What does it all mean? – Contracts

It is hot, it is Summer and there is plenty of time to lie on the beach and think about things, but what does it all mean?Internet+fight+how+i+imagine+internet+fights_b9d573_4868330

This week Ross Dillon looks at how disputes arise. He has specialized in dispute resolution and has a reputation for forging successful resolutions in even the most bitter estate disputes. To read more about Ross click here. To download the full article as a print and tablet friendly PDF link here .

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This is not an existential question, but one faced by lawyers whenever a dispute over the meaning of the words used in a contract arises A majority decision of the Supreme Court[1] has set out what has to be considered when answering this question, and the writer can do little better than setting out the relevant paragraphs of the judgment in full (omitting the footnotes, but the judgment is available free on line for those keen enough).  The judgment works through the basic approaches to interpreting a contract, as follows:


[60] Given the issues in the case, it is not necessary that we discuss the approach to contractual interpretation in any detail. It is sufficient to say that the proper approach is an objective one, the aim being to ascertain “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 the contract”.  This objective meaning is taken to be that which the parties intended. While there is no conceptual limit on what can be regarded as “background”, it has to be background that a reasonable person would regard as relevant.  Accordingly, the context provided by the contract as a whole and any relevant background informs meaning.

[61] The requirement that the reasonable person have all the background knowledge known or reasonably available to the parties is a reflection of the fact that contractual language, like all language, must be interpreted within its overall context, broadly viewed. Contextual interpretation of contracts has a significant history in New Zealand, although for many years it was restricted to situations of ambiguity.  More recently, however, it has been confirmed that a purposive or contextual interpretation is not dependent on there being an ambiguity in the contractual language.

[62] It should not be over-looked, however, that the language of many commercial contracts will have features that ordinary language (even a “serious utterance”) is unlikely to have, namely that it will result from a process of negotiation, will attempt to record in a formal way the consensus reached and will have the important purpose of creating certainty, both for the parties and for third parties (such as financiers).

The fact that parties are aware their contract might be relied upon by a third party may justify a more restrictive approach to the use of background in some instances, the parties’ awareness being itself part of the relevant background. In Re Sigma, where the interpretation of security trust deed was in issue, Lord Collins said that the background was not relevant “except in the most generalised way” and went on to say:

“Where a security document secures a number of creditors who have

advanced funds over a long period it would be quite wrong to take account of circumstances which are not known to all of them. In this type of case it is the wording of the instrument which is paramount. The instrument must be interpreted as a whole in the light of the commercial intention which may be inferred from the face of the instrument and from the nature of the debtor’s business. Detailed semantic analysis must give way to business common sense … .”

To some extent, then, the scope for resort to background is itself contextual. We also note at this point that Lord Collins’ reference to “business common sense” is one that is echoed in many interpretation cases, as we discuss at paras [77]–[79] and [88]-[93] below.

[63] While context is a necessary element of the interpretive process and the focus is on interpreting the document rather than particular words, the text remains centrally important. If the language at issue, construed in the context of the contract as a whole, has an ordinary and natural meaning, that will be a powerful, albeit not conclusive, indicator of what the parties meant. But the wider context may point to some interpretation other than the most obvious one and may also assist in determining the meaning intended in cases of ambiguity or uncertainty.

[64] Against this background, we will begin by assessing cl MD15 in its

contractual context and then move on to consider whether the structure of the bargain, any specialised meaning, or considerations of commercial absurdity affect that assessment. Clause MD15 in its contractual context.

[65] We begin with the disputed clause, cl MD 15, viewed in its contractual setting. For ease of reference we set the clause out again:


In the event of the Insured having insured residential property for which compulsory Natural Disaster Damage cover under the Earthquake Commission Act 1993 applies then in the event of such property suffering Natural Disaster Damage during the Period of Cover and covered by Natural Disaster Damage cover, then the Insurer[’]s liability will be limited to the amount of loss in excess of the Natural Disaster Damage cover.

[66] The question is whether cl MD15 means that the limit of Zurich’s liability for natural disaster cover is to be calculated on the basis that any amount received from EQC is included or excluded. At this point, we are simply attempting to ascertain the meaning of the clause, interpreted in the context of the contract as a whole – we discuss relevant features of the wider background later. Our approach is that of the reasonable person, but taking account of the fact that the parties were an insurer and an insurance broker (acting for the insured): the “background knowledge which would reasonably have been available to [both] parties” therefore includes a significant level of understanding of insurance and insurance policies. The policy wording is that of the broker, which means that, if there were reason to call in aid the contra proferentem rule, it would operate against the broker.

images-25General structure of the bargain

[77] Sir Kim Lewison has observed:

“In the course of the last five decades the court has increasingly sought to elucidate the commercial purpose of the contract under consideration, and as between competing interpretations to select that meaning which best serves the commercial purpose of the contract, as perceived by the court.

[78] Besides what was said by Lord Collins in Re Sigma, to which we have already referred,56 there are many statements in the authorities supporting this proposition. For example:

(a) Lord Diplock said in Antaios Compania Naviera SA v Salen Rederierna AB:

“… if detailed semantic and syntactical analysis of words in a commercial contract is going to lead to a conclusion that flouts business commonsense, it must be made to yield to business commonsense.”

(b) In Mannai Investment Co Ltd v Eagle Star Assurance Co Ltd, Lord Steyn noted that there had been “a shift from strict construction of commercial instruments to what is sometimes called purposive construction”.   His Lordship went on to say:

“In determining the meaning of the language of a commercial contract, and unilateral contractual notices, the law … 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.”

(c) In Chartbrook Ltd v Persimmon Homes Ltd, Lord Walker emphasised the need to understand the “general structure” of the parties’ bargain when interpreting a commercial contract.

[79] There are some dangers in this approach, as we note when we discuss the parties’ commercial absurdity arguments. But despite this, we accept that in interpreting commercial contracts the courts should have regard to their commercial purpose and to the structure of the parties’ bargain, to the extent that they can reliably be identified.

Specialised meaning

[84] Parties to contracts will sometimes use words that have specialised meanings within a particular profession, industry, trade or locality, or words that have a particular meaning simply to them (the private dictionary principle). It is well established that a court is entitled to receive evidence which demonstrates that the parties have adopted such a specialised meaning.

Commercial absurdity

[88] Where contractual language, interpreted in the context of the contract as a whole, has a natural and ordinary meaning, the courts will generally give effect to that as they “do not easily accept that people have made linguistic mistakes, particularly in formal documents”. The “primary source for understanding what the parties meant is their language interpreted in accordance with conventional usage”. It requires a “strong case” to persuade a court that something must have gone wrong with the language. Professor David McLauchlan, who has been one of the principal academic proponents of a liberal contextual approach to contractual interpretation, nevertheless accepts that:

“… most issues of interpretation that cross a practitioner’s desk can be advised upon and solved by a reading of the words in the context of the document as a whole. There will usually be no answer to the solution derived from giving the words their ‘ordinary’ or conventional meaning.”

[89] But if consideration of the relevant background forces a court to the conclusion that something has gone wrong with the contractual language, it is not required “to attribute to the parties an intention which they plainly could not have had”. Just as the courts have accepted that understanding the commercial purpose of a commercial contract is relevant to its interpretation, so have they accepted that if a particular interpretation produces a commercially absurd result, that may be a reason to read the contract in a different way than the language might suggest.   However, it has also been accepted that a court is not justified in concluding that a contract does not mean what it seems to say simply because the court considers that, so interpreted, the contract is unduly favourable to one party. There is an obvious tension between these two positions, and it will often be difficult to determine whether particular cases fall within one category or the other.

[90] Moreover, there is reason to be cautious in this area because commercial absurdity tends to lie in the eye of the beholder. As Lord Hoffmann observed in Chartbrook:

“It is, I am afraid, not unusual that an interpretation which does not strike one person as sufficiently irrational to justify a conclusion that there has been a linguistic mistake will seem commercially absurd to another[.]”

Assessments of commercial purpose or commercially absurd consequences will be influenced by factors such as the background and experience of the court. In Skanska Rashleigh Weatherfoil Ltd v Somerfield Stores Ltd, Neuberger LJ, although acknowledging the importance of a contextual approach to contractual interpretation, noted that the parties have control of the language of negotiated commercial contracts and went on to say:

“[22] Particularly in these circumstances, it seems to me that the court must be careful before departing from the natural meaning of the provision in the contract merely because it may conflict with its notions of commercial common sense of what the parties may must or should have thought or intended. Judges are not always the most commercially-minded, let alone the most commercially experienced, of people, and should, I think, avoid arrogating to themselves overconfidently the role of arbiter of commercial reasonableness or likelihood. … “

[91] In addition, those who negotiate commercial contracts will be influenced by a range of considerations in reaching their final bargains. The contracts that emerge from the process of negotiation will reflect accommodations of the parties’ varying interests, as they assess them at the time. The reasons underlying the compromises that typically occur in commercial negotiations may not be easily perceived or understood by a court, even if they are exposed as part of the relevant background.

[92] Despite his expression of caution in Skanska, Neuberger LJ did accept that commercial common sense still had a role to play.   Of course, in many cases, the commercial common sense of a particular interpretation, either because of the peculiar circumstances of the case or because of more general considerations, is clear. Furthermore, sometimes it is plainly justified to depart from the primary meaning of words and give them what might, on the face of it, appear to be a strained meaning, for instance where the primary meaning of the words leads to a plainly ridiculous or unreasonable result.

[93] All this means that where contractual language, viewed in the context of the whole contract, has an ordinary and natural meaning, a conclusion that it produces a commercially absurd result should be reached only in the most obvious and extreme of cases.”

So that is all clear enough, then.  The process is:

(i)   You start with what the words say, but look at the whole contract, not just the bit that may be in dispute.

(ii)   You consider the contract from the standpoint of a reasonable person with the same background as the parties (this particular case involved insurance company and broker, so good knowledge of insurance law and terms was imputed to the parties), and

(iii)   if necessary look at the background to the negotiations behind the formation of the contract.

(iv)  You must always identify what the underlying purpose of the contract was.

(v)   Sometimes words may have a specialised meaning, which must be considered (insurance terms being the instant case).

(vi)   After all that, if the words used do not make commercial sense, then you might conclude that the contract does mean something other than what the words say.  Weighing up the alternatives that may be available as a result of the 5 earlier steps, should always give something sensible as a result.

But if all that fails and you can not resolve it, you will have to come and see us.  That, after all, is what we are here for.

[1] Firm PI 1 Limited v Zurich Australian Insurance Limited and Anor [2014] NZSC 147

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