Interpreting Contracts

While great care may have been taken to ensure that a valid contract was created, problems may later arise in the interpretation of the contract as its performance unfolds. The best advice to any business person who wishes to avoid subsequent problems related to interpretation of contracts is to take special care and seek advice when making a contract. As the old maxim goes, "An ounce of prevention is worth a pound of cure." The parties to a contract should think about what is contained in the wording of the agreement as well as anything that should be included and is not.

When a court is called upon to interpret a contract, its goal is to explain the meaning of the agreement in a way that would most fairly give effect to the expectations of the two parties. More will be said about how the courts interpret contracts in the next section on defects. However, a few basic concepts will be covered in this section.

Interpretation of Express Terms

When interpreting express terms in contracts, two approaches are possible:

1. The literal or plain-meaning approach relies on the dictionary meaning of words to determine what meaning a term of a contract should bear.

2. The liberal approach determines the purposes the parties had in mind in drafting the contract (or term) and construes the words actually used in light of that purpose.

The courts usually use a balance of the two approaches, with emphasis on one or the other depending on the circumstances. In making their decisions, the courts will consider oral evidence from the parties and give the most weight to that which is corroborated or most credible. The courts also consider evidence of special usage of words in business, specific trades, and geographical regions.

The Parol Evidence Rule

The parol evidence rule does not allow a party to later add a term that was previously agreed upon orally but was not included in the written contract. (The legal definition of parol is oral or unwritten.) To do justice to the parties, however, the courts often find ways to avoid the rule, as shown by the various exceptions in Figure.

Figure 3-21: Exceptions to the Parol Evidence Rule

Implied Terms

An implied term is a term not expressly included in the contract by the parties but one that reasonable people would have included had they thought about it.

Interpretation of contracts by acknowledging the existence of implied terms is very tricky. The courts will consider a number of factors when a party wishes to have an implied term read into a contract: the intentions of both parties, the type of contract, trade customs, previous business dealings between the parties, business efficacy, and the comprehensiveness of the contract.

Since the courts may be reluctant to find implied terms in contracts, business people are encouraged to make anything that is important to them an express term of the agreement.