Bathurst decision – the Supreme Court on contractual interpretation

Since the decision was delivered in the middle of last month, a number of commentators have provided some well-written pieces on the Supreme Court judgment in an appeal in Bathurst Resource Ltd v L&M Coal Holdings Ltd.

The appeal concerned the proper interpretation of a contract for the sale of coal mining rights.  Contract interpretation issues were described in the judgment as a perennial issue, and while over time the test to be applied to find the meaning of the (written) words has become settled, the issue of what evidence outside the words of the contract should be allowed to assist with this task continues to be debated.  The same can be said for the nature of the test for implication of terms in a contract.

As a result, the judgment indicated that all members of the Court agreed on the approach to the admissibility of extrinsic evidence in cases of contractual interpretation – and the test for the implication of terms.  As a result the judgment noted a unanimous decision on the interpretation of a key term of the contract that was in dispute.  However, a minority took a different view to the majority on the application of a second key provision in dispute.  As a result, the Court allowed the appeal, by majority – overturning earlier decisions of the High Court and Court of Appeal.

The appeal raised the issue of what evidence, outside the words of the contract, should be allowed to assist with the task of contractual interpretation, and the application of the Evidence Act 2006 in this area. It also raised the question as to the test to be applied to the scope for implying terms into a contract.

Background

The case arose from a disputed interpretation of a contract for the sale of prospective coal mining rights (primarily exploration permits).  In 2010, Bathurst acquired the shares in Buller Coal from L&M under a Share SPA.  Buller Coal held coal mining exploration permits on the West Coast – for which Bathurst paid US$40 m, with a promise to pay royalties on coal sales and two Performance Payments of US$40 m each – when certain quantities of coal (25,000 tonnes – and then 1 m tonnes) had been shipped.

In 2012, Bathurst and L&M entered into a variation, inserting a new clause 3.10 into the contract which provided that:

Failure to make Performance Payments For the avoidance of doubt, the parties acknowledge and agree that a failure by [Bathurst] to make, when and as due, a Performance Payment is not an actionable breach of or default under [the contract] for so long as the relevant royalty payments continue to be made.

By 2015, Bathurst had extracted more than 25,000 tonnes of coal from the Permit Areas during construction at the mine, and that coal 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, effectively mothballing it, and continued to pay L&M royalties from stockpiled coal.

There two key issues in dispute were:

• First issue:  Whether the first performance payment obligation had been triggered – which hinged on the interpretation of the words “shipped from the Permit Areas”.  Bathurst argued that “shipped” should be given a literal interpretation, meaning carriage by ship, and therefore the first performance payment had not been triggered by its extraction and transport off-site of 25,000 tonnes of coal which it sold into the domestic market.

• Second issue:  Whether, if the first performance payment obligation had been triggered, Bathurst was contractually entitled by way of clause 3.10 of the contract to continue to defer that payment even though it has stopped mining and (therefore stopped paying mining royalties).  L&M said that Bathurst’s entitlement to defer payment lasted only so long as it was continuing to pay royalties (from ongoing mining).  If this meaning could not be reached through the interpretation of the written contract, L&M asked the Court to imply a term to this effect.

Bathurst argued clause 3.10 was clear on its own terms, and meant that Bathurst could indefinitely defer paying the performance payment so long as it continued to pay any royalties that became due.

Decision

The Court was unanimous on the first issue and on the approach to extrinsic evidence and implied terms in contractual interpretation.  

The Court agreed that the approach to be taken to the interpretation of written contracts is governed by the law of contract and is an objective task.

However, the admissibility (or otherwise) of extrinsic evidence is an evidential issue, to be determined in accordance with the law of evidence.  As New Zealand’s evidence law is governed by the Evidence Act, admissibility hinges on – relevance and probative value (and its admission must outweigh any prejudicial effect and not needlessly prolong the proceeding).  This means that, for example, there cannot be a blanket rule that makes evidence of pre-contractual negotiations inadmissible.

Therefore, noting that contractual interpretation is an objective exercise (to determine the meaning the contract to a reasonable person having all the background knowledge reasonably available to the parties in the situation in which they were at the time that the contract was made), the Court stated that evidence of pre-contractual 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, which were not communicated to the other party. Similarly, evidence of post-contractual conduct will often not assist a court to interpret the parties’ objective intentions (of the meaning of the contract) at the time it was made.

On the implication of terms, there was unanimous agreement that the implication of a term is part of the construction of the written contract as a whole.  They held that an unexpressed term can only be implied if it is strictly necessary, in that the term would spell out what the contract, read against the relevant background, must be understood to mean.  

• First issue:  The Court unanimously held in favour of L&M’s interpretation of the expression “shipped from the Permit Areas” – finding that the first performance payment had been triggered.  That is, agreeing with the High Court and Court of Appeal, that “shipped” should be given the generic meaning of “transported”.  

In reaching this decision, the Court rejected as inadmissible the subjective (and uncommunicated) declarations of intent as to the meaning of “shipped” from the principals of both parties.

• Second issue:  The majority, overturning the High Court and Court of Appeal, held that clause 3.10 correctly interpreted simply required royalty payments to be made under [the contract] as and when [the contract] required them.  

It did not impose any new requirement in relation to a certain minimum level of royalties, or any obligation on the part of Bathurst to develop and exploit the mine.  And they found that the requirements for the implication of a term to this effect were not met, and that L&M’s other fallback arguments could not succeed.

Therefore, Bathurst’s deferral of its obligation to pay the performance payment while suspending mining operations had not created an actionable breach, and the appeal was allowed.

The minority concluded that a reasonable person with all the available background would interpret clause 3.10 to mean that Bathurst could only rely on the right to deferral if it was paying royalties at a level consistent with a productive mine.  Since Bathurst was not doing so, L&M had become entitled to be paid the debt owing to it.

On this approach it was not necessary to consider the alternative argument for L&M of an implied term.  If it had been necessary, the minority would have implied a term that Bathurst ceasing to mine on a level equating to that which triggered the obligation to make the performance payment (while, at the same time, refusing to pay the USD 40 million payment that had become due) was a breach of contract, entitling L&M to compensation.

Takeaways (for commercial lawyers)

It seems unlikely that the Supreme Court decision in Bathurst marks some sort of opening of the floodgates for the likely range of evidence that a court may consider when reaching a landing on the disputed interpreting of a contract.  In large part, this is because the impact of rules of evidence under the Evidence Act should continue to act as a gatekeeper and avoid the need for courts to have to consider a smorgasbord of (unnecessary) extrinsic material.

As a result, the key takeaways for commercial lawyers appear to be:

• Clarity (say what you mean):  The words of the contract are the first port of call – and should also be the last.  Clarity is vital.  As a result, the drafter should always seek to ensure that the words reflect accurately what has been agreed.  In most cases, the parties should expect that the terms of the contract will be determinative of the dispute.

• Mean what you say (pre-contract dialogue):  Where necessary and appropriate, a court may rely on pre-contractual negotiations.  At the risk of stating the obvious – the parties must focus on negotiating contract terms that reflect what has been agreed.  They should not focus on “positioning” pre-contractual dialogue and correspondence in an effort to hedge their position just in case it may impact on the subsequent interpretation of the contract.  Such an approach is unlikely to help the negotiation process – let alone the relationship of the parties during the life of the contract.

• Mean what you say (post-contract conduct):  Some care needs to be taken to ensure that conduct and statements demonstrate a consistent position.  Admissions of liability may be held against you – although denials of liability may not carry as much weight.  In this case, the Court looked at Bathurst’s stock exchange announcements, financial statements and reports as aids to interpretation (without ultimately giving them much weight).

Further information

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