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Commercial contracts – defining words, adopting legislation and dealing with contingencies

26 November 2020

#Corporate & Commercial Law, #Dispute Resolution & Litigation

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Commercial contracts – defining words, adopting legislation and dealing with contingencies

Contracts generally need defined terms, they provide conciseness and comprehensibility. But, defining a word is hard and drafting often worrisome. Words can be left out, or definitions may omit a concept whose absence proves ruinous. Opportunist counterparties then take advantage. An example: settlement and release agreements generally try to prevent the released person from making ‘claims’. Sure, but what is meant by ‘claims’ – what counts as a claim and what will not? A court proceeding – certainly; what about a payment demand? Not so clear. The solution: define ‘claim’ by including just about everything the drafter thinks of or has seen used before – incidentally this is why experience can truly count.

The contract, instead of saying ‘X must not bring a claim’, instead says ‘X must not bring a Claim’, where the capitalised ‘C’ signifies a defined term. ‘Claim’ is then defined expansively - say “Claim includes any complaint, action, suit, cause of action, proceedings, arbitration, debt due, account, costs and expenses, claim, demand, verdict or judgment arising under the provisions of any statute, award, order or determination or otherwise, whether or not known as at the date of this agreement”.

The released party, that party’s lawyer, and that party’s lawyer’s insurer hope the words covers all possibilities. Yet the definition does not include an ‘appeal’. Is an ‘appeal’ a claim? Is it caught by other words used in the definition? Is it dragged in by beginning the definition with ‘including’? Arguably yes to each, but there is uncertainty. There is potential for dispute.

Reflecting on the opening remark: definitions are challenging and drafting contracts can be worrisome.

Using legislation for definitions

When a definition is required, but the word or concept is not within the parties’ or draftsperson’s expertise, definitions from other sources may warrant adoption. Legislation is regularly utilised. Another example, say, preventing contamination is important. Instead of the parties figuring out what is and is not ‘contamination’ – better left aside for a thesis – a definition from specific environmental legislation might be adopted.

This approach is neat, and I think worthwhile. Still, it may go wrong, not necessarily because the definition is lacking, but because the contract does not have the machinery enabling the definition to work in the first place or to remain working into the future. This occurred in HDI Global Specialty SE v Wonkana No. 3 Pty Ltd [2020] NSWCA 296. The case accepts merit in using legislation for definitions but highlights that the risks also need to be understood. Once understood, they can be guarded against.

Some risks

Probably the main risk in defining by legislative referencing is that legislation changes – this became the issue in HDI Global. The contract’s utility requires it automatically incorporate amendments and replacement legislation. The drafter must use foresight and skill so the contract automatically adopts the desired legislative changes.

The extent of necessary foresight can itself become complicated. Take long term contracts – say 99-year leases. This period could see political systems end – for example, if an Australian state became independent or the Commonwealth becomes a republic. If the contract defines ‘law’ as ‘the law of New South Wales’, but New South Wales ends, how would the contract react? These expanded scenarios aren’t considered here, but they are contingencies.

Standard approaches to legislation

There are common approaches in dealing with defined terms and legislative changes. Firstly, a contract may define terms by referencing a whole category or class of legislation, such as ‘Environmental Legislation’. Here a host of specific Acts etc are jammed into the term attempting to cover the field. The defined term is now fortified by the legislative suite. How that legislation defines a word applies to the contract. For instance, with ‘Contamination’, this would be defined as “Contamination means how that term is defined in the Environmental Legislation”. This approach can be problematic – a term may not be used consistently under all Acts, but adopted for specific Acts. ‘Contamination’, when defined for farming legislation, may be narrower in scope than how ‘contamination’ is defined in legislation dealing with protecting coral reefs. This may create ambiguity regarding what variant of the definition should be adopted in the contract.

Secondly, and as a narrower approach, the agreement may define a term as the term is itself defined within a specific Act. This would look like “‘Contamination’ has the meaning given to that term in the Pollution Act 2020, and includes any amendments to that term”. This approach captures amendments, forcing into the agreement any future legislative changes.

Finally, the contract may define words again by reference to an Act – e.g. “‘Contamination’ has the meaning given to that term in the Pollution Act 2020”. However, instead of the words used to define ‘Contamination’ addressing changes to the Act, this is done elsewhere in the contract. For example, by the ‘Interpretation’ section stating that “references to legislation include any amendments to the legislation”. 

Can this go astray? (Hint – these questions aren’t posed unless the answer is ‘yes’!)

The above approaches for dealing with legislative changes are common - but not exhaustive. Of the 3 examples, the second and third seem best. The chief practical problem will be the effectiveness of the words endeavouring to adopt legislative changes into the definition into the future.

In HDI Global, an insurance policy covered business interruption. The policy had exclusions, and these included a class of exclusions defined by a legislative reference. Cover did not extend to business interruption for “diseases declared to be quarantinable diseases under the Australian Quarantine Act 1908 and subsequent amendments”. This is like the second example above.

The problem was the Australian Quarantine Act was repealed, and the Biosecurity Act 2015 enacted. The Biosecurity Act did not ‘declare’ what diseases were quarantinable, but instead allowed ‘determinations’ that would specify, by a list, relevant human diseases. Had the Australian Quarantine Act 1908 not been repealed, the diseases ‘listed’ under the Biosecurity Act would have been quarantinable diseases under the Australian Quarantine Act. One such disease was, and no prizes for guessing, COVID-19.

Determining this question involved:

  • whether reference to the Australian Quarantine Act should be read as a reference to the Biosecurity Act because not doing so created an absurdity. This is known as ‘rectification by construction’. The remedy does not depend on any untowardness or unconscionability by the parties – as rectification often does, but just whether the wording is absurd, and a natural correction presents itself. The court can then read the contract as though it includes the sensible meaning. This argument failed – repealed legislation can freely be adopted by parties without absurdity. For example, the parties could agree on a list of diseases at a point in time
  • whether reference to “subsequent amendments” could be read as not only meaning amendments to the Australian Quarantine Act, but captured the Australian Quarantine Act’s repeal and in its place picked-up and adopted the Biosecurity Act into the policy. This too failed – the words ‘subsequent amendments’ are not ambiguous by suggesting any meaning besides amendments to the Australian Quarantine Act
  • whether the insurance contract should be read as adopting how the concept of amendment is used in the various Interpretation Acts. The insurer contended these Acts allowed ‘amendment’ as including a replacement Act where a former Act has been repealed. Again, no. While the Interpretation Acts could have been incorporated into the insurance contract, they were not. That legislation deals with rules for statutory construction, not mandating rules for reading contracts.

What can be learned?

The drafter need not know the future or all contingencies. The skill is foresight based on experience. This requires understanding how legislation may change, and then ensuring the particular contract – if it adopts legislation – allows for these changes being included, or indeed not included if this is desired. Some ideas:

  • ensuring amendments are captured. This may need extension beyond the primary Act to its regulations and other instruments
  • ensuring that if the Act is repealed and replaced, the replacement Act is successfully adopted, including regulations and instruments
  • because an Act can be repealed, but not necessarily replaced by an obvious alternative, there may be need to capture other Acts. This would be if an adopted Act is repealed, but there is no apparent replacement. In this case, another Act (or Acts) having substantively the same purpose and function may need harnessing into the agreement – and contractual words can do this
  • since there could be debate about if there is another Act with the same purpose or function, or if there are several Acts that may be said to share the same purpose and function, a circuit breaker could assist. If the parties cannot agree on the replacement Act, a solution could be defaulting to a specific, stand-by, definition or reference to expert determination. 

One thing a decision like HDI Global offers the commercial world is the chance to review favourite or standard commercial wordings and seeing if they would survive legislation being repealed and replaced. While at it, you are free to think about other possibilities and preventing or limiting the scope for future disputes.

Author: Bede Haines

The information in this publication is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, we do not guarantee that the information in this newsletter is accurate at the date it is received or that it will continue to be accurate in the future.

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