Most contract disputes in the courts are concerned not with whether a contract has been formed, but with what the contract says in terms of the rights and obligations it has created. This highlights the importance of clear and precise legal drafting. The interpretation of contracts primarily requires courts to determine the intention of the parties against the context and background of the contract’s formation.

The rules that courts use for determining the intention of the parties are concerned both with deciding what terms have been incorporated into the contract (incorporation of terms) and what those terms can be understood to mean (construction of terms).

The express terms of a contract are those that have been expressly included by the parties. Where there is a dispute over the express terms of the contract, courts may need firstly to distinguish between terms and representations. The former (whether they are conditions or warranties) are legally binding constituent parts of the contract, whereas the latter are statements made prior to formation with a view to inducing a party to enter into the contract. Breach of the former creates liability under the contract. A false representation or “misrepresentation” may create liability under statute or in tort, but not under the contract.

Some representations may be treated as terms depending on their importance and the circumstances in which they were made. Entire agreement clauses can be used to define and limit the extent to which this may occur.

See Express terms.

In deciding exactly what the contents of a written contract are, courts need firstly to deal with the parol evidence rule. In terms of incorporation of terms, this rule states that nothing extraneous to the contractual document itself can be led as evidence to add to, subtract from or modify what the document actually says on its face. This fundamental rule gives certainty to written contracts. However, courts have acknowledged certain important exceptions to the rule.

Another fundamental rule relates to the importance of a signature on a written contract. The signature rule states that a signed contract is strong prima facie evidence that the signatory read, understood and approved of its contents. All the terms in the document are thereby incorporated into the contract. However, practitioners need to be aware of exceptions to this rule.

Terms may also be incorporated by the giving of notice. This takes on a special importance with terms that appear on signs and documents that may not appear contractual in nature and that purport to exclude or limit the liability of one or other party. Whether a term has been incorporated will depend on the timing and reasonableness of the notice.

Terms may also be incorporated by the nature and extent of any prior dealings between the parties.

Finally, it should be recognised that a binding contractual obligation may be asserted and recognised by way of a collateral contract. This is a separate contract that is connected to the principal contract between the parties through consideration. Where one party relies on a promise in order to enter into the contract, the promise may in some cases be enforceable as a binding separate contract even though it may not, strictly speaking, be a term of the principal contract.

See Incorporation of terms.

The rules of construction and contractual interpretation are subject to the parol evidence rule in the sense that a court will exclude extrinsic evidence that would have assisted the court in interpreting the contract. This relates primarily to evidence of contractual negotiations and post-contractual conduct. Again, courts will recognise some exceptional situations. The main rules of construction relate to the use of an objective approach to ascertain the intention of the parties, and the treatment of ambiguities and inconsistencies.

The interpretation of terms that exclude or limit liability is governed by rules to determine the ordinary and natural meaning of the words used and the nature of the limitation or exclusion in light of the intention of the parties and the scope of the contract as a whole. It must also be kept in mind that terms dealing with the liability of the parties must be interpreted in light of any statutory prohibitions to exclude or limit liability of a party, such as the Australian Consumer Law set out in Sch 2 of the Competition and Consumer Act 2010 (Cth).

See Construction of terms.

The meaning of a contract cannot be separated from the implication into it of terms by operation of law, custom or usage or the necessary facts of the case, regardless of any intention on the part of the parties. Courts will be prepared to imply a term into a contract where it is necessary to give effect to the parties’ true intentions. Certain requirements will need to be established for that to occur. Similarly, a term may be implied because it is customary to do so in the context of the contract. Finally, some terms will be implied simply because of a long-standing common law rule or statutory prescription, especially where the contract belongs to a class of contracts where the public interest must be protected.

Some contracts that require the parties to cooperate toward the performance of a contractual obligation may be subject to the implication of a term requiring such cooperation.

Finally, whether a duty to act in good faith in the performance of contractual obligations may be implied in contracts of a commercial nature is a controversial question that has to date not been authoritatively determined in Australia.

See Implied terms.

See also Checklist for contractual terms.