The main principles of contract interpretation

In many cases, you won’t need to revisit the terms of contracts once signed if the words are clear and the relationship is harmonious. Unfortunately, sometimes disputes can arise and if the words in the contract are not clear enough you could end up asking a court to interpret what they mean. 

Broad principles of contract interpretation exist (rather than strict rules) which can be applied by the courts. In terms of how the principles are applied, this will depend on the particular facts and circumstances of the case.

General principles

The following are the main principles of contract interpretation:

• An objective test is applied in terms of determining the intention of the parties to the contract. This means the analysis is based on an understanding of the contract by a reasonable hypothetical person. The actual subjective intentions of the parties and any previous negotiations are generally deemed irrelevant.
• Words will be given their natural and ordinary meaning – i.e. what does the clause actually say?
• The overall purpose of the clause and the contract will be considered. The facts and circumstances known or assumed by the parties at the time the contract was entered into should also be assessed.
• The factual, legal and regulatory background within which the contract is set may be examined where required to provide further context.
• Where the wording is ambiguous, courts are likely to apply a commercial common sense interpretation.

It is well-established that the courts have no power to improve a contract and should only be concerned to discover what the contract means. Don’t expect a court to step in if you realise you have made a bad deal!

What if inconsistent provisions exist?

Commercial contracts are often complex documents and can comprise multiple parts. Sometimes a provision in one part of the agreement may appear to conflict with a similar term elsewhere. Where this arises, the courts will try to find a consistent interpretation. However, if this is not possible, the following applies:

• Greater emphasis will be placed on terms which have been specifically negotiated rather than standard terms;
• Greater weight is likely to be given to a more precise/detailed provision in comparison to a wider clause; and
• The contract may include an order of precedence clause. This outlines an agreed hierarchy of the various documents that form the contract (e.g. the main part of the agreement supersedes the schedules), in order to determine which clause will prevail in the event of inconsistency.

Can terms be implied into a contract?

If it is not possible to determine the meaning of a clause after considering the express wording of the contract, the court may imply certain terms into a contract. The test for implying terms in contracts has been developed in a long history of case law. This has established that any proposed implied term must meet the following conditions (which may overlap):

• It must be reasonable and equitable
• It must be necessary to give business efficacy to the contract – no term will be implied if the contract is effective without it
• It must be so obvious that ‘it goes without saying’ (the so-called ‘officious bystander’ test)
• It must be capable of clear expression
• It must not contradict any express term of the contract.

In practice, the courts are reluctant to deviate from the express wording of a contract and will only imply a term if satisfied it is necessary to reflect the presumed intention of the parties. Therefore, the circumstances in which courts will imply terms are very limited.

It is important to be clear on what you want to achieve in a contract. Therefore, it is advisable to seek legal advice up-front to ensure your contract reflects your desired outcome and is drafted robustly to avoid ambiguity. Ultimately, this could save time and costs in the long run by potentially avoiding a dispute regarding the meaning of specific clauses.