A reminder why certainty in contracts is so important

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In the recent New South Wales Court of Appeal decision Port Macquarie-Hasting Council v Diveva, the Court considered the contractual interpretation of a renewal clause. The clause was phrased in general terms and did not specify by whom the clause was exercisable.

This case has important implications for the interpretation of renewal clauses which you should be aware of when drafting or entering into contracts.

Background – facts of the case

Diveva, a construction company specialising in the asphalt works, had an ongoing relationship with Port Macquarie-Hastings Council as the result of being the successful bidder for tenders from the Council in 2005, 2008 and 2011.

The 2011 agreement contained a clause which said:

The period of this Tender Agreement is twenty-four (24) months commencing on the 1st August 2011 to 31st July 2013 with a further twelve (12) month option available.

In 2012, there was a dispute between the parties over some works Diveva had carried out which had failed. The Council told Diveva in March 2013 that it would not be exercising the option to extend and would instead advertise a new tender.

However in April, Diveva gave notice to the Council that it would exercise the option to extend. The Council refuted this, arguing the option was only exercisable either by the Council unilaterally or by the mutual agreement of the parties – not by Diveva unilaterally.

The Council proceeded to call for tenders for construction work, which Diveva did not bid for. The Council ceased to give any work to Diveva after late May 2013.

Diveva brought proceedings alleging the Council had breached their contract and seeking damages for their loss of profit and loss of opportunity to bid for further tenders from the Council.

At first hearing, the judge found in favour of Diveva, holding that the option was exercisable unilaterally by Diveva. Damages of just under AU$250,000 were awarded. The Council appealed the decision, arguing that the option was only exercisable either unilaterally by the Council or by mutual agreement.

Decision on appeal

The Court of Appeal dismissed the appeal.

The Court briefly reviewed the settled principles of contractual construction, namely that the meaning of contractual must be determined by reference to the parties’ intention, construed with reference to the context. Terms should also be interpreted in a way that gives internal coherence to the document. Finally, an understanding of the transaction, its background, and the broader context including the market it occurs in can help give light to the commercial purpose and objects of the contract.

Applying these principles to the facts at hand, the Court found the parties’ intent was for the term to give Diveva a unilateral right to renew. This was based first and foremost on a textual analysis – the Court found it significant that the Council could have either expressly indicated in the contract that the right was exercisable only by them or otherwise qualify the right in some way, but this had not occurred. Textual analysis gave rise to the Court’s conclusion that the right granted by the clause was not one exercisable only by the mutual agreement of the parties. The parties’ choice of the word ‘option’, as opposed to ‘agreement’ or something similar, meant that to find the right was exercisable only by both parties mutually would ignore the deliberately chosen words of the clause.

Furthermore, the Court found that, considering the commercial objectives of the Council and the contract as a whole, the right was intended to be unilateral in favour of the successful tenderer because this served as an inducement for parties to bid for the tender. The contract gave the Council greater rights to terminate than the tenderer enjoyed, and so from a commercial perspective the unilateral right to renew served as a benefit to offset the imbalance in rights in other respects of the contract. The Court also found that it was impossible that the clause was intended to be unilateral in favour of the Council because it would be a disincentive to tendering were the Council to have the power to bind the tenderer to continued service at the same price.

Finally, the Court dismissed the Council’s argument that the Court should take into consideration the fact that, in two previous contracts with Diveva, a similarly worded option clause had been exercised by the Council. This, the Council said, indicated that Diveva knew the clause was not one unilaterally in their favour. The Court dismissed this argument and said that extrinsic evidence of the parties’ prior conduct toward one another under previous contracts, even if worded similarly, must be treated with great care. The Court found the Council’s argument in this case was insufficient to have any effect on the conclusion, given the lack of any argument on the grounds of estoppel or a similar cause of action.

An interesting point to note is that at trial the Council argued that, if there was a unilateral right to renew in favour of Diveva, it was subject to an implied condition that Diveva must not be in breach of the contract at the time of exercising the right. However the trial judge found that this term could not be implied as it did not meet the test in BP Refinery – particularly, it was neither reasonable nor equitable between the parties, and was not necessary to give business efficacy to the contract. The Council did not contest this on appeal.

What does this mean for you?

  • Option provisions that do not expressly limit the exercise of the option to one party can be found to apply for the benefit of both contracting parties. If this is not the intended outcome, clear words are necessary!
  • If you’re drafting a contract containing an option to renew, make explicit to whom the option is available and what conditions its exercise is subject to
  • Where rights are intended to be mutually exercisable, ensure you make this explicit and use the appropriate terms – ‘agree’ instead of ‘option’

If you’re basing your interpretation of a contractual clause on prior conduct of the parties, consider framing this in terms of estoppel or reliance to give strength to your argument.

 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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