A GUIDE TO CONTRACT INTERPRETATION - Reed Smith

A GUIDE TO CONTRACT INTERPRETATION

July 2014

by Vincent R. Martorana

? July 2014 Reed Smith LLP All rights reserved.

This guide is intended for an audience of attorneys and does not constitute legal advice ? please see "Scope of this Guide and Disclaimer."

TABLE OF CONTENTS

CONTENTS

PAGE

I.

INTRODUCTION .................................................................................

1

A. Purpose of this Guide ............................................................

1

B. Scope of this Guide and Disclaimer .......................................

2

C. Author Bio ......................................................................... ....

3

II. CONTRACT-INTERPRETATION FLOW CHART ..............................................

4

III. CONTRACT-INTERPRETATION PRINCIPLES AND CASE-LAW SUPPLEMENT ........

5

A. Determine the intent of the parties with respect to the

provision at issue at the time the contract was made............

5

B. Defining ambiguity ...............................................................

6

1.

A contract or provision is ambiguous if it is reasonably

susceptible to more than one interpretation .........................

6

a.

Some courts look at whether the provision is reasonably

susceptible to more than one interpretation when read by

an objective reader in the position of the parties ................

8

b.

Some courts factor in a reading of the provision "by one

who is cognizant of the customs, practices, and terminology

as generally understood by a particular trade or business"...

10

i.

Evidence of custom and practice in an industry is

admissible to define an unexplained term ................

10

ii.

When the plain meaning of a word lends itself to

only one reasonable interpretation, that

11

interpretation controls ..........................................

c.

The contract should be viewed in light of the circumstances

under which it was made ................................................

13

d.

As between two interpretations, the court will not adopt an

interpretation that produces an absurd result ....................

14

e.

Contracts should be construed in a commercially reasonable

manner ........................................................................

15

f.

A provision is not ambiguous simply because the parties

disagree as to its construction or urge alternative

interpretations .............................................................

16

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CONTENTS C.

PAGE

Assessing whether a provision is ambiguous ........................

17

1.

Whether a contract or provision is ambiguous is a

determination of law for the court to make on a claim-by-

17

claim basis ..........................................................................

2.

Parol evidence cannot be used to create an ambiguity ..........

18

3.

Principles for determining whether a provision is ambiguous

19

a.

Holistic Principles ...........................................................

19

i.

Read the contract as a whole; do not read provisions

in a vacuum ........................................................

19

ii.

Provisions and terms should not be interpreted so as

to render any provision or term superfluous or

meaningless ........................................................

21

iii. The terms of the contract should be "harmonized"

and read in context1 .............................................

23

iv. Contracts entered into contemporaneously and for

the same purpose should be read and interpreted

together .............................................................

23

b.

Canons of Construction...................................................

24

i.

Ejusdem generis ..................................................

24

ii.

Expresio unius est exclusio alterus .........................

26

iii. The specific governs over the general .....................

26

iv. The same words used in different parts of a writing

have the same meaning........................................

26

c.

Other Principles2............................................................

27

i.

In determining whether an ambiguity exists, courts

look at the language of the contract itself and the

inferences that can be drawn from that language ....... 27

1 Query whether "harmonize" means (1) to interpret a provision so as to reduce or eliminate surplusage or (2) to let other provisions (which might or might not be superfluous) guide the selection of one alternative interpretation over another. Meaning #2 is slightly broader.

2 In addition to the principles listed below, there are various additional principles (which are not addressed in this guide) that a court might employ to determine whether or not a provision is ambiguous.

ii

CONTENTS D. E.

PAGE

ii.

Preference for construing text as obligation rather

than a condition .................................................... 27

iii. When dealing with sophisticated parties, the court

gives deference to the language used .....................

28

iv. Contractual silence does not necessarily create

ambiguity, but an omission as to a material issue

can create an ambiguity .......................................

29

v.

Punctuation is always subordinate to the text and is

never allowed to create ambiguity or undermine

otherwise clear meaning .......................................

29

When a provision is unambiguous .........................................

30

1.

If the provision is unambiguous, then the court interprets

the contract as a matter of law .............................................

30

2.

If the provision is unambiguous, then the court should look

only to the text of the contract to determine the parties'

intent and parol evidence should not be used ("four-corners

rule") ...................................................................................

31

a.

If the provision is unambiguous, then the court cannot use

notions of equity and fairness to alter the contract ............

32

When a provision is ambiguous.............................................

33

1.

If the provision is ambiguous, then the parties' intent

becomes a question of fact ..................................................

33

2.

If the provision is ambiguous [or incomplete], then parol

evidence can be used to determine the intent of the parties .

34

3.

If the provision is ambiguous, then summary judgment is

not appropriate unless the parol evidence is uncontroverted

or so one-sided that no reasonable person could decide

otherwise .............................................................................

35

4.

An ambiguity is generally construed contra proferentum

(i.e., against the drafter), particularly in adhesion contracts ... 37

a.

Courts are divided as to whether the rule of contra

proferentum applies prior to or after considering parol

evidence ......................................................................

38

i.

Some courts apply the rule of contra proferentum as

one of "last resort," (i.e., only after considering

extrinsic evidence)................................................. 39

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CONTENTS F.

PAGE

ii.

Ambiguities in adhesion contracts (e.g. certificates of

incorporation, insurance contracts) should be

construed against the drafter without considering

extrinsic evidence .................................................. 40

b.

Parties can contract around the contra proferentum rule .....

42

5.

A "whereas" clause cannot create any rights arising from

beyond the contract's operative terms .................................... 42

Specific substantive and miscellaneous areas of contract

interpretation3 ......................................................................

42

1.

Arbitration ............................................................................

42

a.

There is a strong public policy in favor of arbitration, in light

of which courts should seek an interpretation that honors

the parties' decision to resolve disputes by arbitration,

permits an arbitration clause to remain in effect, and

resolves ambiguities regarding the scope of applicability of

such clause in favor of arbitration. ...................................

42

b.

An arbitrator exceeds his or her powers only if the court can

find no rational construction of the contract that can

support the award .........................................................

43

c.

Arbitration will not always be used to resolve an ambiguity

with respect to the scope of an arbitration provision. ..........

44

2.

Certificate of Incorporation ....................................................

44

a.

In the interpretation of certificates of incorporation, the

same rules of construction apply as are applicable to

contracts generally ........................................................

44

b.

When a certificate of incorporation is ambiguous, the court

looks at extrinsic evidence to determine the common

understanding of the language in controversy ....................

44

c.

Unless the extrinsic evidence resolves the ambiguity with

clarity in favor of the Preferred Stockholders, the contract

should be interpreted in the manner that is least restrictive

of electoral rights ..........................................................

46

3 Listed below are principles of contract interpretation that are specific to certain substantive areas of contracts. These principles are based solely upon the limited case law that was reviewed in connection with compiling this guide and this guide does not purport to include a complete set of all such types of contract-interpretation principles.

iv

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