The terms of a contract

Parties to a contract are bound only by its terms, not by other statements made in pre-contract talk. If inducements were promised, they can sit alongside the main contract as a “collateral contract”. Contracts will always contain different types of terms, with “conditions” being more important than “warranties”. It’s possible to have a term that excludes one party from responsibility, but the courts generally view exclusion clauses as unfair.

What are the terms of a contract?

In order to determine what terms have been incorporated into a contract and what the terms mean, courts apply the rules of “construction”. In short, this is:

what a reasonable person would have intended or would have understood by the language used in the contract;

the context of a term within the whole contract;

the surrounding circumstances of the contract; and

the purpose and objective of the transaction.

Accordingly, courts have adopted an objective approach to the construction of contracts; subjective intentions, understandings and expectations are disregarded as irrelevant.

Incorporation of actual terms

A court will consider a term to be incorporated into a contract if it determines that the parties objectively intended to include the term at the time the contract was formulated.

This generally covers “express terms” (terms that are expressly written into a contract) and “inferred terms” (terms that are not made explicit in the contract, but can be inferred from the nature and context of the transaction and the circumstances surrounding the contract).

For example, if a written offer refers to attached terms that are not actually attached to the final contract, this may be sufficient for a court to consider that the parties objectively intended to infer those terms.

Issues about whether or not a term has been incorporated into a contract often come up in the following circumstances:

pre-contractual statements;

signed documents;

unsigned documents.

Pre-contractual statements

Before entering into a contract, various statements may be made by one party that encourage or induce the other party to enter into the contract. If these statements are not explicitly written into the contract, a dispute may arise about whether any of these pre-contractual statements should be considered to be a term of the contract.

Generally, the terms expressly recorded in a contract supersede or override any prior oral statement that was not included or referred to in the contract.

However, if from the surrounding circumstances of the case, the pre-contractual statement could reasonably have been understood by the parties to be promissory, then a court may consider such a statement to be a condition (i.e. an essential term of a contract) or a warranty (i.e. a non-essential and subsidiary term of a contract).

Courts have generally held that where a statement is reasonably likely to induce, and in fact induces, a party to enter into a contract, it is presumed to be a term of the contract. This is particularly the case where the party who makes the statement has more knowledge, information or skill than the other party.

For example, a purchaser buys land after viewing a form from the vendor that indicates that the land is sewered. A court has held that a reasonable person would consider that the vendor was providing a warranty that the land was sewered (and therefore constituted a term of the contract), even though the form was not expressly referred to or formally incorporated into the contract (see Ellul v Oakes (1972) 3 SASR 377).

Regardless of whether a pre-contractual statement is incorporated as a term into a contract, if such a statement is misrepresentative or misleading, a party may have access to other remedies (seeMisrepresentation or misleading conduct”, and Consumer protection laws.

Signed documents

The general rule is that a party is bound by all the terms in a contract if they have signed it. This applies whether or not they have read the contract’s terms or understood them. The exceptions to this general rule are legal, equitable or statutory relief (e.g. mistake) as to the nature of the document, false statements, or unfair contract terms (see5 Consent”).

Unsigned documents

If a party wishes to rely on a term that has not been signed by the other party, the general rule is that such a term can only be incorporated into the contract if reasonable notice is given to the other party. For example, if an airline wants to rely on terms contained on a printed ticket, such terms could only be incorporated into any contract if the passenger has been given adequate notice of the terms; for example, by being given the ticket well before the flight, and not just at check-in.

Incorporation of implied terms

Implied terms are incorporated into a contract on the basis of the parties’ hypothetical intentions. However, they are only implied to the extent that they are consistent with the actual terms of the contract. Accordingly, courts generally determine what the actual terms of the contract are before considering whether any terms are implied.

There are three different types of implied terms:

1 universal terms that are generally implied by law to be a part of all contracts (e.g. an obligation to cooperate and, arguably, an obligation to act in good faith);

2 generic terms that are implied by law in particular classes or types of contracts (e.g. a duty to take reasonable care in professional services contracts);

3 specific terms that are implied on an ad hoc basis, but only where such a term would:

be reasonable and equitable;

be necessary to give the contract “business efficacy”;

be so obvious that is “goes without saying”;

be capable of clear expression; and

not contradict any express term of the contract (see BP Refinery (Westernport) Pty Ltd v Shire of Hastings (1977) 180 CLR 266, 283).

Whether or not any terms are implied can be resolved by adopting an objective approach to the construction of the contract.

Interpretation of terms

Parties can often be in dispute about the meaning of terms and what the terms of a contract require either party to do.

As set out above, the courts have adopted an objective approach to interpreting contractual terms and determine the meaning of terms by referring to what a reasonable person would understand the terms to mean, by:

taking into account the natural and ordinary meaning of the language used in the actual text (if written) or oral term of the contract;

reading the terms in context and as part of the whole contract;

taking into account the objective background and surrounding circumstances known to both parties; and

taking into account the purpose and object of the transaction.

The parties’ subjective intentions, beliefs or expectations are not relevant to determining what a term means. For example, A genuinely believes that a clause requires B to transfer ownership of farming equipment to them immediately. A court will disregard such evidence and determine the meaning of the clause based on what a reasonable person would understand the clause to mean, taking into account the factors listed above.

Collateral contracts

A “collateral contract” is a separate contract that has been entered into as a condition of the main contract. For example, where A promises B to do something in consideration of B entering into the main contract, or where A gives an undertaking to B in consideration of B entering into a contract with C.

Disputes about whether a collateral contract has been made often arise when it is unclear whether a party’s statement was objectively intended to be promissory or to be contingent on the making of the main contract.

Generally, a court will not find that a collateral contract has been made unless its terms are consistent with the main written contract. If a court finds that a collateral contract has been made, then evidence of its terms will be admissable and may be relevant to interpreting the terms of the main contract.

Terms may be conditions or warranties

Contracts always contain different types of terms (said or written), some more important than others. The more important terms are called “conditions”, the less important terms are called “warranties”.

Conditions are so important that without them, a reasonable person would consider that one or other of the parties would not have entered into the contract. If a party misrepresents a condition of a contract, the other party may be entitled to rescind the contract, as if the parties never entered into the contract (seeMisrepresentation or misleading conduct”).

If a party breaches a condition, the other party can terminate the contract/seek damages for any loss suffered. Where the breached term is a warranty, the wronged party can only seek monetary damages for any loss suffered; they can not terminate the contract. The contract remains binding on both parties. (SeeRemedies for breach of contract”).

In determining whether a term is a condition or a warranty, the court will use the objective approach to interpreting contracts and will consider the language used by the parties, the surrounding circumstances, and the object and purpose of the transaction.

The law of contract has been significantly affected by many Acts of parliament (e.g. the ACL) to protect consumers. These Acts provide for minimum standards of trade behaviour and the standard of quality that the consumer ought to be able to expect. (For discussion of these extra standards, see Consumer protection laws and Consumer guarantees.)

Terms limiting or excluding liability

A contract can include a term that limits or excludes one of the parties from responsibility for something that may go wrong in the performance of the contract. Such a clause is called an exclusion clause or an exemption clause. For example, a contract between a builder and a homeowner for a house extension might include a term that excludes any liability for damage done to the lawn by the builder during the build.

Courts have generally taken the view that exclusion clauses can be unfair and have subjected them to special scrutiny. Courts employ the objective approach to the construction of exemption clauses; however, the onus is on the party relying on the exemption clause to establish that the term has been incorporated into the contract and should be interpreted to cover the liability event that it wants excluded.

Accordingly, when a contract is a document signed by the parties, they are generally bound by any express exclusion clause contained within it, regardless of whether the affected party had any notice of the clause.

Where a contract is an unsigned document (e.g. tickets, receipts, dockets), the court looks at whether the parties objectively intended to incorporate the exclusion clause into the contract. This includes considering whether reasonable notice was given to the party who would be disadvantaged by the exclusion clause before the formation of the contract. For example, if an automatic ticket machine in a car park had printed on it “issued subject to the conditions displayed in car park” and these conditions, or exclusion clauses, were on a pillar opposite the ticket machine, then this could potentially be held to be unreasonable notice. The driver may then be entitled to sue despite the exclusion clause in the conditions.

Courts have held that exclusion clauses are to be interpreted like any other clause. That is, according to an exclusion clause’s natural and ordinary meaning, read in the light of the contract as a whole, giving due weight to the context in which the clause appears, including the nature and object of the contract.

The only exception to this is where the exclusion clause is ambiguous and gives rise to more than one meaning; in this case, a court will generally choose the meaning that goes against the party seeking to rely on the exclusion clause.

Further, if the natural and ordinary meaning of an exclusion clause is that a party is absolved from all liability for failing to perform their obligations under the contract, then a court may decide that no contract actually exists. For example, if an airline ticket contains a clause reserving the airline’s right to abandon any flight, cancel any ticket, or refuse to carry any passenger, then no contract actually exists because the airline has excluded any obligation it has to perform the contract (see MacRobertson Miller Airline Services v Commissioner of State Taxation (WA) [1975] HCA 55).

Exclusion clauses may also be excluded on the basis that they constitute misleading or unconscionable conduct or are contrary to public policy. For example, exemption clauses that limit liability for fraud, or breach of trust involving bad faith are invalid. Courts have generally found that unless clear words are used, exclusion clauses generally do not exclude liability for acts that were not authorised or permitted under the contract.

Exclusion clauses may also be subject to statutory controls under the ACL that limit or void exclusion clauses because they are, for example, unfair or contrary to consumer guarantees (see Consumer protection laws and Consumer guarantees.

Penalty provisions

Some contracts contain terms that list the amount payable as damages if a particular term is breached. These terms are called “agreed damages clauses”.

Where the amount is a “genuine pre-estimate” of the likely damage that would be caused by a breach, the amount is “liquidated damages” and is enforceable against the party who breached the contact term.

However, when the amount is “extravagant and unconscionable” (i.e. it is out of proportion to the likely damage that would be caused by a breach), the amount is a “penalty” and is unenforceable.

To preserve parties’ freedom of contract, the courts have generally set a high threshold for what constitutes a penalty, as opposed to what constitutes liquidated damages.

For example, in Paciocco v Australian New Zealand Banking Group Ltd [2016] HCA 28, Paciocco had multiple credit cards and deposit accounts with the bank. The bank charged Paciocco a number of late payment fees, ranging from $20 to $35. Subsequently, Paciocco initiated proceedings alleging the fees amounted to penalties. In determining whether the fees charged were out of proportion to the damage that followed Paciocco’s late payments, the court considered the bank’s loss provisioning, operational and regulatory capital costs. After acknowledging these costs as legitimate interests protected by the late payment fees, the court held that the fees did not amount to penalties and dismissed Paciocco’s appeal.