Don't Bet the Business

As part of lawsuits involving contracts, courts are often called upon to tell the parties what their contracts actually say and mean, odd as that may sound. 

This occurs when a contract term or phrase that seemed clear when the deal was struck, appears anything but when litigants later disagree as to their respective rights and obligations.

In a contract dispute, the court’s principal role is to identify and give effect to the parties’ intention when the contract was made. Generally, the contract language is viewed as the best indication of the parties' intent. This assumption, of course, has its limits.

When interpreting a contract, the court’s first step is to determine if it is unambiguous. When the contract language is clear, the court’s role is simple and limited. Interpretation of an unambiguous contract begins and ends with the actual words the parties used. Parol evidence – which is any evidence pertaining to the contract not included among the written terms – is inadmissible to prove an intent different than what was expressly stated.

When interpreting and enforcing an unambiguous contract, except in very limited circumstances, the courts are legally precluded from modifying or rewriting the agreement to fit their sense of what is fair or reasonable. To do so invades the parties’ freedom to contractually allocate their respective risks, rights and responsibilities. 

Not surprisingly, whether a contract is ambiguous is fertile ground for litigation. However, the law is well settled that merely because parties dispute what their contract means does not render it ambiguous. A contract is ambiguous when two provisions conflict or when a term is reasonably susceptible to more than one meaning. 

Contracts can be patently or latently ambiguous. A patent ambiguity exists if the uncertainty arises on the face of the contract from the use of defective, obscure or insensible language.

A latent ambiguity arises not on the words used but rather how those words apply to the object or to the subject they describe. Put another way, a contract is latently ambiguous when a facially clear term cannot be applied without requiring a choice the outcome of which is not specified in the agreement. 

Whether either type of ambiguity exists is a threshold legal matter for the court to decide.

When an ambiguity is found the court’s task turns to identifying and enforcing the parties’ intent when the contract was made. In doing so, courts should examine the circumstances surrounding the making of the contract as well as its stated or apparent purpose.  While this may help to identify what the parties intended to do, courts also will want to examine available extrinsic evidence to buttress a conclusion the contractual context suggests.

Extrinsic evidence, also called parol evidence, is admissible to aid the court in resolving an ambiguity.  Extrinsic evidence is anything outside of the four corners of the contract, including what the parties previously said or did.  For example, courts typically examine how the parties performed prior to the dispute as this often is considered persuasive evidence of their intention from the start. Where applicable, courts also may look to how the parties previously have acted in their earlier dealings.

If the contract pertains to a specific market or industry, courts may also rely on recognized industry practices or interpretations. Industry specific terms are routinely viewed as persuasive evidence of what the parties meant when including such terms their contract.

When interpreting ambiguous contracts, courts are cautious to limit the use of extrinsic evidence to resolving the ambiguity. By law, consideration of extrinsic evidence is not an opportunity for the parties, or the court, to rewrite or modify the contract under the guise of construction.

In addition to looking at the attending circumstances and extrinsic evidence, courts also resort to traditional rules of contract construction to resolve ambiguities. These rules include reading and construing the contract as a whole.

Courts also strive to give purpose to each word used and to avoid any construction that requires ignoring portions of the writing or rendering them superfluous. Words and phrases are to be given their plain and ordinary meaning and strained constructions are avoided. 

Courts may also examine how the words or phrases are structured. For example, specific terms typically control over more general terms. The same words used in different sections of an ambiguous contract will tend to be given the same meaning. Courts may test how items are grouped or listed. 

Similarly, whether items have been intentionally included or excluded may signal that similar items should be treated the same. Handwritten terms may control over conflicting typed provisions.  The courts may also resort to grammatical rules if doing so helps to identify the parties’ intention.

When all else fails, the courts may resort to the doctrine of contra proferentem, which is a rule of last resort requiring that an ambiguous agreement is construed against its drafter.

This is but a partial treatment of how courts resolve ambiguous contracts. Care should be taken in the individual case because unique rules may also apply to specific types of contracts, including those for insurance, real property, sales of goods, trusts and estates, arbitration, and a host of others.