Interpretation of Contracts – An Update

Introduction

On 20 March 2020 Justice Riordan of the Victorian Supreme Court handed down a decision in Siemens Gamesa Renewable Energy Pty Ltd v Bulgana Wind Farm Pty Ltd [2020] VSC 126 (Siemens v Bulgana). The case considered two significant issues arising in contract disputes:

(a)        under what circumstances a court may stop a call on an unconditional bank guarantee; and

(b)        whether ambiguity is a requirement for looking beyond the terms of the contract and admitting evidence of surrounding circumstances when construing its terms.

Background

Bulgana Wind Farm Pty Ltd (Bulgana) engaged Siemens Gamesa Renewable Energy Pty Ltd (Siemens) to design and build wind turbine generators and a battery storage solution in Western Victoria pursuant to an engineering, construction and procurement contract dated 18 September 2017 (EPC Contract).

• Bulgana, Siemens and the National Australia Bank entered into a consent deed dated 18 March 2018 (Consent Deed) pursuant to which Bulgana granted a security interest over its rights, title and interest in the EPC Contract in favour of the bank. The Consent Deed contained provisions limiting the parties’ ability to amend the EPC Contract.
• Siemens failed to meet practical completion dates as required by the EPC Contract and allegedly was prima facie liable to pay delay liquidated damages (DLDs) at an agreed rate up until practical completion. Siemens claimed extensions of time under the EPC Contract, which were disputed by Bulgana. The resulting dispute was referred to arbitration under the EPC Contract.
• Bulgana threatened to call on its securities under the contract (two unconditional bank guarantees, each in the amount of 5% of the contract sum) (Bank Guarantees) or to offset the DLDs against payments due to Siemens under the EPC Contract.
• On 30 September 2019 Siemens and Bulgana reached an agreement whereby Bulgana agreed not to call on the Bank Guarantees for the DLDs (without giving at least five business days’ notice to Siemens), and Bulgana would instead offset the claim for DLDs against monthly progress payment claims made by Siemens (September Agreement).
• The September Agreement was negotiated via telephone calls, email and text messages, and was evidenced by a three-paragraph letter.
• The offsetting amount fell $3 million short. Accordingly, Bulgana informed Siemens that it intended to call on the Bank Guarantees.
• Siemens sought an interlocutory injunction on the basis of the September Agreement, arguing that Bulgana had agreed not to call on the Bank Guarantees – and that to call on them would be a breach of contract.

Preliminary decision (interlocutory injunction)

On 27 November 2019 Justice Digby dismissed Siemens’ application for an interlocutory injunction. He chose to hear the matter on an ‘as if’ final basis – meaning he decided the injunction on a final basis, rather than an interlocutory basis.

Court of Appeal decision (interlocutory injunction)

The Court of Appeal also dismissed Siemens’ application for the injunction, and did so on the basis that Siemens’ claim of reputational damage could be avoided by Siemens paying the DLDs and not compelling Bulgana to call on the Bank Guarantees. The Court of Appeal found that Justice Digby had erred in determining the matter on an ‘as if’ final basis, because clear conflict surrounded the evidence of discussions between the parties prior to finalising the September Agreement. The Court of Appeal held that the meaning / construction of the September Agreement could only be finally determined at trial.

Supreme Court decision

Issues

For present purposes, the key issue determined by Justice Riordan was whether any ambiguity existed in the meaning of the September Agreement – and, if so, whether evidence of the negotiations and surrounding circumstances could be considered by the Court in determining its meaning (having regard to the ‘true rule’ established by Justice Mason in Codelfa Construction Pty Ltd v State Rail Authority of New South Wales (Codelfa)).

The ‘true rule’

The ‘true rule’ was stated by Justice Mason in Codelfa in the following terms:

‘The true rule is that evidence of surrounding circumstances is admissible to assist in the interpretation of the contract if the language is ambiguous or susceptible of more than one meaning. But it is not admissible to contradict the language of the contract when it has a plain meaning.’[our emphasis]

Findings

Justice Riordan held that:

Consistent with Siemens’ submissions, the September Agreement altered the previous risk allocation under the EPC Contract and restricted Bulgana’s right to call on the Bank Guarantees.

• The September Agreement was ambiguous. However, the negotiations surrounding the September Agreement related to the subjective motivations of the parties and, therefore, were inadmissible.
• Since Codelfa, debate has surrounded whether the true rule ‘requires ambiguity as a precondition to the admissibility of evidence of surrounding circumstances.’

The ‘true rule’ has not been overruled or modified by subsequent decisions of the High Court following Codelfa. This finding supports the purposes of the parole evidence rule, including to preserve ‘finality in written instruments’ and to avoid time-consuming and expensive litigation considering materials external to the contract.(In coming to this conclusion, His Honour disagreed with the views of the New South Wales Court of Appeal and Full Federal Court to the contrary.)

• Pursuant to the ‘true rule’ in Codelfa, ambiguity is a ‘gateway’ required before the Court may examine ‘extrinsic evidence of surrounding circumstances.’
• When determining the terms of a commercial contract, the Court must ask ‘what a reasonable businessperson would have understood those terms to mean’ if the reasonable businessperson was in the position of the parties. In doing so, the Court must consider:
  • objective construction of the terms;
  • the ordinary meaning of the terms, including context and purpose; and
  • the intention of the parties to produce a commercial result.
• After this analysis, if and only if the contract remains ambiguous (ie susceptible to more than one meaning), a party can admit evidence of the surrounding circumstances external to the contract to assist in interpreting the contract. However, statements and actions reflecting the parties’ actual intentions and expectations are inadmissible.
• ‘In my opinion, a reasonable businessperson in the position of the parties would have understood the subject matter of the Second Agreement [ie the September Agreement] to be the General Dispute’ and that, therefore, it was not limited to the subject matter of the August DLDs.
• Although he made no findings on the business commonsense argument, he found that while the commercial intention of the parties is to be considered, the business commonsense test should be applied carefully and courts should refrain from considering the subjective commerciality of the agreement.
• Submissions made by Bulgana that the interpretation of the September Agreement advanced by Siemens would lead to an absurd outcome, were not upheld. His Honour cited Macfarlan JA in Jireh International Pty Ltd v Western Exports Services Inc [2011] NSWCA 137, in that ‘there is a distinction between a finding of absurdity of operation, in the sense that “something must have gone wrong with the language” and a finding that a contract would have an uncommercial or unbusinesslike operation if given a particular meaning.’

Key points

This decision has clarified the legal position in Victoria and confirmed Justice Mason’s ruling in Codelfa, including that the ‘true rule’ remains good law in Victoria in all of its applications. Therefore:

ambiguity as to the meaning of a contract is a requirement for the admissibility of external evidence of surrounding circumstances; and

• external evidence (ie material or evidence outside of the contract) will not be admitted to raise ambiguity about the meaning of a contract.

The case is also an example of how, notwithstanding the terms of an executed contract, parties by subsequent agreement are able to amend the contractual risk allocation and mechanisms under the original contract. Therefore, care must be taken when negotiating disputes – because agreements struck between the parties may change the risk allocation in a contract and prejudice the ability of parties to subsequently rely upon the strict terms of the principal contract.

Siemens Gamesa Renewable Energy Pty Ltd v Bulgana Wind Farm Pty Ltd [2019] VSCA 318.

Siemens Gamesa Renewable Energy Pty Ltd v Bulgana Wind Farm Pty Ltd [2019] VSCA 318

at paragraph 101 per Beach JA, McLeish JA and Hargrave JA.

Codelfa Construction Pty Ltd v State Rail Authority of New South Wales (1982) 149 CLR 337.

Refer to paragraph 90.

Refer to paragraphs 93 to 99, in which Riordan J cited with approval the decisions of Royal Botanic Gardens and Domain Trust v South Sydney Council (2002) 240 CLR 45; Western Export Services Inc v Jireh International Pty Ltd [2011] 282 ALR 604 and Mount Bruce Mining Pty Ltd v Wright Prospecting Pty Ltd (2015) 256 CLR 104. See also the decisions in Pepe v Platypus Asset Management Pty Ltd (2013) 46 VR 694 and Apple and Pear Australia Pty Ltd v Pink Lady America LLC (2016) 343 ALR 112 (cited at paragraphs 101, 102 and 104(c)).

Refer to paragraph 99(b).

Refer to paragraph 103 and the decisions cited therein, being Franklins Pty Ltd v Metcash Trading Ltd (2009) 76 NSWLR 603; Mainteck Services Pty Ltd v Stein Heurtey SA (2014) 89 NSWLR 633; Cherry (2017) 96 NSWLR 548 and Stratton Finance Pty Ltd v Webb (2014) 314 ALR 166; Commissioner of Taxation v Trustee for the Michael Hayes Family Trust [2019] FCAFC 226.

Refer to paragraph 98.

Refer to paragraph 87.

Refer to paragraph 87(d).

Refer to paragraph 87(f) and Mount Bruce (2015) 256 CLR 104, 117 at paragraph 50 per French CJ, Nettle and Gordon JJ.

Refer to paragraphs 87(c) – ‘…the court does not weigh the commerciality of the agreement, and business commonsense is a topic on which reasonable minds may differ.’ See also paragraphs 117 to 121 including the following comments of His Honour: ‘A court should be very wary before applying the so-called “business commonsense” test and should not weigh the commerciality of the agreement. What constitutes business commonsense “may itself be a topic upon which minds may differ” and “bad bargains are not of themselves ‘unbusinesslike’”.’

Refer to paragraphs 126 and 127.

Co Author: Eva-Jane Klepner