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A Sea Change in the Interpretation of Contracts (and much more)

5 minute read

On August 1, 2014, the Supreme Court of Canada handed down a unanimous decision (Sattva Capital Corporation v. Creston Moly Corporation et al, 2014 SCC 53) that amounts to a sea change in the interpretation of contracts in Canada, including with respect to surrounding circumstances, the parol evidence rule, appellate review and much more.

It has long been understood in Canada that not only are the words of a contract considered as a whole relevant to glean its meaning, but also the objective surrounding circumstances, or factual matrix, known to both parties at the time of entering into the contract are also relevant. Parol evidence, that is the subjective evidence of the intention of the parties and negotiations leading up to the entering into of the contract, was not admissible except to assist in the resolution of an ambiguity, if one was found to exist.

In Sattva, per Rothstein, J. for a unanimous court, the Supreme Court of Canada has clarified the interaction between what may be considered to be surrounding circumstances and the parol evidence rule. Surrounding circumstances “should consist only of objective evidence of the background facts at the time of the execution of the contract … that is, knowledge that was or reasonably ought to have been within the knowledge of the parties at or before the date of contracting”; subject to this, it can include “absolutely anything which would have affected the way in which the language of the document would have been understood by a reasonable man”.

Evidence of surrounding circumstances can be considered in interpreting the contract “but they must never be allowed to overwhelm the words of that agreement”, or “change or overrule the meaning” of the written words chosen by the parties.

The determination of what are properly surrounding circumstances is a question of fact.

Rothstein, J. held that “the parol evidence rule does not apply to preclude evidence of surrounding circumstances”, so long as the parol evidence sought to be tendered otherwise meets the test for surrounding circumstances. This is new.

What remains to be seen is the scope of this restatement of the interaction between surrounding circumstances and the parol evidence rule. Will it permit the admissibility of evidence of the negotiations between the parties leading up to the entering into of the contract, to the extent that these negotiations are in the knowledge of both parties, as, for instance, would be the case in the exchange of drafts of the agreement, if such evidence would have “affected the way in which the language of the document would have been understood by a reasonable man”?

The Court went on to change the standard of review in appeals involving the interpretation of a contract. It has long been well understood that a decision of a court on the interpretation of a contract involved a question of law, and thus was not entitled to deference on appeal.

No longer. In Sattva, Rothstein, J. held that the “historical rationale” no longer applies in Canada and should be abandoned. Contractual interpretation will be now be treated as an exercise in deciding a question of mixed fact and law and subject to the principle defined in Housen (Housen v. Nikolaisen, 2002 SCC 32), except in those rare cases where there can be said to be an “extricable question of law” from what was initially characterized as a mixed question of fact and law, such as the application of an incorrect principle, a legal test or a relevant factor, or the appeal otherwise engages various substantive rules of the law of contract. He said that where the “legal principle is not readily extricable” then the matter will be considered to be one of “mixed law and fact” in which “the principles of contractual interpretation are applied to the words of the written contract, considered in the light of the factual matrix”.

This new doctrine will now apply to all appeals from the interpretation of a contract and will preclude appeals in cases (such as some arbitration statutes) where appeals are only permitted on a question of law.

Later in the reasons, in considering the standard of review in the case of commercial arbitration awards where appeals are restricted to a question of law, Rothstein, J. held that the standard of review will now be reasonableness, and the Dunsmuir (Dunsmuir v. New Brunswick, 2008 SCC 9) analysis will apply “unless the question is one that would attract the correctness standard, such as constitutional questions or questions of law of central importance to the legal system as a whole and outside the adjudicator's expertise”.

In other sections of this important case, Rothstein, J. clarified what will and will not amount to a miscarriage of justice, where such a requirement is condition of granting leave. He said “an applicant must demonstrate that the point of law on appeal is material to the final result and has arguable merit”, which requires a preliminary assessment of the standard of review.

More generally, he went on to clarify that a court hearing an appeal in which leave is granted is not bound by the decision of the court which granted leave, even if the leave granting was endorsed by a Court of Appeal. He observed that to hold otherwise “would render an appeal futile”.

Rothstein, J. also held that the Court would hear and decide issues even if they were not included in a successful leave application, subject to a discretion “if the Court considers it appropriate not to do so”.

While nominally Sattva involved the appeal of a commercial arbitration award, the case has much wider implications and application. It is required reading for all commercial litigators and arbitrators, and all appellate counsel.

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Earl A. Cherniak, LLD, Q.C., FCI.Arb

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