Interpreting What a Contract Means
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What general principle(s) are used in interpreting contractual provisions?
The majority of jurisdictions interpret contract provisions based upon their plain meaning. That is, if a contract term is unambiguous, then the court will apply the meaning commonly applied to the term or provision. Example: Marcus manufactures widgets and enters into a contract to sell some widgets to Melvin. In the contract, Marcus agrees to scrub all of the widgets to remove any unwanted dirt or debris from manufacturing. When Melvin receives the widgets, the widgets appear to still have a thin layer of undesirable oil residue from the manufacturing process. Melvin asserts to Marcus that he has definitely not scrubbed the widgets as required by the contract, as evidence by the oil residue. Marcus replies that he subjected the widgets to a cold, spray-washing process, which is the equivalent of scrubbing them and that the oil residue is not his problem. Melvin refuses to pay for the widgets and Marcus sues him for breach of contract. Melvin asserts a defense that Marcus breached the contract by failing to scrub the widgets. The court may interpret the word scrub by its plain meaning, to determine who first breached the contract. Note: The court will generally assume that a contract contains all relevant terms and that there are no contemporaneous or prior terms or pieces of the contract that are part of the agreement. A contract that contains all relevant terms and provisions is known as a complete integration. Other jurisdictions interpret contract provisions based upon how a reasonable person in those circumstances would interpret the contract. This is known as the objective standard. Example: In the above situation, the court would place itself in the shoes of a reasonable person to determine what the parties meant by including the word scrub. If a reasonable person would believe that scrub includes subjecting to a cold spray-wash, then Melvin may prevail in the lawsuit. Note: Generally, if the contract has an integration clause and it does not contain any ambiguous terms or provisions, then the court will employ the objective or reasonable person standard in interpreting the contract. An integration clause is a contractual provision that states that the contract contains all of the terms of agreement between the parties and no outside evidence not specifically mentioned in the agreement should be considered. If the contract does not have an integration clause and/or it appears ambiguous, then the court will take into consideration the subjective intent of the parties when interpreting the contract. This means that the court will look, not at how a reasonable person would interpret the applicable term or provision, but at how the parties themselves interpreted the provision. Finally, some jurisdictions will look to any outside evidence to determine the subjective intent of the parties. Example: In the case of Marcus and Melvin, the court would accept any outside evidence that the parties could offer to demonstrate what meaning the parties attributed or should have attributed to the word scrub. Note: In such jurisdictions, whether the contract has an integration clause is irrelevant.
Do courts employ any rules to aid the interpretation of contracts?
Yes. Each state or individual jurisdiction employs any number of general rules in the interpretation of contracts. These rules are generally established through prior judicial precedent (common law) or practice within the jurisdiction. Some common approaches to interpreting contract provisions are as follows: Interpret terms to give them a reasonable meaning; Note: Reasonable meaning depends upon the plain definition of the word and the context of the contract. Given the situation, the court will determine what meaning is reasonable in light of the circumstances. Afford the greatest weight to the contracts express terms; Note: The express terms of the contract will have the greatest weight and will guide the interpretation of any meaning that is implied from those terms. Nothing will be implied that contradicts the express terms. Look to implied terms originating from the course of dealing, course of performance, or trade usage; Note: If the express terms are not conclusive, the court will look toward these factors to determine what is implied by the express terms of the agreement. Give greater weight to specific terms above general terms; Note: An express contract term will not be contradicted by more general provisions of the agreement. Terms that are actually negotiated between the parties are given greater weight than standard terms or boilerplate; Note: The action provisions, representations, warranties, and conditions will be preferred above the general provisions of the agreement. The court will take into consideration the overall circumstances of the agreement; Note: The court may look at all of the factors surrounding the agreement. This could include the parties, the industry, the subject-matter of the agreement, the objective to be achieved by the agreement, etc. The purpose of the contract, if ascertainable, should be considered in interpreting the intentions of the parties; Note: This regards what the parties hope to achieve through the agreement. For example, if the agreement is a supply contract, the parties intend to supply all of the needed product at a given price. Interpret all parts of the contract as a whole (including when the contract consists of multiple writings); Note: The court will look to interpret all portions of the writing collectively, rather than look at individual provisions in isolation. Words are given their prevailing meaning in the context of the contract; Note: What is the standard for this type of provision or term in similar types of contracts. Specific trade terms are to be interpreted in accordance with their meaning in the trade; Note: The court looks specifically to the trade or industry usage of these types of terms or provisions. The parties intentions are interpreted consistently and in accordance with course of performance, dealing, and trade usage; and Note: The court will look specifically to the prior dealings between the parties in this and previous deals. It will also look to general agreements of this nature within the trade or industry. Ambiguous terms may be interpreted against the drafter. Note: The drafter has the last opportunity to avoid ambiguous terms or provisions. The failure to avoid these situations is held against the drafter.
What is the significance of a prior course of performance, dealing, or trade usage in interpreting a contract?
All of the above rules provide context for interpreting the contract. Often, express terms (terms written or expressed in the agreement) are difficult to interpret. These factors may provide clarity. Also, these factors may serve to fill in inferred or implied meaning in the contract that is not expressed. For example, some courts will interpret a contract to impliedly include additional terms that are not specifically stated in the contract.
What is course of performance and dealing?
Courses of performance and dealing mean any actions taken by a party in carrying out the contract or in prior dealings leading up to the present contract. In cases where a contract is on-going (such as a supply contract) or broken into pieces (such as an installment contract), any prior activity in carrying out any portion of the contract (the course of performance) can provide context, meaning, and additional terms to the contract. Likewise, previous contract agreements or interactions by the parties outside of the contract may provide such context (the course of dealing). Example: Cameron has long-standing, business dealings with Jade. Cameron has purchased supplies from Jade for several years. In a recent supply contract, Cameron refuses to accept a shipment of supplies due to the tardiness of arrival. When Jade sues Cameron for a breach of contract, the parties argue over the provision in the contract requiring that shipment of supplies be received by Cameron within a timely period. Cameron says that the shipment was not made within a timely period, which she concludes is a breach of contract excusing her from the duty to accept the goods. In interpreting the contract, the court may look at the prior course of dealing between the parties to determine the meaning of within a timely period. If the Cameron accepted supplies in the past that were equally tardy in arrival, then it may be reasonable to interpret the provision to include the present time period. If so, Cameron may have breach the contract by failing to accept the supplies. Example: In the above situation, lets assume that the contract is an installment contract. The shipment in question is the third in a series of shipments. If Cameron routinely accepted prior shipments without objections, then this would influence the courts interpretation of the current situation. The course of performance of the contract may indicate that Jade is indeed delivering goods within a timely period. Note: If, when entering the contract, a party expressly objects to considering any prior performance or dealing by the parties in interpreting the contract, the court generally will not use course of performance in interpreting the agreement.
What is trade usage and why is it important?
Specific terms, provisions, phrases, etc., have special meaning in a given trade or business. Any such meaning can influence the contract, as the court may accept the definition or meaning of a word or phrase as it is commonly understood in that trade or business. Example: Tom, an attorney, argues to the court for a ruling based upon equity (fairness). Sharon, a stock trader, sells equity (ownership interest) in businesses. These are the same words, but have different meanings in specific industries. A court would interpret these contracts differently depending on the context of the contract (a legal agreement or a stock-trading agreement).
What is the parole evidence rule?
This rule or doctrine controls whether parties may introduce to the court interpreting the contract evidence of their agreement that is not included within the written document. This rule either allows or disallows a party from introducing that evidence to the court to modify or add terms to a contract. Example: Kate sues Sally for breach of contract. Sally defends this assertion by by claiming that the provision was not meant to be in the agreement. Sally wants the court to consider several communications between herself and Kate prior to the contract in an attempt to show that she did not breach the provision. If the prior communications contradict the terms that are expressly present in the contract, the court may not accept the evidence based upon the parole evidence rule. Note: Parties generally negotiate a contract prior to finalizing the terms in a written agreement. The parole evidence rule primarily serves to exclude any evidence of prior negotiations (either before or contemporaneous with the signing of the contract) that have the effect of altering the express terms of the agreement. The purpose of this rule is to prevent confusion in the interpretation of the contract and fraud by any party against another. Information or communications contemporaneous with execution of the contract may be admissible in interpreting the contract, but are not admissible if they expressly contradict unambiguous, contract terms.
When does the parole evidence rule apply to a contract?
The contract must be the final agreement between the parties. If the party is determined to be a final expression of the parties agreement, then the parole evidence rule is effective to limit what information outside of the writing the parties can introduce to the court in interpreting the agreement. Example: In the above example of Kate and Sally, the court will determine whether the contract is a complete and final expression of the parties agreement. Often a contract will have a clause stating that the document is a complete and final expression of the agreement between the parties. This is known as an integration clause and is discussed below. A complete and final agreement may also be evident by the terms and structure of the agreement. Note: As indicated in the above example, the courts may interpret a contract to be the complete and final agreement between the parties. The best way to make certain that the contract is deemed a complete and final expression of the parties intent is to include an integration clause.
What is integration and why is this concept important to contract interpretation?
As stated above, a contract must be final for the parole evidence rule to apply. Integration means that all of the facts or information constituting the agreement between the parties are present in the written agreement. Example: Grace enters into a contract with Will to provide him with design services. The contract does not make reference to any outside agreements. It appears by all accounts to address all of the terms of the agreement within the written document. As such, the contract would likely be deemed an integration for interpretation purposes. Note: An agreement may appear on its face as simply a partial understanding of the agreement between the parties. In such as case, the contract is not an integration. If a court determines that the document is an integration, it can either be completely integrated or partially integrated.
What is a complete integration and why does it matter?
A complete integration is when the contract contains all of the facts or information regarding the parties agreement. If the court determines that a contract is a complete integration, the parole evidence rule limits all prior or contemporaneous outside evidence that contradicts, modifies, or supplements the contract. Example: In the previous example of Kate and Sally, the court will not allow Sally to introduce the prior communications that in any way contradict, modify, or supplement the contract. There is a limited use for such communications to clarify ambiguous terms, as discussed below. Note: A complete integration will generally contain a strong integration clause specifically excluding any outside information not specifically mentioned in the terms of the agreement.
What is partial integration and why does it matter?
The written document may contain only part of the information constituting the agreement between the parties. If a court determines that a contract is a partial integration, it will allow certain outside evidence that serves to supplement or explain provisions of the contract. Even with a partial integration, the parole evidence rule restricts outside evidence of prior or contemporaneous communications that specifically contradict the terms of the contract. Example: In the situation of Kate and Sally, the court will allow the prior communications if they somehow supplement the terms of the contract or explain terms therein. These communications will not be admissible, however, if they contradict express terms or provisions of the contract. Note: Partial integrations generally do not contain integration clauses. Often, the agreement itself will make reference to outside communications to clarify certain provisions of the agreement.
How does the court determine if a writing is a partial or complete integration?
Courts employ a number of approaches in determining whether an integration exists and, if so, whether it is a partial or complete integration. The dominant approaches are as follows: Reasonable Person Approach The court looks at the contract to determine if a reasonable person would believe the agreement to be a complete expression of all of the terms between the parties (complete integration). If there is evidence of outside terms, the court will look to determine whether the outside terms were meant to be a part of the agreement or whether they would typically form a separate agreement. If they were not intended to be a part of the agreement, then there may be an integration. If they are terms that are typical or common to have in a separate agreement, then the court may find that the document is partially integrated. As previously discussed, a partial integration allows the introduction of prior or contemporaneous terms that do not contradict the existing terms of the contract. Note: The reasonable person approach is the most common approach across jurisdictions. Plain meaning Approach The court will look at the terms of the contract and interpret them in accordance with their plain meaning. The plain meaning may include taking into consideration the context of the contract. If the document appears to be a complete and final expression of the agreement between the parties, then it is presumed to be a complete integration. Note: While there is a presumption of complete integration, the party seeking to introduce external evidence into the agreement may rebut this presumption through any means available. Collateral Contract Approach This approach to determining integration assumes that all final writings are partial integrations. As such, the court will entertain the introduction of outside evidence that does not contradict or add to the express terms of the agreement. Such information is simply seen as a collateral contract or agreement that may affect the interpretation of the present agreement. Note: The introduction of these outside terms may demonstrate that an ambiguity exists in the contract. In such as case, the court may employ the information to resolve any conflicts surrounding the ambiguity. Intention of the Parties Approach The court, under this approach, will allow the introduction of any evidence deemed relevant to the determination of the existence of a contract. This approach offers the greatest latitude in the introduction of prior negotiations or communications between the parties. Note: Aspects of this approach are present in both the Restatement and UCC.
What is an integration clause and how does it relate to integration?
An integration clause, also called a merger clause, is a provision in a contract that says that the contract is a complete and final understanding of all the terms of the agreement. In other words, these clauses state that the contract is intended to be a complete integration. Some merger clauses will specifically state that any outside information or communications contemporaneous with the execution of the contract or prior thereto should not be considered a part of the contract. Other, more specific clauses, will specifically reference outside information, documents, or communications and state whether the terms of those items are included in the final agreement. Example: This Contract contains the entire agreement of the parties with respect to the subject matter of the Contract.The contract supersedes any prior agreements, understandings, or negotiations, whether written or oral.This Contract can only be amended through a written document formally executed by all parties. Note: These clauses are usually conclusive unless a contract defense applies (such as fraud, duress, etc.).
When does the parole evidence rule not bar the consideration of extrinsic evidence to a contract?
As previously stated, the parole evidence rule applies to a complete integration to limit the courts consideration of any prior or contemporaneous information in interpreting a contract. The parole evidence rule, however, does not bar extrinsic evidence offered for the following purposes: to aid in the interpretation of existing terms (for example, when an ambiguity exists), to show that a writing is or is not an integration, to establish that an integration is complete or partial, to establish subsequent agreements or modifications between the parties (i.e., those arising after the contract is completed), or to show that the terms of the contract were the product of illegality, fraud, duress, mistake, lack of consideration or other invalidating cause. Note: These exceptions exist to reduce misunderstanding and fraud between the parties and to promote judicial efficiency in the interpretation of agreements.
How can extrinsic evidence be used to clear up ambiguities?
As stated above, extrinsic evidence or information prior to or contemporaneous with the formation of the contract cannot be introduced to contradict the contract. One exception to this rule is the use of extrinsic evidence to determine the meaning the parties attribute to certain terms or provisions. Generally, a court will give a term its common meaning or the meaning common in the context of the contract (such as a particular trade usage). Nonetheless, often a term or provision of the contract will be ambiguous. In such a case, it may be necessary to employ extrinsic evidence or information from outside of the contract to determine the intentions or meaning attributed by the parties. Example: Clarence enters into a contract with Audrey to sell and deliver specially-manufactured widgets. The contract states that Clarence will deliver the widgets to Audreys place of business. Audrey has multiple places of business, including a central administrative office, but the contract does not differentiate these locations. Audrey is not happy when Clarence delivers the widgets to the headquarters, rather than to one of her retail business locations. Audrey sues Clarence for breach of contract. The court may determine that the phrase place of business is ambiguous. It could mean any of Audreys business locations, or it could mean one of the retail locations. In such a situation, the court may allow extrinsic evidence to show an ambiguity exists or to explain the parties original understanding. Clarence may be able to produce a prior communication where he specifically states that he will deliver the goods to the headquarters location. Note: Ambiguities are broken into latent and patent ambiguities.
What is a patent and latent ambiguity?
Generally, outside evidence may be introduced to clear up an ambiguity that is obvious on the face of the document. This is known as a patent ambiguity. If a party claims that the contract contains an ambiguous term, but it is not obvious on the face of the contract, then the party is claiming that a latent ambiguity exists. In such a case the party may be able to introduce outside evidence to show that an ambiguity exists. If the court determines that an ambiguity exists, it may consider extrinsic evidence to resolve the ambiguity. Example: In the above example of Clarence and Audrey, Audrey may introduce evidence to show that the parties specifically referred to her headquarters location as headquarters. The parties specifically differentiate this location from her retail locations, which are referred to as her businesses. In such a situation, this information would demonstrate that the meaning ascribed to place of business in the contract is ambiguous. As such, this may justify the introduction of additional external evidence to determine the meaning attributed to the term by the parties. Note: Many courts may not distinguish between patent and latent ambiguities. If an ambiguity exists, extrinsic evidence is allowed to the extent necessary to clear up the ambiguity. The parole evidence rules prohibition on the use of evidence to change or add to the contract remains intact.