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LECTURE 6

TERMS OF A CONTRACT

EXPRESS TERMS

INTRODUCTION

Express terms are those explicitly included in the contract by the parties. In many
cases this will not present any difficulties. However, there are cases where the identity
of express terms is not at all clear. The following examples can serve as introductions
to a number of principles used in identifying the express terms of a contract.

Example 1

X and Y undertook lengthy negotiations relating to the sale of Xs Ford
motor vehicle to Y for $5,000. During the negotiations, X stated that the
car was a 1996 model Ford. After the contract was completed Y
discovered that the Ford was a 1994 model, and therefore worth somewhat
less as a trade-in than a 1996 model.

Is the statement by X as to the year model a term of the contract, with the
consequence that X is in breach of contract? In other words, did X
promise to sell a 1996 Ford or simply a Ford? If it is the former, X is
liable to Y for damages for breach of contract, whereas in the latter case
there is no liability for damages because there is no breach of contract.

Example 2

P agreed to lease his farm to Q and a detailed written lease agreement was
prepared by P for the parties to sign. The written lease agreement covered
all the terms one would generally expect to find in a contract of this type.
Q was in agreement with all of its terms. However, before Q signed the
lease, he sought an assurance from P that the drainage system on the farm
was in good working order. The written agreement prepared by P was
silent on this matter. P promised Q that the drainage system was in
excellent condition. Q signed the lease. Q later discovered that the
drainage system was not in good working order.

Can Q sue P for breach of contract in relation to the fact that the drainage
system is not working as promised by P? In other words, does the promise
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made by P about the drainage system amount to an express term in a
contract between P and Q?

TERMS AND REPRESENTATIONS

Example 1 above raises the question of whether Xs statement was a term of the
contract or merely a representation. This is crucial because, if Xs statement is false
and it is held to be a term, X is in breach of contract and liable to Y for damages. If
the statement is a mere representation, it lacks any contractual force and X cannot be
liable for damages for breach of contract. However, a false representation may
constitute a misrepresentation, with the consequence that X may be able to rescind the
contract. Alternatively, the false representation may attract various remedies for
breaching the statutory prohibition of misleading and deceptive conduct.

In ascertaining whether statements such as the one made by X are terms or mere
representations, see Ellul & Ellul v Oakes (1972) 3 SASR 377; Hospital Products Ltd
v United States Surgical Corporation (1984) 156 CLR 41 at 61; Oscar Chess Ltd v
Williams [1957] 1 All ER 325; Dick Bentley Productions Ltd v Harold Smith (Motors)
Ltd [1965] 2 All ER 65; JJ Savage & Sons Pty Ltd v Blakney (1970) 119 CLR 435 at
442

COLLATERAL CONTRACTS

Example 2 above raises the issue of collateral contracts. Ps assurance as to the
condition of the drains could amount to a contract that is separate and distinct from
the written lease. The separate contract is referred to as a collateral contract. Indeed,
in De Lassalle v Guildford [1901] 2 KB 215, on very similar facts to Example 2, a
collateral contract was found to exist. In relation to collateral contracts see Heilbut
Symons & Co v Buckleton [1913] AC 30 at 47; Shepperd v The Council for the
Municipality of Ryde (1952) 85 CLR 1 at 12.

The elements of a collateral contract are: (i) that the statement is promissory in nature;
and (ii) that there is no inconsistency between the main contract and the alleged
collateral contract.
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Promissory Nature of the Statement

For a person to establish a collateral contract he or she must establish that he or she
entered into the main contract in consideration of the statement made by the
representee. See Heilbut Symons v Buckleton, at 51; JJ Savage & Sons v Blakney.

Inconsistency

The alleged collateral contract cannot contradict a term of the main contract. See
Hoyts Pty Ltd v Spencer (1919) 27 CLR 133. What is the effect of an entire
agreement clause? See DKB Investments Pty Ltd v Belcote Pty Ltd (1991) 105 FLR
429 at 431; Inntrepreneur Pub Company (GL) v East Crown Ltd [2000] 2 Lloyd's Rep
611 at 613. Can the principles of equitable estoppel set out in Waltons Stores
(Interstate) Ltd v Maher (1988) 164 CLR 387 or s 52 of the Trade Practices Act 1974
(Cth) provide an alternative remedy?

PAROL EVIDENCE RULE

Example 2 above also raises the application of the parol evidence rule. The parol
evidence rule contains two parts, namely, (i) the exclusion of extrinsic evidence that
would add to, subtract from or vary the terms of a written contract; and (ii) the
exclusion of extrinsic evidence that would otherwise have assisted the court in
interpreting or construing the contract. Our concern here is with the first part of the
rule. The operation of the second part of the rule will be analysed below.

What is covered by the expression extrinsic evidence? See Codelfa Construction Pty
Ltd v State Rail Authority of New South Wales (1982) 149 CLR 337 at 347. To what
contracts does the parol evidence rule apply? See Codelfa Construction, at 347;
Hospital Products, at 61, 89-90, 120. What is the justification for the rule? See
Bacchus Marsh Concentrated Milk Co Ltd v Joseph Nathan & Co Ltd (1919) 26 CLR
337 at 451-2.

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On the parol evidence rule see also LG Thorne & Co Pty Ltd v Thomas Borthwick &
Sons (A/Asia) Ltd (1955) 56 SR (NSW) 81 at 88; State Rail Authority of New South
Wales v Heath Outdoor Pty Ltd (1986) 7 NSWLR 170 at 191-2; Hope v RCA
Photophone of Australia Pty Ltd (1937) 59 CLR 348 at 357-8, 363, 364, 368; Hart v
McDonald (1910) 10 CLR 417

Exceptions to the Parol Evidence Rule

The parol evidence rule is not absolute. Some of the more significant exceptions to
the rule include permit the use of extrinsic evidence to in relation to contingent
contracts : (Pym v Campbell (1856) 119 ER 903); implied terms; recification of
contracts; and collateral contracts (De Lassalle v Guildford and L G Thorne v Thomas
Borthwick & Son).

INCORPORATION OF TERMS BY SIGNATURE

Here we are concerned with the effect of a person signing a document containing
terms of a contract. Signature will ordinarily bind a party to the terms even if the
signatory has not read or understood the terms set out in the document (the signature
rule): LEstrange v F Graucob Ltd [1934] 2 KB 394. On the signature rule see Toll
(FGCT) Pty Ltd v Alphapharm Pty Ltd (2004) 211 ALR 342; Equuscorp Pty Ltd v
Glengallan Investments Pty Ltd (2004) 211 ALR 101 at 108-09, DJ Hill & Co Pty Ltd
v Walter H Wright Pty Ltd [1971] VR 749; Warmings Used Cars Ltd v Tucker [1956]
SASR 249.

Exceptions to the Signature Rule

In LEstrange it was held that the signature rule did not apply to situations where
documents are signed as the result of fraud or misrepresentation. This exception also
extends to signatures obtained as the result of duress, unconscionable conduct and
undue influence. As is noted in Toll the principle of non est factum a species of
mistake also operates as an exception. The non est factum principle will be analysed
later in this book in the lecture on mistake.

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One of the more significant exceptions to the signature rule is where the signature has
been induced by misrepresentation. See Curtis v Chemical Cleaning & Dyeing Co Ltd
[1951] 1 KB 805

INCORPORATION OF TERMS BY NOTICE

Although notice is not a factor in relation to cases where the signature rule applies, it
is a crucial factor in cases of unsigned documents or writing on signs which are
alleged to be part of a contract. In such cases the clauses contained set out in the
unsigned document or on the sign will not be terms of the contract unless notice of
them has been given to the party alleged to be bound by them. There are two major
aspects of the notice rule. They are: (i) the timing of the notice, and (ii) the
reasonableness of the notice.

Timing of Notice

When must notice be given? See Baltic Shipping Co v Dillon (1991) 22 NSWLR 1 at
25; Olley v Malborough Court Ltd [1949] 1 KB 532; Oceanic Sun Line Special
Shipping Co Inc v Fay (1988) 165 CLR 197; Thornton v Shoe Lane Parking Ltd
[1971] 2 QB 163 at 169.

Reasonableness of the Notice

If a party actually knows that the document or sign contains contractual terms then he
or she is bound, irrespective of whether the document or sign has been read: Parker v
South Eastern Railway Co (1877) 2 CPD 416 at 423. In the absence of actual
knowledge, the delivery of the document or the placing of the sign must be done in
such a way that the other party can be taken to have been given reasonable notice of
the terms. In this context is the nature of the document relevant? See Parker, at 422;
Causer v Browne [1952] VLR 1; Oceanic Sun Line Shipping v Fay, at 229; Thornton
v Shoe Land Parking; Interfoto Picture Library Ltd v Stiletto Visual Programmes Ltd
[1989] QB 433.

INCORPORATION OF TERMS BY PRIOR DEALINGS
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What is envisaged here is that parties have regularly contracted in the past on the
same terms. However, on a particular occasion a contract is entered into without
expressly incorporating the terms used in the past. In some cases the terms of the past
contracts are incorporated into the later contract. What is the key concept that is
relevant here? See Henry Kendall & Sons v William Lillico & Sons Ltd [1969] 2 AC
31 at 113. For illustrations see Hollier v Rambler Motors (AMC) Ltd [1972] 2 QB 71;
Henry Kendall v William Lillico; DJ Hill v Walter H Wright.

IMPLIED TERMS

INTRODUCTION

Implied terms can be categorised as follows:

(i) terms implied to give efficacy to a particular contract based upon the facts and
circumstances of a particular case;
(ii) terms which the law finds in a certain class of contract, either pursuant to the
common law or statute, although those terms may not find specific expression
in the contractual statements or documents of the parties;
(iii) terms implied into a contract to give effect to a notorious custom or usage in a
particular trade, industry or locality.

Terms implied in fact or by custom can be described as sub-categories of the broader
category of terms which are implied into a contract to give effect to the presumed
intentions of the parties. Terms implied by law do not depend on the intentions of the
parties and are implied on more general considerations: Lister v Romford Ice and
Cold Storage Co Ltd [1957] AC 555 at 576. Who has the onus of proof in establishing
implied terms? See Heimann v The Commonwealth (1938) 38 SR (NSW) 691 at 695-
6; Codelfa at 346. Note also Roxborough v Rothmans of Pall Mall Australia Pty Ltd
(2001) 208 CLR 516 at 575-6.

IMPLICATION OF TERMS ON THE FACTS OF A CONTRACT

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In this category of implied terms a court is asked to imply a particular term on the
basis of the specific facts and circumstances of the case before it. The rules to be
applied depend upon whether the contract is formal or informal.

Formal Contracts

In BP Refinery (Westernport) Pty Ltd v Shire of Hastings (1977) 180 CLR 266 at 282-
3, the Privy Council listed the five requirements necessary to be satisfied as follows:

Their Lordships do not think it necessary to review exhaustively the
authorities on the implication of a term in a contract which the parties
have not thought fit to express. In their view, for a term to be implied the
following conditions (which may overlap) must be satisfied: (1) it must be
reasonable and equitable; (2) it must be necessary to give business
efficacy to the contract, so that no term will be implied if the contract is
effective without it; (3) it must be so obvious that it goes without saying;
(4) it must be capable of clear expression; (5) it must not contradict any
express term of the contract.

This statement has been approved by the High Court many times. Each of the BP
Refinery elements will be examined in turn.

Equitable and reasonable

See Byrne v Australian Airlines Ltd (1995) 185 CLR 410 at 442; Codelfa, at 346.

Necessary to give business efficacy to the contract

Note State of New South Wales v Banabelle Electrical Pty Limited (2002) 54 NSWLR
503 at 521-2 and see The Moorcock (1889) 14 PD 64.

So obvious it goes without saying

See Codelfa, at 355-6, 374; Heimann, at 695.

Capable of clear expression

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The requirement that a term be capable of clear expression is one which has two
elements. First, the term upon which the parties would have agreed had the matter at
issue been drawn to their attention must be clear. Second, the term to be implied must
be one capable of being formulated with a sufficient degree of precision.

Consistency with express terms

The requirement of consistency with the express terms of the contract requires that the
term said to be implied does not contradict the effect of the express terms of the
agreement and does not deal with a matter which the contract deals with adequately.

Informal Contracts

The elements in BP Refinery will be applied in cases of formal and detailed written
contracts. The question that arises is the relevance of the BP Refinery elements in
cases of less formal and/or verbal contracts. See Byrne v Australian Airlines, at 442.

IMPLICATION OF TERMS BY LAW

The implication of terms by law can be from pursuant to statute or the common law.
The implication of such terms reflects policy considerations rather than the intentions
of the parties.

Terms Implied by Statute

Important statues that imply terms include legislation such as Sale of Goods Act 1923
(NSW) and the Trade Practices Act 1974 (Cth).

Terms Implied by Common Law

In deciding whether a term is implied by the common law a two part test is used.
First, the court must determine the type or class of contractual relationship to which
the term would apply. Second, the court must determine that the term is appropriate
for all contracts in that type or class of contract. To satisfy the second requirement the
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test of necessity is used. The court needs to be satisfied that implication of the term is
necessary in the sense that if the term is not implied the enjoyment of the rights
conferred by the contract would be or could be rendered nugatory, worthless, or,
perhaps, be seriously undermined: Byrne v Australian Airlines, at 450. See Liverpool
City Council v Irwin [1977] AC 239.

An important example of terms implied by the common law is with employment
contracts. What are terms implied into employment contracts? Do they include a term
to the effect that that an employer will not, without reasonable and proper cause,
conduct himself in a manner likely to destroy or seriously damage the relationship of
confidence and trust between employer and employee? See Eastwood v Magnox
Electric plc [2005] 1 AC 503 at 522.

Can terms be implied into all contracts or is the principle confined to implication of
terms in certain types of contracts? See Peters (WA) Ltd v Petersville Ltd (2001) 205
CLR 126 at 142; Spira v Commonwealth Bank of Australia (2003) 57 NSWLR 544 at
551-2.

Implied Term of Good Faith

A more controversial issue in implied terms is whether there is an implied term in
commercial contracts that parties will act reasonably and in good faith. A majority of
the Court of Appeal in New South Wales held such a term arose in the context of a
construction contract in Renard Constructions (ME) Pty Ltd v Minister for Public
Works (1982) 26 NSWLR 234. A later New South Wales case of Burger King
Corporation v Hungry Jacks Pty Ltd [2001] NSWCA 187 saw the implication of
such a term in the context of a development agreement between a franchisor and
franchisee. The implication of such a term was supported in Victoria in the context of
a franchise agreement in Far Horizons Pty Ltd v McDonalds Australia Ltd [2000]
VSC 310 and by the Western Australian Supreme Court in the context of a process
contract in Dockpride Pty Ltd v Subiaco Redevelopment Authority [2005] WASC 211.
Doubts as to the existence of such an implied term are voiced in the Federal Court
decision of Service Station Association Ltd v Berg Bennett & Associates Pty Ltd
(1993) 45 FCR 84 at 95-8; 117 ALR 393 at 404-07, the Western Australian Full Court
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decision in Central Exchange Ltd v Anaconda Nickel Ltd (2002) 26 WAR 33 at 52,
and in Esso Australian Resources Pty Ltd v Southern Pacific Petroleum NL [2005]
VSCA 228 at [25], where Buchanan J A, speaking for the Victorian Court of Appeal,
said:

I am reluctant to conclude that commercial contracts are a class of
contracts carrying an implied term of good faith as a legal incident, so that
an obligation of good faith applies indiscriminately to all the rights and
power conferred by a commercial contract. It may, however, be
appropriate in a particular case to import such an obligation to protect a
vulnerable party from exploitive conduct which subverts the original
purpose for which the contract was made. Implication in this fashion is
perhaps ad hoc implication meeting the tests laid down in BP Refinery
(Westernport) Pty. Ltd. v. Shire of Hastings, rather than implication as a
matter of law creating a legal incident of contracts of a certain type.

In Royal Botanic Gardens and Domain Trust v South Sydney Council (2002) 186
ALR 289 at 301, 327, six High Court judges left open the question of whether there
was such an implied term. Kirby J , at 312, also left the question open but did opine
that such an implied term appears to conflict with fundamental notions of caveat
emptor that are inherent (statute and equitable intervention apart) in common law
conceptions of economic freedom and that [i]t also appears to be inconsistent with
the law as it has developed in this country in respect of the introduction of implied
terms into written contracts which the parties have omitted to include.

According to Paterson, Robertson and Heffey (2005), at 299, the justification for an
implied term of good faith is said to be the need to ensure an acceptable level of co-
operation and fairness in contract performance. However, such concerns may already
be met by existing principles of contract law. This is conceded by Paterson, Robertson
and Heffey(2005), at 300, where they state the following:

[T]here are a number of traditional doctrines that may, in appropriate
cases, have the effect of promoting fair dealing or at least precluding
egregious conduct in the performance of a contract. For example, as a
matter of construction, an apparently broad contractual right might be
qualified by reference to the other terms of the contract or the surrounding
circumstances. Terms may be implied in law or fact to regulate parties
conduct. The doctrines of estoppel or election may qualify the exercise of
contractual rights. A duty of good faith may not go any further than these
doctrines regulating contract performance. It might nonetheless be argued
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that the recognition of a duty of good faith and fair dealing is important
because it would directly acknowledge the relevance of good faith and fair
dealing to contractual relationships. Conversely, critics of a duty of good
faith argue that there is little reason to adopt a duty of largely unknown
content unless the existing doctrines are shown to be inadequate or in need
of reform.

If an implied term of good faith is accepted as part of Australian contract law, the
following questions arise:

(i) to what contracts does it apply?
(ii) what is the meaning of the term?
(iii) can a duty of good faith be excluded?

The Application of the Implied Term

In relation to the first question, in cases considered by appellate courts in Australia,
none have explicitly stated that an implied term of good faith applies to all
commercial contracts. In Vodafone Pacific Ltd v Mobile Innovations Ltd [2004]
NSWCA 15 at [191], the Court of Appeal suggested that, given the width and
indeterminancy of the expression commercial contracts, caution should be
exercised before any court ruled that such a clause applied to all such contracts.
Furthermore, the court, at [198]-[200], regarded the presence of a whole of
agreement clause as inconsistent with the implication of an obligation to act in good
faith. In Tomlin v Ford Credit Australia [2005] NSWSC 540, at [119], McDougall J
ruled that where a power is given to one party to be exercised in its sole discretion so
as to bind the other, the terms of the contract are inconsistent with [an implied term
constraining] the exercise of that power by considerations of reasonableness or good
faith. In such circumstances there can be no implied term of good faith.

On the other hand in a number of first instance decisions in New South Wales, Barrett
J has stated that an implied term of good faith is included in all commercial contracts:
Overlook v Foxtel [2002] NSWSC 17 at [62]; Softplay Pty Ltd v Perpetual Trustees
(WA) Pty Ltd [2002] NSWSC 1059 at [9]. In Commonwealth Development Bank of
Australia Ltd v Cassegrain [2002] NSWSC 965 at [210], Einstein J was less dogmatic
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when he suggested that such a term will usually be implied by law into commercial
contracts made between parties at arms length.

The Meaning of the Term

As to the meaning of the implied term of acting in good faith, in Burger King, at
[171], the Court of Appeal adopted a statement made by Sir Anthony Mason at a
lecture in Cambridge in 1993 in which Mason said that the implied term of good faith
embraced the following three related notions:

(1) an obligation on the parties to co-operate in achieving the
contractual objects (loyalty to the promise itself);
(2) compliance with honest standards of conduct; and
(3) compliance with standards of conduct which are reasonable
having regard to the interests of the parties.

The third notion mentioned by Mason is probably the most helpful. In Overlook v
Foxtel, at [65], Barrett J noted that the essence the duty of good faith suggests a
demand that parties conduct themselves in accordance with standards of conduct
which are honest, as well as being reasonable having regard to the parties interests.
In a contract between X and Y, this does not mean that X is required to subordinate
his or her own interests to those of Y, provided that Xs pursuit of those interests does
not result in an unreasonable interference with Ys enjoyment of any benefit conferred
upon him or her by an express term of the contract.

In Overlook v Foxtel, at [67], Barrett J summed up the duty of good faith as follows:

Viewed in this way, the implied obligation of good faith underwrites the
spirit of the contract and supports the integrity of its character. A party is
precluded from cynical resort to the black letter. But no party is fixed with
the duty to subordinate self-interest entirely which is the lot of the
fiduciary: Burger King at para 187. The duty is not a duty to prefer the
interests of the other contracting party. It is, rather, a duty to recognise and
to have due regard to the legitimate interests of both the parties in the
enjoyment of the fruits of the contract as delineated by its terms.

Burger King provides an useful illustration of the application of the implied term of
good faith. In that case Burger King Corporation franchised its fast food business in
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Australia to Hungry J acks, but also retained the right to operate restaurants by itself.
Following various disputes between the parties a number of new agreements were
entered into by the parties in 1990. Pursuant to one of these agreements, the
Development Agreement, Hungry J acks was, (i) given an unrestricted, but non-
exclusive, right to develop restaurants in Australia and, (ii) required to develop at
least 4 restaurants each year in Western Australia, South Australia and Queensland. In
complying with the Development Agreement Hungry J acks was required to obtain
operational, financial and legal approvals from Burger King for each of the new
restaurants. The agreement stipulated that the granting of approvals was at the sole
discretion of Burger King. From 1993 Burger King decided to take a more active role
in developing its restaurants in Australia itself and by 1995 started to freeze the
recruitment of franchisees by Hungry J acks as well as refusing the approvals required
by the Development Agreement. These actions effectively impeded the development
of restaurants by Hungry J acks. In 1996 Burger King terminated the agreement on
the ground that Hungry J acks had failed to develop the required number of
restaurants. Hungry J acks then sued Burger King for damages for breach of contract
alleging that Burger King had breached an implied term to act in good faith.

The Court of Appeal found in favour of Hungry J acks. The court ruled that the
freezing of recruitment of franchisees and the refusal to grant approvals amounted to
breaches of an implied obligation to act in good faith. The court noted that these
activities were clearly motivated by the desire to increase the number of restaurants
operated by Burger King itself at Hungry J acks expense. The court also held that the
actions of Burger King amounted to breaches of express terms of the Development
Agreement.

The Exclusion of the Term

On the issue of whether an express term purporting to exclude any duty of good faith,
Australian cases are divided. From the perspective of basic principle, given that the
term as to good faith is implied by law, it should be able to be excluded by a clear
express term to that effect or by the presence of any other term that is inconsistent
with a duty of good faith. Cases such as Burger King, at [173] and Central Exchange
v Anaconda Nickel, at 52, support this view. Some doubt on this view was expressed
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in GEC Marconi Systems Pty Ltd v BHP Information Technology Pty Ltd (2003) 128
FCR 1 at 208-09 where Finn J observed that, notwithstanding the basic principle
mentioned above, it is, perhaps, difficult to envisage an express provision authorising
dishonesty and opined that it was a real question yet to be decided by the Australian
courts as to whether an the implied term of good faith could be excluded from a
contract.

IMPLICATION OF TERMS BY CUSTOM

A term may be implied into a contract to incorporate a relevant custom in a particular
market, trade or locality. The leading case here is Con-Stan Industries of Australia Pty
Ltd v Norwich Winterthur Insurance (Australia) Ltd (1986) 160 CLR 226, esp at 237-
8.

CONSTRUCTION OF CONTRACTUAL TERMS GENERALLY

INTRODUCTION

The process of identifying the terms of a contract has been discussed above. This part
of the lecture deals with the principles used by courts in interpreting the words used in
those terms. This process is usually referred to as the construction of terms of the
contract. The process of construction involves two things, namely, the meaning of the
words used and the legal effects or significance of those terms: Life Insurance Co of
Australia Ltd v Phillips (1925) 36 CLR 60 at 78.

This lecture will examine the process of construction of terms of a contract under two
headings, namely:

the meaning of the terms of a contract, and
the construction of exclusion clauses, in particular.

THE MEANING OF THE TERMS OF A CONTRACT

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General Principles

In ascertaining the meaning of the terms of a contract the court is primarily concerned
with determining the intention of the parties: Australian Broadcasting Commission v
Australasian Performing Right Association Limited (1973) 129 CLR 99 at 109.
Furthermore, in construing terms a court will seek to adopt a construction that will
preserve the validity of the contract and in that regard will strive to avoid holding
agreements, in particular commercial agreements, void for uncertainty: Meehan v
Jones (1982) 149 CLR 571 at 589.

In construing terms no hard and fast rules apply. The construction [of contractual
terms] is a composite exercise, neither uncompromisingly literal nor unswervingly
purposive: International Fina Services AG v Katrina Shipping Ltd (The Fina Samco)
[1995] 2 Lloyds Rep 344 at 350. Indeed [t]here has been a shift from literal methods
of interpretation towards a more commercial approach: Sirius International
Insurance Company (Publ) v FAI General Insurance Limited [2005] 1 All ER 191 at
200. The justification for this shift was explained in Mannai Investment Co Ltd v
Eagle Star Life Assurance Co Ltd [1997] AC 749 at 770-1, where Lord Steyn said:

In determining the meaning of the language of commercial contract, and
unilateral contractual notices, the law therefore generally favours a
commercially sensible construction. The reason for this approach is that a
commercial construction is more likely to give effect to the intention of
the parties. Words are therefore interpreted in the way in which a
reasonable commercial person would construe them. And the standard of
the reasonable commercial person is hostile to technical interpretations
and undue emphasis on niceties of language.

In Peppers Hotel Management Pty Limited v Hotel Capital Partners Limited [2004]
NSWCA 114 at [66]-[72], McColl J A set out a number of general principles which
she saw as relevant to the construction of contractual terms. They are:

(i) In interpreting a written contract a court is involved in the ascertainment
of the meaning which the document would convey to a reasonable person
having all the background knowledge which would reasonably have been
available to the parties in the situation in which they were at the time of
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the contract: Investors Compensation Scheme Ltd v West Bromwich
Building Society [1998] 1 All ER 98 at 114, per Lord Hoffmann, cited with
approval by the High Court in Maggbury Pty Ltd v Hafele Australia Pty
Ltd (2001) 210 CLR 181 at 188. (The approach of Lord Hoffmann was re-
affirmed in the House of Lords a few months after the decision in Peppers
Hotel by Lord Steyn in Sirius International Insurance v FAI General
Insurance, at 200.)
(ii) In a commercial contract, if words are ambiguous or susceptible of more
than one meaning, a court, having regard to the origins of the transaction,
its context and the market in which the parties are operating, should
ascertain the contracts commercial purpose in order to give the contract a
sensible commercial operation: Codelfa at 352, per Mason J .
(iii) Where the words of a written contract are unambiguous the court must
give effect to them, even if the result is capricious or unreasonable, even if
one could reasonably surmise that the parties did not intend such a result.
However, if the language used is open to two constructions, preference is
to be given to the one which avoids such capricious or unreasonable
results: Australian Broadcasting Commission v Australasian Performing
Right Association Limited at 109-110.
(iv) It is presumed that parties to written contracts did not intend their terms to
operate unreasonably. Thus, the more unreasonable the result a particular
construction of the terms would produce, the less likely it is that such an
interpretation reflects the parties intentions. However, if the parties did
intend to produce an unreasonable result, such an intention must be
abundantly clear from the words used: L Schuler AG v Wickman Machine
Tool Sales Limited [1974] AC 235 at 251.
(v) Where internal inconsistencies in a contract arise a court can depart from
the ordinary meaning of the words used insofar as it is necessary to avoid
an inconsistency arising a particular term of the contract and the remainder
of its terms: Australian Broadcasting Commission v Australasian
Performing Right Association at 109.
(vi) A court should construe a commercial contract fairly and broadly, without
being too astute or subtle in finding defects: Australian Broadcasting
Commission v Australasian Performing Right Association Limited at 109.
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(vii) Where a detailed semantic and syntactical analysis of a written contract
leads to a conclusion that is inconsistent with business commonsense the
contract must be made to yield to business commonsense What objectively
amounts to business commonsense may itself be a topic upon which
minds may differ and in respect of which an imputed consensus is
impossible: Maggbury v Hafele Australia, at 198.

The summary of principles set out by McColl J A, whilst useful to a point is not
without its difficulties. In point (i) her Honours reference to the House of Lords
decision in Investors Compensation v West Bromwich Building Society, is to a
principle in which Lord Hoffmann did not restrict a court from referring to the
surrounding circumstances of a case to situations involving the use of ambiguous
language in the contract. However, in point (ii) her Honour appears to do just that.
Point (ii) reflects the principle advanced by Mason J in Codelfa that extrinsic
evidence is admissible as an exception to the parol evidence rule to clarify ambiguous
language used by the parties. Indeed McColl J As judgment reflects the confusion on
this issue that has arisen as a result of recent decisions of the High Court. As noted by
McColl J A, Lord Hoffmanns statement was approved by the High Court in
Maggbury v Hafele Australia. It was also referred to, with seeming approval, in Royal
Botanic Gardens and Domain Trust v South Sydney Council at 301. More recently, in
Toll v Alphapharm at 352, the High Court adopted the principle of objectivity by
which the rights and liabilities of the parties to a contract are determined and went on
to say:

It is not the subjective beliefs or understandings of the parties about their
rights and liabilities that govern their contractual relations. What matters
is what each party by words and conduct would have led a reasonable
person in the position of the other party to believe. References to the
common intention of the parties to a contract are to be understood as
referring to what a reasonable person would understand by the language in
which the parties have expressed their agreement. The meaning of the
terms of a contractual document is to be determined by what a reasonable
person would have understood them to mean. That, normally, requires
consideration not only of the text, but also of the surrounding
circumstances known to the parties, and the purpose and object of the
transaction.

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This statement is clearly consistent with the view espoused by Lord Hoffmann.
However, in Royal Botanic Gardens, the High Court, at 301, somewhat unhelpfully
left open for a future time the question as to whether Lord Hoffmanns approach was
broader or preferable to that of Mason J in Codelfa, with the instruction to other
Australian courts that, in the meantime, if they discern any inconsistency between the
two approaches, they should continue to follow Codelfa. In following this
instruction, subsequent Australian courts have been in disagreement.

Exclusion of Evidence the Parol Evidence Rule

As noted above, the parol evidence rule contains two parts. The first part is concerned
with the exclusion of extrinsic evidence that would add to, subtract from or vary the
terms of a written contract. Our concern here is with the second part of the rule which
deals with the exclusion of extrinsic evidence that would otherwise have assisted the
court in interpreting or construing the contract.

In its operation relating to the construction of contracts, the parol evidence rule
excludes extrinsic evidence of a number of matters that would otherwise be relevant
in ascertaining the intention of the parties in relation to the meaning of a written
agreement.

Thus, the parol evidence rule excludes extrinsic evidence of the prior negotiations of
the parties. The justification for this approach was explained in Prenn v Simmonds
[1971] 3 All ER 237 at 240-1, where Lord Wilberforce said:

The reason for not admitting evidence of these exchanges is not a
technical one or even mainly one of convenience ... It is simply that such
evidence is unhelpful. By the nature of things, where negotiations are
difficult, the parties' positions, with each passing letter, are changing and
until the final document, though converging, are still divergent. It is only
the final document that records a consensus. ... The words used may, and
often do, represent a formula which means different things to each side,
yet may be accepted because that is the only way to get agreement and
in the hope that disputes will not arise. The only course then can be to try
to ascertain the natural meaning. Far more, and indeed totally,
dangerous is to admit evidence of one party's objective - even if this is
known to the other party. However strongly pursued this may be, the other
party may only be willing to give it partial recognition, and in a world of
19
give and take, men often have to be satisfied with less than what they
want. So, again, it would be a matter of speculation how far the common
intention was that the particular objective should be realised.

However, evidence of prior negotiations is admissible in some circumstances. In
Codelfa at 352, Mason J said:

It is here that a difficulty arises with respect to the evidence of prior
negotiations. Obviously the prior negotiations will tend to establish
objective background facts which were known to both parties and the
subject matter of the contract. To the extent to which they have this
tendency they are admissible. But in so far as they consist of statements
and actions of the parties which are reflective of their actual intentions and
expectations they are not receivable. The point is that such statements and
actions reveal the terms of the contract which the parties intended or
hoped to make. They are superseded by, and merged in, the contract itself.
The object of the parol evidence rule is to exclude them, the prior oral
agreement of the parties being inadmissible in aid of construction.

As to whether the parol evidence rule excludes evidence of the conduct of the parties
subsequent to the entry into of the contract, judicial opinion is unclear. High Court
decisions such as Maynard v Goode (1926) 37 CLR 529 at 538 and Administration of
the Territory of Papua New Guinea v Daera Guba (1973) 130 CLR 353 at 446,
suggest that evidence of such conduct is inadmissible. On the other hand, in other
cases the High Court has suggested that evidence of subsequent conduct can be used:
Farmer v Honan (1919) 26 CLR 183 at 197 and Howard Smith & Co Ltd v Varawa
(1907) 5 CLR 68 at 78.

In Hide & Skin Trading Pty Ltd v Oceanic Meat Traders Ltd (1990) 20 NSWLR 310
at 316, Kirby P canvassed various reasons in support of the conflicting views on the
admissibility of subsequent conduct. In support of excluding evidence of subsequent
conduct, his Honour noted that, if post-contract behaviour was taken into account, it
could lead a party to tailor such behaviour in order to persuade the other party to
accept his or her understanding of the contract or to provide supporting evidence in
any subsequent court case between the parties. Furthermore, permitting such evidence
would expand the field of enquiry undertaken by a court which would lead to an
increase in the length and costs of litigation. On the other hand, the possibility of clear
20
and mutual post-contract conduct that evidences the parties original intentions would
tend to support the admissibility of such evidence.

Exceptions to the Parol Evidence Rule

In the construction of a contract the impact of the parol evidence rule is qualified by a
number of exceptions that enable extrinsic evidence to be admitted. The major
exceptions are:

(i) (if the approach of Lord Hoffmann to construction as outlined in Investors
Compensation v West Bromwich Building Society, does not apply in Australia)
extrinsic evidence is admissible to clarify any ambiguity in the text of an
entirely written contract, but is not admissible to contradict the plain meaning
of that language. In this respect, evidence of surrounding circumstances only
includes facts that were known to both parties, although knowledge of facts
that are notorious will be presumed: Codelfa, at 352. The ambiguity may be
patent or latent. A patent ambiguity arises if the language used obviously has
more than one meaning, or is intrinsically of doubtful meaning, or has no
generally accepted meaning. A latent ambiguity is established by extrinsic
facts that cast doubt on what would otherwise have a clear meaning. A classic
illustration of latent ambiguity is that of Raffles v Wichelhaus (1864) 159 ER
375, in which parties agreed that goods would be shipped out of Bombay
harbour by the ship called Peerless. Oral evidence was led that indicated that
there were two ships by that name in Bombay harbour at the time. The
recognition of latent ambiguities serves as a warning that the words of a
contract will not necessarily carry their plain or ordinary meaning. An
ambiguity will only arise if there is genuine uncertainty about the meaning of
the words used. Ambiguity will not arise simply because the words used do
not mean what one of the parties hoped they would mean: Hope v RCA
Photophone of Australia Pty Ltd (1937) 59 CLR 348.
(ii) extrinsic evidence is admissible to identify the subject matter of the contract in
circumstances where the description of the subject matter is uncertain or
ambiguous. Thus, in White v Australian and New Zealand Theatres Ltd (1943)
67 CLR 266, two theatrical artists were engaged to provide their professional
21
services for a theatre company. There was no definition of professional
services in the contract. Extrinsic evidence was admitted to establish that it
included producing the performance, as well as acting in it. It is, however,
probably more difficult to introduce extrinsic evidence if the ambiguity relates
to the nature or character of the subject matter. Thus, in Hope v RCA
Photophone, at 356, extrinsic evidence was not admitted to establish that a
lease of electrical sound-reproduction equipment meant new, as opposed to
second-hand equipment, on the basis that the description was clear to all
those who understand the terminology used for the purpose describing sound-
reproducing apparatus.
(iii) extrinsic evidence is admissible to identify the parties to the contract. Thus, in
Edwards v Edwards (1918) 24 CLR 312, a deed provided for the transfer of
property to J ohn Edwards. There was ambiguity as to whether that
description of the transferee referred to the transferors father, brother or
nephew, as they were all named J ohn Edwards. Extrinsic evidence was
admitted to establish that the transferee was the transferors brother. On the
other hand, in Shogun Finance Ltd v Hudson [2004] 1 AC 919, a majority of
the House of Lords held that the parol evidence rule excluded extrinsic
evidence in cicumstances where a rogue, passing himself off as Durlabh Patel,
entered into a contract with Shogun Finance. The majority held that extrinsic
evidence was not admissible to establish that Shogun Finance intended to
contract with the person that they dealt with (the rogue) irrespective of what
he called himself. Because the written contract unequivocally identified Patel
as a party, pursuant to the parol evidence rule, extrinsic evidence that would
show that Shogun Finance did intend to contract with the person who turned
out to be an imposter, was inadmissible. As a result, there was no contract
between Shogun Finance and the rogue. However, It is submitted that this case
is in error on this point, as the parol evidence rule has no application on issues
of mistaken identity. Extrinsic evidence should have been admitted to
establish that Shogun Finance did intend to contract with the rogue. In support
of this proposition it can be noted that in GR Securities Pty Ltd v Baulkham
Hills Private Hospital Pty Ltd (1986) 40 NSWLR 631 at 636-7, it was said
that extrinsic evidence is admissible to identify the true identity of a party to
the contract, irrespective of the name used in the document.
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CONSTRUCTION OF EXCLUSION CLAUSES

INTRODUCTION

Exclusion clauses are terms of a contract that seek to exclude or limit the liability of a
defendant from liability to a plaintiff in the event that the defendant causes loss to a
plaintiff. The defendants liability covered by the exclusion clause is not necessarily
confined to breaches of contract. It can be for any liability that is based upon other
principles, such as torts and statute. Exclusion clauses are sometimes referred to as
exemption or exception or limitation clauses.

Cases involving exclusion clauses may involve determination of any or all of the three
following issues:

(i) whether a defendant is liable to a plaintiff? This will usually require the
plaintiff to establish that the defendant has breached a contract or
committed a tort or breached a statutory provision.
(ii) whether the exclusion clause is term of a contract between the plaintiff and
defendant? This raises the issue of incorporation of terms as discussed
above.
(iii) whether the exclusion clause, on its proper construction or interpretation,
covers the defendants liability that has arisen? This is the issue discussed
below.

Courts have traditionally approached exclusion clauses in accordance with answering
each of these three questions. Such an approach casts an exclusion clause as a defence
to an action by a plaintiff against a defendant. For example, if X contracts with Y to
provide security services for Y and in the course of performing those services
damages Ys property, X would be regarded as having committed a breach of an
implied term to provide the security services in a proper manner and with due regard
to Ys property. If there was an exclusion clause in the contract that protected or
excluded X from liability for the damage to Ys property, the exclusion clause would
be regarded as a defence to an action by Y against X for breach of the said implied
23
term of the contract. However, there is support for the view that such an exclusion
clause is not a defence to an action for a breach of contract, but rather a definition of
contractual obligations, so that Xs conduct in damaging Ys property does not
amount to a breach of contract at all. In other words, the exclusion clause is viewed
simply as part of a freely entered into contract which reflects the allocation of risk or
loss agreed to by the parties: Photo Production Ltd v Securicor Transport Ltd [1980]
AC 827 at 851.

GENERAL APPROACH TO CONSTRUCTION OF EXCLUSION CLAUSES

In determining whether an exclusion clause shields a defendant from liability to a
plaintiff, the principal task of the court is determine the intention of the parties. In the
past courts were quite hostile towards exclusion clauses. However, in more recent
times a more even handed approach has prevailed, especially in the context of
commercial transactions. The contemporary approach is exemplified in Australias
leading case on the construction of exclusion clauses of Darlington Futures Ltd v
Delco Australia Pty Ltd (1986) 161 CLR 500 at 510. What points were made by the
High Court in this case?

What is meant by the expression contra proferentum principle? See Thomas National
Transport (Melbourne) Pty Ltd v May & Baker (Australia) Pty Ltd (1966) 115 CLR
353 at 376; Wallis v Pratt & Hayes [1911] AC 394.

On the general rules of construction of exclusion clauses see Photo Production v
Securicor; Darlington Futures v Delco Australia; Glebe Island Terminals Pty Ltd v
Continental Seagram Pty Ltd (1993) 40 NSWLR 206.

OTHER RELEVANT PRINCIPLES OF CONSTRUCTION

Although the general principles set out in Darlington Futures are to apply, there are
other principles that may be relevant in assisting the court in construing an exclusion
clause. These can be considered in the context of (i) the deviation cases, (ii) the four
corners rule, and (iii) exclusion clauses excluding negligence.

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Deviation Cases

If a carrier deviates from the agreed voyage or route, he or she loses the benefit of an
exclusion clause. See Thomas National Transport (Melbourne) Pty Ltd v May &
Baker (Australia) Pty Ltd (1966) 115 CLR 353.

Four Corners Rule

What is meant by the four corners rule? See Council of the City of Sydney v West
(1965) 114 CLR 481

Exclusion Clauses and Negligence

In what circumstances will an exclusion clause exclude liability in negligence? See
Davis v Pearce Parking Station Pty Ltd (1954) 91 CLR 642 at 649. A statement of
principles is summarised in Canada Steamship Lines Ltd v The King [1952] AC 192
at 208. What are the three rules set out in this case?

Is a clause which excludes liability for losses howsoever caused effective to exclude
loss caused by negligence? See Rutter v Palmer [1922] 2 KB 87 at 94. Other key
cases on the rules in Canada Steamship include Alderslade v Hendon Laundry Ltd
[1945] KB 189; White v John Warwick & Co Ltd [1953] 2 All ER 1021.

Do the Canada Steamship rules survive the statement of principles in Darlington
Futures v Delco Australia? See G L Nederlands (Asia) Pty Ltd v Expertise Events Pty
Ltd [1999] NSWCA 62 at [22]; Glenmont Investments Pty Ltd v OLoughlin (No 2)
(2000) 79 SASR 185 at 243; Glebe Island, at 242; Valkonen & Valkonen v Jennings
Constructions (1995) 184 LSJ S 87 at 98; HIH Casualty and General Insurance Ltd v
Chase Manhattan Bank [2003] 2 Lloyds Rep 61 at 84.

EXCLUSION CLAUSES AND LEGISLATION

Important legislative provisions have been enacted limiting the application of
exclusion clauses. One of the most important examples of legislative intervention in
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this respect is found in ss 68-68A of the Trade Practices Act 1974 (Cth). A less
specific statutory intervention is by means of the Contracts Review Act 1980 (NSW).

The Trade Practice s Act 1974 (Cth)

Section 68 of the Trade Practice s Act 1974 stipulates as follows:

(1) Any term of a contract (including a term that is not set out in the
contract but is incorporated in the contract by another term of the contract)
that purports to exclude, restrict or modify or has the effect of excluding,
restricting or modifying:
(a) the application of all or any of the provisions of this Division;
(b) the exercise of a right conferred by such a provision;
(c) any liability of the corporation for breach of a condition or
warranty implied by such a provision; or
(d) the application of section 75A;
is void.
(2) A term of a contract shall not be taken to exclude, restrict or
modify the application of a provision of this Division or the application of
section 75A unless the term does so expressly or is inconsistent with that
provisions or section.

Thus, the effect of s 68 relates to the consumer protection provisions in Part V,
Division 2 (ss 66-74) and s 75A. For a clause to void under s 68 it must exclude,
restrict of modify the operation of the provisions in Part V, Division 2 (ss 66-74) or s
75A. Whether a clause does this is a matter of construction of the clause.

Two of the more significant provisions in Part V, Division 2 are s 71 which stipulates
an implied condition that goods supplied by a corporation to a consumer are of
merchantable quality, and s 74 which stipulates an implied warranty that services
supplied by a corporation to a consumer will be rendered with due care and skill and
that any materials supplied in connection with those services will be reasonably fit for
the purpose for which they are supplied.

There are qualifications to the application of s 68 as follows:

(i) Section 68A places qualifications upon the provisions of s 68. Thus, by s
68A(1), if a corporation supplies good or services, other than for personal,
26
domestic or household use, a clause will not be void under s 68 if it limits the
corporations liability to: (a) in the case of goods, replacing or repairing goods
or paying for the replacement or repairing of goods, or, (b) in the case of
services, to supplying or paying for the supplying of the said services.
However, s 68A(1) will not apply if it is established that it is not fair and
reasonable for the corporation to rely upon it: s 68A(2). In determining
whether or not reliance upon the term by the corporation would be fair and
reasonable the court should consider all the circumstances of the case
including the relative bargaining strength of the parties, any inducement by the
buyer to agree to the term, whether the buyer had the opportunity to buy the
goods or services without the term being included in the contract, whether the
buyer ought to have reasonably known of the term, and in the case of goods,
whether the goods were manufactured or provided to meet a special order of
the buyer: s 68A(3).
(ii) The conditions and warranties in Division 2 of Part V only apply to
consumers. By s 4B consumers are broadly defined as persons (including
corporations) buying goods or services at a price less than $40,000, or if the
contract is for more than $40,000 the goods or services are of a kind ordinarily
acquired for personal, domestic or household consumption or in the case of a
motor vehicles, the vehicle is used for transport of goods on public roads. In
the case of goods they must also not be purchased for the purpose of resale or
use in a process of transforming them into something else by some process of
manufacture or production.

The Contracts Review Act 1980 (NSW)

Under s 7 of the Contracts Review Act 1980 (NSW) a court can, inter alia, declare a
term of a contract void if it is unjust. Thus, if an exclusion clause is found to be unjust
within the meaning of the Act it could be declared void. In John Dorahys Fitness
Centre Pty Ltd v Buchanan (Court of Appeal in NSW, 18 December 1996,
Unreported) an exclusion clause which effectively excluded the defendant from
liability in both tort and contract was, in the particular circumstances of the case,
found to be unjust. A more detailed analysis of the Contracts Review Act will be
undertaken later in Lecture 11.