Significant Supreme Court judgment clarifies contractual interpretation issues

The Supreme Court has delivered its judgment in an appeal brought by Bathurst Resources Limited (Bathurst) against L&M Coal Holdings Limited (L&M). By majority, the Supreme Court allowed the appeal, finding in Bathurst’s favour. In doing so, it set aside the High Court and Court of Appeal judgments to opposite effect.

The appeal provided an important opportunity for the Court to settle the law on the approach to the admissibility of extrinsic evidence in cases of contractual interpretation and to clarify the test to be used for the implication of terms.  The Court was unanimous on the approach to these issues.

Background

The appeal arose out a dispute concerning the proper interpretation of an agreement for the sale of prospective coal mining rights (principally exploration permits).  In June 2010, Bathurst acquired Buller Coal Limited (Buller) from L&M under a share sale and purchase agreement (the Agreement).  Buller held coking coal mining and exploration permits on the West Coast of the South Island.  Bathurst paid US$40 million to settle the transaction, with a promise to pay royalties on coal sales (as set out in a Royalty Deed executed alongside the Agreement) and two “Performance Payments” of US$40 million when certain quantities of coal (first 25,000, and then 1 million, tonnes) had been shipped from the Permit Areas.

In 2012, Bathurst and L&M entered into a Deed varying the Agreement.  The Deed inserted a new clause 3.10 into the Agreement, which provided that the failure by Bathurst to make the performance payments when and as due would not be an actionable breach, for so long as the relevant royalty payments continued to be made under the Royalty Deed.

By September 2015, Bathurst had extracted more than 25,000 tonnes of coal from the Permit Areas during construction at the mine, which was sold to a domestic buyer.  By early 2016, the international price for coking coal had plummeted and Bathurst suspended construction works at the mine, putting it into ‘care and maintenance’.  Bathurst continued to pay L&M royalties from stockpiled coal.

Supreme Court judgment

There were two core interpretation issues on appeal.  The first concerned the interpretation of the expression “shipped from the Permit Areas” and therefore whether the first performance payment obligation had been triggered.  The second issue considered whether, if the first performance payment obligation had been triggered, clause 3.10 entitled Bathurst to defer that payment even though it had stopping mining.  Both issues were resolved in favour of L&M in the High Court and Court of Appeal.

The Supreme Court were unanimous on the first issue, finding in favour of L&M’s interpretation of the expression “shipped from the Permit Areas”.  The Court found that “shipped” should be given the generic meaning of “transported” and that the first performance payment had therefore been triggered.  However, on the second (and dispositive) issue, a majority of the Court found that, contrary to the High Court and Court of Appeal judgments, clause 3.10 simply required royalty payments to be made under the Royalty Deed as and when required.  Therefore, Bathurst was entitled to defer its obligation to pay the performance payment while making the required royalty payments.  The majority also considered L&M’s argument that a term should be implied, but declined to do so.

Significance of this decision

This decision records a number of important developments in the law of commercial contracts, including the rules relating to the relevance and admissibility of extrinsic evidence, and the distinction between interpretation and implication and the appropriate test for implication of a term.

The Court agreed that the approach to be taken to contractual interpretation is governed by the law of contract and is an objective task.  However, the Court clarified that the admissibility of extrinsic evidence is an evidential issue, to be determined in accordance with the law of evidence in light of the substantive law of contract: “Applying s 7 in the context of contractual interpretation, evidence is prima facie admissible if it has a tendency to prove or disprove anything of consequence to determining the meaning the contractual document would convey to a reasonable person having all the background knowledge reasonably available to the parties in the situation in which they were at the time of the contract”.  The Court emphasised that relevant evidence could still, however, be inadmissible under section 8 of the Evidence Act, which requires a Judge to exclude evidence if there is a risk that the evidence will have an unfairly prejudicial effect on the proceeding or needlessly prolong the proceeding.

The Court clarified the position on the admissibility of certain types of extrinsic evidence:

  • Prior negotiations (early drafts of the contract, pre-contractual communications between the parties, evidence regarding oral negotiations):
    • Evidence of content of prior negotiations will be inadmissible to the extent that it proves only a party’s subjective intention or belief as to the meaning of the words, or what their undeclared negotiating stance was at the time.
    • If evidence shows what a party intended the words to mean, and that this was communicated, it may tend to show a common mutual understanding as to the meaning of the contract – such evidence will be relevant and (subject to section 8) admissible.
  • Subsequent conduct (evidence of a party’s or all parties’ conduct in undertaking their contractual obligations after the agreement has been entered into):
    • The approach to subsequent conduct should be the same as the approach to the admissibility of prior negotiations – the Court must ask itself whether the subsequent conduct tends to prove anything relevant to the objective approach to interpretation.
    • The conduct does not need to be mutual.
    • Conduct that occurs post-dispute is very unlikely to be admissible.

In regard to implied terms, the Court affirmed the BP Refinery test as representing the law in New Zealand, while adding some qualifications:

  • The legal test for the implication of a term is a standard of strict necessity, a high hurdle to overcome.
  • The starting point is the words of the contract – if a contract does not provide for an eventuality, the usual inference is that no contractual provision was made for it.
  • The issue of implication only arises after the express terms of the contract have been interpreted and found not to provide for the eventuality, but both interpretation and implication are part of the construction of the written contract as a whole.
  • An unexpressed term can only be implied if the court finds that the term would spell out what the contract, read against the relevant background, must be understood to mean.
  • The inquiry for the court when considering implication is an objective one – it is the understanding of the notional reasonable person with all of the background knowledge reasonably available to the parties at the time of contract that is the focus of this assessment.
  • The implication of a term does not depend upon proof of the parties’ actual intentions, nor does it require the court to speculate on how the actual parties would have wanted the contract to regulate the eventuality if confronted with it prior to contracting.
  • The five conditions for an implied term set out in BP Refinery are a useful tool to test whether the proposed implied term is strictly necessary to spell out what the contract, read against the relevant background, must be understood to mean.
  • The BP Refinery conditions should not be applied in a rigid and formulaic way – while conditions 4 (clear expression) and 5 (no contradiction of express terms) must be met for the implication of a term, there is considerable overlap between conditions 1 (reasonable and equitable), 2 (business efficacy) and 3 (so obvious that it goes without saying).

The clarification of these issues has significantly developed the contractual interpretation landscape in New Zealand.

Note: MinterEllisonRuddWatts acted for Bathurst in these proceedings.

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