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Study Guide to accompany Canadian Business and the Law, 5th edition Chapter 7

© 2014 Nelson Education Limited 110

CHAPTER 7

THE TERMS OF A CONTRACT

Objectives After studying this chapter, you should have an understanding of • the difference between implied and express terms • how judges determine and interpret the content of a contract • how a party can use terms as a business tool to protect itself from liability

Learning Outcomes • Understand the difference between express and implied terms of a contract (pages 142–144) • Understand how courts interpret written contracts, especially when the parties’ intentions

are not clearly expressed or the contract contains ambiguous language (pages 145–148) • Recognize how parties enumerate conditions in contracts that allow them to escape from

their obligations if those conditions occur (page 152) • Understand how a stronger party may reduce or eliminate any obligation to pay a damage

claim by including exemption clauses in a contract (page 155) • Recognize that consumers are bound by electronic standard form contracts even when

they had no power to negotiate better terms (page 150)

Chapter Summary The nature, scope, and extent of the obligations of the parties to a contract are known as the terms of the contract. The terms may be express, as when they have been specifically mentioned and agreed on by the parties, or they may be implied. Since the court has considerable discretion to imply a term or not, parties are best advised to make their agreement as clear and explicit as possible. How courts will resolve a contractual dispute over terms is an open question, as is any matter that proceeds to litigation. An important evidential rule that guides a judge is known as the parol evidence rule. It prevents the introduction of evidence that varies or adds to the terms of a written contract when the contract is clear and intended to be the sole source of the parties’ obligations. Entire contract clauses are used to propel a court to apply the parol evidence rule in any given case. An important planning function of contract law lies in the fact that it permits parties to manage the risk of future uncertainties. Additionally, it permits them to establish, in advance, the extent of responsibility for breach through limitation clauses and exemption clauses. Furthermore, parties can bargain for what will be payable in the event of breach. Such a term will be enforceable, provided the amount is a genuine pre-estimate of damages and not a penalty. Courts may refuse to apply a clause that disadvantages a consumer if the business in question failed to take reasonable steps to ensure that the consumer was alerted to the clause in question in circumstances where it appears the consumer has not assented. Courts are less likely to assist the commercial or industrial customer, however, on the basis that sophisticated business interests should be left to take care of themselves.



Study Outline Use this outline to prepare a complete set of notes for this chapter.

Terms—page 142

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Express Terms __________________________________________________________

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Judicial Interpretation of Express Terms—page 142

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How Courts Interpret Contracts ____________________________________________

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Rules of construction _________________________________________________

Enforce plain meaning of words______________________________________

Give effect to parties’ intention ______________________________________

Implied Terms __________________________________________________________

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Business efficacy ____________________________________________________

Customs in the trade of the transaction____________________________________

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Previous dealings between the parties ____________________________________

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Statutory requirements ________________________________________________

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Sale of Goods Act _________________________________________________

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Entire Contract Clause ___________________________________________________

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Contractual Quantum Meruit ______________________________________________

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The Parol Evidence Rule—page 148_______________________________________

Evidence of Electronic Contracts ___________________________________________

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Using Contractual Terms to Manage Risk—page 151

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Changed Circumstances __________________________________________________

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Conditional Agreements __________________________________________________

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Conditions subsequent ________________________________________________

Conditions precedent _________________________________________________

Limitation of Liability Clause______________________________________________

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Exemption Clause _______________________________________________________

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Liquidated Damages Clause _______________________________________________

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Electronic Standard Form Contracts—page 156

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Shrink-Wrap Agreements _________________________________________________

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Question of enforceability______________________________________________

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Click-Wrap Agreements __________________________________________________

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Browse-Wrap Agreements ________________________________________________

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SELF-ASSESSMENT

Key Terms Briefly define each term in the space provided.

Express term—page 142

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Rules of construction—page 143

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Implied term—page 144

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Entire contract clause—page 148

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Contractual quantum meruit—page 148

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Parol evidence rule—page 148

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Condition subsequent—page 153

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Condition precedent—page 153

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Limitation of liability clause—page 155

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Exemption clause—page 155

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Liquidated damages clause—page 158

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Matching Match each term to its definition below by writing the correct letter in the space provided.

A Condition precedent B Condition subsequent C Entire contract clause D Exemption clause E Express term F Contractual quantum meruit G Implied term H Limitation of liability clause I Liquidated damages clause J Parol evidence rule

1. ____ A provision of a contract that states one party’s promise to another.

2. ____ A clause that is not in a contract but is necessary to give effect to the parties’

intention.

3. ____ Awarding one party a reasonable sum for the goods or services provided under a

contract.

4. ____ A restriction on evidence that changes the terms of a written contract.

5. ____ A term in a contract in which the parties agree that their contract is complete as

written.

6. ____ An event that brings a contract to an end if it occurs.

7. ____ An event that suspends obligations under a contract until it occurs.

8. ____ A term that limits a damage claim.

9. ____ A term that excludes any damage claims.

10. ____ A term that pre-sets a damage claim.



Questions Write a short, point-form answer for each question in the space provided. To help you understand the chapter, it is recommended that you also use additional paper to write a full and complete essay answer for each question. 1. What is meant by the terms of a contract?

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______________________________________________________________________ 2. Why is it important to include terms in a contract that deal with price, quantity, and

warranties associated with a product?

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______________________________________________________________________ 3. Explain how rules of construction used by courts to interpret contracts are often

conflicting.

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______________________________________________________________________ 4. Does writing a term into a contract reduce all risk with respect to understanding the

term? Explain.

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______________________________________________________________________ 5. How does a court address vague or ambiguous terms?

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6. What rule governs if one party has drafted a contract and used vague or ambiguous language? What is the rationale for the rule?

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______________________________________________________________________ 7. What is the legal result if contract language is so ambiguous that it cannot be

understood?

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______________________________________________________________________ 8. What does the law require of contractual parties with respect to good faith?

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______________________________________________________________________ 9. When will the courts imply a term in a contract?

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______________________________________________________________________ 10. What is implied by either common law or applicable legislation with respect to the sale

of goods and services?

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______________________________________________________________________ 11. What is an entire contract clause?

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12. What was the legal conclusion of the Corey Developments Inc v Eastbridge Developments (Waterloo) decision?

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______________________________________________________________________ 13. Identify the three forms that contracts can take. Does form affect enforceability?

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______________________________________________________________________ 14. Explain the parol evidence rule and its exceptions.

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______________________________________________________________________ 15. What happens to contractual obligations if a disaster strikes?

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______________________________________________________________________ 16. Identify three ways that a party can deal with the risk of a change in the price of a good

over the life of a contract.

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______________________________________________________________________ 17. What is a risk of building flexibility into a contract?

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18. Explain why conditional agreements are essential. What effect does using conditions subsequent and conditions precedent have on a contract?

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______________________________________________________________________ 19. In what instances are real estate agreements based on a condition?

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______________________________________________________________________ 20. What liability results when a party fails to meet its contractual obligations?

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______________________________________________________________________ 21. What is the purpose of a limitation of liability clause?

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______________________________________________________________________ 22. What classic legal test is stated in Hadley v Baxendale (1854), 9 ExCh 341?

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______________________________________________________________________ 23. What is the purpose of an exemption clause?

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24. What clause facilitates consensus and choice in contracts in relation to remedies for breach of contract?

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______________________________________________________________________ 25. What type of clause could cause a court to set aside a term in a standard form contract?

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______________________________________________________________________ 26. What did Abrams v Sprott Securities Ltd (2003), 67 OR (3d) 368 (CA) distinguish in the

Fraser Jewellers case?

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______________________________________________________________________ 27. What is a shrink-wrap agreement and what is its legal status in Canada?

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______________________________________________________________________ 28. What is a click-wrap agreement and what is its legal status in Canada?

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______________________________________________________________________ 29. Identify the controversy regarding the enforceability of browse-wrap agreements and

explain how such controversy can be avoided.

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30. When is a liquidated damages clause enforceable?

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ANSWERS

Key Terms Express term—page 142 A provision of a contract that states a promise explicitly. Rules of construction—page 143 Guiding principles for interpreting or “constructing” the terms of a contract. Implied term—page 144 A provision that is not expressly included in a contract but that is necessary to give effect to the parties’ intention. Entire contract clause—page 148 A term in a contract in which the parties agree that their contract is complete as written. Contractual quantum meruit—page 148 Awarding one party a reasonable sum for the goods or services provided under a contract. Parol evidence rule—page 148 A rule that limits the evidence a party can introduce concerning the contents of the contract. Condition subsequent—page 153 An event or a condition that, when it occurs, brings an existing contract to an end. Condition precedent—page 153 An event or a condition that, until it occurs, suspends the parties’ obligation to perform their contractual obligations. Limitation of liability clause—page 155 A term of a contract that limits liability for breach to something less than would otherwise be recoverable. Exemption clause—page 155 A term of a contract that identifies events causing loss for which there is no liability. Liquidated damages clause—page 158 A term of a contract that specifies how much one party must pay the other in the event of breach. Matching 1. E—page 142 2. G—page 144 3. F—page 148 4. J—page 148 5. C—page 148 6. B—page 153 7. A—page 153 8. H—page 155 9. D—page 155 10. I—page 158



Questions 1. What is meant by the terms of a contract? Page 142: The terms of a contract are the promises made by one party to another by virtue of offer and acceptance. 2. Why is it important to include terms in a contract that deal with price, quantity, and

warranties associated with a product? Page 142: It is important that the essential terms of a contract be express so that each party knows its obligations and the obligations of the other side. Parties negotiating a contract should be very careful not to make assumptions about any aspect of the transaction as only terms, not assumptions, have legal weight. 3. Explain how rules of construction used by courts to interpret contracts are often

conflicting. Page 143: General principles that courts use to interpret contracts are often conflicting. For example, courts are required to rely on the ordinary meaning of words to enforce a contract as it is written, based on how a reasonable person would interpret the words. However, courts also try to give effect to the parties’ intentions that may not be expressed in the words of the contract. In any given case, it is impossible to predict which rule the court will use when application of both rules would lead to different conclusions. 4. Does writing a term into a contract reduce all risk with respect to understanding the

term? Explain. Page 142: No. Even express terms in a contract may use language that is ambiguous or vague, making interpretation difficult. 5. How does a court address vague or ambiguous terms? Page 142: Assuming the existence of the contract is not in doubt, a court will assign as reasonable a meaning as possible to vague or ambiguous terms. 6. What rule governs if one party has drafted a contract and used vague or ambiguous

language? What is the rationale for the rule? Page 142: If the contract has been drafted by one party, any ambiguity in language will be construed against the drafting party in favour of the other party. The rationale for the rule is that the drafter should bear the risk of unclear language. 7. What is the legal result if contract language is so ambiguous that it cannot be

understood? Page 143: The contract will fail for uncertainty, and none of the promises it contains will be enforceable. 8. What does the law require of contractual parties with respect to good faith? Page 145: The law requires that parties to a contract exercise their rights under that agreement honestly, fairly, and in good faith. This standard is breached when a party acts in bad faith manner in the performance of obligations under the contract.



9. When will the courts imply a term in a contract? Pages 144–147: After a contract is made and something happens that is not covered by the express terms of the contract, the courts may be asked to imply a missing term to give effect to the parties’ intention. A judge will do so if satisfied that the parties had intended for the contract to contain the missing term. The courts will imply terms based on a number of grounds: • Business efficacy: a judge is entitled to imply terms necessary to make the contract

workable. For example, the courts are increasingly willing to imply a term of good faith in commercial contracts.

• Customs in the trade of the transaction: courts will rarely imply a term based on trade customs unless the custom is widespread.

• Previous dealings between the parties: courts may imply a term from past deals. • Statutory requirements: Sale of goods legislation requires certain terms to be included in

all contracts for the sale of goods. 10. What is implied by either common law or applicable legislation with respect to the sale

of goods and services? Page 148: The law in both instances will imply a promise to pay a reasonable price for those goods or services. The obligation is not to pay whatever price a supplier chooses to charge or whatever price a customer is willing to pay, but to pay a reasonable amount as determined by a judge. This is known as contractual quantum meruit, which is Latin for “as much as is merited or deserved.” 11. What is an entire contract clause? Page 148: An entire contract clause is a term in a contract in which parties agree that their contract is complete as written. The function of the clause is to require a court to determine the parties’ obligations based only on what is recited in the contract itself. 12. What was the legal conclusion of the Corey Developments Inc v Eastbridge

Developments (Waterloo) decision? Page 150: An entire contract clause, while important, is not absolute. A court will assess the totality of circumstances surrounding a contract that has an entire contract clause, particularly if it appears that reliance on the clause and the parol evidence rule might otherwise allow one party to dupe another and cause an obviously unjust outcome. 13. Identify the three forms that contracts can take. Does form affect enforceability? Page 148: Contracts can be (1) entirely oral, (2) entirely written, or (3) both oral and written. The form of a contract does not affect its enforceability as long as the party claiming there is a contract can prove it. 14. Explain the parol evidence rule and its exceptions. Page 148: Most contracts do not have to be in writing. However, if the parties have made a written contract, the written language is clear, and the document is intended to contain all the terms of the contract, no other evidence, such as oral discussions, can be used to change or add to the contract. However, evidence outside the contract can be considered in the following instances: • There is a possible problem with the formation of the contract, such as fraud. • The contract was intended to be partly oral and partly written.



• A contractual promise is contained in a separate, oral contract. • The language of the contract is ambiguous, in which case evidence outside the written

contract can be used to resolve the ambiguity. 15. What happens to contractual obligations if a disaster strikes? Page 151: If disaster strikes, such as when a plant burns, railways go on strike or are closed, and so on, the obligations in a contract are normally enforceable unless a clause to the contrary is included. The doctrine of “frustration” may provide some legal relief but it operates only in very limited circumstances and cannot be assumed to provide an avenue of escape. 16. Identify three ways that a party can deal with the risk of a change in the price of a good

over the life of a contract. Page 152: (1) A party can provide a formula that sets the price of the goods supplied in a manner tied to market value. (2) The party can set the price according to the cost of materials plus a specific percentage for profit. (3) The parties can agree to reopen negotiations or terminate the contract if specified events occur, such as a commodity price reaching a certain level. 17. What is a risk of building flexibility into a contract? Page 152: Building flexibility into a contract might create a document that is so vague that the parties run the risk of having no contract at all. The flexibility must still have clarity so as to be understandable. 18. Explain why conditional agreements are essential. What effect does using conditions

subsequent and conditions precedent have on a contract? Page 153: Conditional agreements are important when one party wants to incur contractual obligations only under certain circumstances. Conditions subsequent bind the parties to a contract pending fulfillment of the condition. If the condition occurs, the contract is terminated. Conditions precedent suspend any obligations under the contract until the condition occurs. Common examples of conditions precedent include real estate transactions that are subject to financing or rezoning. 19. In what instances are real estate agreements based on a condition? Page 153: Purchasers of real estate often rely on the conditional agreement by making the contractual obligation to buy and sell subject to rezoning, subdivision approval, annexation of property by a municipality, mortgage financing, and provision of essential services. 20. What liability results when a party fails to meet its contractual obligations? Page 154: The party that fails to meet its contractual obligations will be liable for breach of contract and is responsible to the other side for any reasonably foreseeable damages the breach may have caused. 21. What is the purpose of a limitation of liability clause? Page 154: A party who breaches a contract is responsible for damages suffered by the injured party. However, the parties can agree in the contract to limit liability for breach to a lesser amount. The clear words of a contract can place a limit on damages.



22. What classic legal test is stated in Hadley v Baxendale (1854), 9 ExCh 341? Page 154: See footnote 17 at the bottom of the page. In that case, the classic legal test for foreseeability in contract is stated: “Where two parties have made a contract which one of them has broken, the damages which the other party ought to receive in respect of such breach of contract should be such as may fairly and reasonably be considered either arising naturally, . . . such as may reasonably be supposed to have been in the contemplation of both parties, at the time they made the contract, as the probable result of the breach of it.” 23. What is the purpose of an exemption clause? Page 155: Through an exemption clause, a party can identify events or circumstances causing loss for which it has no liability at all. 24. What clause facilitates consensus and choice in contracts in relation to remedies for

breach of contract? Pages 154–155: The ability of contractual parties to agree to limit liability for breach to something less than would otherwise be recoverable through the use of a limitation of liability clause facilitates consensus and choice in contract. 25. What type of clause could cause a court to set aside a term in a standard form contract? Page 155: A clause containing stringent and onerous provisions contained in a standard form contract must be drawn to the customer’s attention. Failure to do so could allow a court to set aside the term. 26. What did Abrams v Sprott Securities Ltd (2003), 67 OR (3d) 368 (CA) distinguish in the

Fraser Jewellers case? Page 156: See footnote 18 at the bottom of the page. The Abrams v Sprott case distinguished Fraser Jewellers by narrowing in three ways the proposition that a person will be assumed to have read and understood any contract he or she has signed: first, the Fraser proposition depends on the absence of misrepresentation by the party seeking to rely on the written agreement (the party seeking to rely on the clause had no legal obligation to draw it to the other party’s attention); second, it depends on there being no special relationship between the parties; and third, a person cannot rely by way of estoppel on a statement induced by his or her own misrepresentation. 27. What is a shrink-wrap agreement and what is its legal status in Canada? Page 156: A shrink-wrap agreement (also called a shrink-wrap licence) is an agreement whose terms are enclosed with a product, such as pre-packaged software. Usually, there is no notice to the effect that opening the package constitutes agreement to the terms. The terms normally cover warranties, remedies, or other issues relating to the use of the product, such as prohibiting the user from making copies. Today, the common practice is to put the terms inside the box and refer to them on the outside of the box. In Canada, it is uncertain whether shrink-wrap agreements are enforceable. 28. What is a click-wrap agreement and what is its legal status in Canada? Page 156: A click-wrap or web-wrap agreement (or licence) is an agreement that appears on a user’s computer screen when that user attempts to download software or purchase goods or services online. The user is instructed to review the terms before assenting by clicking an “I accept” button, a hyperlink, or an icon. Usually, the user cannot proceed without agreeing



to the terms. In Canada, the validity of this method of contracting has been upheld by the courts. 29. Identify the controversy regarding the enforceability of browse-wrap agreements and

explain how such controversy can be avoided. Page 156: Because the browse-wrap agreement does not require the user to do anything unequivocal to signify assent—such as electronically checking a box—its status as a contract has been controversial. To avoid argument regarding enforceability, e-vendors should consider not using browse-wrap agreements at all and instead require their customers to do something affirmative to signify assent, such as clicking an icon. 30. When is a liquidated damages clause enforceable? Page 158: A liquidated damages clause sets out in the contract what one party must pay to the injured party in the event of a breach. The clause is enforceable if it is a genuine pre-estimate of the damages that the injured party will likely suffer. However, it will not be enforced if it is interpreted to be a penalty clause that sets an exorbitant amount as a remedy for the injured party.