Contracts

By: Warren H.O. Mueller, B.A., LL.B., LL.M., Q.C. of the Ontario Bar, and D. Morgan, B.A., LL.B, LL.M.

IX: Interpretation of Contract

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IX.1: General Principles

See Canadian Abridgment: CON.VII.1 Contracts | Construction and interpretation | General principles

The objective of interpreting a contract is to discover and give effect to the parties' true intention as expressed in the written document as a whole at the time the contract was made.1 In the absence of ambiguity, the plain, ordinary, popular, natural, or literal2 meaning of the words, read in light of the entire agreement and its surrounding circumstances,3 should be adopted,4 except where to do so would result in a commercial absurdity or create some inconsistency with the rest of the contract.5 Contractual interpretation is essentially a search for the objective meaning of language, absent proof that all parties mutually interpreted the contract in a way that may not have been apparent to an ordinary person.6 Thus, while modern courts tend to interpret contractual language contextually, in accordance with the surrounding circumstances of the agreement,7 and consistent with the reasonable understanding and expectations of the parties,8 interpretation of a contract must be objectively based.9 Generally, evidence of unexpressed (subjective) intention of the parties is not admissible.10 Lastly, the highest court in Canada recently ruled that contractual interpretation involves issues of mixed fact and law as it is an exercise in which the principles of contractual interpretation are applied to the words of the written contract, considered in light of the factual matrix.11 

Under the so-called modern "contextual approach" to contractual interpretation, particular provisions of an agreement are not to be read in isolation, but, rather, in harmony with the agreement as a whole12 and any related agreements forming part of the larger transaction13 in order to construe properly any given term in its wider context. Further, the contract as a whole may, and sometimes must,14 be considered in light of the facts and circumstances known to and affecting both parties at the time of the making of the contract, in order to understand the object of the parties15 and the frame of reference within which the process of interpretation should take place.16 Such surrounding circumstances are usually referred to as the commercial setting or context17 or the factual matrix18 of the contract, and evidence pertaining to same is to be distinguished from other extrinsic evidence.19 The genesis and aim of the transaction,20 as well as its background and context, and the market in which the parties were operating,21 may be considered as part of the context of the agreement. Business contracts are to be interpreted in accordance with commercial reality unless the language of the agreement clearly precludes this approach.22 The scope of the surrounding circumstances to be considered will vary from case to case, but should encompass those factors which assist the court in searching for an interpretation that promotes the true intent of the parties.23 A the same time, the words of the contract must not be overwhelmed by a contextual analysis, since the court's task is not to make a new contract for the parties.24 The intention of the parties is determined in the objective sense of a reasonable person by reference to the surrounding circumstances at the time of the signing of the contract.25 

Surrounding circumstances which may be considered include correspondence leading up to the making of the agreement,26 informal documents predating the final contract,27 and earlier superseded agreements executed by the parties.28 While recognizing the basic principle that evidence of negotiations (such as earlier drafts of the contract29 and mere statements of intention,30) is not admissible,31 especially where there is no ambiguity to be construed, some courts have considered "objective" evidence of negotiations in reference to the genesis and aim and factual matrix of the contract.32 Evidence of the parties' conduct subsequent to the making of the agreement should generally not form part of the factual matrix.33 Evidence as to the understanding of a party which is at variance with unambiguous terminology is not admissible.34 In conclusion, while the surrounding circumstances will be considered in interpreting the terms of a contract, they must never be allowed to overwhelm the words of that agreement. The goal of examining such evidence is to deepen a court's understanding of the mutual and objective intentions of the parties as expressed in the words of the contract. While the surrounding circumstances are relied upon in the interpretive process, courts cannot use them to deviate from the text such that the court effectively creates a new agreement.35 

Although the motives or objectives of the parties to the contract cannot dictate the interpretation to be given to the language employed in it,36 the clear object or purpose of the contract may be used in construing its broad or general terms.37 

A court's duty is to interpret a contract in accordance with the language used by the parties, rather than to alter the wording in accordance with what the court thinks the parties may or ought really to have intended,38 thereby effectively making a new contract for the parties.39 This duty prevails even if the result is more onerous than the parties may have anticipated.40 If, however, there is a clear contractual intention exhibited in the contract which conflicts with its literal wording, effect may be given to this overriding intention by departing from or qualifying particular terminology.41 

Where possible, effect must be given to all terms of the contract and none are to be rejected as surplusage or as having no meaning.42 The absence of words may be considered.43 Similarly, a court must strive to harmonize apparently conflicting terms by attempting to reasonably give meaning to each of the terms in question;44 one clause or the other will be ruled ineffective only if such an interpretation cannot be found.45 When different parts of the instrument are in conflict, effect will be given to the real intention of the parties as gathered from the instrument as a whole.46 Apparent inconsistencies may be reconciled by construing a specific term as a qualification of a general one.47 Conflicting provisions will not be considered meaningless and unenforceable unless they are so clearly repugnant that the effect of one clause virtually destroys that of another.48 A situation not covered by specific provisions will by default fall within the general regime laid down by the contract.49 

The process of determining the meaning to be given to words in a document is governed by the same principles regardless of whether it occurs in a contract claim or a tort claim: namely, the court seeks the reasonable understanding of the parties, given the purpose, context and entire wording of the document.50 

The principles governing the interpretation of contracts are essentially the same as for statutory interpretation.51 
While contracts drafted by businesspersons are not to be subjected as rigorously to conventional legal canons of construction as deeds prepared by solicitors,52 such will not be the case where business forms have been drafted with the advice or assistance of counsel, such as standard form banking documents.53 

A person dealing with disadvantaged parties has an enhanced duty to ensure clarity and completeness in contractual language.54 

IX.13: Burden of Proof

See Canadian Abridgment: CON.VII.2 Contracts | Construction and interpretation | Burden of proof

A party seeking to have a contract interpreted in a particular manner bears the burden of establishing with reasonable clarity the correctness of such an interpretation.1 The plaintiff in an action to recover on an arrangement understood in a fundamentally different sense by the opposite party is bound to prove strictly that his or her construction of the arrangement is the proper one.2 The party who invokes an exemption clause bears the burden of proving its applicability.3 

There is a particularly heavy burden on a party seeking to set up a custom or usage which would appear to override the otherwise plain meaning of a contract.4 

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