Canada: Considerations Of The "Surrounding Circumstances" In Contract Interpretation Post-Sattva

Introduction

Historically, Alberta courts have tended to downplay the importance of pre-contractual evidence and the surrounding circumstances in determining the meaning of contractual terms. The typical approach to contract interpretation looks to read the contract as a whole, construed in a commercially reasonable manner. In the normal course, there was little reason to bring in evidence of the surrounding circumstances when interpreting contractual language.

The Supreme Court of Canada's ("SCC") blockbuster 2014 decision in Sattva Capital Corp v Creston Moly Corp1 ("Sattva") has expanded the use of surrounding circumstances when interpreting a contract. The most common examples of the "surrounding circumstances" in the construction industry are pre-contractual documents, including letters of intent ("LOIs"), memorandums of understanding ("MOUs"), term sheets and pre-contract meeting minutes.

Following Sattva, it is now clear that the surrounding circumstances leading to a contract, including pre-contractual documents, can play a significant role in the determination of contractual meaning.

However, two years following Sattva's release, the decision continues to raise questions. Among them: Are all pre-contractual communications now potentially relevant to determining the parties' intent? And when should the surrounding circumstances be applied to contract interpretation—only in cases of ambiguity, or in all cases?

What is the Scope of the Surrounding Circumstances?

Sattva established that the range of potentially relevant evidence of the surrounding circumstances is broad in scope and includes "all knowledge that was or reasonably ought to have been within the knowledge of both parties at or before the date of contracting"2, subject to two key limitations:

  1. The evidence must be objective, and
  2. Evidence of the surrounding circumstances cannot be relied upon to the extent that it deviates from the written words of the contract such that the court effectively creates a new agreement.

The effect of these two limitations is to narrow the scope of the surrounding circumstances, making it clear that:

  • Relevant evidence of the surrounding circumstances must be evidence that speaks to what both parties to the contract actually knew (or reasonably ought to have known) in reaching their agreement or at the time of contracting.3
  • Relevant evidence of the surrounding circumstances is to be used as an interpretive aid for determining the intended meaning of the words of the contract as the contract was written and cannot be used to change the contract language.

Examples of potentially relevant pre-contractual documents or communications that are likely to be considered as part of the surrounding circumstances include:

  • LOIs, term sheets, MOUs, pre-contract meeting minutes, as well as other pre-contractual communications, including emails and letters, that show:

    • The parties' mutual understanding of the objectives and subject matter of the agreement or the meaning of particular language.
    • The parties' objective reasons for negotiations and entering into the agreement.
    • The objective negotiating or commercial context leading up to the contract.4
  • Prior, related, or surrounding contracts known to the parties that evidence the parties' understanding of the meaning of language in the later contract (for example, a pre-construction service agreement).5
  • Objective evidence of the parties' awareness of technical, customary or trade language.6

Examples of evidence not likely to be considered as part of the surrounding circumstances:

  • Subjective evidence or pre-contractual communications and documents which do not speak to or indicate the parties' consensus, such as:

    • Prior drafts of the contract.7
    • Pre-contractual communications capturing one party's perspective, feelings or beliefs about the meaning or context of the contract (for example, emails on one side discussing the meaning of contractual terms).
    • Documents setting out or tracking the nuances of the parties' respective or changing positions.
  • Any evidence about surrounding facts or commercial circumstances that are not known (or not reasonably ought to have been known) to both parties at or before reaching their agreement.

When is Evidence of the Surrounding Circumstances Applied?

Several recent decisions, applying Sattva, suggest that evidence of the surrounding circumstances has limited (if any) application where the contract language is clear and unambiguous.

In a recent Alberta Court of Queen's Bench decision,8 the Court interpreted a clearly worded release and commented that where a contract is clear and unambiguous, the courts should not be required to consider the surrounding circumstances as there is no need for interpretive aids.9

The Alberta Court of Appeal also commented recently that where parties employ a standard form or boilerplate contract, it is not reasonable to consider extrinsic evidence. In order for the courts to determine the objective intentions of the parties through evidence of the surrounding circumstances, the parties must actually negotiate the terms of the contract and be present when the terms were set.10

But caution: the question of whether contractual language is ambiguous may itself turn on evidence of the surrounding circumstances. In the majority of cases where the language of the contract is at issue, the parties are likely to disagree over whether the language in question is clear. Further, the question of whether contractual language is clear (or ambiguous) may itself turn on evidence of the surrounding circumstances.

In emphasizing the important role of the surrounding circumstances in contract interpretation, the SCC in Sattva reasoned that words do not have fixed meanings and therefore, looking to the surrounding circumstances known to the parties at the time of formation of the contract, can actually give meaning to the words chosen by the parties.

Until the dust settles on this issue, a cautious approach would be to assume that relevant evidence of the surrounding circumstances could potentially be applied to any exercise of contract interpretation, with the possible exception of very clear cases involving boilerplate contracts where there is truly no reasonable argument that any ambiguity exists.

Entire Agreement Clauses

While the SCC in Sattva did not comment on the effect of entire agreement provisions (or other similar clauses that purport to exclude extrinsic evidence or previous agreements regarding the subject matter of the contract), following Sattva, these clauses should be more closely scrutinized.

Since Sattva is consistent with the parol evidence rule (evidence that would add to, subtract from, vary or contradict the written contract in question would not be admissible in any event), the typical entire agreement clause would not affect the scope of relevant evidence of the surrounding circumstances contemplated by Sattva.

It can be expected that one of the effects of Sattva will be more fighting over what constitutes relevant evidence in a contract interpretation dispute. A specifically worded entire agreement clause (that, for example, expressly excludes reference to such items as draft contracts and pre-contractual negotiations to be used as interpretative aids) may reduce the scope of these disputes.

Concluding Thoughts on Contract Interpretation Following Sattva

  • The primary goal of contract interpretation continues to be to determine the intended meaning of a contract.
  • Following Sattva, it is now clear that when parties are in a dispute over the intended meaning of the words of a contract, evidence of the surrounding circumstances, including pre-contractual documents, may be used as evidence in the event of a dispute and affect how decision-makers (i.e., judges and arbitrators) interpret the final contract.
  • Relevant evidence of the surrounding circumstances could include pre-contractual communications, such as LOIs, term sheets, MOUs, pre-contract meeting minutes and other communications, if they speak to the parties' consensus and intentions giving rise to the agreement or to parts of the agreement. Parties to a contract should pay closer attention to these documents and ensure they do not contain misleading statements about the parties' agreement.
  • Prior contract drafts and pre-contractual negotiations that are subjective and do not speak to the parties' consensus and mutual understanding of the meaning of the contract, are not relevant evidence of the surrounding circumstances.
  • The jury is still out on whether the surrounding circumstances will, in practical terms, be applied by decision-makers only in cases of ambiguity.
  • Entire agreement clauses in contracts should be looked at more closely. Parties should consider adding specific language to explicitly exclude pre-contractual documents (such as drafts of the contract) from being used as interpretative aids.

Footnotes

1. 2014 SCC 53 [Sattva].

2. Sattva, at para 58.

3. Sattva, at paras 59-60.

4. Primo Poloniato Grandchilden's Trust (Trustee of) v Browne, 2012 ONCA 862 at para 69, leave to appeal to SCC refused.

5. Kentucky Fried Chicken Canada v Scott's Food Services Inc. (1998), 41 BLR (2d) 42 at para 33.

6. Georgia Construction Co v Pacific Great Eastern Railway, [1929] SCR 630 at para 7.

7. 1298417 Ontario Ltd. v Lakeshore (Town), 2014 ONCA 802 at para 59.

8. Terwillegar Towne Residents Association v Brookfield Residential (Alberta) LP, 2015 ABQB 14 [Terwillegar].

9. Terwillegar, at para 15.

10. Ledcor Construction Ltd. v Northbridge Indemnity Insurance Co.2015 ABCA 121, at para 14; leave to appeal to SCC granted, [2015] SCCA No. 18.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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