2.09.2021

All about the evidence: Recent Supreme Court decision confirms extrinsic evidence rules and implication of contractual terms

The Supreme Court’s recent decision in Bathurst Resources Ltd v L & M Coal Holdings Ltd provides important guidance on the approach to the use and admissibility of extrinsic evidence for contractual interpretation and the test for implication of contractual terms.

Background

The Denniston and Stockton Plateaus lie within the Buller Coalfield, in the South Island.  Escarpment, a part of the Denniston Plateau, contains significant amounts of high-quality coking coal, used in the steel-making process.  L & M Coal Holdings Ltd (L & M) held exploration permits in these areas.  In 2010, Bathurst Resources Ltd (Bathurst) agreed to purchase coal exploration rights and mining applications from L & M. 

The agreement between Bathurst and L & M (the Agreement) included the sale of two exploration permits and associated rights.  Payment was to be made in a number of ways, including a deposit, performance payments, and royalties.  The first performance payment was to be paid within 30 days of the first 25,000 tonnes of coal being shipped from the permit area. 

After the Agreement was settled, the parties experienced a number of setbacks.  Escarpment took longer than anticipated to open.  Then the international price of coking coal collapsed.  In light of these difficulties, the parties agreed to amend the Agreement (the Third Deed).  The Third Deed provided that as long as Bathurst continued to make royalty payments, a failure to make a performance payment when due would not be an actionable breach or default under the Agreement. 

By September 2015, 25,000 tonnes of coal had been extracted.  L & M argued that this triggered the first performance payment obligation under the Agreement.  Bathurst did not pay, asserting that it was entitled to defer payment under the Third Deed, although it continued to make royalty payments.  In May 2016, Bathurst suspended mining at Escarpment.  It paid no further royalties.

L & M claimed that Bathurst was entitled to defer payment of the first performance payment under the Third Deed only while it continued to pay royalties.  L & M argued that extrinsic evidence should be admitted to demonstrate this.  Alternatively, it argued, such a term should be implied into the Agreement.  In contrast, Bathurst argued that the Agreement gave Bathurst flexibility as to the date of making the performance payments, as long as it complied with the royalty deed.  It also argued that the term which L & M argued should be implied was not one which was capable of clear expression.

There were two key issues at stake on appeal:

  • What extrinsic material can be admitted into evidence to assist with contractual interpretation?
  • What criteria should be used to determine a term to be implied into a contract?

The Court found in Bathurst’s favour on both these issues.

Admissibility of extrinsic evidence

Bathurst proposed a relatively narrow approach to admissibility of extrinsic evidence, arguing that evidence must be “mutual, overt and proximate” to be admissible.  L & M, however, considered that evidence which is neither mutual nor overt could be relevant if it favours the accuracy of one possible interpretation of the words of the contract over another.  Both parties agreed, and the Court confirmed, that admissibility is governed by the Evidence Act 2006. 

The Court held that there are two broad types of extrinsic evidence: evidence as to a party’s subjective intent or understanding of the contract, and evidence as to the parties’ common mutual understanding. 

Evidence as to a party’s subjective intent or understanding of the contract is not admissible if it was not communicated to the other party before the contract was formed.  It is not evidence that would have been available to a reasonable person having all of the information reasonably available to the parties at the time.  However, evidence which objectively proves the parties’ common mutual understanding as to the meaning of the contract is relevant and admissible.

Evidence as to the parties’ common mutual understanding can include prior negotiations, evidence as to the specialised meaning of a word used in the contract, or the parties’ subsequent conduct after the contract is signed.  The important consideration is whether this would prove anything relevant to a reasonable person.  Evidence is inadmissible if it only proves a party’s subjective intention / belief on the meaning of the words, or if it relates to their undeclared negotiating stance at the time.    

The test for implication of terms

Bathurst argued that the legal standard for implication of a term is one of strict necessity, which imposes a high threshold.  It also argued that the Court should confirm the five-stage test for implication of a term as set out in the English Privy Council case BP Refinery (Westernport) Pty Ltd v President, Councillors and Ratepayers of the Shire of Hastings.  That five-stage test is as follows:

  • It must be reasonable and equitable;
  • It must be necessary to give business efficacy to the contract;
  • It must be so obvious that it goes without saying;
  • The term must be capable of clear expression; and
  • It must not contradict any express term of the contract.

In contrast, L & M referred to previous cases to argue that the process of implying a term is a process by which the Court “discovers” a term which represents what the contract must have meant in a situation not directly addressed by the contract. 

The Court held that the starting point for the implication of terms remains the words of the contract.  A term can only be implied if it is strictly necessary to clarify the existing meaning of the contract.  The implied term will not add anything to the contract, but will only spell out what the contract must be intended to mean.  This is an objective inquiry.  Speculation on how the parties would have wanted the contract to handle an unforeseen eventuality is irrelevant. 

The majority held that the performance payment was triggered, but that the contract permitted the payment to be deferred.  They did not consider that the implication of a term was necessary to give business efficacy to the contract.  L & M had already received a deposit, the contract was between two commercially sophisticated parties, and there was always a possibility that the mine would not be developed and no further payments would be made.

Comment

This case provides comprehensive guidance on the use of extrinsic evidence in contractual interpretation and the implication of terms.  Extrinsic evidence is inadmissible if it merely proves a party’s subjective intention or belief as to the meaning of the words.  However, extrinsic evidence which objectively proves the parties’ common mutual understanding will be admissible. 

The previous test for implication of terms remains largely intact, although this judgment reiterates that the most important requirements (which must always be met) are that the term must be capable of clear expression and must not contradict any express term of the contract. While the other three factors remain important, they are analytical tools which overlap and are not cumulative.   

If you have any questions about your contractual obligations, please get in touch with our litigation team or your usual contact at Hesketh Henry.

Disclaimer:  The information contained in this article is current at the date of publishing and is of a general nature.  It should be used as a guide only and not as a substitute for obtaining legal advice.  Specific legal advice should be sought where required.

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Kerry
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