Victorian Supreme Court confirms ‘True Rule’ of contractual construction


Contracts

Siemens Gamesa Renewable Energy Pty Ltd v Bulgana Wind Farm Pty Ltd [2020] VSC 126

Introduction

In Siemens Gamesa Renewable Energy Pty Ltd v Bulgana Wind Farm Pty Ltd [2020] VSC 126, the Victorian Supreme Court recently confirmed the ‘true rule’ of contractual construction. Justice Riordan held that ambiguity was required before evidence of surrounding circumstances could be used in construing a contract that restrained Bulgana Wind Farm Pty Ltd (BWF) from accessing an unconditional bank guarantee to satisfy a right to payment of money by Siemens Gamesa Renewable Energy Pty Ltd (Siemens).

This case highlights the primacy and certainty of written agreements and that parties should not rely on surrounding circumstances to accurately reflect their intentions when executing contracts.

Background

On 18 September 2017, BWF, a wind farm developer, engaged Siemens for the design and construction of its latest project under an Engineering, Procurement and Construction Contract (EPC Contract).

Importantly, pursuant to the EPC Contract, if Siemens failed to reach practical completion of the works by the established due date, it would be liable to pay Delay Liquidated Damages (DLD) until practical completion was achieved.

DLD’s were immediately due and payable on the issue of a notice by BWF, and could be recovered by deducting the amount from:

  • any amount due to Siemens (the progress payments); or
  • two unconditional bank guarantees Siemens was required to provide under the EPC Contract (the performance securities).

It was common ground that BWF’s right to deduct DLD’s from progress payments under the EPC Contract was subject to Siemens’ right to progress payments under the Building and Construction Industry Security of Payment Act 2002 (Vic) (SoP Act).

Siemens failed to achieve practical completion by the due date under the EPC Contract (16 August 2019).

Facts

A dispute arose when BWF claimed an entitlement to DLD’s after receiving notice that Siemens failed to achieve practical completion of the project on time.

BWF proposed to call upon the performance securities to satisfy the DLD’s. However, upon resistance from Siemens, the parties entered into a further agreement (the Second Agreement) for BWF to instead use the progress payments to satisfy the DLD’s, with a promise not to exercise its right to draw on the performance securities, the exact agreement stating:

Without the admission of any liability and reserving any rights SGRE (Siemens) may have, we confirm as follows:

  1. BWF will continue to offset any DLDs against payments or any amounts due to SGRE for the above project.
  2. Except in any process provided for in clause 41 of the EPC Contract, SGRE undertakes not to object to or oppose any such offset (other than for mathematical mistakes apparent in the DLDs calculations) and additionally will not exercise its rights under or in connection with the security of payment legislation in relation to this matter.
  3. BWF 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, BWF will not make a demand or claim under the Performance Securities before giving at least 5 business days prior written notice.

Contrary to this Second Agreement, only two days later, BWF notified Siemens of its intention to call on the performance securities to satisfy its claim for the DLD’s due.

Siemens consequently applied for a permanent injunction restraining BWF from making a demand pursuant to the performance securities, in relation to any disputed claim to DLD’s under the EPC Contract.

The case would require the Supreme Court to interpret the Second Agreement by considering the wording of the contract and the overall context of the agreement.

The Second Agreement

The basis of Siemens’ case was that the Second Agreement precluded BWF from calling on the performance securities for payment of DLD’s.

Siemens submitted that the term ‘matter’ in the Second Agreement referred to BWF’s claim to all DLD’s during the course of the EPC contract. This meant that BWF may recover DLD’s solely by way of set-off against Siemens’s entitlement to progress payments for all DLD’s.

Siemens’ argument was that the Second Agreement should be construed objectively by reference to its text and context which support its construction of ‘matter’. The Second Agreement is not ambiguous, nor does it amount to a commercial nonsense, so it is not permissible to look at further surrounding circumstances.

Importantly, Siemens submitted that the surrounding circumstances were inadmissible as there was no ambiguity in the agreement, the words were objectively clear.

In reply, BWF contended that it only agreed to not call on the performance securities in relation to the DLD’s that had been incurred in the period from 16 August to 31 August 2019 (August DLD’s) which would be set-off against the progress claim certificate dated 6 August 2019.

BWF argued that the words in the Second Agreement limited the circumstances to August DLD’s, however, it was the further surrounding circumstances that most supported its construction of the contract.

BWF’s argument would be strengthened from consideration of the surrounding circumstances. BWF attempted to show that the Second Agreement was a reference to August DLD’s, following from the fact that:

  • the subject matter of the Second Agreement was ‘delayed liquidated damages’, the only delay liquidated damages that had been demanded and that were due and payable at the time of the Second Agreement were the August DLD’s;
  • Clause 3 contains the words: ‘the right to draw on the performance securities in its possession’. The only rights BWF had to draw on the performance securities at the time of the Second Agreement were in relation to the August DLD’s;
  • The Second Agreement must be read in light of the foundational commercial setting – that is, the Second Agreement was executed to resolve a ‘pressing issue’. It is not a standalone agreement, rather, an adjustment measure and should be limited to August;
  • BWF was entitled to recover DLD’s under performance securities pursuant to the EPC contract and it was therefore unlikely that they would have sought to materially amend the terms;
  • under the EPC contract, DLD’s only become payable on the issue of a demand – at the time of the second agreement, only a demand for August DLD’s had been issued;
  • the only DLD’s due were the August DLD’s.

Critically, in contrast to Siemens’ argument, BWF claimed that ambiguity is not a requirement before extrinsic evidence of surrounding circumstance is admissible.

The crux of the case therefore came down to the admissibility of the surrounding circumstances evidence in deciding which construction of the Second Agreement was to be favoured by the Court.

Construction and the ‘True Rule’

The Court decided that the issue in this case was ultimately one of construction. Justice Riordan needed to decide what the Second Agreement meant for the parties. BWF sought to rely on evidence of ‘surrounding circumstances’ to support its construction of the agreement; whereas Siemens opposed the admissibility of such evidence and emphasised the primacy of the text.

His honour relied on the ‘true rule’ stated by Justice Mason in Codelfa governing construction of contracts, primarily examining the question of whether ambiguity is required in order to admit evidence of surrounding circumstances in interpreting a contract.

Principles of construction in commercial contracts

To construe the terms of a commercial contract, the Court asks ‘what a reasonable businessperson would have understood the terms to mean in the position of the parties’. This requires the application of an objective approach with reference to the text and its ordinary meaning together with the context and purpose of the agreement.

The Court generally approaches the task of interpretation on the assumption that the parties intended to produce a commercial result and should construe it to avoid a commercial nonsense.

The surrounding circumstances may be used if this leads to an ambiguous meaning.

Is there an ambiguity requirement?

The ‘true rule’ was stated by Mason J in Codelfa Construction Pty Ltd v State Rail Authority of New South Wales [1982] HCA 24, as follows:

The true rule is that evidence of surrounding circumstances is admissible to assist in the interpretation of the contract if the language is ambiguous or susceptible of more than one meaning. But it is not admissible to contradict the language of the contract when it has a plain meaning.

The Court considered extensive judicial and academic writing on whether the rule requires ambiguity as a precondition to the admissibility of evidence of surrounding circumstances.

Justice Riordan decided that the true rule as expressed by Mason J in Codelfa, requires ambiguity as a gateway to examining extrinsic evidence of surrounding circumstances, because:

  • the true rule does not permit evidence of surrounding circumstances to identify ambiguity; and
  • the true rule has not been varied by subsequent decisions of the High Court.

Conclusion

While it was undisputed that the EPC Contract established a risk allocation regime permitting BWF to call on the performance securities in asserting a right to payment of money by Siemens, Justice Riordan agreed with Siemens’ proposition that the Second Agreement modified the parties’ previous risk allocation and restricted BWF’s right to call on the performance securities.

The Court held that evidence of surrounding circumstances around the Second Agreement was inadmissible under the true rule.

Siemens’ construction of the Second Agreement was preferred because the Court concluded that a reasonable businessperson in the position of the parties would have understood the Second Agreement to refer to DLD’s generally because: there was no reference limiting the DLD’s to August, there was a continuing right to offset future claims for DLD’s in Clause 1, and using the August limitation in interpreting ‘matter’ lead to inconsistencies throughout the agreement.

Evidence of surrounding circumstances may have boosted BWF’s construction and indicated a limit to August DLD’s, however this was inadmissible and could not be considered in the Court’s interpretation.

Finally, the Court noted that BWF’s contentions of commercial nonsense or absurdity fell well short.

Compliance Impact

This case is an important reminder of the primacy and certainty of a written agreement. In construing a contract, courts will not have regard to negotiations between the parties, underlying intentions of either party or any other surrounding circumstances in the absence of clear ambiguity in the plain text of the agreement.

Subscribers that are party to a commercial contract should ensure all agreements are drafted with extreme care and precision to accurately reflect their intentions when executing contracts in order to avoid unfavourable, and potentially costly, interpretations of commercial agreements.