The rules of contractual interpretation have evolved significantly in the last several years in Canada. At one time, the circumstances surrounding the preparation of a contract were rarely considered by the courts; the courts preferred to look within the “four walls” of the contract to interpret ambiguous phrases or to resolve uncertainties. More recently, however, the courts have begun to consider all of the circumstances involved in the drafting of the contract in order to give meaning to it and to ensure that the intention of the parties is carried out.
In addition, the courts have continued to refine the good faith obligation of parties to a contract, as set out in Bhasin v. Hrynew (“Bhasin”).
A major change in the law occurred in 2015 when the Supreme Court of Canada delivered its decision in Sattva Capital Corp. v. Creston Moly Corp. (“Sattva”). In that decision, the Supreme Court explicitly stated that a practical common sense approach to contractual interpretation, considering the entire “factual matrix”, should be followed in interpreting a contract. The Court did caution that the words of the contract were still of primary importance and the factual matrix should not “overwhelm” the words of the contract.
Since the decision in Sattva there has been much discussion about whether the factual matrix should be considered only to resolve ambiguities in contractual interpretation, or whether the factual matrix should be considered as a guide to interpret a contract even in the absence of ambiguity.
The decision of the Alberta Court of Appeal (“ABCA”) in IFP Technologies (Canada) Inc v EnCana Midstream and Marketing, 2017 ABCA 157 has now made it clear that in interpreting a contract, the courts in Alberta have a duty to consider the relevant factual matrix surrounding a commercial contract, even in the absence of ambiguity, and that this duty is not precluded by the existence of an “entire agreement” clause.
Facts and background
IFP Technologies Canada Inc. (“IFP”) and Pan Canadian Resources, a predecessor to Encana Midstream and Marketing, (collectively referred to as “PCR”) entered into an Asset Exchange Agreement (“AEA”) with respect to various leases in the Eyehill Creek area. PCR later sold its interest to a third party who intended to reactivate existing wells and drill new ones using primary production methods. PCR proceeded with this sale notwithstanding that IFP had withheld its consent. Pursuant to the AEA and the relevant CAPL operating procedure, consent to such a transfer of interest was required and was not to be unreasonably withheld. There was also a dispute as to whether it was reasonable for IFP to withhold its consent to a proposed disposition by PCR of its remaining working interest.
The two primary issues are summarized as follows:
- The nature and extent of the interest held by IFP pursuant to the AEA. Specifically, whether IFP held a 20% undivided working interest in all primary and enhanced oil & gas leases at Eyehill Creek (as argued by IFP) or whether IFP’s interest was limited to oil & gas produced through thermal and other enhanced recovery methods, but excluded oil & gas produced through primary production (as argued by PCR).
- Whether IFP unreasonably withheld consent to the sale of PCR’s interest.
At the Alberta Court of Queen’s Bench, Chief Justice Wittmann held that IFP’s working interest was limited to a 20% working interest in oil and gas produced through enhanced recovery methods, and that IFP had unreasonably withheld consent to PCR’s sale of its interest.
The Court of Appeal decision: Court clarifies the principles of contractual interpretation
The ABCA reversed the trial decision, finding in favour of IFP. The Court concluded that IFP had conveyed, pursuant to the AEA, a 20% working interest in all oil and gas leases held by PCR at Eyehill Creek and ordered that IFP be entitled to an accounting for 20% of the net revenue realized through primary production on those lands.
The Court cited the decision of the Supreme Court of Canada in Sattva as the guiding authority for the importance of the factual matrix in any exercise of contractual interpretation, and for the principle that this exercise does not offend the parol evidence rule because evidence of surrounding circumstances is used only as an objective interpretative aid to determine the meaning of the words of the parties rather than to vary or replace their meaning.
The Court undertook a detailed analysis of the circumstances surrounding the AEA in an effort to determine the mutual and objective intentions of the parties in respect of the interest conveyed to IFP. They considered both evidence of negotiations leading up the execution of the AEA and the language contained in a memorandum of understanding agreed to by the parties prior to the execution of the AEA. The Court also considered the meaning of “working interest” in the oil and gas industry and found that it supported the finding that the AEA had conveyed a 20% working interest in all oil and gas rights at Eyehill Creek, not limited to oil and gas produced by thermal recovery. The Court in particular noted that it would be a very strange result if “working interests” or ownership of oil and gas leases, which are usually delineated by spatial area, by vertical zones or by substance, could also be subdivided by production method (thermal vs conventional).
Further, the Court found that IFP had acted reasonably in withholding its consent to the sale. PCR, as the party seeking to limit IFP’s right to consent to the proposed issuance, had argued (based on cases such as Bhasin) that IFP had a duty, as a party exercising discretion under a contract, to perform its obligations in good faith and give appropriate regard to PCR’s legitimate commercial interests. The Court affirmed the obligation of commercial parties to carry out their commercial objectives in good faith, as set out in Bhasin, but found that it was reasonable for IFP to withhold its consent, as the proposed disposition by PCR would have resulted in a significant increase in conventional production from PCR’s 80% working interest and been materially detrimental to IFP’s plans for thermal production. The obligation to perform its obligations in good faith did not require IFP to act in a manner adverse to its legitimate interests.
Conclusions: Businesses should maintain complete records surrounding the contracting process
Contractual interpretation before the courts may involve the examination of evidence beyond the four walls of the contract, including details of the historical relationship between the parties, the customs of the industry in which the contract was created, any antecedent or ancillary agreements, and any evidence of negotiations between the parties. This factual matrix is intended to demonstrate the intentions of the parties, and is applicable even where a written contract contains an “entire agreement” provision. This is particularly important with respect to large scale projects in which there are a number of interrelated contracts that may contain competing or conflicting provisions.
For a lawyer advising a client on the interpretation of a contract, it is now more important than ever to ensure that the lawyer has the full picture of the factual background surrounding the contract. Even where the contract is crystal clear and unambiguous, surrounding facts or circumstances will play a significant role, and must be explored with the client even in the absence of ambiguity. Further, clients should be reminded that it is important to maintain complete records of the preparation of a contract, and in particular to preserve any documentation that will illustrate the mutual intention of the parties. It is no longer sufficient to put an executed contract in a binder and assume that the words of the contract speak for themselves; documentation that may aid in the interpretation of the contract is now more important than ever and should be preserved along with the formal agreement.
Further, because the courts have now reiterated that they will give consideration to any document which may shed light on the intention of the parties in giving meaning to a contract, it is important that precontractual documents (such as letters of intent and memoranda of understanding) accurately reflect the mutual intentions of the party. It should be considered a dangerous practice to sign a letter of intent which does not correctly reflect the details of the transaction while planning to get the details correct in the definitive agreements.