It may be trite to state that contracts are essential to business relations. It is a common perception that the words in a contract are determinative in understanding the parties’ rights and obligations. However, the words in the contract are sometimes just the starting point. There are occasions where Courts examine surrounding circumstances and ancillary documents in interpreting contracts and determining the intention of the contracting parties. When and how is such collateral information assessed?
The Alberta Court of Appeal provided significant guidance in the recent case of Hole v. Hole, 2016 ABCA 34. At issue were amounts owed to the appellants resulting from their withdrawal from a family business. The appellants argued some of their rights were set out in a “Letter of Understanding”, which had been written prior to a written contract, which set out the remainder of their rights. The respondents argued the Letter of Understanding was superseded by the later contract. If the Letter of Understanding was deemed an enforceable contract the appellants would be owed an additional $1 million. At trial, the Court of Queen’s Bench ruled that the Letter of Understanding was not intended to create legal relations and was not an enforceable contract. The Court of Appeal considered the trial evidence of circumstances surrounding the creation of the two documents and overturned the trial judge’s decision.
This case provides a helpful guide to understanding contractual interpretation. The Court noted three key overarching principles related to the evidence of surrounding circumstances:
- “The consideration of surrounding circumstances allows a court to consider what a reasonable person would have thought was the aim of the transaction, if that person knew the facts available to the parties. It does not, however, allow a court to receive direct [subjective] evidence of intent or allow such evidence to contradict the contract, evade a “whole contract” clause, or create ambiguities.”
- “The relevant time for consideration of surrounding circumstances in the context of contractual interpretation is at the time the contract was made, and this contextual evidence of surrounding circumstances is part of the interpretive process.”
- “Courts should choose an interpretation which promotes a sensible commercial result and should discard an interpretation which defeats the intentions and objectives of the document, if construed fairly and broadly in the context of the surrounding circumstances.”
The Court then reiterated the following principles of contractual interpretation set out in the Supreme Court of Canada’s decision of Sattva Capital Corp v Creston Moly Corp, 2014 SCC 53:
- The decision maker must read the contract as a whole giving the words used their ordinary and grammatical meaning, consistent with the surrounding circumstances known to the parties at the time of the formation of the contract.
- The meaning of words is often derived from a number of contextual factors, including the purpose of the agreement and the nature of the relationship created by the agreement.
- Consideration of the surrounding circumstances recognizes that ascertaining contractual intention can be difficult when looking at words on their own, because words alone do not have an immutable or absolute meaning. In a commercial contract, the court should know the commercial purpose of the contract and this in turn requires evidence of the genesis of the transaction, the background, the context, and the market in which the parties are operating.
- While surrounding circumstances will be considered in interpreting the terms of a contract, they must never be allowed to overwhelm the words of that agreement. A court cannot use surrounding circumstances to deviate from the text such that it effectively creates a new agreement.
- The nature of the evidence that can be relied upon under the rubric of “surrounding circumstances” will necessarily vary from case to case. It does, however, have its limits. It should consist only of objective evidence of the background facts at the time of the execution of the contract, that is, information that was or reasonably ought to have been within the knowledge of the parties at or before the date of contracting.
- While the parol evidence rule does not preclude evidence of surrounding circumstances when interpreting a contract, this rule does preclude evidence of the subjective intentions of the parties.
Note that any document that purports to outline parties’ expectations may be deemed an enforceable contract, irrespective of its title. In this case, the Court deemed a “Letter of Understanding” to be an enforceable contract in light of the surrounding circumstances and the commercial context in which it was written.
The lesson is that parties to a commercial relationship or transaction should invest in legal advice to ensure that their intentions are clarified and reduced to writing. In this case, any savings the parties gained from minimizing legal costs was likely outweighed many times over by the costs of years of litigation.