Supreme Court Addresses Contractual Interpretation and Arbitral Review Standard in Sattva Capital decision

The Supreme Court of Canada recently released its decision in Sattva Capital Corp. v Creston Moly Corp., 2014 SCC 53 (Sattva), providing guidance to parties on two major topics: the correct approach to contractual interpretation, and the standard of review of commercial arbitration awards by courts.

Background

Sattva arose from a contractual dispute relating to a finder’s fee to be paid by Creston Moly to Sattva Capital. The parties agreed that under their contract Creston owed Sattva US$1.5 million, and that Sattva was entitled to be paid the value of the fee in shares of Creston. The dispute turned on the date on which the price of the Creston shares should be determined. Based on the price adopted by Creston, Sattva would receive some 9 million fewer shares than it would using the price it believed was the correct one. The arbitrator found in favour of Sattva. The B.C. Court of Appeal reversed that decision but, on appeal, the Supreme Court overruled the B.C. Court and unanimously reinstated the arbitrator’s decision.

The issues addressed by the Supreme Court can be divided into three main categories. First, the Court addressed the proper approach to contract interpretation and the relationship between the words of an agreement and the factual context in which those words should be understood. Second, the Court discussed whether the interpretation of a contract is a question of law or of mixed fact and law. Third, the Court considered the approach that should be taken by courts when reviewing decisions of commercial arbitrators.

Contract Interpretation Principles

The Court described the proper approach to contract interpretation as a "practical, common-sense approach not dominated by technical rules of construction." The overriding concern is to determine "the intent of the parties and the scope of their understanding." To achieve this objective, courts must consider both the words of the contract and the circumstances in which it was made. They "must read the contract as a whole, giving the words used their ordinary and grammatical meaning, consistent with the surrounding circumstances known to the parties at the time of formation of the contract" (para. 47).

While contract interpretation must be rooted in the words of the contract itself, the Court confirmed that an examination of the "factual matrix" should also be conducted. Evidence of surrounding circumstances can deepen the decision-maker’s understanding of those words. The Court pointed out that contracts do not take place in a vacuum; rather, they are made against a background of relevant facts which should therefore be considered by a decision-maker when interpreting the terms of a contract.

The Court further clarified that the goal of examining evidence of the surrounding circumstances is not to "overwhelm the words" of the parties’ agreement. The goal is to better understand "the mutual and objective intentions of the parties as expressed in the words of the contract" (para. 57).

The Scope of "Surrounding Circumstances"

Having confirmed that consideration of the surrounding circumstances, or factual matrix, plays a significant role in the interpretation of contracts, the next question for the Court was what legitimately falls within the scope of that term. While what constitutes "surrounding circumstances" will vary from case to case, as a general rule it includes all knowledge that both parties had or reasonably ought to have had at or before the date of the contract. However, there are limits. The factual matrix consists only of "objective evidence" of the facts the parties were aware of at the time of contracting. It does not, therefore, include the subjective intentions of the parties or evidence regarding the pre-contractual negotiations of the parties, including prior drafts of the agreement. Subject to those two limitations, the Supreme Court held that the surrounding circumstances included "absolutely anything which would have affected the way in which the language of the document would have been understood by a reasonable man" (para. 58). Thus, the Court endorsed the surrounding circumstances or factual matrix as a very broad concept which could include objective evidence of the genesis of the transaction, its commercial purpose, and the market in which the parties are operating.

Question of Law or Mixed Fact and Law

The Supreme Court resolved an issue that had troubled, and divided, appellate courts in Canada. It held, reversing the historical common law rule, that construction of a contract is a matter of mixed fact and law. That was principally because of the recognition of the significant role that surrounding circumstances play in the interpretive process and previous Supreme Court authority on the difference between questions of law and questions of mixed fact and law. The Court held that the interpretive process is not simply one of giving the words used their plain and ordinary meaning, but rather is a matter of ascertaining "the objective intent of the parties—a fact-specific goal—through the application of the legal principles of interpretation" (para. 49). In the Court’s view, that made the interpretive exercise one of mixed fact and law.

Review of an Arbitrator’s Decision—The Role of Deference

The Court provided helpful guidance on the standard of review to be applied on appeals from an arbitrator’s decision. It indicated that courts should generally take a deferential approach to an arbitrator’s decision. Courts should therefore apply a "reasonableness" standard when reviewing those decisions rather than the more stringent "correctness" standard, which would apply only if a question of law of broad importance arose (such as a constitutional question or one of central importance to the legal system as a whole). The Court noted that a question of law will rarely arise in a contract interpretation decision since the decision is typically only of interest to the parties. As a result, in most cases, arbitrators’ decisions on interpretation issues will be given considerable deference on the "reasonableness" standard of review. They will therefore only be overturned if they do not meet "the reasonableness threshold of justifiability, transparency and intelligibility" (para. 119).

Implications of the Decision

The Sattva decision affirms that contract interpretation is not a mechanical task. It involves more than simply reading the words the parties have used and giving them their plain and ordinary meaning. It also involves a consideration of the surrounding circumstances, or the factual matrix, in order to inform the court about the context in which the parties were operating and the objective facts and circumstances that were known to them at the time of contracting. While the surrounding circumstances cannot "overwhelm" the words the parties have used, they nevertheless have an important role to play in the interpretive exercise.

The holding that interpretation of contract is a question of mixed fact and law (and not purely a question of law as was previously thought to be the case) is significant for at least two reasons. First, in respect of arbitration, an arbitrator’s decision on the meaning of a contract cannot be appealed to a court on a question of law. This is important in jurisdictions such as B.C. where its Arbitration Act only permits appeals on questions of law with leave of the court. In jurisdictions such as Ontario, where the Arbitration Act, 1991 permits appeals on questions of fact or mixed fact and law if the arbitration agreement so provides, parties to an agreement which provides for arbitration to resolve disputes will need to consider whether they want the ability to appeal an arbitrator’s decision on the interpretation of their agreement to a court. If so, they must expressly provide for it. Second, in cases where a lower court has interpreted a contract, because interpretation is as a result of the Sattva decision considered to be a question of mixed fact and law, based on previous Supreme Court authority an appellate court must give that decision a high degree of deference. Under that authority, an appellate court can only overrule a lower court decision on a question of fact or of mixed fact and law if it concludes that the lower court made a "palpable and overriding error."

The Supreme Court's holding that a court should review an arbitral decision on a reasonableness standard, unless a pure question of law is involved, is also significant. It continues the trend of courts being deferential to arbitral decisions, since those decisions are made in a forum that the parties have expressly chosen to resolve disputes between them. As the Supreme Court noted, commercial arbitration is typically chosen by the parties to obtain a "fast and final resolution tailor-made for the issues" between them, and the Court’s ruling reflects a reluctance to interfere with the parties’ choice (para. 89). The Court explained that arbitrators are chosen by parties "either based on their expertise in the area which is the subject of dispute or are otherwise qualified in a manner that is acceptable to the parties" (para. 105). This means that courts will generally be deferential in reviewing an arbitrator’s decision. This has two consequences for parties to an arbitration. First, it encourages parties to place confidence in the decisions of arbitrators, since courts will likely view these decisions with a high degree of deference. Second, for parties who are seeking to have an arbitrator’s decision overturned, Sattva sets a high bar. As a practical matter, this may cause parties to carefully consider whether they want the flexibility to appeal arbitration decisions and, if so, on what grounds. If they do want that flexibility, they will need to provide for it expressly in their agreement, to the extent that the applicable arbitration statute permits them to do so.

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* With Assistance from Leora Jackson, Articling Student.