For decades, Canadian Courts have applied the principle that commercial contracts should be interpreted in a way that avoids business absurdities. An agreement between two sophisticated parties should be interpreted in a “commercially reasonable” manner.

While none of this is controversial, the idea that “good business sense” will help Courts resolve ambiguities in contracts or assist them in determining the true intention of the parties raises more questions than it resolves.

Who determines what is commercially reasonable? Do the subjective intentions of the parties matter? Does the Court need expert evidence to assist it in the interpretation exercise?

Interpreting Contracts to Avoid Commercial Absurdities

The “commercial reasonableness” principle, like most common law doctrines, finds its roots in modern English law.

In the 1974 House of Lords decision, Schuler AG v. Wickman Machine Tools Ltd., [1974] A.C. 235, the Court explained that the interpretation of contracts leading to unreasonable results should be avoided.

The rationale is that sophisticated commercial parties would never agree to a contract that leads to an irrational outcome:

….the more unreasonable the result the more unlikely it is that the parties can have intended it, and if they do intend that the more necessary it is that they shall make that intention abundantly clear…

In Ontario, the leading Court of Appeal decision Ventas Inc. v. Sunrise Senior Living Real Estate Investment Trust, 2007 ONCA 205, affirmed that commercial contracts are to be interpreted in a “in a fashion that accords with sound commercial principles and good business sense, and that avoids a commercial absurdity”.

The word “reasonable” as applied in the commercial context suggests a standard that is “objective and contextual”: BCE Inc. v. 1976 Debentureholders, 2008 SCC 69 and A. Swan, J. Adamksi, and A. Na, Canadian Contract Law. 4th ed. (Toronto: LexisNexis, 2018) at §8.81.

In Kentucky Fried Chicken Canada v. Scotts Food Services Inc., [1998] O.J. No. 4368 (C.A.), the Court held that in determining commercial reasonableness, what matters is not the subjective intention of the parties, but an objective analysis of the result sophisticated commercial parties would prefer:

…[The contract] should be construed in accordance with sound commercial principles and good business sense. Care must be taken, however, to do so objectively rather than from the perspective of one contracting party or the other, since what might make good business sense to one party would not necessarily do so for the other.

To summarize:

  1. Canadian Courts adopt commercially reasonable interpretations of contracts.
  2. The “commercial reasonableness” of any interpretation is assessed objectively.The subjective perception of what the parties consider “commercially reasonable” is irrelevant.
  3. Courts interpret agreements in a way that avoids commercial absurdities and emphasizes “good business sense”.

These principles are easier to state than apply.

They also raise the question of who is the best arbiter of “commercial reasonableness”.

While a Court is more than capable of identifying a commercial absurdity, what happens in cases where the contract is technical and specialized? In such cases, is the Court best-suited to determine what makes “good business sense”?

One can clearly envision scenarios where expert evidence would be required to help the Court assess an objectively reasonable interpretation of a specialized contract.

Accordingly, the doctrine of commercial reasonableness has its limits. Where necessary, experts may be well suited to help the Court determine an objectively sound interpretation of a contract.

Avoiding The Absurd

This is not to imply that Courts should not regularly wade into the waters of commercial reasonableness. Nor are experts are required in every case.

A recent decision of the Ontario Superior Court, Old Navy (Canada) Inc. v. Eglinton Town Centre Inc., 2019 ONSC 3740, illustrates the capacity of the Court to identify and avoid commercially absurd interpretations.

Old Navy involved a shopping centre lease. The lease included a rent reduction provision in its co-tenancy operating requirements (the “Co-Tenancy Requirements”) which provided for a rent abatement to the tenant where one or more “key stores” left the shopping centre or where there was a significant failure of the shopping centre as a whole.

In 2016, one of the stores in the mall declared bankruptcy and ultimately closed its doors. Throughout the period of the store closing, however, the rest of the mall was thriving and the store closing had no apparent effect on the “foot traffic” in the mall.

As a result of the store closing, the tenant argued that the Co-Tenancy Requirements had been triggered and there was a co-tenancy failure under the lease such that the tenant was entitled to a rent reduction. The Landlord disputed that a co-tenancy failure had taken place. The Landlord argued that the Co-Tenancy Requirements were only triggered where there had been a catastrophic situation in terms of store closure or foot traffic.

The Court sided with the Landlord.

In doing so, the Court noted that the tenant’s position involved a technical interpretation of the lease that would lead to commercially absurd results:

…If the language used in s.13.3 of the Lease literally means what [the tenant] says it means, then this leads to a commercially absurd situation where [the tenant] would be entitled to enjoy the use of the leased premises for the duration of the Lease and all extensions, while paying considerably less than its share of the operating costs, let along paying any rent to the Landlord. Plainly, such an interpretation fails to take into consideration the legitimate expectations of the Landlord. It fails the business efficacy test.

A Narrow Doctrine?

While there is no question that Courts have an obligation to give business efficacy to commercial contracts, the situations in which a Court denies the interpretation of a contract that would result in a commercial absurdity are limited.

Old Navy is perhaps a clear example of when Courts can interpret an agreement to avoid an absurdity.

But most cases may not be as self-evident.

And what constitutes an absurdity in one industry or context may not in another. This is where expert evidence may play a role in helping the Court determine what is commercially reasonable.