In a judgment released this week, the Supreme Court reviewed and restated the principles relating to contract interpretation and implied terms. In doing so, the Supreme Court rejected the Court of Appeal’s approach, which had sought to narrow those principles by limiting the use of evidence from outside the contract to determine the meaning of the contract.
Principles of Contract Interpretation
The Supreme Court has taken the opportunity to set out the correct approach to be adopted when interpreting a contract. The key principles are:
The Court reaffirmed the objective approach to the interpretation of contracts.
The Court observed that, while giving primacy to the written words in a contract gives the parties commercial certainty, the promotion of commercial certainty should not be allowed to defeat what the parties actually meant by the words in which they recorded their agreement.
Although overseas courts restrict the ability of parties to rely on pre-contractual negotiations and subsequent conduct in interpreting contracts, New Zealand’s Evidence Act provides for a different approach. In particular, all relevant evidence is admissible unless it would be unfairly prejudicial or needlessly prolong the proceeding.
Evidence of pre-contractual negotiations remains potentially admissible when undertaking an objective search for the meaning of the contract.
Evidence of the parties’ subsequent conduct is likewise potentially admissible, and indeed need not necessarily be mutual.
Test for Implied Terms
The Supreme Court also considered the test for implying an unwritten term into a contract. For many years this has been guided by a five-stage test set out in a 1977 decision of the Privy Council, BP Refinery. However, that approach had arguably been overtaken by a new approach developed by the UK Supreme Court in 2009, which was in turn qualified by the UK Supreme Court again in 2015.
The New Zealand Supreme Court sought to synthesize all of this case law, by saying that the BP Refinery approach continues to apply, but with “some qualifications”. In particular, the Supreme Court said that the principal points are as follows:
There is a high threshold for implying an unwritten term into a contract, which it described as a standard of “strict necessity”.
The starting point for implying a term is the words of the contract. If the contract does not provide for an eventuality, the usual inference is that there was no intention to provide for it.
The implication of a term into a contract is part of the construction of the written contract as a whole. An unexpressed term can only be implied into a contract if that term would spell out what the contract, read against the relevant background, must be understood to mean.
That is an objective inquiry (consistent with the general approach to interpreting a contract), where the court asks what a reasonable person with all of the background knowledge reasonably available to the parties at the time of the contract, would assume was intended by the parties.
Some of the limbs of the BP Refinery test (e.g., whether the implied term is necessary to give business efficacy to the contract or is “so obvious it goes without saying”) are best viewed as useful tools to test the necessity of implying a term to achieve what the contract, objectively interpreted by the court, must be understood to mean.
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