The crucial question of whether, or more accurately ‘to what extent’, evidence of surrounding circumstances is admissible to assist in the construction or interpretation of contracts is still a live issue.[1] [2]

First, it is necessary to examine what his Honour Justice Mason (with whom justices Stephen and Wilson agreed) said at page 352 in Codelfa:

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.

This statement of the ‘true rule’ appears to raise two concepts:

The admissibility of evidence, and the use to which that evidence may be put.[3] Importantly, the ‘true rule’ appears at first instance to prohibit any use of evidence of surrounding circumstances, or extrinsic evidence, when construing contracts unless there is ambiguity in the language of the contract.

Codelfa also makes clear that there are at least two other purposes for which extrinsic evidence can be admitted. First, to identify the meaning of a descriptive term and second, to explain the genesis or aim of a transaction.[4] However, what is not clear from his Honour Justice Mason’s judgment is how those two admissibility purposes interact with the so-called ‘ambiguity gateway’, which in effect means that ambiguity is a gateway to the admission of extrinsic evidence.

In addition, Justice Mason approved the following statement of principle by Lord Wilberforce in Reardon Smith Line Ltd v Hansen-Tagen [1976] 3 All ER 570 at 574-576:

When one speaks of the intention of the parties to the contract, one is speaking objectively – the parties cannot themselves give direct evidence of what their intention was.. .Similarly when one is speaking of aim, or object, or commercial purpose, one is speaking objectively of what reasonable persons would have in mind in the situation of the parties.

It is evident from this statement that the parties’ subjective beliefs or understandings about their rights and liabilities that govern their contractual relations are not relevant or admissible. The court will be interested with what each party by words and conduct would have led a reasonable person in the position of the other party to believe. The parties’ common intention to a contract are to be regarded as referring to what a reasonable person would understand by the language in which the parties have expressed their agreement. The determination of the contractual terms must be carried out by reference to what a reasonable person would have understood them to mean. That process, ordinarily, would require consideration not only of the text, but also of the surrounding circumstances known to the parties, and the purpose and object of the transaction.

That objective restriction, together with the ‘true rule’, make it clear that Codelfa expressly prohibits the use of extrinsic evidence:

  1. To contradict the language of the contract when it has a plain meaning; or
  2. To establish the subjective intentions of the parties, even when shared by both parties,

but it can be used to establish the purpose and object of the transaction.

Having said that, Justice Mason does not expressly say that only where ambiguity is apparent may the court admit extrinsic evidence. In fact, courts have been prepared to admit extrinsic evidence to answer the preliminary question of whether ambiguity exists.[5] If ambiguity is found, then the evidence becomes admissible to assist the court in the interpretation of that ambiguous language. Whereas if the preliminary inquiry reveals that the language is plain, the extrinsic evidence is then inadmissible and cannot be relied on.

[1] (1982) 149 CLR 337.

[2] Robert McDougall, ‘Construction of Contracts: The High Court’s Approach’ (2016) 41 Australian Bar Review 103, 104.

[3] McDougall, above n 4, 104.

[4] McDougall, above n 4, 105.

[5] McCourt v Cranston [2012] WASCA 60 at [36] per Pulln and Newnes JJA; Franklins Pty Ltd v Metcash Trading Ltd (2009) NSWLR 603.