Interpreting contracts
Infolet 7
When the parties to a contract are at odds about their contractual rights and obligations, disputes are
resolved according to what those parties have agreed. Some commentators say that determining what was
agreed can prove difficult under Australian contract law.
Freedom to contract
Principles of autonomy and freedom to contract are at the heart of contract law. This means that people
are generally free to enter contracts on their own terms. In doing so, the parties must observe the general
law—such as the Australian Consumer Law (ACL), industrial and tax laws—and must not contract to
perform a crime or other act against the public interest. Contracts can be written or oral or a mixture of
both.
Why is interpretation important?
Most contract disputes are resolved away from court with people working out their differences one way or
another. Many reach early agreements, some need the help of a third party like a mediator or arbitrator,
while others get to harsher results like entering debt agreements or insolvency. Nevertheless, when a
problem arises, contracting parties often assess the risks involved in getting to the best solution.
In working towards a resolution, it can be helpful for the parties to understand how their contract may be
interpreted at law even if they have no intention of ever stepping inside a court. Many commercial law
cases involve disputes about the language of a written contract, and courts do not always reach the same
conclusion as the parties thought they had agreed.
Interpreting a written contract
When interpreting a written contract, Australian courts will consider what the contract says, what was
intended by the words used and the legal effect of those contract terms. The courts will generally look to
the plain and ordinary meaning of the words. To aid interpretation, courts sometimes consider evidence of
the surrounding circumstances of the contract. These are the facts known to both parties, and usually relate
to the origin and aim of the contract.
There is debate about when an Australian court will consider surrounding circumstances. As a general
rule, a court will only consider such evidence when the contract is capable of more than one meaning. On
the other hand, some cases suggest that the surrounding circumstances may always be considered since
language can rarely be understood apart from its context. The lack of clarity may hamper parties in
knowing what information is relevant to working out what their contract means.
Prior and subsequent conduct
Australian courts will not accept evidence of prior negotiations to vary or contradict a written contract.
This approach––known as the parol evidence rule––is intended to ensure that disproportionate weight is
not given to contract negotiations over the actual language of the agreement. There is, too, a need to
provide commercial certainty including to third parties who may enter into separate arrangements with a
party on the basis of the contract. Evidence of prior negotiations is often admitted for other causes of
action, for example, claims arising under the ACL, claims for rectification due to mistake, and estoppel
claims.
Australian courts will also not consider evidence of the parties’ conduct after the contract is made to help
determine the meaning of the written contract. However, in some other jurisdictions—like the United
States and India—subsequent conduct can be used to demonstrate the meaning of contractual terms. Some
commentators argue that the parties’ behaviour may better reveal their intentions in a transparent and
objective way.
Objective versus subjective interpretation
When determining the meaning of a contract term, Australian courts will try to establish the parties’
objective mutual intention, and not their actual intentions. That is, the court will look to what a reasonable
person would have thought was intended by the term if that person had been put in the situation of the
parties. The idea is to consider what the parties objectively sought to achieve rather than the outcome for
which they individually hoped. The intention of this approach is to improve certainty for third parties who
may have acted in reliance on the contract.
Australian courts will not accept evidence of the actual intention of the parties even where they agree.
However, the courts will consider evidence of a refusal by both parties to include a term in the contract.
Some practitioners argue that courts should, at least, consider the parties’ views where they are agreed on
the purpose of the provision.
International approaches
The law relating to the interpretation of contracts varies around the world. Some civil law countries––like
France––take a subjective approach which defers to the actual common intention of the parties. Common
law countries—like Australia, the UK, the US, Canada and Singapore––take an objective approach to the
interpretation of contracts.
While courts in other common law countries still accept the objective approach, they are increasingly open
to considering evidence of the context. In England, the law now holds that courts should consider
‘absolutely anything’ known to both parties which could affect the reasonable person’s interpretation of
the written text. And a similarly broad approach is evident in the United States Restatement of contract
law (for more details see Infolet 11 United States contract law: Lessons for Australia?). Some
Australian judges and commentators have been critical of these trends, arguing that increasing the amount
of admissible evidence can make litigation more time-consuming and expensive.
The International Institute for the Unification of Private Law (otherwise known as UNIDROIT) has
published an internationally adapted set of principles for commercial contract law known as the
UNIDROIT Principles. The UNIDROIT Principles address the interpretation of contracts, and incorporate
subjective and objective approaches. These provide that the parties’ common (subjective) intention
prevails, but an objective approach should be taken where this cannot be established. (More details on the
UNIDROIT Principles can be found in Infolet 12 The UNIDROIT Principles: Lessons for Australia?).
Question for consideration
Should the law on the interpretation of contracts be changed to codify interpretative rules or to adopt the
approach taken in other countries or in the UNIDROIT Principles?
Have your say
As we consider the future direction of Australian contract law, we want to take account of everyone’s
experience and perspective. If you want to respond to the infolets, please email us at
contractlaw@ag.gov.au. You can also access our discussion paper on reforming Australian contract law
on the Attorney-General’s Department’s website at www.ag.gov.au/contractlaw.
DISCLAIMER: This infolet does not provide legal or other professional advice, but contains general information about issues related to Australian contract law.
The Australian Government does not accept responsibility for the accuracy and completeness of the information provided. Nor do the contents of this infolet
commit the Australian Government to any particular course of action.