What evidence can courts consider when interpreting a contract?

Courts generally aren’t allowed to consider pre-contractual negotiations when interpreting a contract – but that may need to be reconsidered, according to a decision from the Supreme Court of Canada (SCC).

The SCC clarified the framework for interpreting releases in Corner Brook (City) v. Bailey. Courts have commented on the implications of the decision in that respect many times.[1] However, the Supreme Court also identified another important issue – the proper role of pre-contract negotiations within the framework for contractual interpretation set out in Sattva Capital Corp. v. Creston Moly Corp., 2014 SCC 53. While not deciding the issue, the Court indicated that the general rule prohibiting the admissibility of evidence of negotiations for such purposes may need to be reconsidered.

The SCC did not discuss any of the current exceptions to that general rule or give any direct indication of how it might be relaxed or revised. The guidelines set out in Sattva and applied in Corner Brook provide some insight as to potential changes to the general rule. The extent to which evidence of negotiations might be admissible appears dependent on whether the evidence is objective and if it fits within the established factual matrix/surrounding circumstances framework.

The facts in Corner Brook provide context for the Court’s obiter

Mrs. Bailey struck a City employee with her husband’s car resulting in the City employee bringing an action against Mrs. Bailey. She and her husband separately sued the City for property damage and personal injuries. That action settled and they signed a release drafted by City solicitors. The release included “all actions, suits, causes of action . . . foreseen or unforeseen . . . and claims of any kind or nature whatsoever arising out of or relating to the accident…”

Years later, in the action the City employee commenced, Mrs. Bailey brought a third-party claim for contribution and indemnity against the City. The City moved to summarily dismiss on the basis that the release precluded the third-party claim. The application judge agreed and found that the broad wording of the release precluded the third-party claim against the City. Both levels of Court considered the negotiations between Mrs. Bailey and the City leading up to the settlement and release of her action. Both came to different conclusions concerning the impact of such negotiations. The trial judge found they were not determinative to the proper interpretation of the release.

Application of Sattva

Justice Rowe on behalf of the SCC concluded that the motions judge properly considered the surrounding circumstances of the release pursuant to the principles delineated in Sattva. The findings of fact made by the motions judge deserved deference. Those findings mostly related to what was common knowledge of the parties. The Court then accepted, against this factual backdrop, that the broadly worded nature of the release was intended to capture any claim related to the car accident in question, not just any claim raised in the settled action.

As noted, the application judge looked at evidence of the contract negotiations but did not consider the negotiations to be determinative. Justice Rowe noted that reviewing pre-contractual negotiations conflicted with the longstanding rule that evidence of negotiations is inadmissible for the purposes of contractual interpretation. However, since it did not affect the outcome in the circumstances of this particular case, Justice Rowe left the issue to another day “where it has been fully argued and is necessary in order to decide the appeal.” But in doing so, he also noted that the longstanding rule “sits uneasily” next to Sattva, which directs courts to consider the surrounding circumstances in interpreting a contract.

Negotiations and the Factual Matrix/Surrounding Circumstances

On the basis of current law, the Court is generally constrained from considering negotiations, changing positions and/or prior drafts of the agreement.[2] The bedrock interpretative principles set out in Sattva at paragraphs 57 and 60 also indicate that courts should exercise some caution when wading into negotiations for the purpose of contractual interpretation:

  • The interpretation of a written contractual provision is to remain grounded in the text and read in light of the entire contract.
  • the surrounding circumstances must never be allowed to overwhelm the words of that agreement or cause a deviation from the text of the contract. They are used as an interpretive aid for determining the meaning of the written words chosen by the parties, not to change or overrule the meaning of those words.
  • The goal of examining the surrounding circumstances is to deepen a decision-maker’s understanding of the mutual and objective intentions of the parties as expressed in the words of the contract.

In Corner Brook Justice Rowe also stressed that subjective knowledge is irrelevant under an objective theory of contract law.[3] The factual matrix therefore excludes subjective intentions, views, understandings, beliefs or opinions before or after the execution of the contract.[4] Evidence of negotiations could easily spill over into such subjective areas. Questions concerning negotiating positions that pry into legal advice are also offside.[5]

Historically, the Courts have also held that evidence of negotiations “is unhelpful. By the nature of things, where negotiations are difficult, the parties’ positions, with each passing letter, are changing and until the final agreement, although converging, still divergent. It is only the final document which records a consensus.”[6]

On the other hand, Geoff Hall contends that such evidence can be helpful if it is relied on for objective contextual purposes other than showing the subjective intentions of the parties. He writes that contractual interpretation is fundamentally about finding the correct meaning by considering both the words the parties agreed upon and the context in which the words were used. Therefore, prior drafts and evidence of negotiation could be helpful in setting that context for a final agreement as long as such evidence does not touch upon subjective intention.[7]

The type of judicially accepted surrounding circumstances that assist with contractual interpretation reflect the objective theory of contractual interpretation. They are typically limited to the commercial purpose of the contract, the genesis of the transaction, background objective facts leading up to the contract and the market in which the parties to the contract were operating within.

Despite the general rule against admissibility of negotiations, there are several examples where courts have found some portion or aspect of the negotiating history to be helpful in providing contextual evidence for interpretative purposes, consistent with Hall’s contention. On the one hand, this has occurred at a general level. For example, the fact that no negotiations took place (i.e. a standard form contract) is relevant in interpreting a contract. On the other hand, the fact that sophisticated parties, relying on professional or legal advisers, engaged in negotiations is also relevant to contractual interpretation.[8] However, the point of relevance is not dependent on examining the minutia of the negotiations. It is simply the fact that negotiations took place within this context that plays some role in interpreting a contract.

In Corner Brook the SCC also emphasized that facts in the common knowledge of both parties, or which should have been, form part of the surrounding circumstances. It is conceivable that historical negotiations might shed light on what was in the common knowledge of the parties. If such common knowledge is material to an interpretative issue, arguably such evidence could be helpful from an interpretative standpoint.[9]

Other courts have engaged in similar reasoning. The Alberta Court of Appeal in IFP Technologies (Canada) Inc. v EnCana Midstream and Marketing, 2017 ABCA 157 concluded that evidence of negotiations can be relevant; “It is true that evidence of negotiations is not itself admissible as part of the factual matrix…Nor generally are prior drafts of an agreement…However, evidence of negotiations is relevant insofar as that evidence shows the factual matrix, for example by helping to explain the genesis and aim of the contract…Moreover, written evidence of those negotiations is far more objective evidence of the parties’ intentions than after-the-fact evidence…”[10]

While targeted evidence from the negotiations could theoretically assist in this respect, courts should not require the entire scope of negotiation for such a singular point. Materiality and proportionality issues therefore might arise when attempting to introduce evidence of negotiations for a relatively narrow point. The IFP approach appears to presume that negotiations are irrelevant but relevancy can be demonstrated if a linkage is made to the accepted categories of surrounding circumstances.

The Alberta Court of Appeal more recently explained IFP as standing for the principle that “evidence of the surrounding circumstances and evidence of the parties’ pre-contract negotiations may overlap in some instances. However, even if there is an overlap, evidence of the parties subjective intentions always remains inadmissible.”[11]

Notably, the Court went on to reject interpreting Sattva as defining surrounding circumstances so broadly as to include all pre-contract negotiations, so long as evidence of subjective intentions is excluded. The rejection was due, in part, to some members of the Supreme Court identifying this as an outstanding issue even prior to Corner Brook.[12] The Alberta Court also expressed practical concerns with an expansive approach to admissibility; “Not only are courts concerned with such evidence ‘overwhelming’ the written words in a contract, but we are also concerned about overwhelming the hearing process with irrelevant extrinsic evidence.” Generally speaking, the Supreme Court’s direction in Hyrniak v Mauldin 2014 SCC 7 to facilitate the take up of streamlined and efficient dispute resolution is also inconsistent with dramatically expanding the volume of evidence required to determine contractual disputes.

Again, the scope of negotiating evidence adduced for targeted purposes could be filtered through the lens of materiality and proportionality to act as a guardrail against descending into the minutia of all negotiations. On a practical basis, the precise delineations may not be clear and the wheat may need to be separated from the chaff after allowing in more negotiating evidence than necessary. What is clear though is that the Supreme Court will provide further direction when the time is right.

Note: This article is of a general nature only and is not exhaustive of all possible legal rights or remedies. In addition, laws may change over time and should be interpreted only in the context of particular circumstances such that these materials are not intended to be relied upon or taken as legal advice or opinion. Readers should consult a legal professional for specific advice in any particular situation.