When a contract goes wrong, it is not uncommon for the parties to disagree about the meaning of its terms. Often they will seek to put before the Court evidence of what they said or did both before and after signing the contract, to support their own interpretation of its provisions.

The extent to which such “extrinsic” evidence is admissible to assist the Judge is an issue which has been debated by the New Zealand Courts for many years. In a significant recent decision (Bathurst Resources Ltd v L & M Coal Holdings Ltd), the Supreme Court has now provided some clear guidance. The Bathhurst decision has also clarified the approach to be taken to implying a term into a contract under New Zealand law.

Extrinsic evidence

In its guidance as to admissibility of extrinsic evidence, the Court has drawn on the Evidence Act 2006 and its “touchstone” principles of relevance and probative value (tendency to prove or disprove anything of consequence). That probative value must be balanced against the risk that the evidence will have a prejudicial effect on, or needlessly prolong, the proceeding.

Under this framework, the Courts will not take a blanket approach to the admissibility of either pre-contractual or post-contractual conduct and communications. Either may, in principle, be used to assist with interpretation, depending on the outcome of the relevance and probative value analysis. While careful to say it was not laying down hard and fast rules, the Supreme Court did provide some guidance as to the likely outcome of that analysis, noting that:

• Evidence of contractual negotiations will not be relevant if it only proves a party’s own subjective intent or belief about the meaning of the words or what their undeclared negotiating stance was. However, if the party’s belief or intent was communicated to the counterparty it may tend to show a relevant common understanding.
  
  
• To the extent that evidence of one or more of the parties’ subsequent conduct is relevant, which the Court suggested would not be often, special care will need to be taken when balancing its probative value against possible prejudice. The Court singled out evidence of conduct arising after the dispute commenced and evidence of the conduct of executives who did not negotiate the contract as likely to be particularly problematic.

Implied terms

Bathurst confirms that the longstanding BP Refinery test for implying a term will continue to be relevant in New Zealand.

In particular, the implication of the term must be strictly necessary and the term must be capable of clear expression and not contradict any express terms. The other BP factors ie that the term must be reasonable and equitable, necessary to give business efficacy to the contract and “so obvious that it goes without saying” should now be seen as overlapping analytical tools. The Supreme Court has emphasised that whether or not to imply a term is an objective enquiry that does not require the Court to consider the parties’ actual intentions. Nor should the Court speculate as to how the parties would have wanted the contract to deal with the eventuality that has led to need to imply the term.  

Why does it matter?

In the Supreme Court’s own words, how to interpret the words of a contract is a perennial issue in the law. The question of what evidence outside those words should be allowed to assist with this task has long been the subject of continuing debate.

Bathurst sets out a new, overarching approach to this issue which looks at it through the lens of the Act. In doing so, the law has moved away from trying to set rigid rules for certain types of extrinsic evidence (for example pre-contractual negotiations). At the same time, the judgment also provides much needed clarification as to how and when to imply a term.

For contracting parties, however, the rule of thumb remains the same. The contract should be as clear and unambiguous as possible and deal with all important issues likely to arise. The starting point for the Court will remain the document itself and the words chosen by the parties to reflect the terms of their deal. It remains essential that these be given careful consideration at the drafting stage.