What does interpreting a contract mean in practice and why is it so important?

Interpreting a contract is the process of working out precisely what it says. Words and phrases can have many interpretations so how they apply to a situation is not always clear. When this happens, it is ultimately a judge who will decide what a contract says and so what the parties have actually agreed.

It is what the parties have agreed and not what they intended to agree that matters. A court will not consider the content of any negotiations that took place before the contract was agreed. This includes draft versions of the contract or related emails. These evidence only what each party tried to negotiate, whereas the contract itself records what was agreed.

If a contract contains a mistake or does not reflect what you thought was agreed, then you could end up having agreed a bad deal that causes you significant loss. This is legally irrelevant, however, because a court will not rewrite a contract.

What are the general principles of interpretation?

The most important principle is to consider the words that have been used and to give them their natural and ordinary meanings. This is an objective exercise so the court will place itself in the shoes of a reasonable person to ascertain what they would understand to have been written. Any word or phrase that is unclear will be viewed in the light of the contract as a whole. The contract will be read in the light of all relevant background knowledge which was reasonably available to both of the parties at the time the contract was made. Business common sense can be used to understand a clause so long as it does not conflict with the natural meaning of the words used. A reasonable interpretation of what a clause says will have priority over a literal interpretation.

These principles must be balanced against each other and considered as a whole. They are guidelines rather than fixed rules and the court has discretion in how it applies them. Nevertheless, the actual words used in the contract will always be the most important factor.

What are implied terms?

Implied terms are ones that are not expressly agreed by the parties and are not written in the contract. They apply either through legislation, previous court judgments (known as case law) or market practice. Any market practice will need to be proved with evidence.

Implied terms form part of a contract when it is necessary to give the contract business efficacy (i.e. in order to make it work in practice) or where it is so obvious that it goes without saying. An implied term will not form part of a contract where there is an express term that contradicts it.

What practical steps can be taken to avoid uncertainty?

To avoid all of the uncertainty created by an unclear contract, both parties should spend time getting it right when they enter into it.

Each contract must be tailored to its specific situation. Every clause should be carefully reviewed to ensure that it reflects the parties’ intentions with clear and precise language. The contract should be as concise as possible containing short sentences and no excess content. This approach minimises the risk of subsequent disagreements and wasted time and costs.

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