The principles of contractual interpretation in New Zealand are governed by the Supreme Court decisions in Vector Gas and Firm PI 1. That is not to say that Vector Gas settled all issues in contractual interpretation. Three key outstanding issues remained in a post-Vector world – the treatment of evidence of prior negotiations and of subsequent conduct as well as the status of the BP Refinery test for implication of terms.
In the recent decision of Bathurst Resources Limited v LM Coal Holdings Limited  NZSC 85, the Supreme Court tackled all three of these issues.
The decision concerns an arrangement that Bathurst Resources Limited had with L&M Coal Holdings Limited, under which Bathurst acquired coal mining rights on the West Coast of the South Island from L&M.
The sale agreement provided that Bathurst would make two performance payments of USD 40 million to L&M, each payment becoming due once a certain amount of coal had ‘shipped’ from the area being mined.
The dispute was concerned primarily with the definition of ‘shipped’ and Bathurst’s obligation to pay the first performance payment in addition to its ongoing payment of royalties to L&M.
However, the importance of this decision lies not so much in the resolution of the dispute but rather in the Court’s assessment of the three remaining key areas of ambiguity in contractual interpretation generally.
What is the status of pre-contractual negotiations evidence and evidence of subsequent conduct?
The Supreme Court in Bathurst confirmed that the approach to whether pre-contractual evidence should be considered to inform the interpretation of contractual terms should be the same as the approach to evidence of subsequent conduct.
In Vector Gas (the latest word from the Supreme Court on the issue), the four judges who took a position on admissibility of prior negotiations differed as to the correct approach and Courts have been grappling with this since then. Courts have tended to follow Tipping J’s approach that evidence of pre-contractual negotiations is admissible in the narrow sense of providing objective evidence on the meaning of the terms of the contract.
The Supreme Court in Bathurst has now clarified that whether pre-contractual evidence is admissible is an evidential issue to be determined by reference to the Evidence Act 2006 and the usual questions of relevance and probative value. The question before the judge in interpreting a contract is the objective meaning of the clause. Evidence of prior negotiations will be inadmissible to the extent that it only proves a party’s subjective intention, because that would be irrelevant to the question before the judge.
While McGrath J argued for a blanket rule excluding extrinsic evidence in Vector Gas, it is clear following Bathurst that there is no such rule. Extrinsic evidence may be considered but only if it is relevant to the objective meaning of the clause.
What about implied terms?
In BP Refinery, the Privy Council held that the following ‘conditions’ apply before a term can be implied:
- It must be reasonable and equitable
- It must be necessary to give business efficacy to the contract so that no term will be implied with the contract is effective without it;
- It must be so obvious that it ‘goes without saying’
- It must be capable of clear expression
- It must not contradict any express term of the contract
The Supreme Court confirmed the continuing role of the conditions when considering whether to imply a term, and referred to them as a ‘useful tool’ but held that they ‘should not be applied in a rigid and formulaic way’.
The Court also noted that, while conditions 4 and 5 must be met, conditions 1-3 should be viewed as ‘analytical tools’ which are not cumulative.
What happens now?
Bathurst provides a clarification of the law and is in line with the Supreme Court’s recent penchant generally for high level principles, flexibility in approach and the avoidance of blanket rules.
Despite this penchant for flexibility, the Court has reinforced the primacy of the objective meaning of the words in the contract.
Post Vector Gas, parties could argue (in reliance on McGrath J) that all extrinsic evidence should be excluded. However, it is now clear that extrinsic evidence is admissible if it is relevant to determining the objective meaning of the clause.
This means correspondence between parties in a contractual negotiation is likely to be admissible to the extent that it is relevant to the question of how a reasonable person would understand the contract. To ensure the evidence is admissible and helpful, parties should take care in pre-contractual negotiations to ensure that they do not place undue reliance on their own subjective intention. It will be important to receive confirmation from the other side that that is also what they intend.
It is, however, unclear how the softening of the BP Refinery conditions will apply to the implication of contractual terms in practice. Judges have been given license to apply the conditions as a ‘flexible tool’ which provides the benefit of adaptability but inevitably also poses the risk of inconsistent approaches.
Bathurst may have expanded judges’ interpretation toolbox but how these tools will be used in practice remains to be seen.