Contract Interpretation

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contract law

Generally speaking, contracts may be written or oral, although there are  exceptions requiring that some contracts be in writing to be enforceable. Of course, parties who enter into any contract would be well advised to put their agreement in writing.  The reason, of course, is that memories fade, and even at a point in time close to the making of a contract, the parties may disagree on what the terms of the contract are.

Theoretically, a written contract will avoid such problems, and the parties will know from their writing what exactly their agreement is. It is surprising, therefore, how many cases the courts have had to deal with in which the parties disagree on what the terms of the document they have signed mean and, therefore, what exactly their agreement is. In those situations, the courts are faced with the task of interpreting the parties’ contract, and this article discusses the rules of interpretation courts employ in doing so.  

  1. Giving Effect to the Parties’ Intention.  

All of the rules of interpretation are applied for the purpose and with the goal of determining the parties’ intention. The parties’ intention may be determined solely from the words they have used, or the court may need to consider the context of the document as a whole in order to ferret out the parties’ intention. The court may also consider all of the surrounding circumstances in an effort to determine the meaning the parties gave to the terms they used.  

  1. The Plain Meaning of the Contract Terms.   

If the language of the contract is clear and unambiguous, the courts will interpret that language according to its clear meaning. The determination of the clear meaning of the words used is a question of law for the court, and not a question of fact for the jury.  

  1. The Use of Extrinsic Evidence.  

Even if it appears that the wording used by the parties is clear and unambiguous and can mean only one thing, the court’s first task in considering the meaning of contract terms is to consider any extraneous evidence offered by a party that would give the meaning of the words used something other than what appears to be their clear meaning. If, for instance, a different meaning than what appears to be unambiguous language is given to that language by those engaged in a particular trade or industry, the court will consider extrinsic evidence of such different meaning. In doing so, the court will first consider whether or not the language of the contract is “reasonably susceptible” to the interpretation asserted by one of the parties.

In one case, as an example, the insurance policy in question used the word “suit”. One of the parties asserted that that word not only meant “lawsuit,” but also included pre-complaint notices. The court determined that the word “suit” was not reasonably susceptible to such meaning.  

  1. Limitations on the Use of Extrinsic Evidence.  

Although the first step a court must take in determining the meaning of a contract is to consider extrinsic evidence offered by one or both of the parties, there is a limit on the use to which extrinsic evidence may be put. Extrinsic evidence is not admissible to add to, detract from or vary the terms of a written contract. The “parol evidence rule” prohibits the admission of any such evidence. The reason for that is that the rules of interpretation may only be applied to explain the meaning of the contract, and not to change the terms of the contract.

As an example, in one case, a party sought to use parol (meaning “oral”) evidence to interpret a contract’s termination provision. The plain language of the contract said that the employee could be terminated at will. The employee sought to have the court consider a discussion between the employee and employer, in which the employer supposedly said that the employee would continue to be employed so long as he did a good job.  However, a requirement that the employee could only be terminated for good cause was directly contrary to the plain language of the contract, which stated the employee’s employment was “at will.” Consequently, the employee’s proffered evidence of an oral agreement with the employer was not admissible.  

  1. 5.  Extrinsic Evidence the Contract Does Not Express the Parties’ Intention.  

Extrinsic evidence may be admitted to show that the written document does not express the real agreement between the parties. The reason extrinsic evidence is admissible for that purpose is that that evidence does not purport to add to, detract from or change the parties’ contract; rather, the purpose is to show that the document does not express the parties’ agreement. As an example, if the intent of the parties was that the terms of the written document be effective only in the event a condition precedent was fulfilled, and the condition precedent was not fulfilled, then there would be no contract between the parties.  

  1. The Parties’ Construction of the Contract.  

The court may consider evidence of the parties’ words or actions indicating what they understood the terms of the contract to mean. This rule of construction applies, however, only if the words or actions of the parties occurred before a dispute arose as to what the contract meant.  

  1. Contract Terms Interpreted in Their Ordinary Sense.

In interpreting the meaning of contract terms, the court will first presume that the words used were meant in their ordinary sense. The burden is then on the parties to present evidence to the court that one or more contract terms was not in fact meant in its ordinary sense. Evidence of an other-than-usual meaning for contract terms is typically limited to situations in which both parties are engaged in a trade or industry in which a different meaning than the ordinary meaning is applied to particular contract terms. In one example, the court ruled that “gross receipts” in an author’s royalty contract meant not only money, but also the value of other consideration received. The court so ruled because that was what “gross receipts” meant according to custom and usage in the entertainment industry.

However, if one of the parties is not engaged in the particular trade or industry in question, the court will not presume that he or she understood the term as it was understood by the other party. That is because, in that situation, there is no basis for determining that the first party understood the term in a different way than its usual meaning.  

  1.   The Use of Implied Terms.  If it appears that the parties have entered into a contract, but one or more necessary provisions have not been included, the court may imply a provision necessary to effectuate the intention of the parties. As an example, if the parties agree that the seller will sell his car to the buyer for $5000 and the buyer agrees to purchase the seller’s car for $5000, but no reference is made as to when payment and delivery of the car will take place, the court may imply a term providing that that will occur within a “reasonable time.”

However, the courts are typically loathe to imply terms, because doing so can be viewed as interfering with the rights of the parties to determine what their contract will be. In order for a court to imply terms, the terms employed must be necessary in order to effectuate the parties’ intention. Nor will the court imply terms if the subject is completely covered by an express provision in the contract. That is because, in that instance, the implied term would add to, detract from or vary the express provision.  

  1. The Implied Covenant of Good Faith and Fair Dealing.  

Regardless of the courts’ reticence to imply terms in a contract, the law is clear that every contract contains an implied covenant of good faith and fair dealing. This implied covenant is an agreement that the parties will not do anything which would deprive the other party of the benefit of his or her bargain. This implied covenant is also a covenant that the parties will do everything the contract presupposes they will do in order to accomplish the purpose of the contract.  

  1. The Entire Contract Must be Given Effect.

The meaning of particular contract terms must be ascertained from a consideration of the entire contract. What is the purpose and the goal of the contract viewed in its entirety? Understanding that purpose and goal will assist the court in determining the meaning of individual contract terms in the event they are  ambiguous.  

  1. Specific Words Give Meaning to General Words.  

Oftentimes, specific terms in a contract are followed by general words. In such a case, it is clear what the specific words mean, but not so clear what the general words mean, at least on their face. In such a situation, the general words are interpreted to include only things that are of a like nature with the specific words used.

In one case, the court was called upon to interpret the meaning of an agreement to arbitrate disputes regarding “fees, costs, or any other aspect of the parties’ relationship.” The words “fees,” and “costs” were specific terms that were clearly understandable, and there was no dispute between the parties as to what they meant. However, the term “any other aspect of the parties’ relationship” was a general term which had to be interpreted. The court ruled that that phrase meant financial matters similar to disputes concerning fees and costs were to be arbitrated, but the provision did not require arbitration of other claimed breaches of the contract.  

  1. Interpreting Terms Against the Party Who Drafted Them.  

One rule of interpretation is that if there is an ambiguity in a particular contract term, and the parties disagree as to its meaning, the contract provision is to be construed against the party who drafted that provision. This rule applies only if the other rules of interpretation discussed above do not remove any and all uncertainty.   

  1. Multiple Contracts Must be Considered Together.   

In some instances, parties enter into multiple contracts concerning the same or similar subjects, and do so at around the same time. In that instance, all the documents will be considered one contract, for purposes of determining the meaning of provisions in any one or more of the documents.  In like manner, the incorporation of one contract into another will result in a consideration of the purpose and meaning of both documents as if they constituted one contract, in determining the parties’ intentions and the meaning of particular contract provisions.

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The Law Office of William J. Tucker is familiar with contract principles, and provides free initial phone consultations to individuals and companies who have issues, concerns or questions about these subjects.  Feel free to Schedule an Appointment.