This decision is helpful for saying when you may use background evidence to help interpret a contract.
Here, the taxpayers were farmers who supplied the Pharmaceutical company Wyeth Organics with estrogen from pregnant mares. Wyeth paid the farmers several different amounts to cancel the supply contracts. The CRA said that one of these amounts was a substitute or “surrogate” for annual revenue so that the taxpayers should include the full amount in income for the year. But the judge agreed with the taxpayers that the amounts were capital payments to compensate the farmers for the fact that “Without that source of revenue, the [horse] herds and the equipment used in the PMU operations became worthless as capital assets.” (Para. 62.)
Justice Hogan allowed the Appellants to give oral and documentary evidence about the background to the cancellation payments to help show that the purpose of the payments was to compensate for lost capital. After a helpful review of the cases in this area of evidence law (paras. 35, 38 and 42-44), the judge said:
“the evidence led by the appellants and discussed above is admissible because it pertains to the factual matrix or circumstances surrounding the Releases and/or because the FHH Payment clauses are ambiguous in light of the inconsistencies noted earlier.” (Para. 59)
From Hogan J.’s case review, the principle seems this: You can offer background evidence about a contract and the Court will consider it. Before relying on background evidence, the Court will look at the terms of the contract. If the contract seems clear, the judge may not need the background evidence and may ignore it. But background evidence is probably always helpful and admissible for understanding a contract’s terms. The background evidence could include “‘the subsequent actions of the parties”. (Para. 52.)
Although some of the cases Hogan J. quoted suggest that the Court should only look at the background evidence if there is an ambiguity in the contract, it can’t be hard for a judge who finds the evidence is helpful also to find that the contract is ambiguous as far as the significance of its terms for taxes.
Justice Hogan quotes an Ontario Court of Appeal case for the general principles for interpreting a contract. These are helpful guides to have:
“. . . Broadly stated . . . a commercial contract is to be interpreted,
“(a) as a whole, in a manner that gives meaning to all of its terms and avoids an interpretation that would render one or more of its terms ineffective;
“(b) by determining the intention of the parties in accordance with the language they have used in the written document and based upon the “cardinal presumption” that they have intended what they have said;
“(c) with regard to objective evidence of the factual matrix underlying the negotiation of the contract, but without reference to the subjective intention of the parties; and (to the extent there is any ambiguity in the contract),
“(d) in a fashion that accords with sound commercial principles and good business sense, and that avoid a commercial absurdity.” (Para. 35, Hogan’s underlining.)