside’s obligation to use “reasonable endeavours” to supply additional gas requested under the original agreement. Verve alleged that Woodside were obliged to provide extra gas if such gas existed. Woodside argued, in essence, that the constrained supply situation and market demand at higher prices were commercial factors which they were properly entitled to take into account in deciding whether or not to supply additional gas.

High Court

Clause 3.3(a) of the original agreement stipulated that Woodside must use reasonable endeavours to make available the extra gas, however, 3.3(b) conditioned this clause by entitling Woodside to take into account its own commercial, economic and operational interests in relation to the suppliers of the extra gas.

In examining the conditioning clause 3.3(b) and the Agreement as a whole, the High Court reaffirmed its previous judgments and approach to the interpretation of commercial contracts, meaning that these contracts should be given a business-like interpretation.

In doing so, the High Court found that contractual obligations framed in terms of “reasonable endeavours” do not oblige a party to forego its business interests. The majority referred to Hospital Products Ltd v United States Surgical Corporation [1984] HCA 64, where it was held that the interests of the opposing party, “could not be paramount in every case“. Terrel v Mabie Todd & Co Ltd (1952) 69 RPC 234 was also referred to in the judgment, where it was held that reasonable endeavours would not require the achievement of a contractual objective to the “certain ruin of the company or with utter disregard of the interests of the shareholders.”

Thus, the High Court held that Woodside was not obliged to forego its business interest when using reasonable endeavours to supply extra gas available for delivery, and did not breach its obligation under the original agreement.

In reaching its conclusion, the High Court applied the following principles in commercial contract interpretation:

  1. Focus on objective meaning;
  2. Consider language, surrounding circumstances, commercial purpose or objects;
  3. Purpose or objects are informed by genesis, background, context and market; and
  4. Adopt a businesslike interpretation (a commercial result not commercial nonsense or inconvenience).

The decision in Verve v Woodside supports the notion that contract interpretation involves drawing conclusions based on the spirit of the text within what we know about the text. It is the drawing of conclusions respecting subjects that lie beyond the direct expression of the text from the elements known from and given in the text – conclusions which are in the spirit, though not within the letter of the text.[2]

Have a question on interpreting contracts?

Contact our client engagement team to make an appointment with one of our commercial litigation team today. Call (07) 3252 0011.


Footnotes

[1] The Intractable Problem of the Interpretation of Legal Texts, Johan Steyn

[2] Legal and Political Hermeneutics (1859) Francis Lieber, p56


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