Introduction
The standard of review is one of the first considerations as a party contemplates appealing an unfavourable decision. Historically, questions of contractual interpretation were considered questions of law, such that appellate courts employed the correctness standard in reviewing lower court decisions. This common law tradition originated in England and dated back to a time when there were frequent jury trials and widespread illiteracy. The rationale was that only judges could be assured to be literate and therefore capable of reading the contract.
So entrenched was the rule that the decision of the Supreme Court of Canada (“SCC”) in Sattva Capital Corp. v. Creston Moly Corp.1(“Sattva”) was described by some as a “sea-change” in the standards of review appellate courts should apply when reviewing a trial court’s interpretation of a contract.
This article reviews standards of review generally and how the law on standards of review has evolved in contractual interpretation cases, as well as the court’s unique considerations in reviewing lower-court interpretations of standard form contracts and in applying the parol evidence rule.
The two standards of appellate review
As the SCC held in Housen v. Nikolaisen2, the general principles of appellate review in civil cases turn on characterizing the nature of the question being reviewed as one of fact, a question of law, or a question of mixed fact and law. Questions of law are reviewed for correctness while questions of fact are reviewed on the reasonableness standard for palpable and overriding error. Questions of fact and mixed fact and law attract a reasonableness standard.
The reasonableness standard gives greater deference to the trial judge than the correctness standard, as the former is based on a logical chain of reasoning. As long as the trial judge’s decision is within the realm of reasonable outcomes in light of the applicable law and the facts, the appellate court will show deference to the trial judge and not interfere with the decision.
With the correctness standard, however, there can only be one right answer in light of the applicable law and facts. If the trial decision is incorrect, the appellate court will substitute its decision instead. A classic example of a question of law is which limitation period applies in a fact scenario, where there can only be one right answer.
Where the basis for a trial contractual interpretation can be traced to a pure legal error, the appellate court is to apply the correctness standard to that particular, extricable question of law. Sattva identifies the application of an incorrect legal principle, the failure to consider a required element of a legal test, and the failure to consider a relevant factor as examples of extricable errors of law. Other extricable errors of law include the failure to properly, accurately, and fully consider the context in which a contract was made, and the failure to consider the contract as a whole by focusing on one provision without giving proper consideration to other relevant provisions3.
When discussing appealing a contractual interpretation decision with a client, therefore, counsel are advised to first consider the applicable standard of review with which the appellate court will scrutinize the trial decision. The current state of the law is that contractual interpretation generally involves issues of mixed fact and law, which attract the reasonableness standard of review. However, extricable questions of law might be embedded within an issue of contractual interpretation as to attract the correctness standard. The precedential value of the contract is also to be considered as standard-form contracts are likely to attract the correctness standard.
Evolution of the law
To delineate the current state of the law on standards of review applicable in appeals of contractual interpretation, it is necessary to refer the reader to recent leading cases from the SCC and the Ontario Court of Appeal, beginning with Sattva. The cases address provisions common in commercial contracts and have widespread application and are likely of interest to commercial parties as well as the public.
Sattva: Departure from traditional view of contractual interpretation as legal exercise
In Sattva, the SCC ruled that for questions of contractual interpretation, appellate courts should apply the “palpable and overriding error” or “reasonable” standard of review rather than the “correctness” standard.
Sattva involved a finder’s fee agreement under which the Sattva corporation claimed compensation in the form of shares. A disagreement arose over the valuation date for calculating the shares owed. The SCC in Sattva emphasized that contractual interpretation is a question of mixed fact and law, not a pure question of law. This is a marked departure from the traditional view, where interpretation was seen primarily as a legal exercise.
With respect to the interpretation of contracts, the court highlighted several important principles:
- Text and context: Contracts should be interpreted in light of facts of which the parties were aware at the time of contract formation. The surrounding circumstances, or factual matrix, include “absolutely anything which would have affected the way in which the language of the document would have been understood by a reasonable man”. The factual matrix is thus a broad concept and will necessarily vary from case to case.
- Objective intent: The analysis should focus on the objective intentions of the parties as expressed in the contract.
- Limited role of parol evidence: While the factual matrix is relevant, courts should avoid considering evidence that contradicts the express terms of the contract.
By framing contractual interpretation as a mixed question of fact and law, Sattva established that appellate courts should generally apply the deferential standard of palpable and overriding error when reviewing trial decisions on contract interpretation.
Ledcor: The SCC refines Sattva in respect of standard-form contracts
Ledcor Construction Ltd. v. Northbridge Indemnity Insurance Co.4 (“Ledcor”) concerned the interpretation of an insurance policy’s exclusion clause. The issue was whether damage to windows caused by cleaning fell within the exclusion. The SCC reaffirmed the contextual approach in Sattva but recognized that standard-form contracts present unique challenges.
The SCC held, in Ledcor, that interpretation of standard-form contracts may revert to being a question of law rather than a question of mixed fact and law because these contracts require consistent interpretation to promote predictability and fairness as they impact more parties than bespoke, non-standard contracts. Also, due to their nature, there is no meaningful factual matrix specific to the parties as compared to bespoke contracts. Trial interpretations of standard-form contracts could be reviewed on a correctness standard due to the precedential value of the interpretation to ensure consistency and fairness across cases. In this case, the SCC found the insurance policy in question to be a standard-form contract and applied the correctness standard, ultimately ruling in favour of the insureds.
Fuller: Standard of review in the interpretation of interrelated contracts with inconsistent terms
This Ontario Court of Appeal case involved a dispute over the interpretation of a consulting agreement, an option plan, and an option agreement, particularly concerning the expiry date for the exercise of certain options granted to the appellants. When read together, there appeared an inconsistency: whereas the consulting and option agreement provided that the options expired in 2019, the option plan appeared to place the expiry date in 2016. The primary issue on appeal was whether the applications judge correctly interpreted the contractual provisions.
The Court of Appeal agreed with the parties and the applications judge that, in the circumstances of the case, the three contracts must be read together and interpreted in light of one another. Referring to Sattva, the court reaffirmed that contractual interpretation is generally a question of mixed fact and law, attracting a deferential standard of review. However, the court acknowledged that extricable questions of law arising from contractual interpretation, such as the application of an incorrect legal principle, are subject to a correctness standard.
In this case, the Court examined the applications judge’s interpretation for any legal errors but found none, thus upholding the first-instance judgment. This decision reinforces the principle that appellate courts should exercise deference in reviewing contractual interpretations, intervening only when there is a clear legal error.
Earthco: Appellate courts cautioned against searching for extricable questions of law
In Earthco Soil Mixtures v. Pine Valley Enterprises Inc.5 (“Earthco”), the SCC addressed the meaning of “express agreement” under section 53 of the Ontario Sale of Goods Act (“SGA”) and the issue of whether the parties executed an “express agreement” that excluded Earthco from liability under section 14 of the SGA. In this case, Pine Valley undertook a flooding remediation project with the City of Toronto that required topsoil of a specific composition and quality. Earthco was the supplier of the topsoil. Earthco’s contract with Pine Valley allowed the latter to test the soil before shipment and stated that if Pine Valley waived this right, Earthco would not be responsible for the soil’s quality post-shipment. Pine Valley waived the testing. Upon delivery, it was determined that the soil did not meet the City’s specifications, leading to additional costs and damages for Pine Valley.
The SCC reinstated the trial decision. With respect to the appropriate standard of review the, SCC reviewed the law in Sattva, Ledcor, and other cases and reiterated that contractual interpretation typically involves questions of mixed fact and law, warranting a deferential standard of review. Appellate intervention is justified only when there is an extricable question of law, such as an error in principle, the application of an incorrect legal standard, or a failure to consider a required element.
The SCC expressed dismay at the approach taken by some appellate courts to search for an extricable issue of law in order to elevate the standard of review to correctness, noting that extricable questions of law should be “rare” and “uncommon”. In this case, the Court of Appeal erred by applying a correctness standard without identifying a genuine extricable error of law.
Pinnacle International: Examples of “rare” and “uncommon” extricable questions of law
Pinnacle International (One Yonge) Ltd. v. Torstar Corporation6 (“Pinnacle”) involved a dispute over profits from a sublease under a commercial lease agreement. Some of the issues on appeal included the applicable limitation period and whether the judge, who heard the underlying summary judgment, errored in her interpretation of “net profits” and “reasonable costs” in one of the key clauses in the lease.
The majority of the Court of Appeal found that “profit” should be understood in its ordinary sense as the excess of revenue over expenses and concluded that Torstar did not realize a profit, as it incurred a $2.6 million loss on the sublet premises. Relying on Sattva, the court reiterated that because the interpretation of a contract involves questions of mixed fact and law, absent an extricable question of law which attracts a correctness standard, the standard of review is palpable and overriding error.
In the instant case, however, the court found that the motions judge erred in law by failing to interpret the lease in a manner consistent with the factual matric, to consider the lease as a whole, and that her interpretation resulted in a commercial absurdity. These errors in law displaced the deference normally afforded to judges of the first instance and the Court of Appeal substituted its interpretation.
With respect to the issues on appeal in this case, the court concluded that the correctness standard applied to the issue on the applicable limitation period, while the interpretation of “net profits” and “reasonable costs” should be afforded the reasonableness standard.
Referring to Ledcor, Earthco, and other leading cases, the Honourable Justice Brown, in dissent, stated that the lease between the parties was on the bespoke-end of the contract interpretation spectrum. He appeared critical of the other judges on the panel, stating that they were for searching for extricable legal issues to justify appellate intervention. He also expressed that, having reviewed the record, he would affirm, not set side, the motions judge’s interpretation.
Parol evidence of an objective, factual nature may assist in contractual interpretation
For some years following Sattva, there remained a question over the role of the parol evidence rule in contractual interpretation and, to the extent that it continued to be relevant, how and when the rule was to be applied. As will be seen below, the admission of certain types of parol evidence, and the application of same in the analysis of the factual matrix surrounding the making of the contract, may be considered an error of law to invite appellate intervention.
The parol evidence rule traditionally excludes evidence of prior negotiations, verbal assurances or statements, or collateral documents that add to, vary, or contradict a written contract. It is based on the presumption that the written contract fully represents parties’ final and complete agreement.
Post-Sattva, the interpretative exercise involves a consideration of not only the text of the contract but also the factual matrix – the circumstances surrounding the making of the contract. This is a departure from a rigid, textualist interpretation and allows courts to consider extrinsic, parol evidence to understand the commercial purpose and background of the contract in question. It is important to remember that the extrinsic evidence must not overwhelm the words of the contract in question.
In IFP Technologies (Canada) Inc. v. EnCana Midstream and Marketing7, the Alberta Court of Appeal concluded that the court has a duty to consider the relevant factual matrix surrounding a commercial contract even if the contract is clearly worded and includes an “entire agreement” clause.
In Ontario First Nations (2008) Limited Partnership v. Ontario Lottery and Gaming Corporation8(“OFNLP”), the Court of Appeal addressed the question of whether the appeal judge of an arbitration panel’s decision ignored an entire agreement clause and allowed extrinsic evidence to overwhelm the words of the agreement in question. The court noted the following caveats in the use of parol evidence in contractual interpretation:
- Evidence of pre-contract negotiations and subjective intentions remained generally inadmissible. The admission of the extrinsic evidence was rather intended to aid in interpreting the meaning of words used in a contract;
- Admissible extrinsic evidence, in contractual interpretation cases, included objective, factual background evidence, such as the market or industry context, the relationship between the parties, the circumstances leading to the formation of the contract, and the purpose of the contract.
- Extrinsic evidence may be admissible where the words of the contracts were ambiguous.
- The nature of the evidence that may be considered will vary from case to case; and
- The purpose of considering surrounding circumstances was to aid in the interpretation of the agreement, not to add to, contradict, dispute or overwhelm the words of the agreement.
In the post-Sattva world, the parol evidence rule continues to have a place in contractual interpretation, though extrinsic evidence of an objective, factual nature may be admitted as an interpretative aid.
Summary of case law on standards of review
Some commentators have lamented in Ledcor, the SCC appeared to have backpedaled on Sattva. In reviewing the caselaw following Sattva, one comes to the realization that one must undertake a nuanced and careful analysis of the precedential nature of the contract, the principles of contractual interpretation applied by the trial judge, the factual matrix surrounding the making of the contract, and the precise issue proposed to be dealt with on appeal before offering an opinion as to the applicable standard of review to one’s client. The following is a summary of factors counsel may consider in determining the which standard of review the appellate court may apply, based on the current state of the law:
- Individualized, bespoke contracts tend to attract the correctness standard;
- The appellate court may detect extricable questions of law in a trial judge’s interpretation and apply the correctness standard;
- The appellate court likely scrutinize the trial judge’s application of principles of contractual interpretation in determining whether an error of law has been committed, thereby displacing the deference normally afforded trial decisions;
- An example of an extricable question of law is whether the trial judge properly considered the factual matrix surrounding the making of the contract. Counsel may consider whether the trial judge appropriately applied the parol evidence rule in accordance with Sattva and OFNLP.
Conclusion
There appears to be no clear answers as to which standard of review applies in the appeal of contractual interpretation, leading to uncertainty for counsel and parties alike. Commercial parties may benefit from maintaining a fulsome records surrounding the contracting process and, as always, clarify and fully understand the terms of contracts before signing on the dotted line.
1 2014 SCC 53
2 2002 SCC 33
3 Fuller v. Aphria Inc., 2020 ONCA 403, para. 50
4 2016 SCC 37
5 2024 SCC 20
6 2024 ONCA 755
7 2017 ABCA 157, leave to appeal refused, [2017] S.C.C.A. No. 303
8 2021 ONCA 592
