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Contract interpretation

Contractual interpretation in Canada is an exercise in giving effect to the objective intentions of the parties at the time they entered into the contract. To determine the parties' objective intentions, courts look foremost to the plain meaning of the language expressed in the contract, reading the contract as a whole (while giving meaning to every word that is used) and in the context of the circumstances as they existed when the agreement was created. Canadian courts avoid rigid constructions or findings of ambiguity in favour of treating the words as flexible instruments meant to achieve a particular purpose; that is, they will seek to reconcile disputes by adopting an interpretation that accords with the overall business purpose of the provision or provisions in question.

In Canada, the circumstances that surround the formation of the contract are referred to as the 'factual matrix'. The factual matrix is relevant in every case, even where the contract is unambiguous on its face, and probative to the extent that considering it deepens the analysis by providing context and does not inform an interpretation that contradicts the express language of the contract. As a further limitation, the factual matrix only comprises that which reasonably ought to have been known by the parties at the time of contract formation.

As the interpretive exercise is objective, the subjective intentions of parties are not relevant. Similarly, extrinsic evidence as to the parties' intentions is barred as a general proposition by the 'parol evidence rule', which precludes admission of evidence outside the words of the written contract that would add to, subtract from, vary or contradict a contract that has been wholly reduced to writing. This rule, however, is subject to myriad exceptions. Notably, moreover, the rule does not preclude evidence adduced as part of the factual matrix.

Another relevant principle of interpretation is that Canadian courts will seek to promote commercial efficacy. Interpretations that make 'no commercial sense' or result in a commercial absurdity will be strenuously avoided, while interpretations that 'allow the contract to function and meet the commercial objective in view' will be preferred. Note, however, the following two limits to the doctrine. First, as with the factual matrix, commercial reasonableness is to be assessed objectively, from the perspective of both contracting parties (and not according to one party's subjective intention or desires). Second, the principle of commercial reasonableness will not save a party from a bargain that, although commercially sensible at the time of contract, has proven to be improvident or disadvantageous.

Where commercial reasonableness has conflicted with a plain reading of the words of a contract, courts have taken inconsistent approaches. The correct approach in Ontario appears to be that, in such cases, commercial efficacy will only overwhelm the written words where the words lead to a result that is 'clearly' commercially absurd. In Manitoba, by contrast, the Court of Appeal has ruled that where 'a tension that exists between the literal meaning of a contract and an interpretation based upon its commercial purpose', the latter interpretation may prevail where dictated by 'business common sense'. The Alberta Court of Appeal has phrased the test differently yet again, holding that an interpretation that 'defeats the intention of the parties and their objective in entering into a commercial transaction in the first place should be discarded in favour of the interpretation that promotes a sensible commercial result'.

Further to the assessment of commercial reasonableness, regardless of which of the approaches described in the preceding paragraph is adopted, the objective evidence that is admissible in the interpretive exercise will include accepted business practice in the field. In order to be admissible, the evidence in this regard must be reasonably certain and generally known and accepted by those operating in the relevant field. Similarly relevant is objective evidence regarding the genesis of the transaction, which, together with evidence of trade practices, forms a vital part of the factual matrix as it better permits judges to construe the parties' commercial purpose.

Generally, provisions that prescribe a governing law are effective. Where a contract is silent on the law that governs it, the general rule is that substantive disputes will be governed by the local laws of the jurisdiction where the contract was entered into (referred to as the lex loci contractus). Procedural disputes, by contrast, are governed by the laws of the local adjudicating forum. In this regard, Canadian courts aim to distinguish between those rules that 'make the machinery of the forum court run smoothly' (e.g., a procedural requirement that a limitations defence be pleaded) and those rules that are 'determinative of the rights of both the parties' (e.g., the specific substantive requirements that must be met for a limitations defence to be successful).