Sattva Principle of Contract Interpretation Applied

In the recent Ontario Court of Appeal decision of Brompton Corp. v. Tuckamore Holding LP, 2017 ONCA 594 the principles of contract interpretation developed by the Supreme Court of Canada were applied to the interpretation a representation and warranty clause in an agreement of purchase and sale of a business.

In 2008, Tuckamore Holding LP (“Tuckamore”) and Brompton Corp. (“Brompton”) entered into an agreement whereby Brompton purchased Tuckamore’s business in exchange for the transfer of securities held by Brompton. The agreement contained  a written representation and warranty regarding tax pools. At issues was clause 5.1 of the agreement which provided:

The Purchaser represents and warrants as follows to the Vendor and acknowledges and confirms that the Vendor is relying on such representations and warranties in connection with the sale by the Vendor of the Purchased Securities:

….

(l)  Taxes.  Immediately prior to Closing and after giving effect to the transactions contemplated by this Agreement, the Purchaser will have tax pools as described in the Purchaser Disclosure Letter.  [Bold in original.]

The Purchaser Disclosure Letter cited in s. 5.1(l) set out, in Exhibit “A” thereto, the tax losses, deductions and credits referred to as “tax pools” in s. 5.1(l) of the Agreement.  Exhibit “A” listed the relevant non-capital losses and scientific research and experimental development expenditures and tax credits, together with their years of expiry and associated values for federal and provincial income tax purposes.

In 2010, Tuckamore determined to divest its minority interest in Brompton.  Accordingly, it approached Brompton and this led to a further agreement among the parties, dated July 5, 2011, regarding the sale of Tuckamore’s minority interest.  As a term of that agreement, Tuckamore agreed to indemnify Brompton for its proportionate share of any tax liabilities, including interest or penalties, assessed against Brompton under the Income Tax Act of Canada in respect of the period when Tuckamore was a Brompton shareholder (the “Tuckamore Indemnity”).  Although several other agreements concern the commercial dealings between the parties, the focus of the dispute was s. 5.1(l) of the Agreement and the Tuckamore Indemnity.

The issue was whether s. 5.1(l), properly construed in the context of the Agreement as a whole, constituted a representation and warranty as to the future tax utilization of Brompton’s tax pools or, in contrast, whether it was directed solely to the accurate identification of the tax pools in existence, and their values, up to the date of closing of the purchase transaction.

The interpretation of s. 5.1(l) was important because, after the closing of the transaction provided for under the Agreement and after the date of the Tuckamore Indemnity, the Canada Revenue Agency (“CRA”) disallowed Brompton’s attempted use of the tax pools to reduce its taxable revenues during the 2009-2013 taxation years.

A summary judgment application was heard and granted before Justice Hainey who found against Tuckamore.

Justice Hainey recognized the interpretive issue before him regarding s. 5.1(1) was one to which the principles in Sattva Capital Corp. v. Creston Moly Corp.,  [2014] 2 S.C.R. 633 applied. Justice Hainey held:

Applying these principles to the interpretation of s. 5.1(l) of the Acquisition Agreement, I have concluded that Brompton did not give Tuckamore a representation and warranty that the tax pools would not be subject to a future tax assessment by the CRA.  The Purchaser Disclosure Letter does nothing more than list the amounts of the tax losses on a yearly basis specifying when each tax pool will expire.  The Purchaser Disclosure Letter says nothing about the future use of the tax pools and there is no mention of whether they could be assessed by the CRA.

Brompton and Tuckamore are both sophisticated investors who carried out their own due diligence in respect of the tax pools.  Commercial reality dictates that they both had to know that there was a risk that their intended tax applications of the tax pools could be assessed and disallowed by the CRA in the future.  Neither could definitively predict what the CRA would decide if there was an assessment.

Under these circumstances it does not make commercial sense that Brompton would provide Tuckamore with a guarantee as to how the CRA would assess the use of the tax pools in the future.  Considering the plain meaning of s. 5.1(l) of the Acquisition Agreement and the Purchaser Disclosure Letter against the factual matrix and the commercial reality of the transaction, I have concluded that Brompton’s representation and warranty was only as to the existence, amount and expiry dates of the tax pools and did not guarantee their availability for future use without the risk of a CRA assessment.  If Tuckamore truly wanted a guarantee that the future use of the tax pools would not be subject to an assessment by the CRA, the Acquisition Agreement could easily have specified this in clear unequivocal language.  It did not do so.  [Emphasis added.]

 The Ontario Court of Appeal held that Tuckamore failed to identify either an extricable error of law or a palpable and overriding error in the motion judge’s interpretation of s. 5.1(l) of the Agreement.  “As Sattva instructs, the motion judge’s interpretation is therefore entitled to deference from this court.” (para. 13). In approving of Justice Hainey’s decision the Court noted:

[14]      We note, first, that the Agreement is far from a standard form contract.  It is the critical centrepiece of a series of associated contracts that implemented complex commercial transactions.  It was negotiated by sophisticated parties with the assistance of professional legal and tax advisors.

[15]      In these circumstances, the motion judge was obliged to consider the commercial context in which the Agreement was concluded, the surrounding circumstances that were known or ought to have been known to the parties at the time of contract formation, and the language employed by them.  As Sattva instructs, at para. 47, in matters of contractual interpretation, “a decision-maker must read the contract as a whole, giving the words used their ordinary and grammatical meaning, consistent with the surrounding circumstances known to the parties at the time of formation of the contract.”  The overriding interpretive task, Sattva instructs, is to determine “the intent of the parties and the scope of their understanding”.

[16]      In our view, that is precisely the interpretive exercise that the motion judge undertook.  His reasons confirm that he was alert to the controlling interpretive principles, to the commercial context and factual matrix in which the Agreement was concluded, and the language employed in the Agreement by these informed and knowledgeable parties.

The Court of Appeal emphasized that the commercial context of the agreement formed part of the circumstances surrounding the formation of the agreement that Justice Hainey was obliged to consider. The Court also noted that Justice Hainey’s assessment of those circumstances attracted deference from the Court.