When should what the parties say be used to interpret contracts?

“An oral contract is not worth the paper it is written on.” This oxymoronic aphorism usefully illustrates why we write our agreements down: so that the words in the document determine what each party to it must do; and to avoid confusion and arguments. When arguments arise, the Court tells the parties to look to the contract they wrote for the resolution. What the parties thought about the contract before writing down what they agreed is irrelevant to interpreting what they agreed, right?

The problem is, as Denning LJ once famously said, “The English language is not an instrument of mathematical precision.”¹ Words are capable of different interpretations and can be ambiguously expressed. The Court has decided that when there are ambiguities it can look at “extrinsic evidence” (things outside the words of the contract), to determine meaning. The Court has now expanded the circumstances in which it can look to extrinsic evidence even where there is no ambiguity.

Does the Court’s modern approach undermine the intention of written contracts? Where can we draw the line between undermining the importance of the written contract and using extrinsic evidence to understand and interpret the contract?

Traditionally, a Court would only consider extrinsic evidence where there was a latent ambiguity in the text. For example, in Raffles v Wichelhaus the parties agreed that 125 bales of cotton were to be sold arriving in Liverpool on the ship the Peerless from Bombay. Unfortunately, there were two ships called the Peerless coming from Bombay carrying cotton, one in October and one in December.

Because there was no way to tell which Peerless was meant, the contract was ambiguous. The Court was then entitled to look behind the words of the contract (i.e. evidence of negotiations and intent) and it concluded that the parties had not had a “meeting of the minds” and so there was no contract (because each thought a different Peerless was the correct one).

Traditionally, the Court would not consider extrinsic evidence when interpreting contracts because it was thought that by entering into a written contract the parties intended that the Court would not go beyond the words of the contract when determining a related dispute between the parties. The external evidence was not inadmissible, it was irrelevant to the interpretation of the contract.

The traditional rule though was recast in Investors Compensation Scheme Ltd v West Bromwich Building Society (ICS).² In that case the Court found that the broad factual matrix (being anything reasonably available to the parties may be used to help understand the language of the contract) was relevant to the interpretation of the contract. Even where there was no ambiguity in the words of the contract, the Court considered that the factual matrix was relevant. However, it excluded from this factual matrix prior negotiations and evidence of subjective intent. These were considered inadmissible.

The issue that ICS raises (and that arguably the New Zealand Courts are still struggling with) is: what is the doctrinal basis for saying that evidence of negotiations are inadmissible in interpretation contracts?

Subjective intent (what the parties thought the contract meant) is relatively easy to disregard in interpretation of contracts. We have a largely objective (mistake/rectification/latent ambiguity notwithstanding) view of contract, so subjective intent is not relevant in determining what a contract means.

However, this reasoning doesn’t apply to statements made in negotiations and as part of bargaining. Why is this evidence also excluded? The logic of ICS is that the parties cannot be considered to have entered into the contract with the intention that only the written words of the contract would be considered, otherwise none of the factual matrix would be considered.

In my opinion Lord Hoffmann found himself in a bind in ICS. He had to have a workable theory of contract which supported the common-sense conclusion that written contracts are good ways of agreeing. So he needed a system which allowed the factual matrix to be considered but that excluded, not only subjective intent, but pre-contract negotiations. Had he not done so, people would have little reason to reduce contracts to writing., The words of a written contract would always be re-interpreted in light of what each party said to the other prior to writing down what they apparently had agreed, undermining the reason for the written words.

This bind is the genesis of the rule of evidence that negotiations were inadmissible. It had to be a rule of evidence because once the factual matrix was able to be examined in interpreting contracts there was no reason other than one founded on a rule of evidence not to examine all extrinsic evidence.

This approach has been affirmed by the United Kingdom Supreme Court in several recent decisions including Arnold v Britton³ and Wood v Capita Insurance Services Ltd.⁴

New Zealand’s leading case on use of extrinsic evidence is undoubtedly Vector Gas Ltd v Bay of Plenty Energy Ltd.⁵ In practical terms, Tipping J’s decision in Vector Gas has been followed the most widely by the Courts. Justice Tipping’s view appears to be that the rule against particular sorts of evidence being admissible stems from the fact that contractual interpretation is an objective exercise. The reason that subjective intent is irrelevant is that it does not conform with an objective rule of contract.⁶ On such a view, there is nothing in principle wrong with negotiations being admissible to assist with interpretation of contracts so far as they establish the objective background for the interpretation of the Contract.

It is arguable that Tipping J’s analysis does not represent the majority view, at least in terms of the admissibility of negotiations.

Justice Blanchard did not go as far as Tipping J. His Honour held that negotiations can be used (if known to both parties) to establish the objective commercial purpose of the agreement. His Honour stated, “The question of how much further the courts of this country should go towards admitting evidence of negotiations for the light they may shed on the objective intention of the parties can be left for another day.” Justice Gault concurred with Blanchard J.

Wilson and McGrath JJ held fast to the traditional view that only when there are ambiguous words are evidence of negotiations allowed.

It appears the majority in Vector Gas held that other than to establish the commercial purpose of a contract (where Gault and Blanchard JJ seem to think negotiations are admissible) prior negotiations are excluded (or, at least, there was no decision on the point).

One of the reasons that Tipping J’s view may have been followed in subsequent cases is that it offers a principled reason for a rule against subjective intent being relevant, and His Honour suggests that Blanchard and Gault JJ’s ‘half-way house’ approach is not sustainable in principle. Be that as it may, it cannot be said that the Court has fully opened the door to the admissibility of negotiations for interpretation of contracts.

While Blanchard J’s decision is difficult to sustain, at first blush, in principle, it may make sense on other grounds. Purposive interpretation of contracts has a long pedigree and prior to ICS was a powerful tool available to the Court. The Court needs some mechanism to be able to determine the purpose of any particular contract. This is easy when contracts fit into traditional categories such as sale of goods, contract of carriage, insurance, sale of land, lease, letters of credit and similar areas, but contracts (especially in complex commercial transactions) often fall outside our ordinary contract categories. Therefore, admitting evidence of contract negotiations is a potential pragmatic necessity to be able to determine the commercial purpose of a contract.

Admitting negotiations in such a circumstance might be conceptualised as being consistent with the traditional policy of not admitting negotiations. Where the purpose of the contract is unclear or ambiguous, the Court might be allowed to look to the party’s objectively expressed negotiations to determine what purpose the contract has. Whether this reasoning is sufficient justification for Blanchard J’s decision, is perhaps open, but it is a potential argument in its favour.

This is a case of the New Zealand Privy Council, which post-dates the UK decision in ICS. The Privy Council, in a decision of Lord Hoffmann no less, considered the admissibility of negotiations. Lord Hoffmann soundly rejected Thomas J’s Court of Appeal (NZ) decision⁸ in which Thomas J had relied on evidence of negotiations to interpret the contract in question. Lord Hoffmann held that such evidence was unhelpful (although the Privy Council left the door open to its use on occasion).

While Lord Hoffmann’s decision is light on reasoning, it provides some support for the argument that in New Zealand Courts pre-contractual negotiations will not generally be admissible to interpret contracts. Unfortunately, this point was not considered in Vector Gas.

One of the difficulties New Zealand Courts face is that once you undermine the traditional rule against admitting negotiations to interpret contracts (being that the parties decided to write down what they meant rather than use their negotiations to determine what they meant), it is hard to justify not using pre-contractual negotiations to interpret contracts in all cases. Any rule against the use of negotiations must be a unique rule of evidence rather than a rule of contract interpretation.

It is difficult to maintain the rule as a unique one of evidence, because the reason for it must come down to a policy decision. Once you accept that reference to negotiations should be allowed in some instances, why just those instances and not others?

What does this rule do to certainty in commercial contracts? What is the point of a written contract if pre-contractual negotiations are relevant to its interpretation? What is the contractual principle that would allow reference to pre-contractual negotiations to interpret the written contract?

There are many questions for which there appear to be no good answers. In my opinion, Thomas J’s decision in Yoshimoto, makes the argument for allowing pre-contractual negotiations as well as it can be made. Justice Tipping’s decision in Vector Gas is also a strong statement in favour of this position.⁹

In many ways, this difficulty (determining when as a matter of the law of evidence pre-contractual negotiations are admissible) is the underlying difficulty with ICS. It is interesting that the Courts in New Zealand appear also to be struggling with this.

1. Seaford Court Estates Ltd v Asher [1949] 2 KB 481 (CA) at 499.
2. Investors Compensation Scheme Ltd v West Bromwich Building Society [1998] 1 WLR 896 (HL).
3. Arnold v Britton [2015] UKSC 36, [2015] AC 1619. Note that some commentators have indicated that Arnold v Britton represents a change in approach from the UK Supreme Court regarding contractual interpretation. In light of Wood v Capita Insurance Services Ltd, this seems unlikely to be the position in the UK.
4. Wood v Capita Insurance Services Ltd [2017] UKSC 24, [2017] AC 1173.
5. Vector Gas Ltd v Bay of Plenty Energy Ltd [2010] NZSC 5, [2010] 2 NZLR 444.
6. At [28]-[29].
7. Yoshimoto v Canterbury Gold International Ltd [2002] UKPC 40, [2004] 1 NZLR 1.
8. Yoshimoto v Canterbury Gold International Ltd [2001] 1 NZLR 523 (CA).
9. It is worth noting, that part of the problem in this area are the changes to the law of rectification made in Chartbrooke Ltd v Persimmon Homes Ltd [2009] UKHL 38, [2009] AC 1101. The changes to the law of rectification do tend to force arguments into the interpretation sphere.