Contractual interpretation in Australia: when is extrinsic evidence admissible?

The Queensland Court of Appeal’s decision in Built Qld Pty Limited v Pro-Invest Australian Hospitality Opportunity (ST) Pty Ltd (Built v Pro-Invest), and the earlier Supreme Court of Victoria decision in Siemens Gamesa Renewable Energy Pty Ltd v Bulgana Wind Farm Pty Ltd [2020] VSC 126 (Siemens v Bulgana), raise a number of points on which parties to commercial contracts should be mindful.

These include that:

• a contractual term must be “ambiguous or susceptible of more than one meaning” before the courts will look to the surrounding circumstances to assist in the interpretation;
• ordinarily, the surrounding circumstances which may be admissible as extrinsic evidence are limited to the events and circumstances known to both parties to the contract. Evidence of the parties’ statements and actions reflecting their actual intentions and expectations are inadmissible;
• notwithstanding the above, extrinsic evidence may be used to identify the meaning of a ‘descriptive term’ in the contract, which is a term that has virtually no meaning without reference to extrinsic circumstances. Descriptive terms may, for example, include those which describe the subject matter of a contract, such as “my car”, “my shop”, “your wool”;
• this kind of extrinsic evidence cannot be excluded by an “entire agreement” clause; and
• parties should be careful to avoid imprecise language when drafting contracts and amendments to them.

The principles of contractual interpretation applied in the Siemens v Bulgana and Built v Pro-Invest decisions are especially relevant during the negotiation of ad-hoc / ‘side’ agreements common in construction and engineering projects. These may include agreements between the parties, typically negotiated by commercial or project teams, during the construction phase of a project, such as standstill agreements and settlement agreements.

Parties should take special care to ensure that the terms of such agreements are clear and certain. As was the case in the Siemens v Bulgana case, ambiguous terms can be assigned a meaning which is fundamentally different to the one that was intended, even where the effect of that interpretation fundamentally alters the risk allocation of the primary contract between the parties.

Ambiguity as a precondition to admissibility of extrinsic evidence: Siemens v Bulgana

In 2017, Bulgana engaged Siemens under an engineering, procurement and construction (EPC) contract to build a wind farm and battery energy storage system in Victoria. In 2019, a dispute arose in relation to delays to the works and Siemens sought, and was denied, an extension of time to the date for construction completion. Accordingly, Bulgana exercised its contractual discretion to call upon two of Siemens’ performance bonds to satisfy its claimed entitlement to liquidated damages (LDs) under the EPC Contract.

On 30 September 2019, shortly after Bulgana had proposed to call upon the performance bonds, the parties undertook commercial negotiations and entered into an informal agreement to amend the contract (‘the agreement’). The agreement was negotiated in something of a rush over the period of a day or so, with some 26 discussions, emails and text exchanges between the parties. Ultimately, the Agreement relevantly provided:

“1. [Bulgana] will continue to offset any LDs against payments or any amounts due …for the [project].

…

3. [Bulgana] will accordingly not exercise its rights to draw on the Performance Securities in its possession in relation to this matter. For the avoidance of doubt, [Bulgana] will not make a demand or claim under the Performance Securities before giving at least 5 business days prior written notice.”

Two days later, notwithstanding the terms of the Agreement, Bulgana notified Siemens of its intention to call upon the performance bonds. Accordingly, Siemens sought (amongst other things) an urgent interlocutory injunction from the court restraining Bulgana from calling on the bonds. Siemens’ application was dismissed at first instance, but overturned on appeal.

At trial, the issue before the court was whether the terms of the Agreement prevented Bulgana from calling on the performance bonds.

Siemens argued that Bulgana agreed not to call on the performance bonds for payment of the disputed LDs, and that it would instead exercise its right to set-off those LDs against outstanding progress payments. Bulgana’s position was that it only agreed not to call on the bonds in relation to the LDs that had been incurred in the period from 16 August to 31 August 2019, which would be set-off against Siemens’ corresponding August progress claim.

Admissibility of extrinsic evidence

Bulgana sought to rely on extrinsic evidence including letters, emails and diary records of meetings between the parties throughout 2019, in support of its interpretation of the agreement.

Finding in favour of Siemens’ interpretation of the agreement, the court held that:

• the terms of a contract must be ambiguous before a court may have regard to extrinsic evidence. This is principle is set down in the “true rule” as framed by Justice Mason in the 1982 High Court of Australia case Codelfa Construction Pty Ltd v State Rail Authority (NSW);
• it follows that extrinsic evidence of surrounding circumstances cannot be admitted to identify if there is, or isn’t, an ambiguity;
• while there was ambiguity in the terms of the agreement, the only surrounding circumstances which are admissible as extrinsic evidence are events and circumstances known to both parties to the contract. Evidence of a party’s statements and actions reflecting their actual intentions and expectations are inadmissible.

By entering into the agreement, Bulgana had therefore given up its rights to have recourse to Siemens’ bonds to recover LDs connected to the dispute generally, fundamentally altering the risk allocation in the EPC Contract.

Use of extrinsic evidence to identify the meaning of a ‘descriptive term’: Built v Pro-Invest

In 2015, Pro-Invest Australian Hospitality Opportunity (Pro-Invest) engaged Built Qld Pty Limited (Built) to design and construct a hotel in Spring Hill, Queensland. As part of the tender process, tenderers were asked to submit a design for an air-conditioning system which complied with certain technical performance requirements (Thwaite Requirements). In its tender bid, Built proposed an alternative design for the air-conditioning system, which did not meet the Thwaite Requirements, but improved its final tender price by AU$800,000.

To cater for the fact that the contract was, in some respects, on the basis of alternative (rather than conforming) parts of Built’s tender, the contract included a defined term: “clarifications”, which was defined as “the clarifications to the Works or the contract sum set out in Annexure Part O”.  Annexure Part O relevantly provided:

“[The Works] includes:

                    …

(u)   The Contractor’s alternative proposal for structural and mechanical systems on the basis that the Contractor meets the performance requirement of the tender drawings and specifications.

…

(ag)   Refer [value engineering] items listed below:

(i)     Mechanical Services: The Contractor, in conjunction with its preferred subcontractors has reviewed the documented design criteria and has offered an alternative air conditioning system based on VRF type arrangement. The system operates on a variable power supply and without the need for stand alone controls and variable speed drives. Additionally, the proposal also adopts a revised pipe and duct configuration.”

Clause 8.1(a)(ii) of the contract then provided for an order of precedence including that “the clarifications have precedence over the preliminary design”.

During the project, the superintendent (as agent for Pro-Invest) issued various defects notices to Built requiring it to install an air-conditioning unit which allowed the occupant of each individual room in the hotel ‘mode’ control, as opposed to temperature control.

Built carried out the works to Pro-Invest’s satisfaction, but commenced proceedings in the Supreme Court of Queensland to recover the costs of the air-conditioning works which it considered to be a variation.

Pro-Invest submitted that the air conditioning system was, instead, defective because it did not give the occupant of each individual room mode control, which was one of the Thwaite Requirements. Conversely, Built’s position was that, on the proper construction of the contract, it was not contractually required to install an air-conditioning system which provided for ‘mode control’ in each individual room and, accordingly, the defects notices amounted to variations.

Admissibility of extrinsic evidence

Built submitted that there was ambiguity in the contract as to what was meant by the expression “the contractor’s alternative proposal” in subclause (u) of Annexure Part O.  Accordingly, it asked the court to look at emails exchanged between the parties between the tender phase and contract execution in order to understand what it was the parties had agreed Built would, in fact, design and construct by way of air conditioning system for the hotel.

At first instance, the court held that the extrinsic material was inadmissible to give meaning to the term “the contractor’s alternative proposal”, as there was no ambiguity as to what the alternative proposal was.

On appeal, the Court of Appeal overturned the trial judge’s decision, finding that the extrinsic material was admissible because:

• the term “contractor’s alternative proposal” in subclause (u) was a ‘descriptive term’ because it has virtually no meaning unless reference can be made to extrinsic circumstances;
• the trial judge had erred in finding that ambiguity in the terms of the contract was required before referral to extrinsic evidence to identify the meaning of a ‘descriptive term’.
• the court can look to extrinsic evidence to discover what is meant by a ‘descriptive term’ because the extrinsic evidence does not add or change the meaning of the contract. Instead, it provides the court with information as to the subject matter of the contract.

Co-written by Jack Tivey of Pinsent Masons