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No Contract is an Island


March 31, 2015   by Michael S. Teitelbaum, partner, Hughes Amys LLP|Michael S. Teitelbaum, partner, Hughes Amys LLP


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In August 2014, the Supreme Court of Canada released Sattva Capital Corp. v. Creston Moly Corp. (2014 SCC 53) – a decision hailed as a “blockbuster” addition to its canon of contract interpretation jurisprudence.

Sattva is important for three reasons. It definitively establishes that contract interpretation is a matter of mixed fact and law rather than law alone. It also clarifies that context, otherwise known as the “factual matrix,” is to play a central role in contract interpretation. Lastly, the case is also the source for the Court’s most recent guidance on the principles to apply when interpreting a contract.

While Sattva does not specifically address insurance, the history of interaction between commercial contract and policy interpretation suggest that the Court’s findings will apply to insurance as well.

Background

In Sattva, a contract dispute arose as to the proper date upon which to value outstanding common shares of the defendant, who was obligated to transfer $1.5 million worth of shares as a finder’s fee to the plaintiff. The difference in value between the proposed dates was approximately $9 million.

Initially, the dispute went to arbitration. The arbitrator sided with the plaintiff and awarded shares based on the lower valuation. The defendant appealed, stating that the arbitrator failed to address a key provision of the project. The B.C. Supreme Court denied leave to appeal on a jurisdictional basis.

The Court of Appeal overturned this ruling on jurisdiction, stating that a potential failure to properly interpret an agreement is a question of law. Now finding itself with the jurisdiction to hear the appeal, the B.C. Supreme Court ultimately sided with the arbitrator.

The appeal made its way to the Supreme Court, which had to determine the essence of contract interpretation – is it a matter of law, or a matter of mixed fact and law? And if the interpretation is reviewable, how exactly is proper interpretation to be performed?

A Matter of Mixed Fact and Law

The foremost issue resolved in Sattva is the classification of contract interpretation. The Supreme Court states, unequivocally, that contract interpretation is a matter of mixed fact and law. Therefore, it is subject to a spectrum of judicial review with “correctness” at one end and “palpable and overriding error” at the other.

The Court began its analysis with an overview of prior decisions demonstrating the “historical approach” to contract interpretation. Under this approach, interpretation was viewed as a matter of law that would be reviewable on a standard of “correctness.” The Court proceeds to declare that this approach “should be abandoned” and recognizes that contract interpretation is more properly understood as a question of mixed fact and law:

The Court states that the modern approach to contract interpretation is “practical [and] common-sense” focussed and “not dominated by technical rules of construction.” The overriding concern is to determine the intent of the parties and the scope of their understanding.

Guidance on Contract Interpretation

The Court proceeds to elaborate on the approach to take in contract interpretation, and summarizes the principles as follows: “[A] decision-maker must read the contract as a whole, giving the words used their ordinary and grammatical meaning, consistent with the surrounding circumstances known to the parties at the time of formation of the contract.”

This quotation suggests that one should not parse a sentence using the dictionary-definition of words if this would undermine the intention that can be gleaned from the contract’s surrounding circumstances – alternatively known as the “factual matrix.” Put another way, contract wording is not to be interpreted in splendid isolation as if the reader is on a deserted island.

Surrounding Circumstances

Although words should be viewed in their context, they cannot be ignored entirely. The Supreme Court says the fundamental purpose of considering surrounding circumstances is to understand the mutual and objective intentions of the parties as expressed in the words of the contract.

Therefore, while surrounding circumstances can be considered when interpreting a contract, they must not overwhelm the words of that agreement. Interpretation must be grounded in the text and read in light of the entire contract. A court must not deviate from the text such that it has effectively created a new agreement.

The Court says that what constitutes evidence of surrounding circumstances will “necessarily vary from case to case.” These guidelines were explained as thus: “[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 both parties at or before the date of contracting.”

Parol Evidence

The parol evidence rule prevents a party to a written contract from presenting extrinsic evidence that discloses an ambiguity and clarifies it or adds to the written terms of the contract that appears to be whole. The Supreme Court clarified the relationship between parol evidence and surrounding circumstances in Sattva:

“The parol evidence rule does not apply to preclude evidence of the surrounding circumstances. The surrounding circumstances are facts known or facts that reasonably ought to have been known to both parties at or before the date of contracting; therefore, the concern of unreliability does not arise.”

With this statement, the Court appears to be distancing itself from the parol evidence rule with a view to ensuring the factual matrix cannot be considered extrinsic evidence. While the court notes that the rule might be an “anachronism,” it declines to do away with it completely. This has some significance to policy interpretation.

Applying Sattva to Insurance

Sattva might initially appear to be more recognition of the status quo as it applies to contract interpretation rather than any groundbreaking new statement of the law.

Courts in Ontario have a history of interpreting policy language to determine the parties’ reasonable expectations and achieve a commercially sensible result. For example, this is done even where the language is clear and unambiguous. This may occur where an exclusion clause is contrary to the “reasonable expectations” of an insured when they entered into the contract – an approach found in 2002’s Zurich Insurance Co. v. 686234 Ontario Ltd. (62 OR (3d) 447).

And, very recently, the Ontario Court of Appeal in two decisions, Dunn v. Chubb Insurance Co. of Canada (2009 ONCA 538,) and Coventree Inc. v. Lloyds Syndicate 1221 (2012 ONCA 341), formulated an approach to policy interpretation that, in our view, foreshadowed Sattva. It held that the factual matrix of the parties’ dealings must be considered when interpreting a policy, while also maintaining the rule that extrinsic or parol evidence cannot be considered in that same endeavour.

The Court of Appeal indicated that the latter can only be considered if the policy language is ambiguous, defined in Dunn v. Chubb as meaning “reasonably susceptible of more than one meaning.” At that juncture, the courts will receive such evidence.

Conclusion

It remains to be seen whether Sattva will have any significant impact on insurance policy interpretation. The case has already been applied or referenced in at least 35 decisions, but only one involving insurance policy interpretation.

Ultimately, whether Sattva serves as a sword or shield will be left to counsel. But it now appears clear that the “correct” interpretation result will belong to those who are best able to marshal t
he “surrounding circumstances” in their favour.

Michael S. Teitelbaum is a partner with Hughes Amys LLP. Hughes Amys is a member firm of The Arc Group of Canada, a network of independent law firms across Canada.


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