The Top Court Spoke in Earthco: Context is Key in Contract Interpretation
Anna Wong
As contracts form the backbone of economic transactions, construing the meaning of contracts is bread-and-butter work for many solicitors, barristers, judges and arbitrators. Just because the task is routine does not mean that it is straightforward. Indeed, contract interpretation has been described as “the most important source of commercial litigation” 1 and “one of the most contentious areas of the law of contract.”2
What makes interpretation such an intractable affair is that jurists and academics are divided over the optimal method for construing agreements—in particular, what evidence is permissible to aid in the exercise. On one side of the divide are the textualists who believe that written contracts can and ought to be interpreted by honing in on the language of the document. Unless the contract is ambiguous, there is no need for a court to consider extrinsic evidence bearing on the parties’ relationship and the circumstances surrounding the contract. The parol evidence rule, which in its strict formulation instructs that evidence from beyond the four corners of the written contract is inadmissible to contradict, vary, add to or subtract from its terms 3, is a good example of textualism in action.
On the other side of the divide are the contextualists who believe in reading contractual terms in context. In ascertaining the intention of the parties, they argue, both the contract’s text and contextual evidence are relevant. That is because the written word is not an infallible guide to the parties’ true intent. Courts should not be deprived of information such as surrounding commercial circumstances, usages of trade, and preliminary negotiations that could elucidate what the parties actually intended the words they used to mean. When such evidence is categorically excluded, what we end up with is not an acontextual interpretation, for there is no such thing, but an interpretation that is informed by the background and experience of the judge rather than that of the parties to the transaction. 4 Contextualists would prefer a ‘softened’ version of the parol evidence rule with generous carveouts.
The latest contribution to the prevailing debate over text and context comes from the Supreme Court of Canada in the case of Earthco Soil Mixtures Inc. v. Pine Valley Enterprises Inc. 5 The decision is significant in more than one respect, not least for its dictum on the law governing the sale of goods. For our purposes, what is significant about Earthco is that the Court endorsed an interpretative methodology that sits closer to the contextualist end of the continuum, if not squarely within the contextualist camp.
Underlying Dispute in Earthco
Pine Valley (B for Buyer) entered into a contract with Earthco (S for Seller) to buy topsoil with a specified composition for drainage use to remediate flooding. Their contract included two exclusion clauses negotiated by the parties—without counsel—stating that B “has the right to test and approve the material at its own expenses…before it is shipped” and that if B waived its right, S “would not be responsible for the quality of the material once it leaves [S’s] facility.”S provided B with the lab reports of tests done on samples six weeks earlier, but warned B against not doing updated tests to confirm the soil composition. However, because B was in a rush to get the topsoil, it waived its right to test. After the topsoil was delivered, it was discovered that its compositional properties were different than the test results had indicated. B then sued S for damages, alleging that it didn’t get the topsoil it had bargained for.
The dispute hinged on whether the exclusion clauses constitute an “express agreement” to contract out of the implied condition under s. 14 of Ontario’s Sale of Goods Act that goods sold by description must correspond with their description. How are the exclusion clauses to be interpreted? What can the court take into account in construing those clauses?
Use of Extrinsic Evidence in the Interpretative Process
Justice Martin, writing for a 6-1 majority, confirmed that the contextualist approach to interpretation reigns supreme.Her analysis began by giving nod to the fact that it wasn’t always so. 6 It used to be that agreements were interpreted by applying “technical rules of construction”, giving the words used their ordinary, grammatical meaning.7 Over time, the old textualist regime gave way to a more flexible, practical, common-sense approach. Justice Martin explained the rationale for the shift:
While the language used is central, courts recognize that words are not ends in themselves: they are a means to demonstrate, discern and determine the true intention of the parties. The jurisprudence seeks certainty but acknowledges the limits of language. This Court recognized how “words alone do not have an immutable or absolute meaning” and cannot, by themselves, convey the commercial purpose of a contract ( Sattva, at para. 47). When seeking the meaning of a document, the focus of the court is properly on what the parties objectively intended and what they reasonably understood their words to mean. This is because the “meaning of words is a matter of dictionaries and grammars; the meaning of the document is what the parties using those words against the relevant background would reasonably have been understood to mean” [citations omitted].8
Even if a contract seems clear on its face, it is possible that parties meant for the text of their contract to have a different meaning than what is ‘plain’. The parties’ understanding, then, can only be determined by considering all the circumstances that reveal the particular meaning they attributed to the words used. Accordingly, Justice Martin instructs:
Courts are therefore directed “to have regard for the surrounding circumstances of the contract — often referred to as the factual matrix — when interpreting a written contract” ( Sattva, at para. 46). The meaning of the words of a contract can be derived from reference to various contextual factors, which include the purpose of the agreement and the nature of the relationship created by the agreement (para. 48). Sattva allows courts to interpret contractual terms in light of the contract as a whole and with reference to objective evidence that illustrates what was within the parties’ knowledge at or before the time of their contract’s formation (para. 58). Ultimately, ascertaining the objective intent of the parties involves not only a consideration of the actual words used in a contract but also a consideration of the factual matrix surrounding the contract.9
Applying this approach, Justice Martin found that the parties had turned their minds to the allocation of risk in inserting the exclusion clauses into their contract, and expressly tried to restrict S’s liability with those clauses. 10That language with distinct legal meanings was not used is of no moment given that they had negotiated the terms without legal assistance. Contracting parties in their situation are not expected to “know all about the legally significant differences between conditions and warranties, and between identity and quality.”11A key surrounding circumstances is that B was a rush to receive the soil. Because of this, it was prepared to assume the risk of taking delivery without performing soil tests—a risk whose realization it chose to bear when it entered into the contract.
Takeaway
The methodology used to resolve interpretative disputes has evolved greatly over the years. Textualist interpretation dominated back in the days when courts insisted on fidelity to the text used by the parties on the presumption that they chose their words with care and intention. Unless the language is reasonably amenable to both parties’ asserted meanings, no interpretative aids are required. Justice Iacobucci put it crisply in Eli Lilly & Co. v. Novopharm Ltd: “it is unnecessary to consider any extrinsic evidence at all when the document is clear and unambiguous on its face.”13
This is no longer the case. With Earthco, there is no question that courts should take into account evidence of the contextual scene in ascertaining the meaning of contractual terms that the parties had in mind.They will likely have to assess—meaning parties are expected to adduce—substantially more materials about the genesis of the transaction and the relevant background (e.g., the parties’ negotiations, past practices and trade customs) than judges in textualist jurisdictions who are confined to the text when determining whether an agreement is ambiguous.
Each interpretative approach comes with its advantages and disadvantages. Under a contextualist regime, litigation over contract interpretation could become more complicated, culminating in a trial with more witnesses and a trove of background evidence. On the plus side, a contextualist approach could result in greater interpretative accuracy particularly in cases involving legally unsophisticated commercial parties or parties operating in esoteric settings where words given their plain meaning may not illuminate the parties’ actual understanding.
1 Ronald J. Gilson, Charles F. Sabel and Robert E. Scott, “Text and Context: Contract Interpretation as Contract Design” (2014) 100:23 Cornell L Rev 23 at 25. See also Omri Ben-Shahar, “A Bargaining Power Theory of Default Rule” (2009) 109 Colum L Rev 396 at 396; Benjamin E. Hermalin, Avery Katz and Richard Craswell, “Contract Law” in A. Mitchell Polinsky & Steven Shavell, eds, Handbook of Law and Economics, Volume 3 (Amsterdam: Elsevier, 2007) 1 at 68.
2 David Mclauchlan, "Contract Interpretation: What Is It About?" (2009) 31:1 Syd L Rev 1 at 1.
3 Indian Molybdenum Ltd. v. The King, [1951] 3 D.L.R. 497 (SCC) at 502-503; Hawrish v. Bank of Montreal, [1969] S.C.R. 515; Leitch Gold Mines Ltd. v. Texas Gulf Sulphur Co., [1969] 1 O.R. 469 (HC) at para 238.
4 This is an argument famously made by Arthur L Corbin, “The Interpretation of Words and the Parol Evidence Rule” (1965) 50 Cornell L Q 161 at 164.
5 2024 SCC 20 [Earthco].
6 Ibid at paras 61-62.
7 Ibid at para 61.
8 Ibid at para 64. See also Ibid at para 96.
9 Ibid at para 65.
10 Ibid at paras 102-112.
11 Ibid at paras 85-86.
12 Lampson v. City of Quebec (1920), 54 D.L.R. 344 (Eng. P.C.) at 350.
13 Eli Lilly & Co. v. Novopharm Ltd., [1998] 2 S.C.R. 129 at para 55.