A timely reminder of the importance of careful drafting

A recent Supreme Court decision¹ raised issues concerning the proper approach to contract interpretation and the admissibility of extrinsic evidence. The court's approach serves as a timely reminder about the importance of careful and accurate drafting of commercial contracts. Solicitor Lisa Tat summarises the court's findings.

In 1995, the Natural Gas Corporation of New Zealand and Bay of Plenty Energy entered into an agreement under which NGC agreed to supply gas to BoPE (the Agreement). NGC gave notice of termination of the Agreement in 2004, which BoPE disputed and filed proceedings in the High Court challenging its validity.

In the interim, the parties reached an agreement whereby, pending the outcome of the proceedings, NGC would continue to supply gas to BoPE (the Interim Agreement). The main terms of the Interim Agreement were that:

• NGC would continue to supply gas based on the terms of the Agreement; and

• if BoPE was unsuccessful in, or withdrew, the proceedings, it would pay NGC "for each GJ supplied, the difference between the price set out in the Agreement and $6.50 per GJ", plus interest.

BoPE was ultimately unsuccessful in the proceedings and had to pay to NGC the amount specified in the Interim Agreement.

The court had to consider whether the "$6.50 per GJ" recorded in the Interim Agreement was inclusive of transmission costs or whether it referred to the cost of gas energy only. NGC (now Vector Gas) appealed to the Supreme Court after the Court of Appeal held that "$6.50 per GJ" included transmission costs.

Supreme Court's findings

General principles of contract interpretation

The ultimate objective in contract interpretation is to determine the intention of the parties as reflected in the words of the contract. The starting point is that the words of a contract should be given their ordinary meaning in the context of the contract in which they appear.

The court recognised that the ordinary or plain meaning of contractual text is always a principal, and usually the primary, consideration, but also emphasised that context and certain extrinsic material will often throw important light on the true meaning of a contract.

Pre-contract negotiations

The court accepted that pre-contractual negotiations are admissible in questions of interpretation to the extent that they establish the circumstances in which the contract was entered into, but not where they go towards showing individual intentions. Justice Wilson, however, appeared to be willing to go a step further and allow evidence of the parties' subjective intentions in some situations.

Commercial context

The court recognised the importance of considering the commercial context in which a contract was made. In particular, it placed emphasis on the importance of ensuring that a contract is interpreted in accordance with commercial or business commonsense.

Application to the facts of the case

The court considered that, in isolation, the phrase "$6.50 per GJ" could be interpreted as meaning either inclusive or exclusive of transmission costs. The Interim Agreement, however, imported the terms of the Agreement, under which the cost of gas was inclusive of transmission costs. On this basis, the court concluded that, on the ordinary and unambiguous meaning of the words of the contract, "$6.50 per GJ" was inclusive of transmission costs.

Despite there being no ambiguity based on the words of the Interim Agreement, the court went on to consider the context in which the agreement was made. It found that both parties knew:

• if the Interim Agreement was not reached, BoPE would have applied for an order for NGC to continue supply on the terms of the Agreement pending resolution of the proceedings. The parties also would have known that a court would have given such an order only if BoPE undertook to meet the loss to NGC (based on market rates) if BoPE were unsuccessful; and

• based on current market rates, NGC was managing to obtain, at that time, $6.68 per GJ plus transmission costs.

The court considered that for NGC to have agreed to the price of $6.50 per GJ inclusive of transmission costs would "flout business commonsense". Accordingly, to achieve a "commercially sensible" outcome, the court, by unanimous agreement, reached the decision that "$6.50 per GJ" in the Interim Agreement was exclusive of transmission costs.

Practical implications

The Supreme Court's decision may seem quite radical in what appears to be a disregard for the unambiguous written text of a contract. Courts have, however, generally been shifting towards the view that extrinsic material should be used in interpretation where it establishes the context in which a contract was made and it is not necessary for there to be ambiguity in the written text before a court can use extrinsic material to assist it in ascertaining the meaning intended by both parties to a contract. The Supreme Court has now confirmed and applied that approach to contract interpretation in New Zealand.

On that basis, the underlying principles applied in the case are not as drastic a departure from established principles as the case might initially appear to suggest. The case does still raise some questions about the extent to which such an approach to interpretation may erode certainty of contract.

Some might consider that the Supreme Court approached interpretation in the way that it did to achieve a fair outcome on the facts of the case before it. But, it does not follow, and it should not be assumed, that the courts are now more likely to help a party get out of a bad deal. The reminder and lesson to take from the case is simple: always ensure commercial contracts are drafted with utmost care and attention to detail.

¹ Vector Gas Limited v Bay of Plenty Energy Limited [2010] NZSC 5

Enquiries and information

For more information on any of the cases, articles and features in Commercial Quarterly, please email Diane Graham or call her on 64 9 916 8849.