How Is a Contract Interpreted?

The Interpretation of Contracts Involves More Than Just a Technical Review of Words Written Within a Document. Typically, Interpretation Requires An Understanding of the Contract Purpose and Context In Which the Contract Was Formed.

Understanding That Interpretation of Contracts Involves a Contextual Approach Rather Than Just Reviewing the Words

Contract Document Much more goes into the review and interpretation of a contract than just applying the precise formal meaning of the words used within the contract.  Indeed, the surrounding context of the contractual relationship including the purpose of the transaction will be considered, and used, by the court that is hearing a contract dispute.

The Law

The rules for contract interpretation were well expressed within the case of Tire Discounter Group Inc. v. MacGibbon, 2021 ONSC 5199, while citing the Supreme Court case of Sattva Capital v. Creston Moly[2014] 2 S.C.R. 633, among others, wherein it was said:

[37]  Both parties rely on the law as set out by the Supreme Court of Canada in the leading case of Sattva Capital v. Creston Moly 2014 SCC 53 (CanLII), [2014] 2 S.C.R. 633.  At paragraphs 47-48 the Court states:

…the interpretation of contracts has evolved towards a practical, common-sense approach not dominated by technical rules of construction. The overriding concern is to determine “the intent of the parties and the scope of their understanding” (Jesuit Fathers of Upper Canada v. Guardian Insurance Co. of Canada, 2006 SCC 21, [2006] 1 S.C.R. 744, at para. 27, per LeBel J.; see also Tercon Contractors Ltd. v. British Columbia (Transportation and Highways), 2010 SCC 4, [2010] 1 S.C.R. 69, at paras. 64-65, per Cromwell J.). To do so, 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. Consideration of the surrounding circumstances recognizes that ascertaining contractual intention can be difficult when looking at words on their own, because words alone do not have an immutable or absolute meaning: No contracts are made in a vacuum: there is always a setting in which they have to be placed. . . . In a commercial contract it is certainly right that the court should know the commercial purpose of the contract and this in turn presupposes knowledge of the genesis of the transaction, the background, the context, the market in which the parties are operating. (Reardon Smith Line, at p. 574, per Lord Wilberforce)

The meaning of words is often derived from a number of contextual factors, including the purpose of the agreement and the nature of the relationship created by the agreement (see Moore Realty Inc. v. Manitoba Motor League, 2003 MBCA 71, 173 Man. R. (2d) 300, at para. 15, per Hamilton J.A.; see also Hall, at p. 22; and McCamus, at pp. 749-50). As stated by Lord Hoffmann in Investors Compensation Scheme Ltd. v. West Bromwich Building Society, [1998] 1 All E.R. 98 (H.L.):

The meaning which a document (or any other utterance) would convey to a reasonable man is not the same thing as the meaning of its words. 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. [p. 115]

[38]  Further, at paragraphs 57-58:

While the surrounding circumstances will be considered in interpreting the terms of a contract, they must never be allowed to overwhelm the words of that agreement (Hayes Forest Services, at para. 14; and Hall, at p. 30). The goal of examining such evidence 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. The interpretation of a written contractual provision must always be grounded in the text and read in light of the entire contract (Hall, at pp. 15 and 30-32). While the surrounding circumstances are relied upon in the interpretive process, courts cannot use them to deviate from the text such that the court effectively creates a new agreement (Glaswegian Enterprises Inc. v. B.C. Tel Mobility Cellular Inc. (1997), 1997 CanLII 4085 (BC CA), 101 B.C.A.C. 62).

The nature of the evidence that can be relied upon under the rubric of “surrounding circumstances” will necessarily vary from case to case. It does, however, have its limits. It should consist only of objective evidence of the background facts at the time of the execution of the contract (King, at paras. 66 and 70), that is, knowledge that was or reasonably ought to have been within the knowledge of both parties at or before the date of contracting. Subject to these requirements and the parol evidence rule discussed below, this includes, in the words of Lord Hoffmann, “absolutely anything which would have affected the way in which the language of the document would have been understood by a reasonable man” (Investors Compensation Scheme, at p. 114). Whether something was or reasonably ought to have been within the common knowledge of the parties at the time of execution of the contract is a question of fact.

Parol Evidence Rules

At first glance, it may seem that the concept of looking outside the written contract, for context that would assist in interpreting the contract, violates the parol evidence rules of contract interpretation; however, it is necessary to review the decision in Tire Discounter, while relying on the jurisprudence expressed in Sattva Capital, and to appreciate that looking outside the written contract for objective context differs from attempting to use evidence beyond the contract as a means to alter the meaning of the words within the contract.  In Tire Discounter, while citing Sattva Capital, it was explained that looking outside the contract as a contextual approach for contract interpretation fails to conflict with parol evidence rules whereas it was said:

[39]  The Court explained the application of the parol evidence rule in this context at paragraphs 59-60:

…The parol evidence rule 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 (King, at para. 35; and Hall, at p. 53). To this end, the rule precludes, among other things, evidence of the subjective intentions of the parties (Hall, at pp. 64-65; and Eli Lilly & Co. v. Novopharm Ltd., 1998 CanLII 791 (SCC), [1998] 2 S.C.R. 129, at paras. 54-59, per Iacobucci J.). The purpose of the parol evidence rule is primarily to achieve finality and certainty in contractual obligations, and secondarily to hamper a party’s ability to use fabricated or unreliable evidence to attack a written contract (United Brotherhood of Carpenters and Joiners of America, Local 579 v. Bradco Construction Ltd., 1993 CanLII 88 (SCC), [1993] 2 S.C.R. 316, at pp. 341-42, per Sopinka J.).

The parol evidence rule does not apply to preclude evidence of the surrounding circumstances. Such evidence is consistent with the objectives of finality and certainty because it is 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 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.

Learn More About
Parol Evidence Rules
Summary Comment

The process for interpreting a contract involves more than just reading the written words upon the contract document whereas more than just the technical meaning of the written words should be considered. Generally, a court will use a contextual approach that involves review of the written document, if any, as well as review of the circumstances within which the contract was formed.


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