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I didn’t order this! - The effects of misconstruing written contracts

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Cite as: (2007) 81(7) LIJ, p. 34

Australian courts are divided on whether subsequent conduct can be used to construe the terms of a contract.

By Dr Michelle Sharpe

Australian courts are divided on whether subsequent conduct can be used to construe the terms of a contract.
By Dr Michelle Sharpe

In FAI Traders Insurance Co Ltd v Savoy Plaza Pty Ltd (FAI Traders),[1] Nathan J famously declared: “[a] meat pie does not become an apple tart merely because it is served for dessert. A lease does not change its character or ingredients simply because the parties conduct themselves as if it were of a different character or contained different ingredients”.[2]

Despite Nathan J’s insistence that subsequent conduct cannot be used by a court to construe the terms of a contract, authority in Australia on this point remains divided. Many authorities enthusiastically permit the use of subsequent conduct but many condemn it. Like Australia, the law in England on the use of subsequent conduct was at one time similarly unsettled. English courts have now, however, adopted a firm position against its use. The English position is the most consistent with the objective approach used by courts to construe contracts and Australian courts would do well to be guided by it.

This article briefly outlines the law determining when evidence extrinsic to a contract can be used in construing the terms of that contract and the objective approach taken by courts in construing contracts. It then looks at the authorities for and against the use of subsequent conduct before detailing the position in English law.

Construing written contracts generally

Where the whole of a contract has been reduced to writing, the parol evidence rule provides that extrinsic evidence cannot be used to explain the meaning of the written terms of the contract.[3] Instead, the court must interpret the contract by giving the terms of the contract their plain and ordinary meaning.

There are, however, a number of exceptions to the parol evidence rule. The main one is that extrinsic evidence can be used by a court to construe a contract if the terms of the contract are ambiguous. Courts may also, under the “objective background” exception, admit evidence of mutually known facts to identify the meaning of a term and the aim of a contract. Under a broad approach to this exception courts may have regard to this objective background evidence, even in the absence of ambiguity.[4]

In construing the terms of a contract, whether alone or with the assistance of extrinsic evidence, the court aims to give effect to the presumed, rather than the actual, intentions of the parties.[5] This objective approach requires the courts to determine from the words and conduct of the parties the intention that reasonable people would have had if placed in the parties’ position at the time of entering into the contract.[6]

The question that then remains to be answered by Australian courts is to what extent subsequent conduct assists courts in determining the presumed intention of the parties.

Authorities for the use of subsequent conduct

The latest High Court authority permitting the use of subsequent conduct is White & Anor v Australian and New Zealand Theatres Limited.[7] This case, which was decided at the time of World War II, concerned a contract for the engagement of the “sole professional services” of theatrical artists without defining what these services were to include. The High Court held that extrinsic evidence, including evidence of subsequent conduct, was admissible in defining the scope of the services contracted for. The High Court did not attempt to enunciate in any detail what the relevant principles were in using extrinsic evidence, but rather simply stated that evidence of subsequent conduct was admissible to construe the terms of an ambiguous written contract.

While many cases have been decided by the lower courts in support of the use of subsequent conduct, the most influential of these is Spunwill Pty Ltd v BAB Ltd (Spunwill).[8] In this case, Santow J considered in detail many of the preceding authorities, in particular FAI Traders, in which the use of subsequent conduct had been condemned.

Santow J dismissed the English authorities relied on in FAI Traders as having failed to consider the use of subsequent conduct as an exception to the parol evidence rule. He argued that contrary to FAI Traders, the weight of Australian authority only prohibited the use of subsequent conduct where, as dictated by the parol evidence rule, a written contract was clear and unambiguous. He argued that subsequent conduct was admissible, as an exception to the parol evidence rule, to assist in the construction of a written contract where its terms were ambiguous.

In particular, Santow J argued that subsequent conduct could be used as an exception to the parol evidence rule to establish the objective background of an ambiguous contract.

He contended that subsequent conduct could be used under the exception where it provided evidence of the contracting parties’ “shared subjectiveness”.[9] He argued that “[s]uch matters are themselves part of the objective framework of facts within which a contract came into existence, and are thus receivable as part of the surrounding factual circumstances”.[10]

In reaching this conclusion, Santow J addressed the common concerns raised by courts in using subsequent conduct. Specifically, he dealt with the “meat pie – apple tart” concern voiced by Nathan J in FAI Traders, namely that a contract might be taken to mean one thing when it was formed and then something altogether different after it was formed through the subsequent conduct of the parties.

Santow J dismissed this concern as being irrelevant, arguing that subsequent conduct was only to be used where a contract was ambiguous. He further argued that Nathan J’s concern was of even less relevance where the subsequent conduct was being used to establish the existence of an estoppel or a new contract. Santow J’s decision, although not overruled, has been criticised in later cases, as noted below.

The most recent case to have supported the use of subsequent conduct is Miller v JLCS.[11] In this case Sundberg J, citing the English authorities, noted the existence of the rule that subsequent conduct can be used by a court to determine the existence of a contract but cannot be used to construe the terms of the contract. Sundberg J declared the rule to be “nonsensical” in cases where a contract could only be found by subsequent conduct. [118] He argued that:

“In such cases, the subsequent conduct does not resolve ambiguities but rather discloses whether the parties reached agreement and the content of such agreement. Without evidence of subsequent conduct relevant to the terms of the contract, all that could be said is that the parties reached agreement; it could not be said about what”. [118]

Sundberg J, however, does not deal with the long line of Australian authorities which, consistent with the English authorities, reject the use of subsequent conduct in construing the terms of a contract.

Authorities against the use of subsequent conduct

The latest High Court authority to reject the use of subsequent conduct in construing a contract is the well-known case of Codelfa Construction Pty Ltd v State Rail Authority of NSW (Codelfa).[12] In this case, Mason J held that evidence of the objective background of a contract could be used by a court to interpret a contract where the terms of that contract were ambiguous.[13]

Santow J in Spunwill referred to the judgment of Mason J in support of his argument that the use of subsequent conduct was only excluded by the parol evidence rule where a written contract was unambiguous.[14] Mason J, however, in identifying the kind of evidence a court might have recourse to in establishing the objective background of a contract, cited with approval a number of English authorities which held that such evidence should consist of facts known to both parties at or before the formation of the contract.[15]

There are, however, many cases decided by the lower courts which are more emphatic than the High Court in Codelfa in their rejection of the use of subsequent conduct, in particular Brambles Holdings Ltd v Bathurst City Council (Brambles).[16]

In Brambles, Heydon J set out to enunciate the main principles governing the interpretation of contracts. He stated clearly that subsequent conduct was admissible to determine whether a contract had been formed, but was inadmissible where it was being used to determine what a contract meant.[17] In making his judgment, Heydon J noted that High Court authority on this point was unclear and that he was instead guided by later decisions of the Victorian Full Court and Court of Appeal such as FAI Traders. He made no reference to Santow J’s decision in Spunwill, but another case relied on by Heydon J in his judgment – Ryan Textile Clothing & Footwear Union of Australia[18] – did. In this case the Court of Appeal held that the subsequent conduct of the parties could not be used to construe the agreement between them recorded in a letter. Hayne J referred in his judgment to Spunwill. Although he refused to express a “concluded view” about whether the decision in Spunwill should be accepted, since he noted that the facts in Ryan differed from those of Spunwill, he did declare that:

“In my view there are considerable difficulties in reconciling the use of post contractual conduct of parties as an aid to the construction of the agreement and the fact that the “intention of the parties” that is to be ascertained by the process of construction is an objective rather than subjective intention”.[19]

It is interesting to note that all three cases have recently been cited with approval by the Full Federal Court in Bowesco Pty Ltd (Receiver and Manager Appointed) v Zohar (Bowesco).[20] The court in Bowesco referred to the cases of Brambles, Ryan and FAI Traders and held that the “weight of authority” was that subsequent conduct was not admissible to construe the terms of a commercial contract.[21]

It might be argued in light of Bowesco that the weight of authority is indeed in favour of rejecting the use of subsequent conduct in construing contracts. However, there remains no settled High Court authority on the issue and other cases decided by lower courts in favour of the use of subsequent conduct have not been expressly overturned. The law on the use of subsequent conduct in construing contracts remains unclear. The law in England on the use of subsequent conduct had, before 1970, been similarly unclear. The development of the law in this area in England may provide helpful guidance in the development of the law in Australia. Indeed, as noted above, many of the Australian authorities, such as FAI Traders, have already taken their lead from such cases.

English authorities

Before 1970, authority in England on the admissibility of subsequent conduct in construing a written contract was mixed. There were a number of cases which held that subsequent conduct could only be used to construe ambiguous written instruments that were ancient, on the basis that the meaning of the terms used in such documents may well have changed over time.[22]

However, in Chapman v Bluck (Chapman), Chief Justice Tindall held that subsequent conduct could also be used by the court in construing modern contracts, arguing that “there is no better way of seeing what they (the parties) intended than seeing what they did, under the instrument in dispute”.[23] Tindall CJ’s judgment in Chapman was later cited with approval in Watcham v Attorney-General of the East Africa Protectorate (Watcham),[24] in which the Privy Council held that subsequent conduct was admissible to construe an ambiguous written contract. Likewise, in Whitworth Street Estates (Manchester) Ltd v James Miller & Partners Ltd (Whitworth)[25] the Court of Appeal held that subsequent conduct could be used to determine what law the parties had intended a written contract to be governed by. In Whitworth, Lord Widgery reasoned that evidence of subsequent conduct was admissible because “[i]f the parties’ conduct shows that they have adopted a particular view with regard to the proper law, then it may be inferred that they have agreed that that law shall govern the contract accordingly”.[26]

The Court of Appeal decision, however, was later overturned in the House of Lords. In his judgment Lord Reid stated:

“I must say that I had thought that it is now well settled that it is not legitimate to use as an aid in the construction of a contract anything which the parties said or did after it was made. Otherwise one might have the result that a contract meant one thing the day it was signed, but by reason of subsequent events meant something different a month or a year later”.[27]

The decision in Whitworth was affirmed by an emphatic decision by the House of Lords against the use of subsequent conduct in L Schuler AG v Wickman Machine Sales Ltd (L Schuler).[28] Watcham, which permitted the use of subsequent conduct, was rejected and declared to be “nothing but the refuge of the desperate”.[29] The House of Lords decision in L Schuler is now held by English courts to state the position in relation to the use of subsequent conduct in English law.

Conclusion

The English position of not permitting the use of subsequent conduct in construing contracts should be the preferred position in Australian law. This position is most consistent with the objective approach to construing contracts that has long been favoured by Australian courts.

As noted above, the objective approach is concerned with determining the intention that reasonable people might have had, in the parties’ circumstances, on entering into the contract. Subsequent conduct is clearly subsequent to the parties entering into the contract and therefore can be of little or no assistance in ascertaining the presumed intentions of the parties at the time the contract was formed.

If such conduct were to determine the presumed intentions of the parties then this might well give rise to Nathan J’s “meat pie – apple tart” criticism in FAI Traders. Santow J in Spunwill did not deal adequately with Nathan J’s criticism and his observation that subsequent conduct might be useful in establishing an estoppel or a variation of the contract is entirely separate to the question of the construing of the terms of a contract per se.

In any event, the trend of recent authority appears to be in favour of the English position and we can only await the passing of a High Court decision that will put the matter entirely beyond doubt.


DR MICHELLE SHARPE is a Victorian barrister, practising mainly in commercial and trade practices law, and a lecturer in dispute resolution at the University of Melbourne.
The numbers in square brackets in the text refer to the paragraph numbers in the judgment.


[1] [1993] 2 VR 343.

[2] Note 1 above, at 353.

[3] Goss v Lord Nugent (1833) 110 ER 713, at 715.

[4] See Codelfa Construction Pty Ltd v State Rail Authority of NSW (1982) 149 CLR 337.

[5] Fitzgerald v Masters (1956) 95 CLR 420, at 426.

[6] Codelfa, note 4 above, at 401 and Maggbury Ltd v Hafele Australia Pty Ltd (2001) 185 ALR 152 at [11].

[7] (1943) 67 CLR 266.

[8] (1994) 36 NSWLR 290.

[9] Note 8 above, at 309.

[10] Note 9 above.

[11] [2007] FCA 74.

[12] Note 4 above.

[13] Note 4 above, at 352.

[14] Spunwill, note 8 above, at 307.

[15] Codelfa, note 4 above, at 348-349.

[16] [2001] NSWCA 61.

[17] Note 16 above, at 164.

[18] [1996] 2 VR 235.

[19] Note 18 above, at 261.

[20] [2007] FCAFC 1.

[21] Note 20 above, at 23.

[22] See for example Chad v Tilsend (1821) 2 Brod & B 403 and Lord Hastings v North-Eastern Ry Co [1899] 1 Ch 656. The ancient documents referred to in these cases were deeds or grants that were dated two centuries prior to the matter being heard by the court.

[23] (1838) 4 Bing NC 187, at 195.

[24] [1919] AC 533.

[25] [1969] 1 WLR 377.

[26] Note 25 above, at 384.

[27] [1970] AC 583, at 603.

[28] [1974] AC 235.

[29] Note 28 above, per Lord Wilberforce at 261.

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