SOLA BASIC AUSTRALIA LIMITED v MORGANITE CERAMIC FIBRES PTY LIMITED [1989] NSWCA 187

Priestley JA Three companies are concerned with the answers to the two questions raised in this appeal. Two of the companies are the parties to these proceedings. The third is not, but has a substantial interest in them.

The first company is Sola Basic Australia Limited ("Sola"), the appellant, a manufacturer and seller of heavy duty electrical transformers and accessory equipment. The second is Morganite Ceramic Fibres Pty Limited ("Morganite"), the respondent, which produces ceramic fibre thermal insulation products for sale. In 1983 Morganite bought from Sola a Transformer/Reactor system ("the equipment") for use in connection with an arc furnace which made some of its products. The third company, not party to the proceedings, is an insurer which indemnified Morganite against risks defined in two policies, one called an "Industrial Special Risks Insurance Policy" and the other a "Business Interruption Insurance Policy".

The two questions in the appeal stem from breakdowns in the equipment. One is whether Sola and Morganite reached a binding agreement settling between them the legal consequences of the breakdowns. The other is, if the first question is answered yes, is Morganite's insurer also bound by the agreement. The circumstances from which those questions arise are most easily set out by reproducing the material parts of correspondence passing between Morganite and Sola together with some linking and explanatory material.

The first two failures in the equipment happened in April and May of 1984. By letter dated 5 June 1984 Mr Sumsion, Sola's engineering manager, wrote to Mr Eady of Morganite saying:

"The accompanying resume certainly describes an extraordinary sequence of events, which has cost both Morganite and Sola Basic dearly. Error on Sola's part caused a large proportion of the problem. However, the extreme pressure applied by Morganite to Sola during all remedial measures has been a contributing factor. Sola Basic has, as is the Company's normal practice, greatly exceeded its contractual obligations in an attempt to minimize down-time.

In view of the enormous consequential costs due to failure, we urge you to seriously consider the purchase of a spare saturable reactor, and either a spare controller/rectifier or a 'Variac' controlled rectifier. We offer the first two items at $4260 and $1322 respectively; the third item would be purchased elsewhere."

There was a third failure of the equipment on 6 July 1984, a fourth on 24 July 1984 and a fifth on 27 July 1984. Then by letter dated 3 August 1984 Mr Peddie, executive director of Morganite, wrote to Mr D Williams, managing director of Sola, saying:

"T have just received the verbal report from your Mr Ken Sumsion on the most recent failure of the transformer/reactor that was supplied by your company for installation in January 1984. You appreciate, I am sure, the economic embarrassment to our business that has been caused by the series of catastrophic failures of this unit. We have lost production, caused major inconvenience and delivery delays to many of our customers; indeed have almost certainly lost many minor sales through inability to supply from stock at our Branches both in Australia and overseas.

The final position is that we are threatened with the withdrawal of our insurance cover if we continue to operate with the existing Solar Basic Transformer/Reactor.

I therefore wish to advise you that it is our intention to replace the Solar Basic Transformer/reactor with a unit precisely as supplied to our sister company in the UK; these units have performed the same function over several years without problems.

I am therefore at the current position of being unable to risk any further exposure to attempts by your company to rectify the existing unit and suggest that we return the unit to you and that you return to us the cheque for $24,005, being the invoiced price less $6,000 retention, paid by us to you on the 20th March, 1984.

Furthermore, I would seek your assistance to cover the additional cost of buying a replacement unit from the United Kingdom. This cost is estimated to be $25,000 in excess of your original price to us.

You will, Iam sure, understand that this has been an extremely expensive and costly exercise for our Company and I suggest that we meet on my return from the USA after the 13th August, to agree to the above proposal.

I should further point out that the proposal put above is designed to resolve this company's claim relating to the cost of replacing the defective transformer/reactor. It does not, in any way, affect any claim which this company's insurer may have against you under its rights of subrogation having paid our claims for loss of profits."

On 14 August 1984 Mr Williams wrote to Mr Peddie acknowledging his letter of 3 August and saying he would contact him again to discuss his proposals.

The reason for the failures of the equipment was not easy to pin down. Morganite's insurer sought the opinion of an independent expert, Dr Grantham of Unisearch. Dr Grantham asked permission from Sola to examine the remains of the equipment and discuss design criteria at Sola's Melbourne plant. Sola agreed to that request upon condition that a copy of the report be made available to Sola at the same time as to Morganite or its insurer. Morganite agreed to the condition saying the report would be available to Sola "without prejudice". Dr Grantham's report appears to have been completed by mid October 1984.

(LA BASIC AUSTRALIA LIMITED v MORGANITE CERAMIC FIBRES PTY LIMITER (Priestley JA)

In the report, Dr Grantham, after describing the course of his investigation in some detail, and discussing the possible explanations of what had happened with the equipment, stated his conclusions. These were that there had been two types of failures; the first type, which he, in a guarded way, indicated he thought was Sola's responsibility, was less serious than the second type. By a process of deduction which he described, he concluded that the second and more serious type of fault was caused by "transients induced in the system" (par xiii). The final two paragraphs of his conclusions were:

"(xv) In the opinion of the writer, Morganite should have specified that there was a transient voltage requirement for the new saturable reactor and should have taken some steps to identify the order of magnitude of these transients with respect to the existing system.

(xvi) In the opinion of the writer, Sola Basic having not been given details of expected transient magnitudes, should have prompted Morganite for such information."

Mr Peddie sent a telex dated 18 October 1984 to Mr Sumsion, saying:

At long last report received from Unisearch. We understand that copy has been sent to you. This raises some disturbing issues which we clearly need to discuss. The delays caused by awaiting this report from the insurers require us to reappraise our options for the future. I have already expressed my concern to Mr David Williams over the risks involved in any attempt by Solar Basic to rectify the existing unit.

However if we accept the conclusion of the report it seems to me that the issue revolves around the question of the generation of occurrence of hazardous voltages or spikes as originally discussed with your Mr Alan Hughes reference Morganite Ceramic Fibres letter - Mike Crowther to J McAllister 30/6/83.

This is an area of particular expertise to your company and therefore one which we would normally refer to you for advice. In the light of this I would appreciate your recommendation and advice on how you would now attempt to resolve the matter and the warranty cover and assurance that you will provide to this company that failure will not occur.

There remains an overriding requirement that our insurer must be satisfied and in agreement if a successful solution can be found by your company. Because of the delays this matter has assumed some urgency. Would you please contact me as soon as possible therefore if you wish to pursue a solution option."

(The court was told in the course of argument that the "transients" spoken of by Dr Grantham as the cause of the more serious problem with the equipment (see also pars (xv) and (xvi) set out above) were the same thing as the "hazardous voltages or spikes" referred to in Mr Peddie's telex.)

Mr Sumsion replied by letter dated 1 November 1984, as follows: "Thank you for your telex of 18 October. I apologize for the delay in writing to you but as I think you know, I was overseas when your telex was received. If I may first correct a misconception. In the letter from Mike Crowther to Mr McAllister of 30 June 1983, to which you refer, the reference to the prevention of hazardously high ac voltages is a reference to ac voltages from the normal transformer action between the ac and the de windings of the reactor. The smaller the available dc control current, the greater the number of turns in the control winding and the greater the ac voltage which will appear across the control winding. We have kept the number of turns in the control winding to a minimum by increasing the control current electronically.

This really has nothing to do with the present problem. Indeed, the quotation from Sturdy of 9th June 1983 assumes that the load is to be a 'resistive load at UPF. 'Such a load is quite incapable either of generating transients or of producing resonance effects which may increase the amplitude of transients from the power source.

I agree with most of the comments in the report from Dr Grantham, but apart from his comment that 'arc furnaces are notorious for producing transients', he has not suggested the magnitude of the transients which may be produced, other than that they may be 'large'. As this is a matter of fundamental importance, we are seeking further technical advice concerning possible transient generation and I would hope to be able to let you have our comments in more detail once this advice has been received."

Mr Peddie wrote to Mr Williams by letter dated 7 December 1984 saying: "As may have been reported to you, we commissioned Unisearch to undertake further tests at the MCF plant to establish and quantify if possible the presence of transients during the normal operation and.start up of the air furnace. These tests were carried out on 13th November and 27th November respectively.

A report has not yet been received from Unisearch but the following findings have, at this stage, been given to us.

1. Unisearch identified transients, (as expected), at startup and although none were measured during normal operation it could be assumed that some may occur during the furnace life. However, the auxiliaries have a dampening effect and therefore in normal operation any occurrences would be minimised.

2. Unisearch further advised that when the reactor is wired in series any transient is multiplied by a factor of 9 (nine) creating a surge of sufficient potential to damage insulation. Windings should be connected in parallel to minimise this effect.

No further advice has been received from your company on what action you may be able to take, although Mr Ken Sumsion advised me that you were seeking technical assistance from overseas.

Further to my letter to you of 3rd August and in the light of our findings from Unisearch, I believe that with this information Sola Basic should be able to construct a transformer reactor that will meet the necessary operating conditions and I am prepared to recommend this course of action to the board of MCF provided that I can receive from you a guarantee and undertaking to meet the following conditions.

A five year guarantee against failure through fusion, poor workmanship or any other cause directly attributable to manufacture or failure to meet specification.

The opportunity for an inspection of the winding and assembly of the unit by independent experts nominated by Morganite.

The replacement of the existing unit or parts thereof as desired by Sola Basic to meet the above requirements at no cost to Morganite other than local installation.

The provision of detailed wiring diagrams and design specification to Morganite.

The provision of a test certificate duly authorised by an independent tester. Regrettably, I cannot confirm that such a guarantee will be accepted by the Board and would therefore request that you undertake that should the Board not accept this proposed course of action, that you will accept return of the existing unit providing full restitution of moneys paid to Sola Basic amounting to $24,005.

(LA BASIC AUSTRALIA LIMITED v MORGANITE CERAMIC FIBRES PTY LIMITEB (Priestley JA)

I plan to be in Melbourne in the next week and would like to discuss this matter with you. Please could you phone my office to advise a suitable time."

Following this letter a meeting took place at the offices of the appellant on 11 December 1984. Mr Peddie later swore an affidavit concerning this meeting. In pars 5 to 7 of this affidavit he said:

"5. At that meeting apart from myself there was also present the said David Williams, Ken Sumsion and another person on behalf of the Defendant, and also Tan Robinson, the Sales Manager for Victoria of the Plaintiff.

During the meeting and in the course of other conversation between myself and the officers of the Defendant already referred to I said, Right oh, my proposal in my letter of August 3rd stands. As far as the unit goes, if you will pay us back the moneys we paid we will return it. We have suffered considerable further losses in production and sales, not as yet fully quantified, and we are not certain whether we can recover all of them from our Insurer. "David Williams then said, 'We couldn't supply a replacement, and we undertake to respond in writing setting out our position.

I am unable to recall the content of other conversations at that meeting, suffice to say that the only issue discussed was with respect to the return of the unit itself and that at no time then or thereafter was it my intention to compromise the rights of the Plaintiff's Insurers, Zurich Australian Insurance Limited." Mr Peddie was not cross-examined on the contents of this affidavit. There was no objection to par 7.

By telex of 18 December 1984, Mr Williams said to Mr Peddie: "Thank you for your letter of 7 December I have considered the position further and I think that it is true to say that in hindsight neither my company nor yours appreciated the problems which would be involved in the design of a power source for your application.

We were under the impression, gained from the quotation which was provided to your parent by Sturdy Electric Co Ltd that the load presented by the furnace would be a resistive load with unity power factor. Further, that only the kind of transients involved be such as might be expected in such a load from normal power supply fluctuations.

The report prepared by Dr Grantham indicates that there was not any design fault with respect to the insulation stress levels and it thus follows that the equipment would have been satisfactory, after the first failure and the rectification of the manufacturing error, had the assumption made by both of us concerning the characteristics of the load been correct.

Whether this company would have enquired further had it not been for the Sturdy quotation is a matter for conjecture, but I note that Dr Grantham is of the view that you should have specified the fact that there was a transient voltage requirement and identified the order of magnitude for the transients and we should have prompted Morganite for such information.

The enquiries which we have made indicate that in certain circumstances, quite large transients can occur with arc furnaces. This is because of the negative resistance characteristics of the arc under particular operating conditions which tends to cancel out the circuit loading, reducing the damping effect of the auxiliaries. I am not certain how far this effect can be isolated with the present equipment, although I do note that Unisearch has not isolated any transients during normal operation, but of course such transients must have been present.

We are still waiting for a report from overseas, but on the information which I have to date I would be reluctant to commit this company to a guarantee of the kind which you have suggested at this stage. In this respect I have in mind paragraph 9XV of Dr Grantham's report.

Thus I propose that we accept the return of the unit to us and refund to you the sums which you have paid to us, with the result that we each will bear our own not-inconsiderable losses which have otherwise resulted from this venture."

"Your telex of December 18 received. I note your proposal and am issuing instructions for the unit to be duly returned to you freight to your expense and would appreciate your earliest refund of the amount in question, $24,005."

Thereafter, the equipment was returned without anything further being said or done upon which either party relied as bearing upon the question whether the parties had agreed to compromise all their differences.

Sola's first submission was that the telexes of 18 and 19 December 1984 unambiguously showed an accord and satisfaction between the parties. It was therefore impermissible for the court to look at surrounding circumstances. Alternatively, if the court did look at surrounding circumstances, the result would be the same.

The first submission was based on what was said by Mason J in Codelfa Constructions Pty Limited v State Rail Authority of New South Wales (1982) 149 CLR 337 at 352. This court has recognised what Mason J there said as binding upon it: see, inter alia, Burns Philp Hardware Ltd v Howard Chia Pty Ltd (1987) 8 NSWLR 642 at 643, 655. The passage is as follows:

"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."

There are several things to be recognised about this passage. One is that it applies to the construction of what is already known to be a contract. That is, the court has decided what the terms of the contract are, and is embarked on the next question, what do they mean? A second thing to be noted about the passage is that although evidence of surrounding circumstances is not admissible to contradict the language of the contract, once the court has decided what the terms of the contract are, when the meaning of those terms is plain, there are many cases where the meaning of the terms of a contract is not plain. Sometimes a court feels

(LA BASIC AUSTRALIA LIMITED v MORGANITE CERAMIC FIBRES PTY LIMITED (Priestley JA)

no need to look beyond the terms themselves; the nature of the instrument, its terms and the length of time during which it is to operate make it relatively easy for a court to arrive at a sufficiently plain meaning from the instrument itself in the light of the knowledge any ordinarily intelligent reader of the document would bring to its reading. Burns Philp Hardware is an example of this. With many other documents, the circumstances are likely to bring into play what is essentially a truism in regard to the meaning of words, but one frequently overlooked in the light of apparently dogmatic statement of rules of construction, that is that, as McHugh JA recently said,

".. few, if any, English words are unambiguous or not susceptible of more than one meaning or have a plain meaning. Until a word, phrase or sentence is understood in the light of the surrounding circumstances, it is rarely possible to know what it means... evidence of surrounding circumstances will generally be admissible if it known to both parties or sufficiently notorious to be presumed to be within their knowledge." (Manufacturers Mutual Insurance Ltd v Withers, Court of Appeal, unreported, 19 May 1988.)

"Tt is true that when a judge reads the words of a contract he may jump to the instant and confident opinion that they have but one reasonable meaning and that he knows what it is. A greater familiarity with dictionaries and the usages of words, a better understanding of the uncertainties of language, and a comparative study of more cases in the field of interpretation, will make one beware of holding such an opinion so recklessly arrived at." (Corbin on Contracts, (1950-1964) Vol 3, s535, pp 17-18.)

But, as already noted, these two aspects of what Mason J said in Codelfa apply to the construction of what a court has first decided are the terms of a contract. When a court is seeking to ascertain whether a contract exists and what are its terms, different rules apply. A recent statement of one aspect of these other rules appears in Norwest Beef Industries Ltd v Peninsula and Oriental Steam Navigation Co (1987) 8 NSWLR 568. Hope JA said (at 570):

"Tt was once the received doctrine that a document which appeared on its face to be a complete record of the parties' contract was conclusively presumed to be the contract. This proposition was discussed by McHugh JA in State Rail Authority of New South Wales v Heath Outdoor Pty Ltd (1986) 7 NSWLR 170. He concluded that the correct rule is that the existence of writing which appears to represent a written contract between the parties is no more than evidentiary foundation for a conclusion that their agreement is wholly in writing. The tendering of evidence, whether oral or in writing, to prove a contractual term cannot be excluded until it is determined that any term in writing recorded the whole of the parties' agreement. I respectfully agree with his Honour's conclusions in this regard."

Another rule relevant in deciding whether a contract has been made, and if so what its terms are in circumstances where the parties have been corresponding, is that a court is entitled to consider the whole of the correspondence: see Howard Smith and Co Ltd v Varawa (1907) 5 CLR 68. It seems to me necessarily to follow from this rule that if a course of correspondence between two parties is interspersed with conversation between them on the subject matter of the alleged contract, then that conversation must be considered along with the correspondence in determining whether or not a contract came into existence and what were its terms.

When these various rules are considered, it seems to me that the appellant's first submission does not deal with what is really the first issue in the case: both parties have assumed there was a contract between them, but they are not agreed as to its terms. The first question therefore is not what is the meaning of a contract whose terms are known, in which case the Codelfa rules apply, but, what are the terms of the contract, in which case the Codelfa rules do not apply, and the Court must decide from all the evidence arguably-relevant to the existence of particular terms of the contract, what the terms of the contract are. This involves looking at the case in light of the appellant's alternative submission, in anticipation of which I have set out what seem to me to be the relevant facts in the detail that I have.

Upon considering the course of written communications along with the conversation of 11 December 1984, I see the matters bearing upon the terms of the contract, in the following way. Mr Williams's telex of 18 December began by referring to Mr Peddie's letter of 7 December. That letter referred to Mr Peddie's letter of 3 August. It is beyond doubt that in the letter of 3 August Morganite offered to return the unit to Sola on the terms there stated, and that the offer was limited to resolving Morganite's claim relating to the cost of replacing the defective equipment. There was no offer to resolve all outstanding claims between the two companies. Therefore, when in Mr Peddie's letter of 7 December, after referring to his letter of 3 August, Mr Peddie made the offer in the second last paragraph, I do not see how it could convey any meaning to Mr Williams other than that the offer in the letter of 3 August was being renewed, and that all that was there being spoken of was the resolution of Morganite's claim relating to the cost of replacing the defective equipment. The reference to the letter of 3 August made it unnecessary to repeat what the words of that letter had made plain, namely that the proposal did "not in any way affect any claim which (Morganite's) insurer may have against [Sola] under its rights of subrogation having paid [Morganite's] claims for loss of profits". That this was Morganite's position was again made clear in the conversation of 11 December. Mr Peddie's unchallenged account, in par 6 of his affidavit, of what he then said could not have made the position clearer. Morganite had thus made its position clear in its letters of 3 August and 7 December and at the meeting of 11 December.

Thus it seems to me that when Mr Williams began his telex of 18 December by referring to the letter of 7 December, he was acknowledging that he understood what Morganite's position was. As I have already said, the meaning of the letter of 7 December was in the circumstances unmistakable so far as the offer to return the equipment was concerned, and that meaning had been confirmed to him by Mr Peddie at the meeting of 11 December. Mr Williams, having thus acknowledged Morganite's position, in the first sentence of his telex, in the balance of it, until the last sentence, reflected upon the degree of blame to be laid on Morganite and Sola for the various failures of the equipment. These reflections amounted to a denial that Sola was responsible for all of Morganite's losses flowing from the failures.

Then came the final sentence, which if it had ended at the first comma, would have left the matter completely clear: "Thus I propose that we accept the return of the unit to us, ".

If the telex had ended there, there could have been no doubt that Sola was accepting Morganite's offer in its letter of 3 August. Sola argues however that the remainder of the sentence altered everything:

(LA BASIC AUSTRALIA LIMITED v MORGANITE CERAMIC FIBRES PTY LIMITED (Priestley JA)

"with the result that we each will bear our own not-inconsiderable losses which have otherwise resulted from this venture."

What Sola submits is that the first part of the sentence must be understood in the light of the second part, so that the meaning of the first part becomes not "We accept your offer to return the unit and accept a refund" but "We offer to accept the return of the unit and refund what you paid, in full discharge of any obligations each of us has to the other". That is one possible meaning of the words. It is not the meaning they convey to me in the full context. Rather, the meaning they convey to me, (as I trust, the objective reader) is that the first part of the sentence is an acceptance by Sola of what Morganite had previously offered, and was the operative part of the sentence; the second part was non-operative, being the writer's opinion of the consequence of the acceptance he had immediately before communicated. On this understanding, the parties reached agreement about the return of the unit, but nothing more, when Sola's telex of 18 December accepted Morganite's standing offer; Morganite's telex of 19 December added nothing to the position that had been reached, it simply confirmed it.

If the better construction of the last sentence of Sola's telex of 19 December were not the one I have stated, but one which takes the sentence as making an offer to compromise all matters outstanding between the two companies, the question would arise whether Morganite's telex of 19 December was an acceptance of it. There are two features of the 19 December telex which in combination would lead me to conclude that it was not an acceptance, but a counter offer. One is that it did not in terms accept what was said in the previous day's telex; it acknowledged receipt of the telex, and "noted" the proposal; it then added a proposal not previously mentioned, so far as the evidence goes, that Sola should pay the cost of returning the equipment. There is nothing in the evidence to indicate whether the amount of the freight would be trifling, substantial, or something in between. Mr Peddie apparently thought it worth mentioning, and unless such reference was merely pedantic, the introduction of the matter prevented the telex of 19 December being an acceptance of the proposal in Sola's 18 December telex. I do not think, on the material before the Court, the reference to freight can be treated as merely pedantic. The other matter is that Morganite's telex of 19 December strikes me, in the whole context, as being a repetition (with an additional ingredient) of what Morganite had previously offered, and in saying again what had been said before, I would take the meaning to be the same, that only the matter of the return of the equipment itself, and nothing wider, was being raised for discussion. In other words, the telex of 19 December should be understood not only by reference to the telex to which it was immediately replying, but to the whole course of communication of which the telex of 18 December was part.

The most important point to emerge from this interpretation is that there was no acceptance by Morganite of Sola's "offer" in Sola's telex of 18 December. Although the parties argued the case on the footing that there had been a contract (although what its terms were was disputed) it is not necessary for the Court, on this alternative interpretation, to decide whether there was in fact a contract. The Court was told that the equipment was returned at some time after 19 December, but that does not demonstrate that there was a contract. It is possible, for example, that each party thought a different contract was on foot, the contract in each case requiring the return of the equipment, when both objectively and subjectively there had been no consensus. On this alternative interpretation it

does not matter whether or not this was the case. On the alternative interpretation all that is relevant to the litigation is that Sola did not establish its defence of accord and satisfaction. On the interpretation which I have said I favour, there was a binding legal agreement between the parties, but again not one which amounted to the accord and satisfaction relied on by Sola.

In my opinion, the first question in the appeal must be answered in favour of Morganite. Because of that conclusion, the second question does not need to be decided in this Court. Smart J dealt with the second question at some length, although the final paragraph of his reasons makes it fairly plain that his decision was based on the construction and not on the subrogation issue. As I feel clear in my own mind that Morganite should succeed in this Court, as it did before Smart J, on the construction issue, I see no utility in embarking on a series of obiter dicta on the subrogation point, which seems to me to be difficult, and a proper consideration of which would take up a good deal of time.

In my opinion, the appeal should be dismissed with costs.

Meagher JA In this matter the facts are fully set out in the judgment of Priestley JA, and I shall not repeat them. The first question which arises is whether the interchanges of telexes between the parties on 18-19 December 1984 constitute an accord and satisfaction. In my view they do.

The essential facts could be stated briefly. The reactor system which the appellant contracted to supply to the respondent in July 1983 was installed in January 1984, it had no less than five failures after installation, commencing on 22 April and ending on 27 July. Those failures of the system caused considerable damage to the respondent, which can be grouped under three heads:

(a) the loss of the purchase price it had paid for the system,

Negotiations between the parties in August 1984 to settle the claims of the respondent against the appellant proceeded on the basis that the failures of the system and the consequent damages were entirely due to the appellant's fault, a situation which the appellant seemed, albeit reluctantly, to accept. Those negotiations in essence were negotiations to settle the first head of damages which I have described and were expressly so limited.

Then in October 1984 the situation changed fundamentally when Dr Grantham's report ascribed the bulk of the blame for the system's failure to the respondent. In this context the appellant's attitude stiffened somewhat and the appellant sent the offer contained in the telex of 18 December. The last paragraph of that telex is critical. It says:

"Thus I propose that we accept the return of the unit to us and refund to you the sums which you have paid to us with the result that we each will bear our own not inconsiderable losses which have otherwise resulted from this venture."

It is not disputed that that offer was accepted. I do not see how the offer could be construed as meaning anything else but that if the appellant refunded the purchase price of the system (ie, satisfied in full the first head of loss) the respondent would bear the other two heads of loss. I do not see what other construction can be given to the words "which have otherwise resulted". For these reasons, in my view the submissions of Mr Sheller QC for the appellant that the telexes constituted an accord must be accepted. That accord was an agreement to satisfy all the respondent's causes of action against the appellant. That the accord was followed by satisfactions is not denied.

(LA BASIC AUSTRALIA LIMITED v MORGANITE CERAMIC FIBRES PTY LIMITED (Meagher JA)

We heard considerable debate as to whether this was a case in which resort could be had to the circumstances surrounding the contract, and if so to what extent and what basis. To my mind this issue is immaterial, as one reaches the same result whether one has regard solely to the written words of the contract or inquiries into the surrounding circumstances. Indeed, it seems to me that an examination of the surrounding circumstances strengthens the interpretation to which one arrives by the consideration of the plain words of the contract itself.

That raises the second issue in the case. This was pleaded by the respondent in its reply as follows:

"The plaintiff further says that there is a principle of law to the effect that a release given to a Third Party by an Insured, entitled to indemnity under a policy of insurance, will not bind an Insurer who has made payment in respect of such Indemnity if at the time the release was given the Third Party was aware of the existence of the Insurer, of its having made such payments, and the release is given without the knowledge and approval of the Insurer." It is conceded that at all material times the appellant knew of the existence of the respondent's insurances.

The respondent's submission in this regard was founded on a statement made by Sir Garfield Barwick in Government Insurance Office (Queensland) v Brisbane Stevedoring Pty Limited (1969) 123 CLR 228. It is as follows:

"Tt is also settled law that an insured may not release, diminish, compromise or divert the benefit of any right to which the insurer is or will be entitled to succeed and enjoy under his right of subrogation. On occasions an attempt by the insured to do so will be ineffective against the insurer because of the knowledge of the circumstances which the person under obligation to the insured may have."

In my view this argument is fundamentally misconceived.

It is undoubtedly true, as Sir Garfield Barwick pointed out, that in every contract of insurance there is an obligation, implied if not expressed, as between the insurer and his insured that the latter will not do anything to diminish the former's right to subrogation. It does not emerge clearly from the cases what is the source or the nature of that obligation. It may be, and I think it is, a term of the contract of insurance which is implied by law. It could also conceivably be, although I doubt if this be the case, an equitable obligation arising independently of contract. If it be the former, it is a negative stipulation, which has the same consequence as any other negative stipulation; that is to say, the insurer may enjoin any apprehended breach of the stipulation, may subsequently sue for any actual breach in damages, may plead the breach as a defence if the insured claims under the relevant policy of insurance, and may sue for an injunction or damages any third person who induces a breach of the stipulation. But one thing is clear; it does not enable an insurer to treat as void a transaction which has been completed in breach of the stipulation. Just as if A covenants with B not to sell Blackacre to C and he subsequently does sell Blackacre to C B cannot allege that the sale is void, and this is so whether C knew of the covenant or not. Likewise, if the obligation in question is not a consequence of an implied term but is the consequence of some independent equity, the doctrine of Demattos v Gibson (1858) 4 De G and J 45 ER 108, produces the same result.

As Mr Rofe of Queen's Counsel correctly pointed out to us, his contention has received a certain amount of support in the text books. See, for example, Derham Subrogation in Insurance Law (1985) page 91; Tarr Australian Insurance Law (1987) page 266; Sutton's Insurance Law in Australia and New Zealand 1980 page 564; Halsbury's Laws of England 4th Ed Vol 25 page 184; Mustill and

Gilman Arnould, Law of Marine Insurance and Average 16th Ed page 1096; Browne Macgillivray on Insurance Law 5th Ed paragraph 1904; Parkington, O'Dowd, Legh-Jones and Longmore Macgillivray and Parkington on Insurance Law 6th Ed paragraph 1890; (although that statement is retracted in the 7th Edition paragraph 1175); and (I regret to say) in Meagher, Gummow and Lehane Equity, Doctrines and Remedies 2nd Ed paragraph 937. There is no judicial authority in England or in this country which would support such a proposition, unless it be an obscure decision of Judge Bulger sitting in Salisbury County Court: Haigh v Lawford (1964) 114 LJ 208. The early New South Wales decision, Smidmore v The Australian Gas Light Co (1881) 2 NSWR LR (L) 219 has a headnote which would support that proposition, although a reading of the case demonstrates that the headnote is inaccurate. There is also some American and Canadian authority which would support the proposition. However, as I have explained, the submission is both contrary to principle and unsupported by authority in this country. It must therefore be rejected.

The submission also offends the principle firmly established in this country, that an insurer could not sue in his own name and is subject to all of the defences available if the action were brought by the insured for his own benefit; see Sydney Turf Club v Crawley [1971] 1 NSWLR 724 at 734. Finally, since the principle contended for in Mr Rofe's submission is basically that an insured cannot destroy his insurer's right to subrogation, the principle could hardly operate before the right of subrogation arises, and the right does not arise until the insurer pays in full; see Meagher, Gummow and Lehane Equity Doctrines and Remedies 2nd Ed paragraph 937. In the present case it is clear on the facts that the insurer had not paid the respondent's claim in full until after the accord and satisfaction had been completed.

Counsel for appellant: C Sheller QC, P Biscoe and J Marshall Solicitors for appellant: Moore and Bevins