[co-author: Graham Cook - Student at Law]

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 parties at the relevant time, and be capable of affecting how a reasonable person would understand the language of the document. In other words, objective background facts relevant to the interpretive exercise.

Surrounding circumstances do not, however, include evidence of subjective intention. In considering the admissibility of pre-contract negotiations, the Court clarified that Sattva does not define surrounding circumstances "so broadly as to include all pre-contractual negotiations, so long as evidence of subjective intentions is excluded." Instead, "[e]vidence of pre-contract negotiations, including prior drafts, is generally inadmissible as part of the surrounding circumstances." Clarifying the meaning of subjective intention, the Court stated that "at the very least it refers to a contract party giving direct evidence at a trial or arbitration to the effect: 'I think that the phrase means X' or 'at the time we entered into the contract, I thought that the provision meant Y.'"

On the facts of the case, the Court helpfully provided examples of evidence properly falling within the scope of surrounding circumstances, along with examples of evidence falling "on the wrong side of the line between evidence of surrounding circumstances … and evidence of the parties' subjective intentions about the meaning of the phrase 'Operational Restructuring'". Falling on the right side of the line included the following evidence (as stated by the Court):

• AHS was in the process of implementing a program called "Operational Best Practices" that could have an impact on the job security of health care workers;
• AHS had publicly committed to implement the OBP without layoffs of health care workers;
• the Government of Alberta directed AHS to enter into LOUs with the relevant unions confirming no layoffs;
• AHS and its unions were meeting to confirm that the no layoff commitment would be formalized in an LOU;
• AUPE and AHS are sophisticated parties with a long history of collective bargaining and collective agreements;
• AUPE proposed an LOU to AHS on November 2, 2016, that contained the words "Operational Best Practices";
• on November 4, 2016, [United Nurses of Alberta] and AHS entered into an LOU with the words "Operational Best Practices";
• AUPE and AHS met on November 5, 2016, to negotiate an LOU; and
• the current collective agreements between AUPE and AHS are not of assistance in interpreting the LOU.

The following evidence, however, fell on the wrong side of the line (as stated by the Court):

1. AHS representatives told AUPE of their intention to limit the negotiations to the adverse job consequences arising from the OBP program;
2. AHS representatives told AUPE representatives that AHS’s mandate was limited to negotiating about the OBP program only;
3. AHS negotiators stated they did not have authority to sign the LOU and it would have to go 'upstairs' to be signed;
4. AUPE representatives told AHS that they were not prepared to limit the LOU to job protections arising from OBP-related changes because the employer controlled when it applied and the employer could rebrand its program;
5. AHS representatives acknowledged that AHS could rebrand the OBP program and call it something else;
6. After a break, AUPE representatives submitted to AHS representatives a draft LOU that included the phrase "Operational Restructuring" instead of OBP; and
7. AUPE representatives offered no explanation for the meaning of "Operational Restructuring" and AHS representatives did not ask AUPE any questions about what it meant.

By relying on evidence of the parties' subjective intentions, the arbitrator "let extrinsic evidence overwhelm the text of the agreement." In the result, he put himself in the unworkable position of deciding which party's subjective intention should prevail.

AUPE is a reminder that the Supreme Court's decision in Sattva does not give courts and commercial arbitrators free rein to consider any evidence they wish when assessing the circumstances surrounding contractual formation. Instead, they must limit such evidence to "objective background facts relevant to the interpretive exercise", and be vigilant in screening out evidence of subjective intention.