What Constitutes Surrounding Circumstances In Contractual Interpretation? The Alberta Court Of Appeal Weighs In

Pre-contract negotiations, such as prior drafts of agreements, are generally inadmissible as part of "surrounding circumstances" when interpreting a contract, and parties' subjective intentions are always inadmissible, the Alberta Court of Appeal recently confirmed in Alberta Union of Provincial Employees v Alberta Health Services, 2020 ABCA 4 [AUPE].

In AUPE, Alberta Health Services (AHS) promised that no unionized employees would lose their jobs as part of a cost savings initiative called "Operational Best Practices" (OBP). The Alberta Union of Provincial Employees (AUPE) and two other unions negotiated with AHS to formalize the promise. AUPE and AHS signed a letter of understanding (LOU) in which AHS agreed not to layoff members of AUPE unions during "Operational Restructuring". This language diverged from LOUs with the other unions in which AHS promised only that no unionized employees would lose their jobs as a direct result of the OBP initiative.

Shortly after signing the LOU, AHS laid off several AUPE employees in a decision unrelated to the OBP initiative. The parties disagreed on whether the term Operational Restructuring was synonymous with the OBP initiative or if the divergent language extended the LOU to layoffs unrelated to the OBP program. AUPE and AHS referred the dispute to an arbitrator who concluded that the parties intended the LOU to apply only to layoffs directly connected to the OBP initiative.

On appeal, the Court of Appeal quashed the arbitrator's award and referred the dispute back to the parties for further action. The Court focused on whether the arbitrator reasonably applied the law of surrounding circumstances in contractual interpretation, as set out by the Supreme Court of Canada in Sattva Capital Corporation v Creston Moly Corporation, 2014 SCC 53 [Sattva]. While the arbitrator was right to consider the circumstances surrounding contract formation, the Court held that he ultimately went too far and relied on evidence of subjective intentions to determine the meaning of the term "Operational Restructuring", resulting in an unreasonable decision.

In arriving at this conclusion, the Court of Appeal confirmed that the principles of contractual interpretation from Sattva require courts and commercial arbitrators to consider the surrounding circumstances known by the parties at the time of contracting, which consist of:

… background facts which would likely be uncontroversial to the parties, be known to both...