Drafting, interpreting, and enforcing contracts is a fundamental part of how we assist our clients. A number of recent court decisions in New Zealand and the United Kingdom have provided guidance on the approach that should be taken in relation to contract law.

Contract interpretation

Interpreting the meaning of contracts can be a complex task. Along with the ordinary meaning of words in the contract, a Court can also take account of the background to the agreement, the commercial context, and whether a clause makes logical sense. Recent decisions in New Zealand and the United Kingdom show that the judiciary may be moving away from a liberal, purposive interpretation of contracts.

Where the plain wording of a provision is clearly drafted, judges are increasingly less likely to depart from that meaning on the basis that it clashes with the overall purpose or subjective intent of the parties.

Lakes International Golf Management Ltd v Vincent [2017] concerned Mr Vincent, the owner of a property located in a residential golf resort. Mr Vincent was bound by a land covenant requiring him to join and pay the membership fees of the associated golf club. Mr Vincent successfully argued in the Supreme Court that he was not obliged to belong to the club, as the covenant defined “Golf Club” as being an incorporated society, and the club had actually ended up being operated as a limited liability company. The Supreme Court refused to consider the background and context of the covenant, on the basis that the covenant’s wording was clear. Mr Vincent thus avoided having to pay any club membership fees, on the basis of a poorly drafted land covenant.

As a result of the trend away from liberal interpretation towards a more literal interpretation of contracts it is important that legal agreements are thoroughly drafted. Definitions, correct legal terminology and careful structure should be used, in order to avoid costly unintended consequences. 

Implied Terms 

Where a contract does not make provision for a particular action or breach, the Courts may imply a particular term into the contract. The implied term must spell out in express words what the contract, taking into account the relevant background, would reasonably be understood to mean. The New Zealand Courts currently use a number of authorities in order to help determine whether a term is implied in a contract. In particular, contracting parties should ask:

• Is the term necessary to give business efficacy to the contract?
• If an officious bystander had suggested to the parties during the formation of the agreement that the term be implied in the contract, would they have dismissed that bystander with a common 'oh of course'?

For example, a commonly implied term is that a loan is repayable in full upon reasonable notice by the lender, where repayment conditions are otherwise unspecified. Certain terms are specifically implied by law, including the Consumer Guarantees Act, or by custom developed in a particular industry or variety of contract.

Law of Penalties

The long held legal position in relation to penalties contained in contracts has until recently been that a contractual clause containing a penalty would be void, unless the clause operated as a genuine pre-estimate of damages which would be caused by breach. More recently, this approach has been reconsidered by overseas and New Zealand Courts. The inquiry has moved from assessing the potential damage suffered following the breach, to whether there is a need to protect the broader interest that the clause is seeking to protect.

In 2015, the United Kingdom’s Supreme Court considered whether an £85 fine for overstaying in a shopping mall carpark was void as a penalty. The Supreme Court held that the fine was not void. The parking company had a legitimate interest in charging overstaying motorists, which extended beyond the recovery of any direct loss (ie lost income from another motorist being able to use the park). The wider interest of the landowners was the provision and efficient management of customer parking for the retail outlets.

There has not been a clear decision from New Zealand’s senior courts regarding penalty clauses since the recent judicial developments overseas. However, a recent High Court decision upheld a clause which required a landlord to repay over $500,000 to an early childhood centre tenant following the landlord’s failure to install a second lift in the building, as agreed in the lease. The High Court, adopting the UK’s recent approach, held that the considerable amount payable by the landlord was not out of proportion to the tenant’s interest in being able to operate a functional and financially viable child care centre. The case is currently on appeal.

Until the Court of Appeal or Supreme Court provides a clear statement as to the law on penalties, we recommend that our clients continue to frame clauses requiring payments on breach of contract as genuine pre-estimate of damages.

We are happy to help - please contact us on 03 377 2900 / law@mmlaw.co.nz.