This week’s post discusses settlement agreements (a type of contract) and how they’re interpreted by the courts. Often times, parties will attempt to revise a deal after its agreed upon by trying to insert new words or meanings that aren’t present within the four corners of the document. This is rarely a good idea.
Instead, the key to a good contract is: (1) frank negotiation; (2) clear simple language; and (3) the retainer of a lawyer who will look after your interests when the agreement is being negotiated and drafted (because, unless they explicitly say so, another party’s lawyer won’t do it for you).
Let’s make a deal
In one of my firm’s recent successful decisions, we were involved in a dispute that engaged several mortgagees to a house. In short, the dispute focused on how approximately $80,000 in sale proceeds were to be paid out after the property sold. This was important as the $80,000 was subject to a larger dispute that still required settlement.
On the day of our court argument, which is called a motion, as the parties were preparing to make our legal arguments, the judge suggested that we should try and reach an agreement over the $80,000 and save ourselves the trouble. We took the court’s advice and after three hours of negotiation amongst the parties (all of whom had their lawyers present), we thought we’d fashioned a written agreement that everyone was happy with. The parties reached an agreement which stated that the $80,000 was to be “paid into court” i.e. given to the court for safekeeping until the parties could determine what was to be done with it. The agreement was signed, and all the parties went home thinking the dispute had been resolved.
But what I meant to say was
Months later however, the mortgagee who was one of the parties to the agreement dragged the parties back to court on the grounds that the agreement had to be “clarified”. The mortgagee assumed that when the property was sold, there would be enough funds left over to discharge the mortgage and pay $80,000 into court. That didn’t happen. The property sold for less than the mortgagee expected therefore leaving a deficiency to discharge the mortgage if $80,000 was paid into court. Suddenly, the $80,000 to be paid into court took on a much grander significance.
The crux of the mortgagee’s argument was that it was an implied term of the agreement that the property must sell for a certain amount before the $80,000 could be carved out and paid into court. To do otherwise, the mortgagee argued, would be commercially unreasonable. After all, argued the complainant: why would we agree to a deal in which it was possible that we wouldn’t receive any benefit?
Interpreting contracts: objective vs. subjective interpretations
And this is where the mortgagee got into trouble. The agreement itself was entirely silent upon whether the property had to sell for a certain sum for the $80,000 to be paid out. That being the case, the mortgagee was attempting to insert this clause after-the-fact by arguing that to do otherwise would lead to a commercially unreasonable result.
We successfully argued against this proposition and ensured that $80,000 remained in the court’s hands and ultimately available to our client. In explaining exactly why we succeeded, it’s important to understand how courts interpret contractual agreements. Generally speaking, courts interpret agreements objectively and not subjectively. This means that courts usually don’t care about how one party personally interprets a contract. If that were the case, there would be no concept of certainty or finality in contract litigation.
Instead that court will usually adopt what’s called the “reasonable bystander” test. This means that the court will interpret a disputed agreement by reading it plainly, without assuming any special knowledge. Using that prism, the court will decide what a reasonable observer would interpret the contract to mean. Clearly, using this analytical approach, it is difficult for any party to successfully argue that a contract somehow incorporates terms that were not specifically written down when the contract was negotiated.
The inevitable exception: common mistake, fraud and material change
However, it’s not impossible for a court to reach this conclusion. In some cases, a court will cancel a contract when the parties were subject to: (1) a common mistake; (2) fraud; (3) misrepresentation; or (4) a material change in circumstances after the contract was made.
That said, this is a very narrow band of exceptions and essentially covers three situations: first, where one of the parties is lying; second, where both parties have a common belief as to a certain state of affairs that does not exist (i.e. where two parties honestly contract for the sale of certain goods, only to later find that those goods were never available to be sold); or third, where an unforeseen event that was beyond that parties’ contemplation intervenes to make the contract impossible to complete.
Mistake vs. simple inadvertence
In our case, we successfully argued that none of these exceptions were applicable. This was not a case where any party was untruthful, or where there was some fact that neither party was aware of when they executed the agreement. Nor was there any “act of God” such as a hurricane that made the premise of the contract invalid. Instead, the court accepted our submission that this was simply a case where the mortgagee had made an agreement to have $80,000 carved out of the proceeds from a real property transaction without specifically turning its mind to what would happen if the property sold for lower than the mortgagee personally expected. In the end, the court’s ruling stands for the proposition that you can’t simply rewrite an agreement after the fact because the results aren’t what you expected.
The question then becomes how do you avoid this happening to you? There are a few takeaways:
Always have a lawyer when negotiating a contract – it is your best way to insulate yourself against the unforeseen.
Be sure to think critically about the negotiation: don’t simply assume that the parties are all “on the same page” or that they have the same concept of how a contract should operate in practice. If you think something is important enough to mention specifically, then specifically mention it.
Use plain language: In most basic contract disputes, a court will not entertain arguments about the one party’s subjective interpretation of language or business practice.
Walker Law's Mark Donald also contributed to this article.