Contract Interpretation

Whose Meaning Prevails?

Where the parties attach the same meaning to the terms used in their agreement, the interpretation of the agreement should be in accord with that meaning even if a third party might interpret the language differently. (Rest.2d §201(1).)

Whatever an objective observer might think, if the contracting parties attach different meanings to the same term, then neither is bound by the understanding of the other unless one of them knew or had reason to know what the other understood the disputed term to mean. (Rest.2d §201(2).)

In the case of Raffles v. Wichelhaus (1864) 159 Eng.Rep. 375, the seller agreed to sell cotton to the buyer. Shipment was to made from Bombay on the ship named Peerless. However, there were two ships named "Peerless." One was to sail in October and the other in December. Defendants intended to accept the cotton on the ship that sailed in October and refused to accept the cotton on the ship that sailed in December. It was held by the court that there was no binding or enforceable contract. The rule of the Peerless case is that no contract arises unless both parties have the same meaning in mind. I.e., there must be agreement on the same thing. (Rest.2d §20).

General Rules of Contract Interpretation

Meaning of Contract Ascertained From 4 Corners of Instrument Where contract language is clear and explicit and does not lead to an absurd result, a court will ascertain contractual intent from the written provisions of the contract itself and go no further. (Cal.Civ. Code §§ 1638, 1639.)

Contract Construed Most Strictly Against Drafter Any ambiguities caused by the drafter of the contract must be resolved against the drafter or the party employing him or her. ( Cal.Civ.Code §1654; United States v. Seckinger, 397 U.S. 203 (1970)).

Words Used Given Their Ordinary Meaning The words of a contract generally are to be understood in their ordinary and popular sense unless the parties use them in a technical sense or a special meaning is given to them by usage. (Cal.Civ.Code § 1644.)

"Usage of Trade" (See, UCC 1-303 ) Technical words in a contract must "be interpreted as usually understood by persons in the profession or business to which they relate, unless clearly used in a different sense." ( Cal.Civ. Code §1645).

Omitted Terms

What happens when the parties omit a term from their contract? Rest.2d § 204 provides that when the parties omit a term from their contract which is essential to the determination of their rights the court will supply a term which is reasonable. If the contract is for the sale of goods Article 2 of the UCC provides for a number of statutory terms to be used to fill gaps in the contract when missing terms cannot be supplied through resort to course of performance, course of dealing or usage of trade. By setting forth statutory terms, the Code supplies the commonly accepted term on the matter and prevents the contract from failing for lack of a reasonable basis for enforcement. In case of conflict statutory terms are subordinated in rank to course of performance, course of dealing, and usage of trade.

Parol Evidence Rule

Where the parties have reduced their agreement to final written form, evidence of prior or contemporaneous agreements is inadmissible to vary or contradict the terms of the final written agreement. ( Cal.Code.Civ.Proc. § 1856(a), see also Rest.2d § 213 Cal.Civ.Code § 1625 & UCC 2-202) The thrust of the parol evidence rule is that if the court finds the writing to have been intended as a complete and exclusive statement of the terms of the parties' agreement, then the writing alone constitutes the contract and evidence of prior negotiations or "side agreements" will not be resorted to in interpreting the final written agreement.

When the parties to a written contract have agreed to it as an "integration"--a complete and final embodiment of the terms of an agreement-- parol evidence cannot be used to add to or vary its terms. 

The crucial issue in determining whether there has been an integration is whether the parties intended their writing to serve as the exclusive embodiment of their agreement. Proof of a collateral oral agreement (which would show that the agreement is not integrated) is admissible if it is such an agreement as might naturally have been made a separate agreement under the circumstances. (Masterson v. Sine, 68 Cal.2d 222, 436 P.2d 561 (1968).)  

When only part of the agreement is integrated, the same rule applies to that part, but parol evidence may be used to prove elements of the agreement not reduced to writing.

Exceptions to the Rule  A written contract may be conditioned on an oral agreement that the contract shall not become binding until some condition precedent resting in oral or extrinsic evidence shall have been performed. (Burke v. Dulaney, 153 U.S. 228, 14 S.Ct. 816, 38 L.Ed. 698 (1894)

The Plain Meaning Rule

The plain meaning rule states that if a writing, or the term in question, appears to be plain and unambiguous on its face, its meaning must be determined from the four corners of the instrument without resort to extrinsic evidence. Both Professor Corbin and the Restatement Second have rejected the plain meaning rule. Corbin says that all relevant extrinsic evidence is admissible on the issue of meaning including evidence of subjective intention and what the parties said to each other with respect to meaning. (See Rest.2d § 214(c).) This is true even if there is an integration and there is no ambiguity. However, the trial judge must initially decide whether the asserted meaning is one to which the language taken in context, is reasonably susceptible in the light of all the evidence. If it is not then that asserted meaning may not be attached to the language in question. (See Rest.2d §§ 210 and 215.)

When parties set down their agreement in a clear, complete document, their writing, should as a rule be enforced according to its terms. (W.W.W. Associates, Inc. v. Giancontieri, 77 N.Y.2d 157, 566 N.E.2d 639 (1990).) The test of admissibility of extrinsic evidence to explain the meaning of a written instrument is not whether it appears to the court to be plain and unambiguous on its face, but whether the offered evidence is relevant to prove a meaning to which the language of the instrument is reasonably susceptible. ( PG&E v. G.W. Thomas Drayage & Rigging Co., 69 Cal.2d 33, 442 P.2d 641 (1968).)

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© 2015 by and Craig A. Smith