Contract - Interpretation - Exclusion and limitation clauses - Contra proferentem rule - Brokerage contract for dealings on commodity futures market - Unauthorized dealings by broker - Unauthorized transactions substantially connected with broker-client relationship - Broker's liability limited by contract.

MASON, WILSON, BRENNAN, DEANE AND DAWSON JJ.: The appellant is a broker which engages in transactions on the commodity futures market. The respondent is an engineering company which earned large profits in the financial year ended 30 June 1981. As that year drew to a close the respondent's accountant, Mr Schultz, discussed with Mr Kleemann, an employee of the appellant, means by which the expected profit might be postponed until the succeeding financial year for tax purposes. Mr Kleemann recommended that the respondent engage in transactions known as tax straddles. The respondent acted on that recommendation and instructed the appellant to enter into such transactions on its behalf.

2. A tax straddle is a child of the futures market. As King C.J. noted in his judgment in the Full Court of the Supreme Court of South Australia, the tax straddle is not designed for the making of profits out of trading; it is intended to avoid, so far as possible, exposure to trading losses. Its purpose is to enable a loss to be made in one financial year which is offset by a corresponding profit in the succeeding financial year. This is achieved by matching contracts to sell commodities with contracts to buy commodities. The taxpayer acquires a contract to sell a given quantity of a commodity in the future, at the same time acquiring a contract to purchase the same quantity of that commodity. Both contracts are acquired at the then prevailing price. At a later stage in the financial year in which it is desired to generate a loss at a time when the market price changes, the next step in the transaction takes place. If the price falls, the contract to buy is sold at the lower price yielding a loss. At the same time a contract to buy the same quantity of the commodity at the lower price is acquired. The taxpayer then holds the original contract to sell at the higher price as well as the new contract to buy at the lower price. This will yield a "locked-in" profit to be realized in the following financial year. If, on the other hand, the price rises rather than falls, the taxpayer sells the contract to sell at the higher price, again generating a present loss. At the same time he acquires a new contract to sell the same quantity of the commodity at that price. Either way the taxpayer's taxable income is said to be reduced in one year and increased in the next year.

3. The parties executed a written contract dated 12 June 1981 which incorporated a proposal from the appellant addressed to the respondent. The front page of the contract contained a number of questions. One question was: "Do you wish this account to be traded at the discretion of Darlington Futures Limited?" The answer was "No". A provision in the contract authorizing the appellant to operate a discretionary account on behalf of the respondent was crossed out. The contract provided that, unless the client's account was to be traded as a discretionary account by the appellant, the client should be solely responsible for operating and controlling it (cl.9). At or about the time when the contract was executed Mr Dimasi, the respondent's managing director, and Mr Schultz made it clear to Mr Kleemann and to Mr Botten, the appellant's South Australian manager, that transactions were to be upon the instructions of Mr Schultz and, in his absence, of Mr Dimasi.

4. Initially the transactions were entered into by the appellant in such a way that the risk of loss to the respondent was minimized, leaving the respondent with no disadvantage except brokerage fees. In July 1981 Mr Dimasi and Mr Schultz decided to take some risks with a view to recouping the brokerage fees. They instructed Mr Kleemann to engage in day trading. Day trading leaves the investor exposed to the market for one day in the hope of making profits. Market fluctuations within one day are limited so that losses are confined.

5. On 21 August 1981 Mr Kleemann closed one side of five matching coffee contracts for the respondent without closing the other side until 1 September. On 27 August he closed one side of another five matching coffee contracts without closing the other side until 1 September. Between 15 and 17 September Mr Kleemann closed one side of 15 matching silver contracts for more than one day. In each instance he generated heavy losses. These losses reduced substantially the amount paid by the respondent to the appellant to fund futures trading on the respondent's behalf.

6. In the event the respondent sued to recover $279,715.36 damages from the appellant, claiming that this was the amount of the losses it sustained on contracts as a result of the appellant's breach of duty in trading in futures contracts without the respondent's authority. At first instance Prior J. found that Mr Kleemann received three general instructions: (1) to effect the closing out process as part of the straddle and to take the locked-in profit; (2) to engage in day trading and remain exposed to the market for short periods; (3) at all costs to avoid the making of losses on the closing out. His Honour found that the exposure of the coffee contracts and the silver contracts to the risks of the market for a substantial period of time was outside the ambit of the general instructions which had been given to the appellant. He accepted the evidence of Mr Dimasi and Mr Schultz that they had not authorized these transactions and were unaware that the respondent was exposed to those risks. Mr Kleemann himself did not give evidence. However, the primary judge found for the appellant on the ground that, notwithstanding that the relevant transactions were not authorized by the respondent, cl.6 of the written contract between the parties excluded the appellant's liability for any loss arising in any way out of any trading activity undertaken on behalf of the client whether pursuant to the contract or not.

Client has not entered into this Agreement and will

acknowledges that the Agent will not be responsible

Agent's trading recommendations or suggestions, nor

acknowledges that the Agent will not be responsible

activity undertaken on behalf of the Client whether

such circumstances result in a loss to the Client."

"a) Neither the Agent nor its servants or agents

shall be liable to the Client for any loss or

damage resulting directly or indirectly from delays

in the transmission or execution of orders whether

or not such delays involve negligence.

b) Neither the Agent nor its servants or agents

shall be liable to the Client for any loss or

damage arising or resulting directly or indirectly

from any statement, information or advice made or

given, whether negligently or otherwise, in

relation to any commodity or the sale or purchase

thereof.

c) Any liability on the Agent's part or on the

part of its servants or agents for damages for or

in respect of any claim arising out of or in

connection with the relationship established by

this agreement or any conduct under it or any

orders or instructions given to the Agent by the

Client, other than any liability which is totally

excluded by paragraphs (a) and (b) hereof, shall

not in any event (and whether or not such liability

results from or involves negligence) exceed one

hundred dollars.

d) Every exemption from liability, defence and

immunity of whatsoever nature applicable to the

Agent or to which the Agent is entitled hereunder

shall also be available and shall extend to protect

every one of its servants or agents acting

hereunder or making or giving statements,

information or advice as aforesaid and for the

purpose of this clause the Agent shall be or shall

be deemed to be acting as agent or trustee on

behalf of and for the benefit of all persons who

are or might be its servants or agents from time to

time as well as on its own behalf and all such

persons shall to this extent be or be deemed to be

parties to this agreement."

8. On appeal the Full Court of the Supreme Court (King C.J., Mohr and Jacobs JJ.) considered that the exclusion clause should be construed strictly and that, in accordance with this approach, the last sentence in cl.6 had no application to the case because the relevant trading activity was unauthorized. The Full Court also held that cl.7 did not apply. In particular their Honours considered that, as the transactions were unauthorized, the claim did not fall with cl.7(c).

9. By way of preliminary to his principal contention that his client is protected by cl.6, Mr Bennett Q.C. for the appellant, submits that the negligence of the appellant in leaving the respondent exposed to the risk of loss on the coffee and silver contracts was a negligent performance by the appellant of its contract with the respondent and of its instructions. It was, he says, an error of omission, not of commission. He points to an acknowledgment in evidence by Mr Dimasi that the opening and closing of matching positions, apparently even on the same day, could not necessarily be achieved without some risk of loss and that day trading involved a risk of loss, albeit small. The instruction to avoid losses at all costs on closing out was therefore subject to these risks. Mr Bennett argues that the longer exposure of the respondent's risk in the case of the coffee and silver contracts was but a larger instance of the risks already mentioned and of the breaches of contract consisting of the omission to dispose of one of the two matching contracts at the time of closing. On this argument, the essence of the appellant's breach of contract was the failure to unlock the straddle by taking the final step to complete the process. A competing view of what happened, that adopted by the Full Court, is that Mr Kleemann deliberately disregarded his instructions to limit exposure to day trading and decided to subject the client to longer exposure, in the hope of reducing a loss or making a profit. Mr Bennett submits that there is no evidence to support such an inference and that the evidence shows that in all relevant transactions the market immediately moved against Mr Kleemann and deteriorated during the period of exposure. Although the primary judge was not satisfied that Mr Kleemann was deliberately defying his instructions, the Full Court thought that deliberate defiance of those instructions was the proper, if not the inevitable, inference to be drawn from the evidence.

10. In our view the Full Court was correct. The evidence revealed that Mr Dimasi and Mr Schultz had stressed the importance of avoiding losses and that day trading was the only permitted exception to the embargo against exposure to the market. The evidence does not indicate that Mr Kleemann believed at any stage that his instructions permitted him to leave the contracts in question exposed for more than one day. In the light of these circumstances and of the appellant's unexplained failure to call Mr Kleemann as a witness, the Full Court was right to draw the inference that it did. When the critical transactions are viewed in this light, the failure to unlock the straddle by taking the final step on the same day, or within a day, was not a negligent performance of the respondent's instructions. It positively committed the respondent to a form of speculation quite beyond the ambit of the authority given to the appellant.

11. The question then is whether cl.6 protects the appellant from the consequences of what otherwise would be breaches of contract. Mr Bennett relies on statements in recent decisions of the House of Lords to support the approach that exclusion clauses should be simply construed in accordance with their language and that they should not be subjected to a strained construction in order to reduce the ambit of their operation. These statements have been made in a series of cases beginning with Photo Production Ltd. v. Securicor Ltd. [1980] UKHL 2; (1980) AC 827 in which the House of Lords rejected the doctrine of fundamental breach previously adopted in Suisse Atlantique Societe d'Armement Maritime S.A. v. N.V. Rotterdamsche Kolen Centrale (1967) 1 AC 361. In place of that doctrine their Lordships have stated that, although an ambiguous exclusion clause will be construed contra proferentem, such a clause is to be given its natural construction. So, in Photo Production, a case decided on a contract entered into before the Unfair Contract Terms Act 1977 (U.K.) came into operation, Lord Diplock, observing (at p.851) that the court was not entitled to reject the exclusion clause "however unreasonable the court itself may think it is, if the words are clear and fairly susceptible of one meaning only", said (at p.851):

"In commercial contracts negotiated between

business-men capable of looking after their own

interests and of deciding how risks inherent in the

performance of various kinds of contract can be

most economically borne (generally by insurance),

it is, in my view, wrong to place a strained

construction upon words in an exclusion clause

which are clear and fairly susceptible of one

meaning only even after due allowance has been made

for the presumption in favour of the implied

primary and secondary obligations."

12. This approach to the construction of exclusion clauses was subsequently reiterated in Ailsa Craig Fishing v. Malvern Fishing [1981] UKHL 12; (1983) 1 WLR 964; (1983) 1 All ER 101 where a distinction was drawn between exclusion and limitation clauses. Lord Fraser of Tullybelton, with whom Lord Elwyn-Jones, Lord Salmon and Lord Lowry concurred, observed (at p.970; p.105 of All E.R.) that the principles applicable to exclusion clauses do not apply "in their full rigour" to conditions which merely limit liability, though such conditions will be read contra proferentem. This distinction in the treatment of the two types of clause was subsequently endorsed in George Mitchell Ltd. v. Finney Lock (1983) 2 AC 803, at pp 813-814. There the House of Lords concluded that the conditions of a contract for the sale of late cabbage seed limited the liability of the seller to a refund of the price paid or replacement of the seeds and that the ambit of the conditions could not be confined to breaches of contract arising without negligence on the part of the seller. The condition, read as a whole, unambiguously limited the seller's liability to replacement of the seeds or refund of the price. Their Lordships declined to read an ambiguity into it by the process of strained construction deprecated by Lord Diplock in Photo Production (at p.851) and subsequently by Lord Wilberforce in Ailsa Craig (at p.966; p.102 of All E.R.). However, the House of Lords held that the limiting condition was unenforceable on the ground that it would not be "fair or reasonable" within the meaning of s.55(4) as modified by Schedule 1 par.11 of the Sale of Goods Act 1979 (U.K.) to allow reliance on the condition. This aspect of the decision has no relevance to the present case.

13. Although these three decisions contain statements giving emphasis to the natural meaning of the words of exclusion and limitation clauses read as a whole, we do not understand the statements to deny the legitimacy, indeed the necessity, of construing the language of such a clause in the context of the entire contract of which it forms part. The formulation by the House of Lords of a new approach to the construction of exclusion and limitation clauses in place of the earlier approach based on the doctrine of fundamental breach explains why the emphasis in these statements is upon the language of the particular clauses rather than upon the context in which they appear.

14. Be this as it may, this Court has in past decisions authoritatively stated the approach to be adopted in Australia to the construction of exclusion and limitation clauses, without relying on the doctrine of fundamental breach. In Sydney Corporation v. West [1965] HCA 68; (1965) 114 CLR 481, the plaintiff, who had parked his car in the defendant's parking station, received a parking ticket, containing the following condition (at p.486): "The Council does not accept any responsibility for the loss or damage to any vehicle ... however such loss, damage ... may arise or be caused." The ticket also contained a statement which required that the ticket be presented for time-stamping and payment before delivery was taken of the vehicle. The plaintiff's car was taken from the parking station by an unauthorized person who surrendered to the attendant a duplicate parking ticket relating to another car which he had obtained by falsely representing that he had lost his ticket. It was the attendant's duty not to allow cars to proceed out of the station otherwise than upon the surrender by the driver of the appropriate ticket. The Court held that the defendant was not excused from liability for the loss of the plaintiff's vehicle. Barwick C.J. and Taylor J. said (at p.488):

"... in the case where a contract of bailment

contains an exempting clause much as we have to

consider the protection afforded by the clause will

be lost if the goods the subject of the bailment

are stored in a place or in a manner other than

that authorized by the contract or if the bailee

consumes or destroys them instead of storing them

or if he sells them."

Their Honours then made it clear that they reached this result by a process of construction of the contract and not by applying the doctrine of fundamental breach. Their Honours continued (at p.488):

"But we would deny the application of such a

clause in those circumstances simply upon the

interpretation of the clause itself. Such a clause

contemplates that loss or damage may occur by

reason of negligence on the part of the

warehouseman or his servants in carrying out the

obligations created by the contract. But in our

view it has no application to negligence in

relation to acts done with respect to a bailor's

goods which are neither authorized nor permitted by

the contract....Negligence in these circumstances

would be right outside the purview of the clause."

Windeyer J. reached the same conclusion as a matter of interpretation of the contract.

15. Subsequently in Thomas National Transport (Melbourne) Pty. Ltd. v. May & Baker (Australia) Pty. Ltd. [1966] HCA 46; (1966) 115 CLR 353, Windeyer J., though dissenting in result, stated (at p 376) that the effect of an exclusion clause must be "resolved by construing the language that the parties used, read in its context and with any necessary implications based upon their presumed intention". And later, in H. & E. Van Der Sterren v. Cibernetics (Holdings) Pty. Ltd. (1970) 44 ALJR 157, Walsh J., with whom Barwick C.J. and Kitto J. agreed, said (at p 158):

"The terms of exception clauses must sometimes be

read down if they cannot be applied literally

without creating an absurdity or defeating the main

object of the contract ... But such a modification

by implication of the language which the parties

have used in an exception clause is not to be made

unless it is necessary to give effect to what the

parties must be understood to have intended."

See also Port Jackson Stevedoring Pty. Ltd. v. Salmond & Spraggon (Aust.) Pty. Ltd. [1978] HCA 8; (1978) 139 CLR 231, at p 238.

16. These decisions clearly establish that the interpretation of an exclusion clause is to be determined by construing the clause according to its natural and ordinary meaning, read in the light of the contract as a whole, thereby giving due weight to the context in which the clause appears including the nature and object of the contract, and, where appropriate, construing the clause contra proferentem in case of ambiguity. Notwithstanding the comments of Lord Fraser in Ailsa Craig (at p.970; p.105 of All E.R.), the same principle applies to the construction of limitation clauses. As King C.J. noted in his judgment in the Supreme Court, a limitation clause may be so severe in its operation as to make its effect virtually indistinguishable from that of an exclusion clause. And the principle, in the form in which we have expressed it, does no more than express the general approach to the interpretation of contracts and it is of sufficient generality to accommodate the different considerations that may arise in the interpretation of a wide variety of exclusion and limitation clauses in formal commercial contracts between business people where no question of the reasonableness or fairness of the clause arises.

17. Turning now to cl.6 of the contract between the appellant and the respondent, the question is whether the relevant losses arose "in any way out of any trading activity undertaken on behalf of the Client whether pursuant to this Agreement or not". Read in context these words plainly refer to trading activity undertaken by the appellant for the respondent with the respondent's authority, whether pursuant to the Agreement or not. It can scarcely be supposed that the parties intended to exclude liability on the part of the appellant for losses arising from trading activity in which it presumed to engage on behalf of the respondent when the appellant had no authority so to do.

18. The final question is whether the appellant is protected by cl.7(c) of the contract. This provision limits the liability of the appellant to $100 in relation to claims of three kinds : (1) claims arising out of or in connection with the relationship established by the agreement; (2) claims arising out of or in connection with any conduct under the agreement; and (3) claims arising out of or in connection with any orders or instructions given by the client to the broker. The Full Court of the Supreme Court considered that cl.7(c) by its terms had no application to claims arising out of conduct which is outside the scope of the agreement and the relationship between the parties established by it. This, in our opinion, is to place a more restrictive interpretation on the clause than its language will naturally bear. In particular, it is expressed to comprehend claims arising out of or in connection with the relationship established by the agreement. A claim in respect of an unauthorized transaction may nonetheless have a connection, indeed a substantial connection, with the relationship of broker and client established by the agreement. We are unable to discern any basis on which cl.7(c) can be construed so as not to apply to such a claim. The present case is one in which the respondent's claim arises in connection with the relationship of broker and client established by the contract between the parties, notwithstanding the finding that the relevant transactions were not authorized.

19. In the result cl.7(c) operates to limit the appellant's liability to $100 in respect of each of the unauthorized coffee and silver contracts.

Order that the order of the Full Court of the Supreme Court of South Australiabe varied by substituting for paragraphs 2 and 3 of that order the following new paragraphs:

2. That judgement be entered for the plaintiff in the

action in the sum of $2,500.

3. That each party pay its own costs of this appeal.

4. Remit the question of costs of the action to the

trial judge for determination, in view of the

defendant's payment into court.