Morton v Elgin-Stuczynski & Anor [2008] VSCA 25

22 Finally, counsel for the appellant said that her Honour may have relied on letters written by Mr Morton after the loan was made, as indicating the personal nature of the relationship between the parties. It was submitted that if this was the case, such reliance would be in error because such evidence was not admissible under the parole evidence rule. Counsel further submitted that in any event, the existence of a personal relationship would not displace the parties' intention that compound interest should be payable under the loan.

23 Counsel for the respondents submitted that cases holding that banks were entitled to compound interest were distinguishable because the lender, Mr Morton, was not a banker but a private individual. The reference in the loan agreement to the 'rate of interest charged by the Commonwealth Bank' clearly referred only to the percentage interest rate and not to the basis on which interest should be calculated. Thus her Honour had correctly distinguished Saunders v Nash on the basis that the oral agreement in that case referred to both the rate and interest and the conditions of a bank loan.

24 Counsel also submitted that the conclusion that the appellant was entitled to compound interest could only be reached by implying a provision in the loan agreement requiring the interest to be payable on the terms and conditions of a Commonwealth Bank loan. The court could not imply such a term into the contract because it was unnecessary to do so in order to give it business efficacy.[12]

25 Further, the use of the words 'accrued interest' did not mean that compound interest was payable, but simply referred to 'interest owing'. The effect of the agreement was that if seven days' notice was given requiring payment of the loan the amount would have to be paid with 'outstanding' or accrued interest. This was confirmed by the reference to 'outstanding interest' elsewhere in the agreement.

26 Counsel for the respondent also submitted that the Court could take account of the circumstances in which the loan was made in order to determine the meaning of the interest clause in the loan agreement. As her Honour had said, the loan was not made to the company, REA, but to the Elgins personally. Mr Morton's letters were admissible as evidence of the circumstances which existed when the loan was made. The appellant had himself confirmed the non-commercial nature of the loan by referring in letters to the fact that the agreement was made between friends and by the reference in the agreement to a 'private loan'.**

**27 In my opinion the words of this contract are capable of bearing the meaning that either simple or compound interest is payable. Although both counsel relied on case law in support of their submissions, a comparison of the meaning which courts have given to the words used in other contracts of loan provides little assistance in interpreting the words used in this particular contract. Whether interest is to be calculated on a simple or compound basis depends on the true construction of the contract, read in the light of surrounding circumstances.

28 Whatever may have been the case historically, today there is no presumption that interest payable on a loan made by a private lender is to be calculated as either simple or compound interest. In Alington Group Architects Ltd v Attorney-General the New Zealand Court of Appeal said that:[13]**

The question whether the interest payable ... is to be simple or compound interest is to be approached without reference to any predisposition the Courts may have demonstrated in favour of simple interest as against compound interest. It is purely one of contractual interpretation. The agreement is to be interpreted so as to give effect to the meaning intended by the parties. Hence, any ... "presumption" in favour of simple interest is out of place in determining the meaning of the words in issue.

**29 As I have said, counsel for the respondent submitted that a term requiring interest on the loan to be compounded required the implication of a term to this effect into the contract. In Codelfa Construction Pty Ltd v State Rail Authority of New South Wales[14] the High Court refused to imply a term into a construction contract that if the construction company was restrained by injunction from carrying out the work in the shifts it had planned, the State Rail Authority would indemnify it against the additional costs it incurred as a result of being unable to run working shifts between 10 pm and 6 am.

30 Mason J said that a court could only imply a term into a contract to give it business efficacy, and that it was not sufficient to show that it would be reasonable to imply the term. He said:**

The implication of a term is to be compared, and at the same time contrasted, with rectification of the contract. In each case the problem is caused by a deficiency in the expression of the consensual agreement. A term which should have been included has been omitted. The difference is that with rectification the term which has been omitted and should have been included was actually agreed upon; with implication the term is one which it is presumed that the parties would have agreed upon had they turned their minds to it - it is not a term that they have actually agreed upon. Thus, in the case of the implied term the deficiency in the expression of the consensual agreement is caused by the failure of the parties to direct their minds to a particular eventuality and to make explicit provision for it. Rectification ensures that the contract gives effect to the parties' actual intention; the implication of a term is designed to give effect to the parties' presumed intention.

For obvious reasons the courts are slow to imply a term. In many cases, what the parties have actually agreed upon represents the totality of their willingness to agree; each may be prepared to take his chance in relation to an eventuality for which no provision is made. The more detailed and comprehensive the contract the less ground there is for supposing that the parties have failed to address their minds to the question at issue. And then there is the difficulty of identifying with any degree of certainty the term which the parties would have settled upon had they considered the question.

**31 The respondents contended that it was not necessary to imply a term into the loan agreement requiring payment of compound interest in order to give it business efficacy.

32 In Codelfa Mason J said that 'in the case of the implied term the deficiency in the expression of the consensual agreement is caused by the failure of the parties to direct their minds to a particular eventuality and to make explicit provision for it.'

33 The distinction between simply interpreting an ambiguous term in a contract and implying a new contractual term in order to give business efficacy to an agreement is not always clear-cut.[15]

34 In McCormick v Riverwood International (Australia) Pty Ltd, Weinberg J said: [16]**

The actual terms of a contract are those which the parties intended to incorporate in that contract. They comprise the terms expressed by the parties as well as terms which it must be inferred were intended though not expressed. The law may infer such an intention from the nature and context of the transaction. The difference between inferred terms based on actual intention, and implied terms based on presumed intention is not always easy to discern - see Hawkins v Clayton (1988) 164 CLR 539 at 570 per Deane J; Breen v Williams (1996) 186 CLR 71 at 91 per Dawson and Toohey JJ. Particular terms will be considered in the light of all of the facts which bear upon their meaning.

35 Likewise the learned authors of Cheshire and Fifoot's Law of Contract state:[17]

Although implied terms are, by hypothesis, terms which were not actually agreed by the parties, the border between actual and implied terms cannot be precise. This is so in part because the actual terms of a contract comprise not only the terms expressed by the parties, but also unexpressed terms... The truth is that in many cases the court, in interpreting the meaning of the words of the parties, in effect adds to them, although its conclusion is expressed in the language of exegesis rather than of implication.

**36 Although there may be a conceptual difference between the implication of a term where the parties have not directed their minds to a situation which later arises and the conventional process of contractual interpretation, in practice this distinction will sometimes be a question of degree rather than one of kind.

37 In my opinion this is a case where the court was called upon to interpret the relevant term, rather than to decide whether a term could be implied into the contract requiring interest to be compounded. The reference in the loan agreement to 'the rate of interest charged by the Commonwealth Bank of Australia' is capable of being interpreted as requiring payment of interest on either a compound or a simple interest basis. Counsel's submission that compound interest is only payable if a term to this effect can be implied reflects the assumption that simple interest is payable, unless the contract specifies otherwise. However, as I have said, there is no such presumption. Rather this is a case of 'orthodox construction of a contract'[18] according to its terms.

38 As both counsel acknowledged, the parol evidence rule restricts the admission of extrinsic evidence to determine the meaning of the loan agreement. As Mason J commented in Codelfa:[19]**

The broad purpose of the parol evidence rule is to exclude extrinsic evidence (except as to surrounding circumstances), including direct statements of intention (except in cases of latent ambiguity) and antecedent negotiations, to subtract from, add to, vary or contradict the language of a written instrument.

39 However the parol evidence rule does not exclude evidence of surrounding circumstances to assist the court to construe the contract. In Codelfa, Mason J summarised the law as follows:[20]

The true rule is that evidence of surrounding circumstances is admissible to assist in the interpretation of the contract if the language is ambiguous or susceptible of more than one meaning. But it is not admissible to contradict the language of the contract when it has a plain meaning. Generally speaking facts existing when the contract was made will not be receivable as part of the surrounding circumstances as an aid to construction, unless they were known to both parties, although, as we have seen, if the facts are notorious knowledge of them will be presumed.

It is here that a difficulty arises with respect to the evidence of prior negotiations. Obviously the prior negotiations will tend to establish objective background facts which were known to both parties and the subject matter of the contract. To the extent to which they have this tendency they are admissible. But in so far as they consist of statements and actions of the parties which are reflective of their actual intentions and expectations they are not receivable. The point is that such statements and actions reveal the terms of the contract which the parties intended or hoped to make. They are superseded by, and merged in, the contract itself. The object of the parol evidence rule is to exclude them, the prior oral agreement of the parties being inadmissible in aid of construction, though admissible in an action for rectification.

Consequently when the issue is which of two or more possible meanings is to be given to a contractual provision we look, not to the actual intentions, aspirations or expectations of the parties before or at the time of the contract, except in so far as they are expressed in the contract, but to the objective framework of facts within which the contract came into existence, and to the parties' presumed intention in this setting. We do not take into account the actual intentions of the parties and for the very good reason that an investigation of those matters would not only be time consuming but it would also be unrewarding as it would tend to give too much weight to these factors at the expense of the actual language of the written contract.

The meaning of a written contract may be illuminated by evidence of facts to which the writing refers, for the symbols of language convey meaning according to the circumstances in which they are used. "The time has long passed", Lord Wilberforce said in Prenn v. Simmonds, "when agreements, even those under seal, were isolated from the matrix of facts in which they were set and interpreted purely on internal linguistic considerations". Both the internal and extrinsic context in which a word or phrase is used may throw light upon the meaning with which the parties must be taken to have used it, though an extrinsic fact known to only one of the contracting parties can shed no light upon the meaning with which that word or phrase was used by the other or others.

When the court picks up a written contract in order to construe the writing, it must "place itself in thought in the same factual matrix as that in which the parties were" as his Lordship said in Reardon Smith Line v. Hansen-Tangen. But, having construed the writing, the court cannot take its pen and add a clause merely because it thinks the addition would be reasonable or fair or prudent.

**41 The words of the contract were ambiguous, because it was not clear whether the contractual term provided for payment of simple or compound interest. In my view, the reference to 'accrued' interest is neutral. It is therefore appropriate to take account of 'the objective framework of facts within which the contract came into existence'[22] in interpreting the relevant clause in the loan agreement.

42 In my opinion, the intention of the parties, viewed objectively in the light of the circumstances in which the loan was made, was that interest should be compounded. The loan agreement was not drafted by lawyers who might have appreciated the difference between a provision relating to the rate of interest and the manner in which interest was to be assessed. In my opinion a reasonable bystander would have assumed that the reference to the Commonwealth Bank's rate of interest meant that interest was to be assessed and paid on the same basis as it would be assessed and paid on a bank loan.

43 As I have said, counsel for the appellant submitted that the letters in which Mr Morton referred to his friendship with the Elgins were inadmissible because they were written after the loan was made. In my view these statements were admissible as evidence of the context in which the loan was made.[23] In any event, Mr Morton gave similar evidence as to the friendly nature of the relationship between the parties in cross-examination. For example:**

Counsel: Mrs Elgin will say that you were a friend of the Elgin family. This is in paragraph 3 of her statement. You would lunch with the Elgins when you visited the office. Is that correct?

Counsel: [Mrs Elgin] will say that when she left with her ... children ... [for Saudi Arabia] - "We all kissed and hugged each other". Do you recall that?

Mr Morton: That is possible. We were all very friendly. We had a very good relationship at the time.[24]

**44 However these statements, and the fact that the parties had a friendly relationship, do not require the conclusion that the loan agreement required payment of simple interest. While the loan may well have been motivated by Mr Morton's concern for the Elgins, he also had a professional relationship with them in his capacity as their accountant.

45 Another factor which might be thought to support the respondents' case is that the loan was made to enable the Elgins to avoid their immediate financial difficulties. In these circumstances it might be contended that only a short term loan was contemplated and hence that it was likely that the parties intended that only simple interest would be payable.

46 But in my opinion the other circumstances which existed when the loan was made provide strong support for the appellant's claim to compound interest. When the loan monies were advanced to the respondents they knew that Mr Morton was withdrawing them from his two companies and his family trust. The respondents had previously sought an extension of credit from their banker, ANZ, and from other banking institutions and must have known that banks charge compound interest on loans. Mr Marcus Elgin accompanied Mr Morton to his bank at the time Mr Morton drew funds from his accounts. He knew that Mr Morton had insufficient funds in one of his companies to make up the full $25,000 in the first advance and that this amount was drawn from two different sources. The respondents would also have been aware that the appellant would have had to pay compound interest on any indebtedness to the bank.**

**47 Having regard to these circumstances, I consider that the loan agreement, viewed in the context of extrinsic circumstances, required the respondents to pay compound interest. The reference in the agreement to 'a private loan' does not detract from this conclusion. It simply refers to the fact that the loan was made to the Elgins personally, rather than to REA.

48 I would therefore allow the appeal and order that the respondents repay the loan together with compound interest, calculated in accordance with the relevant Commonwealth Bank practice, at the rates specified in the schedule to the reasons for decision of Williams J.[25]

49 I have had the advantage of reading the judgment of Neave JA in draft and agree that the appeal should be upheld. I do so for the reasons stated by Neave JA.

[1] The learned trial judge held that relevant rate of interest between 9 January 1990 and 1 June 1992 was the 'readily ascertainable standard rate of interest in relation to local overdrafts in excess of $100,000', and thereafter the 'readily ascertainable "Overdraft Interest Rate"... plus a standard margin of 1.75%'. See Morton v Elgin-Stuczynski [2006] VSC 279, [86].

[2] Morton v Elgin-Stuczynski [2006] VSC 279, [90].

[3] Ibid. Her Honour relied upon Codelfa Construction Pty Ltd v State Rail Authority of New South Wales (1981-2) [1982] HCA 24; 149 CLR 337, 347 (Mason J).

[5] [1991] VicRp 47; [1991] 2 VR 63.

[6] [1991] VicRp 47; [1991] 2 VR 63, 65-66 (Vincent J).

[7] [1991] VicRp 47; [1991] 2 VR 63.

[8] Reference was made to Yourell v Hibernian Bank Ltd [1918] AC 372; Paton v Inland Revenue Commissioners [1938] AC 341; Bank of New South Wales v Brown [1983] HCA 1; (1983) 151 CLR 514; National Bank of Greece SA v Pinios Shipping Co No 1 [1990] 1 AC 637; Jalmoon Pty Ltd v Bow (Unreported, Supreme Court of Queensland Court of Appeal, 5 September 1997); Alington Group Architects v Attorney General and Ministry of Foreign Affairs [1998] 2 NZLR 183; Kitchen v HSBC Bank Plc [2000] EWCA Civ 12; Kerr v Nationwide Building Society [2002] EWCA Civ 116; Habib Bank Limited v Central Bank of Sudan [2006] EWHC 1767; [2007] 1 WLR 470.

[9] [1990] 1 AC 637.

[10] [1990] 1 AC 637, 675-685. At 681 Lord Goff quoted from the judgment of Lord Romer in Commissioners of Inland Revenue v Lawrence, Graham and Co [1937] 2 KB 179, 192.

[11] [1991] VicRp 47; [1991] 2 VR 63, 66.

[12] Codelfa Construction Pty Ltd v State Rail Authority of New South Wales [1982] HCA 24; (1981) 149 CLR 337.

[13] [1998] 2 NZLR 183, 189.

[14] [1982] HCA 24; (1981) 149 CLR 337.

[15] Indeed, this may be an example of the kind of judicial reasoning described by Professor Julius Stone as involving converging categories which are a form of category of illusory reference. See Julius Stone Legal System and Lawyers' Reasonings (1964) Chapter 7, particularly 245-252.

[16] [1999] FCA 1640; (1999) 167 ALR 689, [78] 702-703.

[17] N Seddon and M Ellinghaus Chesire and Fifoot's Law of Contract (8th Australian ed, 2002) 414.

[18] Codelfa Construction Pty Ltd v State Rail Authority of New South Wales [1982] HCA 24; (1981) 149 CLR 337, 347 (Mason J).

[23] See paras [39]-[41] above.

[24] Although this relates to the period in the early 1990's after the loan was made, it is evidence of the continuing friendly nature of the relationship.

[25] Morton v Elgin-Stuczynski [2006] VSC 279, 26 "Schedule of Applicable Interest Rates".