Drafting Contracts to Avoid (if you can) and Embrace (if you must) Litigation Amanda M. Quayle I. Overview This paper is intended as a general primer for legal practitioners involved in contract negotiating and drafting. It is written from the point of view of a commercial litigator attempting to identify the general principles that a court or arbitrator will apply where there is a dispute about the meaning of a contact, as well as litigation issues arising from the most common procedural and substantive provisions bargained for in contracts. Finally, suggestions are provided for preventing contractual disputes caused by poor drafting. II. Canons of Construction General Principles of Contract Interpretation General principles have been developed by the courts to assist an interpreter of a contract. 1 Generally, the intention of the parties to the contract should be objectively ascertained from the words of the contract itself. Prior negotiations, subjective intentions, and/or subsequent conduct are not relevant or admissible considerations. 2 However, exceptions to this general principle have been developed by the courts to recognize commercial realities and to promote and ensure commercially reasonable results in resolving contractual disputes. The following general principles are relied on by decision makers in considering and resolving contractual disputes: (a) The departure point for contract interpretation is the well-established proposition that a contract should be interpreted in its grammatical and ordinary sense, except to the extent that some modification is necessary in order to avoid absurdity, inconsistency or repugnancy. 3 Words of ordinary use must also be construed in their ordinary sense taking into consideration the circumstances that obtained at the time of contract formation. The meaning of the words should not be determined without regard for their 1 G.H.L. Friedman, The Law of Contract in Canada, 4 th ed. (Scarborough: Carswell, 1999) at 478. 2 G. McMeel, Prior Negotiations and Subsequent Conduct The Next Step Forward for Contractual Interpretation? (2003) 119 L.Q.R. 272 at 272. 3 K. Lewison, The Interpretation of Contracts, 2 nd ed. (London: Sweet & Maxwell, 1997) at 85.
2 context or factual matrix. 4 parties, to be gathered from the words they have used. 5 In other words, effect must be given to the intention of the (b) Where a particular clause is being scrutinized, it should not be examined in isolation. Rather, it should be considered within the context of the entire contract, unless the result would result in an inconsistency. 6 (c) In the case of a standard form contract, greater weight will be given to provisions that have been specifically or intentionally added, and where there is a conflict between the standard additional condition, the latter will prevail. 7 (d) Where there are two plausible interpretations of a contract, the one that gives effect to all parts of the contract will be preferred and, where possible, no part of the contract should be treated as inoperative or surplus. 8 (e) Where one party primarily drafted the contract or a particular provision of the contract, the doctrine of contra proferentem requires that if there is an ambiguity, the contract will be interpreted against the party that inserted the clause and is now attempting to rely on it. 9 (f) The courts have identified ambiguity as a term that is reasonably susceptible of more than one meaning. 10 And for a contract to be ambiguous, it must be an ambiguity that exists in the language as it stands, not one that is itself created by the evidence that is 4 Prenn v. Simmonds, [1971] 3 All. E.R. 237 at 240-241 (H.L.) and SaskPower International Inc. v. UMA/B&V Ltd. 2007 SKCA 40, 293 Sask. R. 66 (C.A.) [SaskPower]. 5 Consolidated Bathurst, [1980] 1 S.C.R. 888. 6 SaskPower at par. 23. 7 Supra note 3 at 162. 8 Supra note 3 at 161. 9 Supra note 5 and Saskatchewan Government Insurance v. Patricia Hotel (1973) Ltd. 2011 SKCA 70, 375 Sask. R. 50 (C.A.) at para. 23. 10 Hi-Tech Group Inc. v. Sears Canada Inc. (2001), 52 O.R. (3d) 97 (C.A.) at para. 18 [Hi-Tech].
3 sought to be adduced. 11 Where there is no ambiguity, no extrinsic parol evidence may be admitted to alter, vary, or interpret in any way the words used in the writing. 12 (g) Exceptions to the parol evidence rule in order to avoid injustice are (i) to explain incomplete documents; (ii) to prove that a condition precedent has not been fulfilled; and (iii) to assist in ascertaining the intentions of the parties. 13 (h) Where a contract is ambiguous, an interpreter can consider prior conduct of the parties and/or negotiations subsequent to the formation of the contract in order to ascertain the meaning and legal effect of the contract. 14 (i) Where ambiguity exists and there are two possible interpretations, the more reasonable one which produces a fair result, or the commercially reasonable result, is to be assumed to be intended by the parties. 15 (j) Although looking beyond the contract is generally impermissible, the use of dictionaries and other resource material is acceptable. A decision maker may also consider the commercial purpose of the contract, and in considering that purpose may rely upon its own experience of contracts of a similar character to that under examination. Accordingly, even where there is no ambiguity on the face of the contract, a decision maker may still consider what is commercially reasonable to determine the objective intentions of the parties. 16 III. If It s Broke, Fix It Rectification Another exception to the general principle that the subjective intentions of parties to a contract and extrinsic evidence to the written words of the contract are inadmissible where there is no 11 Supra note 1 at 483, referring to Alampi v. Swartz, [1964] 1 O.R. 488 (C.A.). 12 Supra note 1 at 480 and Eli Lilly & Co. v. Apotex Inc., [1998] 2 S.C.R. 129 [Eli Lilly]. 13 Ibid. 14 Manitoba Development Corporation v. Columbia Forest Products Ltd. and GNC Industries Limited, [1974] 2 W.W.R. 237 (Man C.A.) and Moose Jaw (City) v. British American Oil Co., [1937 2 W.W.R. 35 (K.B.). 15 Supra note 5. 16 Supra note 3 at 13, Eli Lilly, and Guarantee Co. of North America v. Gordon Capital Corp., [1999] 3 S.C.R. 423.
4 ambiguity in the written contract is the remedy of rectification. The remedy is used by decision makers where an oral agreement that was reduced to writing does not accurately represent the original intentions of the parties. Rectification is premised on the existence of a prior oral written contract whose terms are definite and ascertainable. The plaintiff must establish that the terms agreed to orally were not written down properly. 17 In order to obtain the rectification remedy, the party seeking it must establish three prerequisites: 1. The existence and nature of a common intention by the parties prior to the making of the written document or instrument that contains the error or deficiency. In other words, the existence and content of an inconsistent prior oral agreement; 2. That the common intention remained unchanged as at the date the document or the instrument was made; and 3. That the written document or instrument does not conform to the parties prior common intention and that permitting one party to take advantage of the mistake in the written contract would result in fraud or the equivalent to fraud. 18 The standard of proof for the rectification remedy is higher than the normal civil standard of a balance of probabilities. Court have consistently used the phrase convincing proof in discussing the calibre of the evidence that will be necessary to satisfy the burden of proof that the parties actual agreement is something other than that which the writing reflects. The prerequisites for rectification have been interpreted to be high hurdles that must be overcome to ensure that the remedy does not become an escape route for contracting parties seeking to get out of improvident bargains. 19 17 Sylvan Lake Golf and Tennis Club Ltd. v. Performance Industries Ltd., [2003] 1 S.C.R. 678 and Saskatoon Credit Union Ltd. v. U.F.C.W., Local 1400 2009 SKCA 87, 331 Sask. R. 230 (C.A.). 18 Ibid and Wasauksing First Nation v. Wasausink Lands Inc., [2004] O.J. No. 810 (C.A.) at para. 18. 19 Public Service Alliance of Canada v. NAV Canada (2002), 59 O.R. (3d) 284 at para. 45.
5 IV. Some General Considerations Respecting Oft-Used Procedural and Substantive Contract Clauses Parties engaged in contact negotiation are often focused on ensuring that the terms and conditions most favourable to them in the execution of the contract are bargained for. However, equally important are the rights and responsibilities of the parties in the event of a breach. Certain, often boilerplate, clauses contained in many contracts have a significant impact on the manner in which an action can be litigated if a dispute arises. These types of clauses should be considered in light of the specific circumstances and ultimate objectives of the parties to the contract at the time of contract formation to ensure the manner in which a potential dispute is resolved in a manner that is anticipated by and acceptable to your client. Some examples of boilerplate clauses that can have a significant impact on litigation in the event of a breach of the contractual relationship include the following. 1. Forum, Jurisdiction and Choice of Law If a dispute on a contract arises, the first issue to be determined is what is the appropriate forum? Does the contract contain an arbitration agreement which requires the dispute to be arbitrated, or litigated in a certain jurisdiction regardless of where the substance of the dispute actually arose? What law applies to the dispute? In some cases, the forum, jurisdiction and law to be applied to the dispute may act as a practical bar to an action, for instance, where the dispute is to be arbitrated in another country where the lack of proximity and the resultant cost of the dispute resolution mechanism makes pursuing a dispute impracticable. In addition, alternate dispute resolution provisions or procedural rules of another jurisdiction can have a significant impact on the procedural rights of parties to a dispute including in relation to timelines, discovery and rights of appeal. Finally, where a contract imports the law of a different jurisdiction, understanding the impact of that law on your client s understanding of the bargain is necessary in the course of negotiating the contract, including the retainer of an expert in that jurisdiction to provide advice in that regard.
6 2. Injunctive Relief Often contracts contain a clause that in the event of a breach by one party to the contract, such breach will be considered to cause the non-breaching party irreparable harm and entitle that party to injunctive relief to prevent a continuing breach, including without the posting or filing of any bond or other security. Such clauses are not determinative of the issue and clients should understand that despite the inclusion of such a clause, obtaining injunctive relief will depend on the ability to satisfy the Court or arbitrator that the tripartite common law test for injunctive relief has been met, including the general prerequisite for the provision of an Undertaking as to Damages by the party seeking the injunctive relief. 3. Representations and Warranties The Reps and Warranties section of the contract is frequently one of the most important sections when a dispute arises. A representation is a statement of fact as of a moment in time intended to induce reliance. The truthfulness of the representation is determined by going back in time to when the representation was made and comparing it to the facts at that time. If the representation was untrue at the time made, and the other party relied on the representation, that party can sue for misrepresentation. A warranty, by contrast, does not require reliance. A warranty is a promise that a particular statement is true. For instance, one of the contracting parties may represent that it is not subject to any conflicting obligation or any disability that will or might prevent it from performing its obligations under the agreement. If the warranty turns out not to be true, the party who so warranted will be obligated to pay damages to the recipient of the warranty is any damages were suffered as a result of the breach of warranty. Careful consideration and crafting of both representations and warranties are a critical part of communicating the parties understanding of their agreement and should be included in the written contract in order to ensure that they can be relied on in the event of a breach.
7 4. Exclusion Clauses Central to common law contracts is the notion that where a party agrees to a contractual obligation, that party is responsible for damages when the obligation is not met. The presumption is that parties intend to be bound by their intention. Consistent with that notion, courts will strictly and narrowly construe exculpatory clauses, such as exclusion clauses, restrictive convenants and limitations contained in contracts and the doctrine of contra proferentem will apply. Accordingly, a party seeking to exclude or restrict his liability must do so in clear and unequivocal terms. 20 5. Term and Termination Not all contracts contain a term. Some are implicit in the agreement, for instance a contract governing the one-time supply and purchase of goods. But whether there will be an ongoing relationship between the parties, a well-drafted contract should provide for the term of the agreement, as well as any right to renew the agreement for another term. The absence of a provision setting the term or ambiguity in the drafting of the clause often leads to litigation. Included in considering the term of the contract is a consideration of whether the contract should include an Act of God or force majeure clause that will discharge a contracting party from its contractual obligations where a supervening, sometimes supernatural, event, beyond the control of either party, makes performance impossible. 21 Like other exclusion clauses that attempt to remove or limit liability for non-performance, force majeure provisions will be strictly and narrowly construed. 22 In the result, careful and explicit drafting of force majeure clauses, if relevant, in contract formation is critical in order for a party to find safe harbour in such a clause. Another source of contract disputes that lead to litigation is the failure to provide for circumstances under which contracts can be terminated. What can your client do when 20 Chitty on Contracts, 30 th ed. (London: Thomson Reuters, 2008) at 14-001 and 14-009. 21 Atlantic Paper Stock Ltd. v. St. Anne-Nackawic Pulp and Paper Company Limited, [1976] 1 S.C.R. 580 at 583. 22 Lowell A. Westersund, Force Majeure Clauses in Construction Contracts (Calgary: Fraser Milner Casgrain LLP, 2008) at 13.
8 confronted with a bad deal or a bad relationship? One answer is to continue to operate under the contract until its term expires. However a default or termination clause can provide for a list of circumstances under which a contract may be terminated by one or both of the parties. Bargaining for and including such circumstances in contracts provides for the orderly windingup of a contractual relationship. Failing to provide for such circumstances can result in breach and litigation. Drafting termination provisions is often not challenging. The difficult part is trying to foresee all the potential grounds for termination at the drafting stage and, obtaining the other party s agreement to a termination provision during the negotiations. V. Conclusion Through the use of the remedy of rectification, the Courts have widened the risk for contracting parties who, absent ambiguity in the terms of their written contracts, could rely on their relationship being governed by the four corners of the written contract. Precision and clarity remain the Holy Grail of contract drafting. These characteristics avoid ambiguity and opening the door to the exceptions to the general principle that the contract is what the contract says. Slavishly following a precedent is as dangerous as it is safe. Setting out the basis for and the terms of the deal in plain language, anticipating both the uneventful execution and unanticipated breach of the agreement is, at all times, the objective. Contract drafting is intended to provide the parties with certainty about their rights and obligations and to allocate risk. In almost all instances, the first time a litigator is consulted about the contract is after the fact, rather than addressing potential issues before the event. Litigators do not get many opportunities to share contract-drafting tips that could help our clients avoid having to see us. Litigators jokingly refer to refer to the transaction work as pre-litigation work. There is value in consulting with a litigator in the drafting of the contract in the initial instance. A litigator s perspective adds value by filling in substantive and procedural information for things like indemnification, choice of law, venue, jurisdiction, etc. which are essentially the areas
9 of law in which they have expertise. It gives the contract drafter the benefit of a second set of eyes - eyes belonging to someone in the trenches litigating inartfully drafted contract provisions.