A bird’s eye view of the current state of the law relating to the interpretation of contracts and the slow death of the parol evidence rule | Knowledge

‘The Constitution demands an audit of all law and that demand cannot be defended by the idea that legal certainty will be compromised. The journey to legal change may cause understandable anxiety but if honestly managed it will introduce a rule of law for the protection of 55 million South Africans without the detrimental consequences suggested, often as if they required no justification.’[1]

The South African law applicable to the interpretation of contracts has undergone substantial development over the last two decades, which development was encapsulated by the seminal judgment of Wallis JA in Natal Joint Municipal Pension Fund v Endumeni Municipality[2] where the learned judge summarized the now accepted expansive approach to the interpretation of legal documents as follows:

‘Whatever the nature of the document, consideration must be given to the language used in the light of the ordinary rules of grammar and syntax; the context in which the provision appears; the apparent purpose to which it is directed and the material known to those responsible for its production.’[3]

It is submitted that the shift in focus away from the clear and unambiguous meaning of the words used to the context in which a provision appears, its apparent purpose and the material known to those responsible for its production has created uncertainty when interpreting contracts. Contractual parties cannot be sure as to whether a court, when faced with the task of interpreting the provisions of a written agreement, will give effect to the clear and unambiguous words used in that contract, or whether evidence of the context, apparent purpose, surrounding circumstances of the conclusion of the agreement and the conduct of the parties subsequent to the conclusion of that contract will override the apparent literal meaning of the words used in the contract.

The common law parol evidence rule, and more specifically the integration facet of that rule, is aimed at limiting such uncertainty, as this common law rule disallows the admission of evidence by a contractual party which seeks to contradict, add to or modify the written terms of a contract in legal proceedings.[4] The Courts have, however, struggled to balance the conflict between the need to allow evidence in order to understand the context in which an agreement has been concluded and the restriction placed on the admission of extrinsic evidence by the parol evidence rule.[5]

The Supreme Court of Appeal (“SCA”) in KPMG Chartered Accountants (SA) v Securefin Ltd & Another[6] attempted to reconcile this conflict by explaining that although the parol evidence rule remains part of our law, and that ‘to the extent that evidence may be admissible to contextualise the document (since “context is everything”) to establish its factual matrix or purpose or for purposes of identification, “one must use it as conservatively as possible”’.[7]

Following the decision in KPMG, contractual parties increasingly adduced larger amounts of evidence regarding the surrounding circumstances in relation to the conclusion of an agreement which inevitably reduced the weight placed on the actual text used in that agreement. This trend was addressed by the SCA in City of Tshwane Metropolitan v Blair Atholl Homeowners Association[8] where the court warned:

‘This Court’s more recent experience has shown increasingly that the written text is being relegated and extensive inadmissible evidence has been led. The pendulum has swung too far’.[9]

The SCA in City of Tshwane further took the view that evidence of the parties’ prior negotiations is inadmissible when interpreting the provisions of a contract and that this approach is in line with the expansive approach to the interpretation of contracts and the parol evidence rule.

The principles to be taken from the judgments in KPMG, Endumeni and City of Tshwane regarding the interplay between the admission of extrinsic evidence to provide context to an agreement and the parol evidence rule were summarized by the SCA in Silostrat (Pty) Ltd and others v Strydom NO and others[10] as follows:

‘Central to the interpretation of legal documents is the principle that meaning must be attributed to the words used by the parties in the document. Although evidence of context is admissible as an interpretative aid such evidence may not be led to alter the meaning of the clear and unambiguous words used in an agreement.’[11]

Accordingly, although evidence of the context and purpose of a provision in an agreement may be led, the parol evidence rule had a critical role to play in ensuring that any evidence which is led, does not alter the meaning of the clear and unambiguous words in the agreement.

In the very recent judgment of the Constitutional Court (‘CC’) in University of Johannesburg v Auckland Park Theological Seminary and Another[12], the CC had the opportunity to grapple with the interplay between the need to adduce extrinsic evidence to determine the context in which a contractual provision appears and the parol evidence rule. The CC, after re-emphasizing the importance of considering the context and purpose of a contractual provision as matter of course when interpreting a contract, stated that a court should:

‘Where, in a given case, reasonable people may disagree on the admissibility of the contextual evidence in question, the unitary approach to contractual interpretation enjoins a court to err on the side of admitting the evidence.’[13]

The Court also explicitly included evidence of the contracting parties’ pre-contractual exchanges as the evidence which could be adduced by a contracting party.[14] The CC therefore endorsed the view that there is no clear limit as to the amount or type of contextual evidence which may be adduced and that it is for the Court to determine the weight to be placed on such evidence. This seems to be a drastic departure from the SCA decisions in KPMG, City of Tshwane and Silostrat.

The Court further rejected the argument that a whole agreement clause, which is commonly found in commercial agreements, precludes a court from applying the contextual approach to interpretation, as this approach is peremptory.[15] This drastically reduces the effectiveness of a whole agreement clause and precludes parties to an agreement from excluding extrinsic evidence when a contractual dispute arises. 

In relation to the effect of this wide remit to admit extrinsic evidence on the parol evidence rule the Court explained that:

‘The integration facet of the parol evidence rule relied on by the Supreme Court of Appeal is relevant when a court is concerned with an attempted amendment of a contract. It does not prevent contextual evidence from being adduced. The rule is concerned with cases where the evidence in question seeks to vary, contradict or add to (as opposed to assist the court to interpret) the terms of the agreement.’[16] 

Shortly after the decision in University of Johannesburg was handed down the SCA had the opportunity to appraise the impact of the CC’s judgment on the interplay between the admission of contextual evidence and the parol evidence rule in Capitec Bank Holdings Limited and another v Coral Lagoon Investments 194 (Pty) Ltd and others[17].

In dealing with the effect of the decision in University of Johannesburg on the process of interpreting a contract and determining the remit of the evidence which may be admitted by the Court and the concomitant effect of the admission of such evidence on the parol evidence rule, Unterhalter AJA made the following observations:

1. Since the interpretative exercise affords the meaning yielded by text no priority and requires no ambiguity as to the meaning of the text to admit extrinsic evidence, the parol evidence rule is likely to become a residual rule that does little more than identify the written agreement, the meaning of which must be determined;
2. There are limits to the evidence that may be admitted as relevant to context and purpose; and evidence of the parties’ prior negotiations and what they intended (outside cases of rectification) or understood the contract to mean should remain an important limitation on what may be said to be relevant to the context or purpose of the contract; and
3. Endumeni has become a ritualised incantation in many submissions before the courts. It is often used as an open-ended permission to pursue undisciplined and self-serving interpretations. Neither Endumeni, nor its reception in the Constitutional Court, most recently in University of Johannesburg, evince skepticism that the words and terms used in a contract have meaning.[18]

As is correctly noted by the SCA in Capitec Bank, the indiscriminate admission of extrinsic evidence will inevitably diminish the effect of the parol evidence rule and the weight given to the words used in a contract. This is so as the meaning of the words used in a contract will be subject to the broad context, including the pre-contractual negotiations, in which these words appear or have come about and the apparent purpose of such words. This will invariably alter the meaning of the clear and unambiguous words used in an agreement. 

The SCA in Capitec Bank, however, attempted to reconcile the courts’ previous hesitancy to admit extrinsic evidence in line with the parol evidence rule and the injunction by the CC in University of Johannesburg to err on the side of admitting extrinsic evidence. It restated the focus of the enquiry as being:

‘…interpretation begins with the text and its structure. They have a gravitational pull that is important. The proposition that context is everything is not a licence to contend for meanings unmoored in the text and its structure. Rather, context and purpose may be used to elucidate the text.’[19]

The judgment in Capitec Bank confirms that the judgment of the CC in University of Johannesburg has developed the legal rules applicable to the interpretation of contracts and the approach to the admission of extrinsic evidence which must be applied by the Courts. As contracting parties now have a broad entitlement to adduce evidence regarding the context and purpose of a contractual provision, it will remain imperative for a court to ensure that the interpretation of the relevant provision remains grounded in the text used.

Having regard to the preceding discussion, the current state of our law of interpretation can be summarized as follows:

1. Interpretation is the process of attributing meaning to the words used in a document having regard to the context provided by reading the particular provision or provisions in the light of the document as a whole and the circumstances attendant upon its coming into existence;
2. Meaning is ultimately the most compelling and coherent account the interpreter can provide, making use of the sources of interpretation. It is not a partial selection of interpretational materials directed at a predetermined result;
3. All extrinsic evidence which is relevant to the context, apparent purpose and material known to those responsible for the production of the document is admissible and the parties cannot preclude a court from considering such evidence through the use of a whole agreement clause. Such evidence may include evidence of the parties’ pre-contractual negotiations; [20]
4. It is for the Court to determine the weight of the evidence admitted; and
5. The parol evidence rule will only be applicable after the Court has determined what the meaning of the relevant provision of the contract is and will apply only insofar as any evidence is adduced which is not in line with the meaning already attributed to the relevant provision by the Court.

It is important that the drafters of contracts express the terms of a contract in the clearest possible terms and  ensure that the intention of the parties is set out in the terms of the agreement so as to limit any future disputes. As the Courts’ application of the expansive approach to interpretation of contracts has become difficult to predict and because of the reduced effect of the parol evidence rule resulting from the CC judgment in University of Johannesburg, there will be continuing uncertainty about the manner in which a contract will be interpreted by a court, having regard to the evidence adduced by the contractual parties.

This article originally appeared in “Business Tax & Company Law Quarterly”, edited by Milton Seligson; Michael Rudnicki; Des Kruger, available here – Siber Ink | Leaders in Legal ebooks, law journals and Sibergrammes|BTCLQ The Business Tax & Company Law Quarterly journal by Milton Seligson, Des Kruger & Michael Rudnicki is published by Siber Ink Publishers