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Ambiguity in context: When can "surrounding circumstances" be used to aid contractual interpretation?

The New South Wales Court of Appeal has concluded that it is not always necessary for an ambiguity to exist before surrounding circumstances may be taken into account when construing a contract (Cherry v Steele-Park [2017] NSWCA 295). Rather, ambiguity is a conclusion to be reached after consideration of the context of the words in issue that are revealed by the surrounding circumstances.

The decision adds to a line of NSW appellate authorities which are seemingly inconsistent with the High Court of Australia's "true rule" about admissibility of surrounding circumstances described by Mason J in Codelfa Construction Pty Ltd v State Rail Authority of New South Wales (1982) 149 CLR 337, but which the Court in Cherry reasons can be reconciled on the basis that:

• the "true rule" in Codelfa did not say how ambiguity was to be identified;
• the subsequent High Court decisions of Victoria v Tatts Group [2016] HCA 5 and Simic v New South Wales Land and Housing Corporation [2016] HCA 47 promote the proposition that an agreement is to be determined objectively by reference to its text, context and purpose; and
• whether a term in issue is ambiguous or bears a plain meaning will be affected by its context.

Until clarity is brought to this issue by the High Court, it seems that analysis of the surrounding circumstances will have heightened importance in exercises of contractual interpretation, even where "clear" drafting is used.

Federal Court provides clarity on inoperability of contracts

A recent decision by the Federal Court of Australia provides guidance on inoperability of arbitration agreements and highlights the complexities of contracting structures in public private partnerships (CPB Contractors Pty Limited v Celsus Pty Limited (formerly known as SA Health Partnership Nominees Pty Ltd) [2017] FCA 1620).

The special purpose project vehicle responsible for designing and constructing the new Royal Adelaide Hospital, together with the principal, the State of South Australia applied for a stay of judicial proceedings brought by the builder, CPB Contractors and Hansen Yuncken, on the basis of existing arbitration agreements between the parties.

The State and the project vehicle relied on section 8 of the Commercial Arbitration Act 2010 (NSW) which allows the court to refer a dispute to arbitration at the request of one of the parties where an arbitration agreement exists, unless if the court finds that the agreement is null and void, inoperative or incapable of being performed.

The builder contended that section 8 did not entitle the respondents to a stay of the proceedings as the arbitration agreement between it and the project vehicle was rendered inoperative by a later arbitration agreement entered into "upstream" in the contracting structure between the State and the project vehicle.

The upstream arbitration agreement sought to streamline arbitration proceedings so that common issues throughout the contracting structure could be heard together. The arbitration agreement between the builder and the project vehicle did not contemplate this process.

Justice Lee held that although inoperability can exist in circumstances where there is no termination for breach, inoperability necessarily involves the relevant arbitration agreement 'ceasing to have effect.' As the upstream arbitration agreement contemplated the builder’s participation in the streamlined arbitration process only if the builder agreed to become involved, it could not be found to have interfered with or affected the operation of the downstream arbitration agreement. Accordingly, the Court found that the downstream arbitration agreement did not cease to have effect, and the stay was granted.

The decision highlights the importance of including a consistent dispute resolution process throughout the complex contracting structures often adopted in infrastructure projects.

Good faith & acting reasonably: important ingredients for your contract

The Full Federal Court recently confirmed that principles of good faith and reasonableness when implied in contracts are interrelated (Virk Pty Ltd (in liq) v YUM! Restaurants Australia Pty Ltd [2017] FCAFC 190).

The Court dismissed an appeal brought against Pizza Hut franchisor Yum! Restaurants Australia Pty Limited by a number of its franchisees who claimed that Yum! breached an implied obligation of good faith and reasonableness when it exercised its discretionary power under its franchising agreements to fix maximum prices as part of a price strategy to increase revenue.

Yum! follows a line of cases which consider the existence and scope of an implied obligation of good faith and reasonableness in a commercial contract.

At first instance, the Court held that while Yum!'s discretionary power under the franchise agreement was subject to obligations of good faith and reasonableness, the franchisees had failed to establish that Yum! had acted dishonestly, in bad faith, or with reckless disregard for the franchisees. It reasoned that such obligations must be understood with reference to the commercial context, the different interests of the parties, and the particular terms in the contract and that poor business judgment will not necessarily result in a breach of good faith.

On appeal, the franchisees argued that reasonableness was an obligation separate from good faith and that Yum! had breached that obligation as the methodology and set prices were objectively unreasonable.

The Full Federal Court rejected these arguments and dismissed the appeal, finding that:

• the implied obligations of acting reasonably and in good faith are "composite and interrelated", which means there must be reasonableness where there is a finding of good faith.
• context is critical when assessing reasonableness objectively or subjectively. Reasonableness does not necessarily mean something which produces a reasonable outcome. In this case, the "reasonableness" test is focused upon assessing the behaviour or conduct of another party in determining if it was "capricious, dishonest, unconscionable, arbitrary or product of a motive which was antithetical to the object of the contractual power".

Can an email constitute a binding agreement varying a construction contract?

The Supreme Court of Western Australia concluded that an email purporting to constitute a binding agreement varying a construction contract did not have that effect (Built Environs WA Pty Ltd v Perth Airport Pty Ltd [No 2] [2018] WASC 17).^[1]

Built Environs, the head contractor for the construction of the T1 Domestic Pier and International Departures Expansion Project at Perth Airport claimed that the principal, Perth Airport Pty Ltd (PAPL), wrongly had recourse to performance bonds provided to it pursuant to the construction contract in order to pay itself moneys owed in partial satisfaction of liquidated damages owed to it under the contract.

Built Environs did not allege that the presentation of the performance bonds was a breach of the main contract, but rather that it was a breach of a separate agreement constituted by an email sent by PAPL's Executive General Manager to Built Environs' Managing Director.

Built Environs alleged that the email constituted a binding agreement containing an intention to create legal relations. The email provided that PAPL would be prepared to release the bank guarantee as requested by Environs and would not take steps to recover the liquidated damages provided that Environs agree to certain conditions.

Justice Tottle found that the email did not constitute a binding agreement between the parties and that even if it had, PAPL did not breach its terms. The action was dismissed.

The case highlights the importance of use of clear language to evidence an intention to be bound (or not to be bound) by email exchanges or other communications purporting to create a contractual relationship or vary or supplement existing contractual relationships.