Ontario Court of Appeal Reaffirms Importance of Objective, Contextual Contractual Interpretation

In Project Freeway Inc. v. ABC Technologies Inc. (Project Freeway), the Court of Appeal for Ontario reaffirmed the importance of objective, contextual contractual interpretation when faced with ambiguous wording. Courts will continue to prefer contractual interpretation that best reveals the objective intent of the parties at the time of contracting, including admitting evidence of pre-contractual negotiations where applicable, and that avoids commercial absurdities.

Background

Project Freeway Inc. (Project Freeway) was incorporated to sell the shares of an automotive parts business to ABC Technologies Inc. (ABC) for C$225-million cash consideration, plus the potential for C$40-million in earn-outs to be paid over three years if the acquired business hit certain performance targets. The earn-out clause in the share purchase agreement (SPA) contained a trigger that accelerated the payment of the entire earn-out amount in certain circumstances, including where ABC “directly or indirectly sells, transfers or licences a material portion of the assets of the Business of the Target Companies…to any Person other than an Affiliate of [ABC]” without Project Freeway’s consent.

Post-closing, ABC entered into sale and leaseback (SLB) transactions for the acquired business’s real property, receiving C$120-million, and sold the business’s receivables through a set of factoring agreements, all without Project Freeway’s consent.

Decisions

Project Freeway made an application before the Ontario Superior Court of Justice for an order that payment of the full earn-out amount was triggered by the SLB transactions and/or the factoring transactions. It argued that the word “material” in the SPA referred to the magnitude or dollar value of the assets sold, and that the SLB and factoring transactions therefore constituted a sale of a “material portion of the assets of the Business.”

ABC, on the other hand, argued for a purposive interpretation of “material” requiring that the transactions had to be material to the earn-out itself — in other words, they had to affect Project Freeway’s entitlement to the earn-out for the accelerated payment to be triggered.

The application judge preferred ABC’s interpretation and dismissed the application. The Court held that the word “material” was ambiguous in the circumstances, and applied the framework set down by the Supreme Court of Canada in Sattva Capital Corp. v. Creston Moly Corp. (Sattva) to interpret the provision having regard to the factual matrix at the time of contracting. The factual matrix included, among other things, Project Freeway’s pre-contractual knowledge of ABC’s history of using SLBs and the terms of a non-binding letter of intent (LOI) signed before the SPA. The Court rejected Project Freeway’s argument that an entire agreement clause in the SPA precluded recourse to the LOI as part of the factual matrix.

The Court further held that interpreting “material” as “material to the operation of the earn-out” accorded with the intent of the contract as a whole. It also prevented a commercially absurd result, which would have given Freeway a windfall of C$40-million despite the business falling far short of earnout targets over the prescribed time periods. The Court found that the SLBs and factoring arrangements were ordinary course financing transactions that had no impact on the business’s ability to meet the earn-out targets.

The Court of Appeal unanimously dismissed Project Freeway’s appeal from the bench. It found no error in the application judge’s consideration of the LOI and affirmed that recourse to pre-contractual evidence as part of the factual matrix is not precluded by an entire agreement clause. Importantly, the LOI was not used by the application judge to modify the words of the contract, but rather to assist in understanding the parties’ intent at the time of contracting.

Key Takeaways

Project Freeway reinforces several well-established principles of contract interpretation:

1. Sattva continues to be the leading framework for contract interpretation. Objective evidence of the surrounding circumstances at the time of contracting — the factual matrix — is admissible for the purpose of contract interpretation. To minimize the risk of disputes and potential court intervention, parties should use clear and well-defined language throughout their contract that also aligns with the parties’ objective intentions at the time of contracting.
2. Entire agreement clauses do not preclude consideration of pre-contractual negotiations as part of the factual matrix.Project Freeway continues an existing line of appellate cases confirming that pre-contracting documents, like the LOI, are admissible factual matrix evidence even when the contract includes an entire agreement clause (see, for example, Ontario First Nations (2008) Limited Partnership v. Ontario Lottery and Gaming Corporation, 2021 ONCA 592 and IFP Technologies (Canada) v. EnCana Midstream and Marketing, 2017 ABCA 157). If parties are concerned about potential reliance on pre-contractual negotiation evidence, they should ensure that the contract is clearly worded to reflect their intent, particularly if their position has changed during negotiations.
3. Ambiguous wording will be interpreted in consideration of the contract as a whole and given a commercially reasonable meaning (no windfalls). Where a provision is capable of more than one meaning, courts will prefer the interpretation that fits with other provisions of the contract, aligns with the contract’s purpose and is commercially reasonable. In Project Freeway, other provisions of the SPA allowed ABC to move, close or consolidate manufacturing facilities without the seller’s consent, provided they did not impact the business’s ability to meet the earn-out targets; Project Freeway’s position was inconsistent with this provision. Parties intending to incorporate terms not reflecting standard market practices or commercial expectations should ensure they are unambiguously worded.
4. Appellate intervention on matters of contract interpretation is limited. Sattva affirmed that deference is owed to first-instance decision-makers on matters of contractual interpretation. Parties will not be permitted to reargue their case on appeal unless they have identified an extricable error of law or a palpable and overriding error of fact in the first instance decision.

Blakes represented the successful party, ABC, at both the Ontario Superior Court and the Court of Appeal.

For more information, please contact the authors or any other member of our Litigation & Dispute Resolution group.