What the Ontario Court of Appeal Wants You to Know About Commercial Contracts

One of the fundamental rules of contract interpretation is that Courts adopt a practical, common-sense approach that is not “dominated by technical rules of construction”.[1] 

The contract is read as a whole, giving the “words used their ordinary and grammatical meaning consistent with the circumstances known to the parties at the time” of contract formation.[2]

What these principles mean in practice has been the subject of much judicial ink since the Supreme Court of Canada’s 2014 decision, Sattva Capital Corp. v. Creston Moly Corp.[3] 

A recent ruling of the Ontario Court of Appeal, Project Freeway Inc. v. ABC Technologies Inc.,[4] establishes some of the basic principles that every party to a commercial agreement needs to know about contractual interpretation.

‘Cuz We are Living in a “Material” World

Project Freeway concerned a share purchase agreement (the “Contract”) between ABC Technologies (“ABC”) as purchaser and Project Freeway (“PF”) as vendor of several “multi-million-dollar” companies.

As part of the transaction, ABC agreed to make “Earn-Out Payments” to PF (the “Earn-Out Payments”).

The Contract further provided that PF would be entitled to the Earn-Out Payments at the end of each Earn-Out period, depending on the financial performance of the companies being acquired.

However, the Contract stipulated that there were certain “triggering events” that would require immediate payment to PF of the whole maximum Earn-Out (the “Accelerated Payment”). 

One triggering event occurred where ABC sold a “material portion of the assets of the Business of the [companies]” to a non-affiliated purchaser”, without obtaining PF’s prior written consent.

Shortly after the transaction closed, ABC sold assets owned by the companies to a non-affiliated purchaser in which ABC was permitted to continue to lease and operate the assets (the “Sale Leaseback”). 

ABC did not obtain PF’s prior written consent with respect to the Sale Leaseback.

PF brought an action against ABC, claiming that the Sale Leaseback was a triggering event which required an Accelerated Payment to PF. 

Specifically, PF argued that phrase “material portion” referred to the size of the sale at issue and not to the “impact of the transaction on the ability to” achieve the Earn-Out. 

According to PF, the term “material”, as used in the Contract, did not mean “material impairment of the ability to earn Earn-Out Payments”, but to the quantitative size of the transaction in question.

The trial judge rejected PF’s position and dismissed the action.

On appeal, the Court of Appeal upheld the trial judge’s finding, holding that the trial judge made no palpable and overriding error in their interpretation of the Contract.

In reaching this conclusion, the Court of Appeal took a “back to basics” approach to contractual interpretation, emphasizing some of the key lessons from Sattva concerning how Courts discern the parties’ intentions in commercial agreements.

1. The Words Are the Starting Point.

The Court of Appeal dismissed PF’s position that the term “material portion” referred to the size of the transaction at issue, rather than the “impact of the transaction on the ability to earn”.

In doing so, the Court noted that the “cardinal presumption” in contract interpretation is that the parties “intended what they said”. The Trial Judge did not err in reading the text of the Contract as a whole, giving “the words used their ordinary and grammatical meaning”. 

Applying this approach, the Trial Judge found that the term “material portion” was ambiguous: it could refer either to the size of the asset sold or the impact of the sale on the Earn-Out Payments.

The Trial Judge made no palpable and overriding error in so ruling.

2. Commercial Practicalities Govern, Not Business Absurdities.

When interpreting a Contract, the Courts must adopt a “practical, common-sense approach”. This contrasts with previous common law constructions of commercial agreements, which often turn on technical, impractical meanings.

The Trial Judge in this case made no error in rejecting PF’s position that because other provisions in the Contract made reference to “material impairment” and specifically defined what that term meant, the failure to do so for the provision in question meant that “material portion” had to refer to the size of the sale. 

The Court of Appeal held that a common-sense approach to the term “material portion”, on an objective reading, meant that the term was ambiguous and did not necessarily accord with PF’s interpretation.

Related to this ruling, the Court further upheld the Trial Judge’s finding that it would be commercially absurd to accelerate Earn-Out Payments “simply because the purchaser engaged in a sale that has no effect on the Contribution Margin”.  

Confronted with the ambiguity of the term “material”, the Trial Judge avoided a commercially absurd construction to “reflect the ‘bargain struck’ by the parties”.

3. The “Factual Matrix” Matters.

The Court further upheld the Trial Judge’s position that, in preferring ABC’s interpretation to PF’s, it was necessary to examine the factual matrix at the time of the Contract’s formation. This is a non-controversial adoption of the Sattva methodology.

4. Letters of Intent (LOIs) Can Form Part of the Factual Matrix.

In discerning the objective meaning of the Contract, the Trial Judge relied on a letter of intent (“LOI”) executed by the parties. 

PF took the position on appeal that the Trial Judge erred in so doing because the Contract included an “entire agreement” clause which expressly stated that the Contract superseded all prior arrangements, including the LOI.

The Court of Appeal held that the entire agreement clause did not preclude consideration of the LOI. In the Court’s view, the LOI constituted one in “all the circumstances” that led to the Trial Judge’s ruling that the word material meant “material to the [Earn-Out] regime”. 

The LOI was simply employed as an “interpretive aid” and the Trial Judge was within their rights to use the LOI in this way.

5. The Parties’ Post-Contract Conduct May Matter.

Before Project Runway, the Court of Appeal made it clear in its 2016 decision, Shewchuk v. Blackmount Capital Inc.,[5] that while conduct by the parties after a contract is entered into does not form part of the factual matrix because such evidence can be self-serving, in the face of ambiguity, the Court can use such evidence to resolve contractual uncertainty.

Though the Court of Appeal in this case made no reference to Shewchuk, it clearly had the decision in mind when it held that the Trial Judge did not err in considering the post-agreement conduct of the parties, particularly in the face of the ambiguity of the term “material portion”.

The Court further noted that even if the Trial Judge erred in considering such evidence, given that this evidence did not form the crux of the Trial Judge’s analysis, any such error was not “palpable and overriding”.

The Lessons of Project Freeway

Project Freeway illustrates the difficulty in seeking to overturn a contractual interpretation exercise on appeal. 

Absent an egregious error, appellate Courts will defer to the lower Court’s analysis.

Project Freeway also provides a number of lessons on how Courts will engage the interpretation exercise: the words of the contract remain paramount. 

However, in the face of ambiguity, the Courts will turn to the factual matrix at the time of the contract formation and even afterward, to glean the parties’ objective intentions.

Marco P. Falco is an appellate and judicial review litigator at Torkin Manes LLP.  You may contact Marco about your business agreement at mfalco@torkin.com.  A conflict search will need to be conducted before your matter is discussed.