Interpretation of Contracts
1. Contractual interpretation: scope, purpose and terminology
The interpretation of contracts is concerned with determining whether a contractual provision applies to a given set of facts or not. In English legal terminology the concepts of ‘interpretation’ and ‘construction’ are used synonymously. The former notion can be traced to the Latin word interpretatio, as is possible with equivalent expressions employed in other European languages (interprétation, interpretazione, interpretación, Interpretation). German and Dutch lawyers also resort to a synonymous term that highlights the idea of ‘unfolding’ the text (Auslegung, uitleg).
Despite these far-reaching terminological similarities, the concept of ‘interpretation of contracts’ has divergent scopes in different European legal systems. In England, for example, it has a relatively narrow ambit and does not include certain situations which would be classified as ‘interpretation’ in many civilian jurisdictions, such as the so-called ‘supplementary’ or ‘creative’ interpretation of contracts (ergänzende Auslegung, interprétation créatrice or supplétive) and the problem that arises if the parties concurrently chose to employ words in a distinctive sense which does not correspond to the literal meaning (cases of falsa demonstratio or ‘erroneously wrong denomination’). English law also provides solutions for these cases, but it uses separate, functionally equivalent doctrines (implication of terms, rectification for common mistake). Rectification, incidentally, is a good example of the difficulty of drawing a clear borderline between interpretation and the doctrine of mistake—a problem that is resolved in different ways in different European legal systems.
In European private law, issues of contractual interpretation normally concern contracts between natural or legal persons. The somewhat overlapping rules of public international law on the interpretation of treaties between states (partially codified in Arts 31 ff of the 1969 Vienna Convention on the Law of Treaties) have fallen out of use in EU law, following recognition that the European Union is a legal system sui generis rather than the product of an ordinary treaty.
2. Trends of international development
a) Canons of contractual interpretation and their codification
European legal systems share a set of well-established rules, principles and maxims of contractual interpretation. These are based on Roman law and were strongly influenced by the scholars and practitioners of the ius commune who developed them with ample reference to the rules and principles of the interpretation of statutes (interpretation of statutes, history of) and wills. The English courts borrowed many of the ius commune maxims which thereby became a part of the [[common law. On the continent these maxims were included in the early codifications. The Allgemeines Landrecht für die Preußischen Staaten (ALR) of 1794 spelt out as many as 28 provisions on interpretation in its sections dealing with declarations of intent and contracts in general as well as a further dozen rules on the construction of specific types of contracts. The drafters of the Code civil also codified a comprehensive catalogue of interpretative precepts (Arts 1156–1164); these are still in force and have been borrowed extensively by the other legal systems of the Romanistic legal family (see Arts 1362–1371 Codice civile; Arts 1281–1289 [[Código civil). In contrast, during the second half of the 19th century, lawyers from the Germanic systems expressed doubts as to the feasibility and desirability of codifying the principles of contractual interpretation. Thus the [[Bürgerliches Gesetzbuch (BGB) dealt with the subject matter in a highly selective and fragmentary way (§§ 133 and 157). These provisions were borrowed by the drafters of the revised Austrian Allgemeines Bürgerliches Gesetzbuch (ABGB) and the Greek Civil Code. In a similar vein, the Swiss Code of Obligations (OR) highlights just two issues of interpretation (Arts 2(2) and 18(1)). The new Burgerlijk Wetboek (BW) of 1992 refrains from codifying any rules of contractual construction.
However, a variety of interpretative maxims of the ius commune survive in the continental jurisdictions under the guise of judge-made rules developed alongside the codifications. These include the construction of ambiguous contract terms against their supplier (contra proferentem), which is of particular relevance with regard to standard contract terms today, the interpretation in favour of upholding the validity of the contract (favor negotii; ut res magis valeat quam pereat; effet utile) and the ‘narrow’, ‘strict’ or ‘restrictive’ construction of ‘odious’ terms, such as exemptions and limitations of liability, waiver clauses ([[release), compromise settlements and penalty clauses.
The trend towards a decodification of the rules and principles of contractual interpretation seems to have been reversed in the course of the ongoing harmonization of European contract law. Whilst the 1980 CISG still makes do with one basic rule of construction (Art 8), the more recent harmonization projects contain more comprehensive catalogues of provisions which, as far as their formal structure is concerned, largely follow the French model (ch 4 of the UNIDROIT Principles of International Commercial Contracts (PICC); ch 5 of the Principles of European Contract Law (PECL); Title V of the Code Européen des Contrats (Avant-projet); and ch II.-8 of the Draft Common Frame of Reference (DCFR)).
b) Interpretation of contracts versus interpretation of declarations of intent
A similar return to a common European tradition can be seen with regard to the object of interpretation. The jurists of the ius commune focused on the construction of the contract as a whole; common lawyers and the Romanistic legal systems maintained this position. In contrast, the individual ‘declaration of intent’ (Willenserklärung) became the central and constitutive building block of private law, and therefore also of contractual interpretation, in the Germanic systems under the influence of the 19th-century Pandectist writers (Pandektensystem). The repercussions of this approach can still be seen in Art 8 CISG which deals exclusively with ‘statements made by and other conduct of a party’. The more recent harmonization projects refocus on the construction of entire contracts although most provide for a broadly analogous application of the rules of contractual interpretation to statements and other conduct of the parties (Art 4.2 UNIDROIT PICC; Art II.-8:202 DCFR; Art 4 Code Européen des Contrats (Avant-projet)).
c) ‘Objective’ and ‘subjective’ approaches to contractual interpretation
The rise and fall of the notion of declaration of intent was connected to the continental distinction between the ‘intention theory’ and the ‘expression theory’. The debate on these viewpoints became more pronounced after the ‘declaration of intent’ had become the focal point of private law doctrine: it was now important to decide which of the two constitutive elements of such declarations generated legal effects—the internal intention of the person making a declaration, or the outward expression of that intention in the declaration itself. It was argued that in the former case the object of interpretation had to be the determination of the ‘subjective’ intention of the party making a declaration. In the latter case the interpretation was bound to aim at determining the ‘objective’ meaning of the declaration. The issue was debated across Europe, but it was most heatedly discussed in the German-speaking jurisdictions. There (as well as in France, but in contrast to England) the ‘subjectivist’ view prevailed at first. It was not until the turn of the 20th century that the ‘objectivist’ conception carried the day in Germany: there was less interest in how the parties to the contract had actually understood what had been declared, but rather in how they reasonably ought to have understood their statements and other conduct. The task of the interpreter, particularly of the judge, was thus seen to be normative and evaluative, rather than empirical and descriptive. The doctrine of interpretation thereby became one of the vehicles for a broader transformation: a more liberal philosophy of contract law that was primarily based on party autonomy developed into a more social welfarist contract law ideology that was not a priori hostile to judicial intervention.
These debates had only marginal influence on the practice of contractual interpretation in the European legal systems. The courts developed adequate solutions for certain groups of cases even when these solutions deviated from the theoretical and abstract point of departure of the respective contract law. French contract law, for example, prima facie follows a decidedly subjectivist conception to this day, although French lawyers acknowledge that the intention of the parties must normally be determined by having recourse to ‘objective’ criteria. English law emphasizes the objective character of contractual interpretation, although where this starting point leads to inadequate results (eg if both parties had a similar intention but did not express it correctly) it ensures that the intention of the parties prevails by drawing on the doctrine of rectification for common mistake.
Today this theoretical debate has little practical relevance outside of civil procedure. In France, the interpretation of a contract is seen as a question of fact (determination of the actual intention of the parties) that cannot be reviewed by the Cour de cassation; English and German law classify the issue as a question of law (determination of the ‘objective’ or ‘true’ meaning). Meanwhile, legal writings on the construction of contracts have adopted a less doctrinal and more relaxed approach that refrains from postulating an exclusive ‘object’ or ‘aim’ of interpretation in the abstract. Instead they combine the recourse to ‘subjective’ and ‘objective’ factors and balance these elements according to the particularities of the case at hand and the interests of the parties involved.
d) Weight of the interpretative factors
As a result of the developments referred to in the last paragraph, the 20th century saw an increasing interest in the question of how to conduct the weighing and balancing of the interpretative factors. This primarily concerned the so-called ‘literal’ or ‘plain meaning rule’ (théorie de l’acte clair, Eindeutigkeitsregel), according to which the interpreter may not deviate from the ‘clear’ und ‘unambiguous’ meaning of a contract term, even if other criteria of interpretation point in another direction (eg the context of the term within the overall contract, the purpose of the term or the negotiations of the parties). This rule has its precursors in both classical and medieval Roman law, but it did not assume primacy amongst the maxims of interpretation before the late 18th century and particularly the 19th century. During the same period, considerations of equity, fairness and reasonableness were allocated less weight than they had previously had, particularly in early modern times. In the course of the 20th century the pendulum swung back again, so that such ‘policy arguments’ received considerably more weight in the guise of ‘reasonableness’, good faith or an ‘interpretation taking into account the interests of the parties’ (interessengerechte Auslegung). At the same time, legal systems across Europe gradually overcame the strict literal rule, with England being the last jurisdiction to move in a more ‘contextual’ or ‘purposive’ direction from the 1960s onwards. Today there is a tendency to assume what might be called a ‘prima facie-priority’ of the literal meaning vis-à-vis the other factors of interpretation: the contractual language must be adhered to as long as the other criteria do not strongly militate in favour of a different result.
Partly in response to the decline in weight attributed to the literal meaning of terms, drafting practice has increasingly moved towards inserting so-called ‘merger clauses’ (‘entire agreement clauses’, ‘no oral modification clauses’; Integrations-, Vollständigkeits- or Schriftformklauseln) in written contracts, particularly in cross-border commercial transactions. The parties thereby agree that the contractual document contains the entirety of their agreement. Any recourse to circumstances extraneous to the document is to be disregarded in the event of subsequent litigation. In particular, the statements and other conduct of a party during the contractual negotiations and subsequent to the conclusion of the contract may not be referred to in order to add to or vary the words of the contract. In doing so, the parties aim to increase legal certainty and get to a result which European contract laws traditionally achieved by relying on an array of rules protecting the ‘integrity of the writing’. In England this result is achieved through the parol evidence rule. The Romanistic codifications exclude witness evidence of everything that is ‘against and outside the content’ of contracts if the value of the transaction exceeds a certain sum (see Art 1341 Code civil). In German law, the judge-made ‘theory of indication’ (Andeutungtheorie) ensures that recourse to extraneous circumstances in the interpretation of contracts which are subject to formal requirements is confined to circumstances that have been ‘at least somehow, maybe even imperfectly, indicated’, ‘reflected’ or ‘alluded to’ in the written document. All these rules have in common that they have become riddled with exceptions and are thus more or less irrelevant in legal practice today. For example, the parol evidence rule has been reduced to a rebuttable presumption that the contractual document reflects the entirety of the agreement. Therefore it does not provide stronger protection against supplementations and amendments on the basis of extraneous circumstances than the similarly rebuttable ‘presumption of completeness and accuracy of the written contract’ (Vermutung der Vollständigkeit und Richtigkeit der Vertragsurkunde) known to the German law of procedure. These doctrines do not seem to meet sufficiently the concerns of legal practice for legal certainty and predictability which explains the increasing use of merger clauses and similar agreements. So far there is no pan-European consensus on the validity and the legal effects of such clauses. The trend seems to be towards accepting the parties’ autonomy to exclude the supplementation or variation of the contractual words. However, these clauses are not normally understood as prohibiting recourse to extraneous circumstances for the purpose of merely interpreting the contract (see Art 2.1.17(2) UNIDROIT PICC). Different considerations will probably apply if the clause expressly extends to the interpretation of the contract and has been individually agreed upon (see—even for consumer contracts—Art 2:105(3) PECL and Art II.-4:104(3) DCFR).
3. Provisions on the interpretation of contracts in international uniform law and in projects for the harmonization of contract law
a) Basic rules
Recent proposals for the harmonization of contract law set forth a set of basic rules on the interpretation of contracts that draws its inspiration from Art 8(1) and (2) CISG (Art 4.1 and 4.2 UNIDROIT PICC; Art 5:101 PECL; Art II.-8:101 DCFR; Art 39 Code Européen des Contrats (Avant-projet)). According to these provisions, contracts shall be interpreted according to the common intention of the parties. The unilateral intention of one of the parties is only relevant if the other party knew or could not have been unaware of that intention at the time of concluding the contract. If neither a common intention nor a relevant unilateral intention can be established, the contract shall be interpreted according to the meaning that reasonable persons of the same kind as the parties would give to it in the same circumstances. These rules reject the notion of a ‘literal rule’ for a future European contract law. At first sight, they also seem to provide for an unlimited priority of the parties’ subjective intentions. Consequently, it is frequently said that these projects subscribe to the ‘subjective theory’ of interpretation. Such comments fail to recognize that cases where the intention of the parties prevails are few and far between: how often will it be possible to prove that a common intention of the parties or the relevant intention of one of the parties deviated from the meaning that reasonable persons of the same kind as the parties would give to the words in the same circumstances? Therefore, the interpretation of contracts in European contract law will usually accord to the meaning that reasonable parties would attribute to the contract.
b) Factors to be taken into account
The harmonization projects proceed to enumerate a number of ‘circumstances’ which must be taken into account when establishing the intention of the parties or the meaning that a reasonable person would give to the contract (Art 4.3 UNIDROIT PICC; Art 5:102 PECL; Art II.-8:102 DCFR; Art 39 Code Européen des Contrats (Avant-projet)). These include the practices which the parties have established between themselves, the circumstances in which the contract was concluded (including the preliminary negotiations), the conduct of the parties subsequent to the conclusion of the contract, and relevant customs. These factors were already mentioned in Art 8(3) CISG. In addition, more recent projects mention the standard of good faith and fair dealing, the nature and purpose of the contract and the meaning commonly given to terms and expressions in the trade concerned. These catalogues of interpretative criteria are not exhaustive. They are mostly in line with the most important aids to interpretation used in national contract laws. The only major exception is recourse to preliminary negotiations which is not admitted under English law (recently affirmed in Chartbrook v Persimmon  UKHL 38).
c) Maxims of interpretation
As opposed to the CISG, the harmonization projects spell out a fair number of traditional maxims of interpretation that are widely used in national contract laws. First, contract terms shall be interpreted in the light of the contract as a whole (Art 4.4 UNIDROIT PICC; Art 5:105 PECL; Art II.-8:105 DCFR; Art 39(1) Code Européen des Contrats (Avant-projet)). Secondly, terms shall be interpreted so as to give effect to all the terms rather than to deprive some of them of effect (Art 4.5 UNIDROIT PICC; Art 5:106 PECL; Art II.-8:106 DCFR; Art 40(2) Code Européen des Contrats (Avant-projet)). Thirdly, the contra proferentem rule—the only rule on contractual interpretation that is codified in EU private law (Art 5 ss 2 and 3 Dir 93/13; see Art 6:203 Acquis Principles)—is given the widest possible scope by not confining it to consumer contracts (Art 5:103 PECL; Art II.-8:103 DCFR; Art 40(3) Code Européen des Contrats (Avant-projet)) and, in one instance, even extending it to individually negotiated terms (Art 4.6 UNIDROIT PICC). Fourthly, there are innovative rules for cases of a discrepancy between different language versions of multilingual contracts (Art 4.7 UNIDROIT PICC; Art 5:107 PECL; Art II.-8:107 DCFR).
d) ‘Supplementary’ interpretation
The harmonization projects attempt to draw a distinction between the interpretation and the implication of obligations (Art 5.1.1 and 5.1.2 UNIDROIT PICC; Art 6:102 PECL; Art II.-9:101 DCFR; Art 32 Code Européen des Contrats (Avant-projet)) and, in one case, ‘supplying an omitted term’ (Art 4.8 UNIDROIT PICC). In doing so they reject the modern approach of German and French law which assumes, drawing in no small measure on the insights of modern hermeneutics, that the ‘interpretation’ and the ‘supplementation’ of contracts cannot be rigidly distinguished and that so-called ‘supplementary interpretation’ (interprétation supplétive, ergänzende Auslegung) is but a species of the construction of contracts. The proposals follow the Anglo-American model of the implication of contract terms that has close structural proximity to the doctrine of conditio tacita that prevailed on the Continent under the ius commune. Subject to a number of specific requirements, the court may read a ‘tacit’ or ‘implied condition’ into the contract if the parties have omitted to provide for a certain issue. For the purposes of establishing the implied obligation, the projects refer the court to the same circumstances that shall be taken into account in the interpretation of contracts. The attempt to distinguish between interpretation and implication (or supplementation) thus proves to be illusory.
Alexander Lüderitz, Auslegung von Rechtsgeschäften (1966); Tony Weir (tr), Hein Kötz, European Contract Law, vol I (1997) 106 ff; Silvia Ferreri, ‘The Interpretation of Contracts from a European Perspective’ in Reiner Schulze (ed), Informationspflichten und Vertragsschluss im Acquis communautaire (2003) 117; Stefan Vogenauer ‘§§ 133, 157. Auslegung’ in Mathias Schmoeckel, Joachim Rückert and Reinhard Zimmermann (eds), Historisch-kritischer Kommentar zum BGB, vol I (2003); Antje Baumann, Regeln der Auslegung internationaler Handelsgeschäfte (2004); Jacques H Herbots, ‘Interpretation of Contracts’ in Jan Smits (ed), Elgar Encyclopedia of Comparative Law (2006) 325; Nicole Kornet, Contract Interpretation and Gap Filling (2006); Stefan Vogenauer, ‘Interpretation of Contracts’ in Andrew Burrows and Edwin Peel (eds), Contract Terms (2007) 123; Stefan Vogenauer ‘§§ 305-310. Gestaltung rechtsgeschäftlicher Schuldverhältnisse durch Allgemeine Geschäftsbedingungen, Teil III: Auslegung und Umgehungsverbot’ in Mathias Schmoeckel, Joachim Rückert and Reinhard Zimmermann (eds), Historisch-kritischer Kommentar zum BGB, vol II/2 (2007); Olaf Meyer, ‘Die privatautonome Abbedingung der vorvertraglichen Abreden’ (2008) 72 RabelsZ 562; Stefan Vogenauer in Stefan Vogenauer and Jan Kleinheisterkamp (eds), Commentary on the UNIDROIT Principles of International Commercial Contracts (2009) Arts 4.1 ff; Reinhard Zimmermann, ‘Die Auslegung von Verträgen: Textstufen transnationaler Modellregelungen’ in Festschrift Eduard Picker (2010) 1353; Claus-Wilhelm Canaris and Hans Christoph Grigoleit, ‘Interpretation of Contracts’ in Arthur S Hartkamp and others (eds), Towards a European Civil Code (4th edn, 2011) 587.