Appealing Interpretations of Your Business Contract: What You Need to Know

Appellate courts will reluctantly intervene in a previous judicial interpretation of a commercial agreement.

This is because lower courts are best positioned to wade through the evidence of what the parties intended when drafting their contract.

Since the Supreme Court of Canada’s 2014 decision, Sattva v. Creston Moly Corp., 2014 SCC 53, an appeal Court will show deference to the lower court’s contractual interpretation, unless a party can show an error engaging an “extricable question of law”.

A recent decision of the Supreme Court of Canada, Earthco Soil Mixtures Inc. v.  Pine Valley Enterprises Inc., 2024 SCC 20, reiterates a number of key themes about how appeal courts approach business contracts:

1. Appellate courts will not readily identify “questions of law” in analyzing the lower courts’ contractual interpretation exercise.   Where questions of law are raised, however, appellate intervention is justified and little deference need be shown to the lower court’s ruling; and
   
2. When interpreting a business agreement, the metric for understanding the meaning of the words used in an agreement and the parties’ objective intentions is the “factual matrix” or evidence of surrounding circumstances when the contract was reached.

Contracts Are a Dirty Business

Earthco involved an agreement for the sale of topsoil for a municipal remedial project in Toronto (the “Project”). The buyer of the soil was retained by the municipality to complete the Project.  

The buyer entered into a contract with the seller, a topsoil provider, to purchase 3,678 cubic yards of topsoil (the “Contract”).

Because topsoil is an organic substance and its physical properties can change with time, the contract provided that the buyer had the right to test and approve the topsoil at its own expense before the soil was shipped.  

The Contract included an exclusion clause which provided that if the buyer waived “its right to test and approve the material before it [was] shipped, [the seller would] not be responsible for the quality of the material once it leaves [the seller’s] facility” (the “Exclusion Clause”).

Under section 53 of Ontario’s Sale of Goods Act, R.S.O. 1990, c.S.1 (the “Act”), parties have the right to exclude any statutory condition requiring that goods delivered, such as topsoil, meet certain compositional requirements. Though the Act imposes certain implied conditions about the state or condition of goods delivered, the parties have the right to contract out of these warranties.

The buyer chose to waive its right to test and approve the topsoil before it was shipped.

After the soil had been delivered to the Project site, the parties noticed water ponding and concluded that the topsoil had a high degree of clay in it. The city demanded that the buyer replace the topsoil, which it did.  

The buyer replaced the soil and sought damages of approximately $700,000 against the seller for breach of contract.

The main issue at trial was whether the Exclusion Clause could exclude the seller’s liability for the conditions and identity of the soil as warranted under the Act.

The trial judge dismissed the buyer’s action. The Court held that the buyer was in a rush to receive the topsoil and clearly waived the right to test it. The Exclusion Clause in the Contract was meant to apply to the exact situation that transpired:  the buyer failed to test the soil and the seller could therefore not be held liable for such waiver by the buyer. The Exclusion Clause acted to oust the any implied terms regarding the condition of the soil under the Act.

The Court of Appeal reversed. It held that a number of “questions of law” were raised by the trial judge’s contractual interpretation analysis. Accordingly, no deference was owed to the trial judge’s decision and the standard of review was therefore “correctness”. The Exclusion Clause did not use clear, explicit and direct language to oust the statutory implied condition under the Act;  moreover, the trial judge erred by reading the Exclusion Clause broadly by giving too much weight to the “factual matrix” at the time of contract formation.

On further appeal to the Supreme Court of Canada, the majority of the Court restored the trial judge’s ruling.  

In so doing, the Court emphasized two key principles about how appeal Courts must approach the contractual interpretation exercise:

1. Appeal Courts Will Rarely Intervene in a Lower Court’s Contractual Interpretation.

When analyzing whether a lower court’s analysis of an agreement is subject to examination on appeal, the appeal Court must decide the “standard of review”, i.e., the lens through which it will view the previous court’s decision.

The court can either show significant deference to the lower court, applying the “palpable and overriding error” standard for questions of fact. The less deferential standard of review, known as “correctness” applies to questions of law. Questions of mixed fact and law lie along a spectrum, though if the court can identify an “extricable question of law”, then the decision will be reviewed on the more exacting standard of correctness: Housen v. Nikolaisen, 2002 SCC 33.

In Sattva, the Court established that questions of contractual interpretation engage issues of mixed fact and law, i.e., the application of legal standards to a set of facts. As such, they are usually afforded deference on appellate review. However, there is an exception to the deferential standard for “extricable questions of law”, as set out above, in which case the less deferential standard of review applies.

Earthco cautions courts from too easily identifying pure questions of law so as to justify appellate intervention.  

In Earthco, the contract at issue was, in the Court’s view, one of “utter particularity”, given that the Exclusion Clause was drafted by the seller “in response to the buyer’s particular demand for speedy delivery of goods without additional testing…”.   

Given the unique nature of the contract issue, there were “no errors [by the trial judge] on extricable questions of law”.  This was the case even though the Exclusion Clause arguably implicated questions of statutory interpretation under the Act, which usually involve pure questions of law:

…the interpretive approach must be flexible enough to account for the parties’ varying commercial circumstances and it follows that the appropriate standard of review must be that of palpable and overriding error, even where the analysis necessarily implicates s.53 [of the Act] and implied statutory conditions…

2. “Factual Matrix” Is Key to Determining the Meaning of a Business Agreement.

Citing Sattva, the Court in Earthco reiterated that the “paramount goal” of contractual interpretation is to determine the parties’ objective intentions.

Thus, the meaning of the words used, while important, are to be read in light of the surrounding circumstances, or “factual matrix” at the time of the agreement’s inception.

The Court noted that commercial contracts can be understood only by reference of the evidence of what the parties intended. While words are important, their meaning arises out of the context in which the contract was formed:

While the language used [in an agreement] is central, courts recognize that words are not ends in themselves…words alone do not have an immutable or absolute meaning, and cannot, by themselves, convey the commercial purpose of the contract…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…

Applying these principles to Earthco, the majority rejected the buyer’s argument that clear, explicit and direct language was required before the Exclusion Clause could exclude the seller’s liability for the “conditions” or “identity” of the soil under the Act.   

Looking at the factual matrix, it was clear that the parties inserted two clauses to say that if the buyer waived its right to test and approve the topsoil, the seller would not be responsible for its quality.

In the “commercial context of the agreement”, there was no unfairness in refusing to find the seller liable for what the trial judge characterized as the buyers “expensive but calculated mistake”.

The purpose of the Exclusion Clause was to “avoid the exact situation in which a customer failed to test the product and then attempted to hold the supplier responsible for a loss”.

Meaning of Commercial Agreements Depends on Context

Earthco illustrates that Canadian appeal courts will ordinarily approach the question of contractual interpretation as one that engages facts and context.

In discerning the meaning of words in a commercial contract, the “factual matrix” remains the most important means of ascertaining the parties’ objective intentions.

For this reason, even where an agreement’s meaning engages obvious legal questions (such as implied statutory conditions in Earthco), the contractual interpretation analysis remains, at its core, a factual one.

Appellate courts will therefore show significant deference to the trial judge’s analysis of the context surrounding the agreement – after all, the original trier-of-fact is in the best position to weigh the evidence of the meaning of the words chosen by the parties.

Marco P. Falco is a Partner in the Litigation Department at Torkin Manes LLP who focuses on appellate litigation and judicial review.  You may email Marco with your questions at mfalco@torkin.com.  Please note that a conflict search will need to be conducted before any matter can be discussed.