The terms of a contract

30 Jan

What are the terms of a contract and what do they mean?

To determine what terms have been incorporated into a contract and what the terms mean, courts apply the rules of ‘construction’. In short, this means having regard to:

the natural and ordinary meaning of the language used in the actual text (if written) or oral term of the contract;
the terms in the context of the whole contract;
the purpose and objective of the transaction; and
what a reasonable person would have intended or would have understood by the language used in the contract.

Generally, this process of construction can be done by referring only to the contract, but sometimes it is necessary to refer to the objective background and surrounding circumstances of the contract that were known to both parties.

Accordingly, courts have adopted an objective approach to the construction of contracts; subjective intentions, understandings and expectations are disregarded as irrelevant

A court will consider a term to be incorporated into a contract if it determines that the parties objectively intended to include the term at the time the contract was formulated. This generally covers ‘express terms’ (terms that are expressly written into a contract) and ‘inferred terms’ (terms that are not made explicit in the contract, but can be understood from the nature and context of the transaction and the circumstances surrounding the contract).
For example, if a written offer refers to attached terms that are provided to the other party and that are agreed to by that party, but those terms are inadvertently not attached to the final contract, this may be sufficient for a court to consider that the parties objectively intended to incorporate those terms.
Issues about whether or not a term has been incorporated into a contract often come up in the following circumstances:
- pre-contractual statements;
- signed documents; and
- unsigned documents.
Pre-contractual statements
Before entering into a contract, various statements may be made by one party that encourage or induce the other party to enter into the contract. If these statements are not explicitly written into the contract, a dispute may arise about whether any of these pre contractual statements should be considered a term of the contract.
Generally, the terms expressly recorded in a contract supersede or override any prior oral statement that was not included or referred to in the contract.
However, if from the surrounding circumstances of the case, the pre-contractual statement could reasonably have been understood by the parties to be promissory, then a court may consider such a statement to be a condition (i.e. an essential term of a contract) or a warranty (i.e. a non-essential and subsidiary term of a contract).
Courts have generally held that where a statement is reasonably likely to induce, and does induce, a party to enter into a contract, it is presumed to be a term of the contract. This is particularly the case where the party making the statement has more knowledge, information or skill than the other party.
Regardless of whether a pre-contractual statement is incorporated as a term into a contract, if such a statement is misrepresentative or misleading, a party may have access to other remedies (see ‘Misrepresentation or misleading conduct’, above, and Chapter 7.2: Consumer protection laws).
Signed documents
A party is bound by all the terms in a contract if they have signed it. This applies whether or not they have read the contract’s terms or understood them. The exceptions to this rule are legal, equitable or statutory relief (e.g. mistake) as to the nature of the document, false statements, or unfair contract terms.
Unsigned documents
If a party wishes to rely on a term that has not been signed by the other party, the general rule is that such a term can only be incorporated into the contract if reasonable notice is given to the other party.
Implied terms are incorporated into a contract on the basis of the parties’ hypothetical intentions. However, they are only implied to the extent that they are consistent with the actual terms of the contract. Accordingly, courts generally determine what the actual terms of the contract are before considering whether any terms are implied.
There are three different types of implied terms:
1. Universal terms that are generally implied by law to be a part of all contracts (e.g. an obligation to cooperate and, arguably, an obligation to act in good faith);
2. Generic terms that are implied by law in particular classes or types of contracts (e.g. a duty to take reasonable care in professional services contracts);
3. Specific terms that are implied on an ad hoc basis, but only where such a term would:
  – be reasonable and equitable;
  – be necessary to give the contract ‘business efficacy’;
  – be so obvious that it ‘goes without saying’;
  – be capable of clear expression; and
  – not contradict any express term of the contract.
Whether or not any terms are implied can be resolved by adopting an objective approach to the construction of the contract.

A ‘collateral contract’ is a separate contract that has been entered into as a condition of the main contract.
- For example, where A promises B to do something in consideration of B entering into the main contract, or where A gives an undertaking to B in consideration of B entering into a contract with C.
Disputes about whether a collateral contract has been made often arise when it is unclear whether a party’s statement was objectively intended to be promissory or contingent on the making of the main contract.
Generally, a court will not find that a collateral contract has been made unless its terms are consistent with the main written contract. If a court finds that a collateral contract has been made, then evidence of its terms will be admissible and may be relevant to interpreting the terms of the main contract.
Contracts always contain different types of terms, some more important than others. The more important terms are called ‘conditions’, the less important terms are called ‘warranties’. The contract does not have to identify these terms specifically as conditions or warranties (although it might be helpful to do so). A court will use the rules of construction to determine the type of term.
Conditions are so important that without them, a reasonable person would consider that one or other of the parties would not have entered into the contract. If a party misrepresents a condition of a contract, the other party may be entitled to rescind the contract, as if the parties never entered into the contract (see ‘Misrepresentation or misleading conduct’, in this chapter).
If a party breaches a condition, the other party can terminate the contract and/or seek damages for any loss suffered. Where the breached term is a warranty, the wronged party can only seek monetary damages for any loss suffered; they cannot terminate the contract and it remains binding on both parties. (See ‘Remedies for breach of contract’, next.)
In determining whether a term is a condition or a warranty, the court will apply the rules of construction described above.
The law of contract has been significantly affected by many Acts of parliament (e.g. the ACL) to protect consumers. These Acts provide for minimum standards of trade behaviour and the standard of quality that the consumer ought to be able to expect. (For discussion of these extra standards, see Chapter 7.2: Consumer protection laws and Chapter 7.3: Consumer guarantees.)
A contract can include a term that limits or excludes one of the parties from responsibility for something that may go wrong in the performance of the contract. Such a clause is called an ‘exclusion clause’ or an ‘exemption clause’.
- For example, a contract between a builder and a homeowner for a house extension might include a term that excludes any liability for damage done to the lawn by the builder during the build.
The onus is on the party relying on the exemption clause to establish that the term has been incorporated into the contract and should be interpreted to cover the liability event that the party wants excluded.
Accordingly, when a contract is a document signed by the parties, they are generally bound by any express exclusion clause contained within it, regardless of whether the affected party read the clause.
Where a contract is an unsigned document (e.g. tickets, receipts, dockets), the court looks at whether the parties objectively intended to incorporate the exclusion clause into the contract. This includes considering whether reasonable notice was given to the party who would be disadvantaged by the exclusion clause before the formation of the contract. For example, if an automatic ticket machine in a car park had printed on it ‘issued subject to the conditions displayed in car park’ and these conditions, or exclusion clauses, were on a pillar opposite the ticket machine, then this could potentially be held to be unreasonable notice. The driver may then be entitled to sue despite the exclusion clause in the conditions.
Courts have held that exclusion clauses are to be interpreted like any other clause. That is, according to the ordinary rules of construction described above. However, where the exclusion clause is ambiguous and gives rise to more than one meaning; a court will generally choose the meaning that goes against the party seeking to rely on the exclusion clause.
Further, if the natural and ordinary meaning of an exclusion clause is that a party is absolved from all liability for failing to perform their obligations under the contract, then a court may decide that no contract actually exists.
Exclusion clauses may also be excluded on the basis that they constitute misleading or unconscionable conduct or are contrary to public policy. Courts have generally found that unless clear words are used, exclusion clauses generally do not exclude liability for acts that were not authorised or permitted under the contract.
Exclusion clauses may also be subject to statutory controls under the ACL that limit or void exclusion clauses because they are, for example, unfair or contrary to consumer guarantees (see Chapter 7.2: Consumer protection laws and Chapter 7.3: Consumer guarantees).
Some contracts contain terms that list the amount payable as damages if a particular term is breached. These terms are called ‘agreed damages clauses’.
Where the amount is a ‘genuine pre-estimate’ of the likely damage that would be caused by a breach, the amount is called ‘liquidated damages’ and is enforceable against the party who breached the contract term.
However, when the amount is ‘extravagant and unconscionable’ (i.e. it is out of proportion to the likely damage that would be caused by a breach), the amount is considered to be a ‘penalty’ and is unenforceable.
To preserve parties’ freedom of contract, the courts have generally set a high threshold for what constitutes a penalty, as opposed to what constitutes liquidated damages.