February 13, 2019 Contract Boilerplate Series

Effective Use of Merger Clauses: Part V

Rule of practical construction of merger clauses in the context of the parol evidence rule.

By Jason R. Scheiderer and Michael Malone

Note: In the first installment of this series, we discussed the history of the parol evidence rule and the use of merger clauses. In the second, we discussed the legal effect of merger clauses and various jurisdictions’ approaches to them. In the third, we discussed the enforcement of merger clauses. In the fourth, we discussed the effect of exceptional circumstances on the enforceability of merger clauses. Here, in the fifth and final installment of this series, we discuss the rule of practical construction and consideration of extrinsic evidence to determine the parties’ intent as to merger clauses.

The Rule of Practical Construction and Merger Clauses

Some extrinsic evidence may be admissible to prove the parties’ intent even where the agreement is integrated and contains a merger clause. Courts may look to the parties’ conduct to inform their analysis. Whether the court must first find the agreement to be ambiguous before looking to the parties’ conduct is subject to some dispute. The general rule, however, is that the contract need not be ambiguous for the court to look to the conduct of the parties. While this article focuses on how this rule has developed under Tennessee law, it has developed in similar ways in other jurisdictions. See, e.g., Soberman v. Groff Studios Corp., 99 Civ. 1005 (DLC) 2000 WL 328781, at *6 (S.D.N.Y. March 28, 2000); Simon & Son Upholstery Inc. v. 601 West Assocs., LLC, 702 N.Y.S.2d 256, 257 (1st Dep't 2000); Federal Ins. Co. v. American Ins. Co., 691 N.Y.S.2d 508, 512 (1st Dep't 1999).

The Conduct of the Parties

Similar to trade usage and other contextual evidence, courts may look to the conduct of the contracting parties to interpret the meaning of their written agreement. For over a century, the Supreme Court of Tennessee has followed and applied the rule of “practical construction” for interpreting contracts:

The interpretation given by the parties themselves to the contract as shown by their acts will be adopted by the court, and to this end not only the acts, but the declarations of the parties may be considered.

Canton Cotton Mills v. Bowman Overall Co., 149 Tenn. 18, 257 S.W. 398, 402 (1924), quoting 2 Williston on Contracts, par. 623. One of the earliest reported cases applying the rule of practical construction was State v. Board of Trust of Vanderbilt University, 129 Tenn. 279, 164 S.W. 1151, 1164 (1914), where the Tennessee Supreme Court used the doctrine to resolve a dispute over who had authority to appoint trustees to Vanderbilt University. The court discussed how the best and most authoritative answer came not from the parties’ proffered interpretations of the voluminous minutes of the many nineteenth-century ecclesiastical conferences and resulting resolutions that established the university, but rather from the prior 35 years of actual practice under the university’s charter:

Such, indeed, for a period of 35 years or more after the organization of this corporation, was the uniform construction of its charter by all parties concerned. . .
The practical interpretation of a contract by the parties thereto is entitled to great, if not controlling, influence.

Id., 164 S.W. at 1164

The Tennessee Supreme Court later applied the rule of practical construction in Canton Cotton Mills. There, the court considered whether certain communications between merchants constituted a contract, even though later communications indicated that the merchants had not yet agreed to terms. The court quoted and applied the rule of practical construction as stated in the Williston treatise to hold that whether or not the parties’ initial communications might be sufficient to establish a contract, their later continuing negotiations over terms showed that they had yet agreed to be bound. Canton Cotton Mills, 257 S.W.2d at 402.

Ambiguity Required?

Importantly, the court’s decision in Board of Trust of Vanderbilt University did not predicate the application of the rule of practical construction on the existence of ambiguity, but rather accepted and indeed apparently preferred the approach because of its probative force.

The current version of the rule of practical construction in the Williston treatise addresses the issue of whether ambiguity is a necessary predicate to its application:

Given that the purpose of judicial interpretation is to ascertain the parties' intentions, the parties’ own practical interpretation of the contract—how they actually acted, thereby giving meaning to their contract during the course of performing it—can be an important aid to the court. Thus, courts give great weight to the parties' practical interpretation.
Nonetheless, the parties’ conduct, no matter how probative in the abstract, will not be considered by many and perhaps most courts unless the contract is ambiguous. Other courts, as well as the Uniform Commercial Code and the Restatement Second, permit consideration of the parties’ conduct regardless of the existence of any ambiguity. Indeed, sometimes it is difficult to determine within a given jurisdiction whether an ambiguity must exist before the parties' conduct may be considered.

11 Williston on Contracts § 32:14 (4th ed.) (emphasis added).

There is conflicting authority, however, regarding whether ambiguity is a required predicate for applying the rule of practical construction. In Canton Cotton Mills, the Tennessee Supreme Court indicated that ambiguity is a predicate for applying the rule, holding the rule of practical construction is not applied where the contract language “is susceptible of but one construction.” 257 S.W. 398, 402 (rule of practical construction is not applied where the contract language “is susceptible of but one construction.”). However, a later Tennessee Supreme Court case includes the rule of practical construction as a generally applicable rule of contract construction, and not a special rule reserved for resolving textual ambiguity:

The evidence of intent is to be found in the language used by the parties in the guaranty agreement, considered in the light of their respective interests and other relevant circumstances existing at the time the guaranty was executed, and in the practical construction given to it by the parties, as disclosed by their actions subsequent to its execution.

City of Columbia v. CFW Constr. Co., 557 S.W.2d 734, 739 (Tenn. 1977) (emphasis added). CFW Constr. Co. makes no reference to ambiguity as a predicate for applying the rule of practical construction.

This question of whether ambiguity is a predicate to applying the rule of practical construction was authoritatively addressed and resolved by the Tennessee Supreme Court in Hamblen County v. City of Morristown, 656 S.W.2d 331 (Tenn. 1983). There, a city and county disputed who had control over two high schools. The city and county entered into a 1965 contract to construct one high school and renovate the other, and for the next decade the city ran both high schools. Rather than basing its analysis entirely on the 1965 contract, the Tennessee Supreme Court noted that the rule of practical construction was particularly apt, regardless of whether the 1965 contract was ambiguous:

The rule of practical construction is particularly applicable to this case. That rule, long recognized and applied in this jurisdiction, is that the interpretation placed upon a contract by the parties thereto, as shown by their acts, will be adopted by the court and that to this end not only the acts but the declarations of the parties may be considered.

Id. at 335. The Court then adopted the formulation of the rule in Section 235 of the Restatement (First) of Contracts:

The rule is stated in Section 235 of the Restatement of Contracts as follows:
“If the conduct of the parties subsequent to a manifestation of intention indicates that all of the parties placed a particular interpretation upon it, that meaning is adopted if a reasonable person could attach it to the manifestation.”

Id. The Tennessee Supreme Court also noted one of the comments to Restatement Section 235, to the effect that a court properly considers the parties’ situation and accompanying circumstances even if the contract is not ambiguous:

Also applicable here is a principle which has been aptly stated as follows:
“The court in interpreting words or other acts of the parties puts itself in the position which they occupied at the time the contract was made. In applying the appropriate standard of interpretation even to an agreement that on its face is free from ambiguity it is permissible to consider the situation of the parties and the accompanying circumstances at the time it was entered into--not for the purpose of modifying or enlarging or curtailing its terms, but to aid in determining the meaning to be given to the agreement.”

Id., 656 S.W.2d at 334 (citing Restatement (First) of Contracts, § 235(d) and Comment) (emphasis added). The court also discussed how the parties’ intent is sometimes implied rather than expressed in the language of the contract. Id. (“Intention or meaning in a contract may be manifested or conveyed either expressly or impliedly, and it is fundamental that that which is plainly or necessarily implied in the language of a contract is as much a part of it as that which is expressed.”) citing 17 Am.Jur.2d Contracts § 255, at 649 (1964).

Hamblen County is the Tennessee Supreme Court’s latest and most thorough and authoritative discussion of the rule of practical construction, and it adopts the Restatement approach that ambiguity is not a necessary predicate for applying the rule.

Commentators have discussed how the Tennessee Supreme Court’s opinion in Hamblen County is widely cited, giving the case particular stature and authority on this issue. Steven W. Feldman & James A. DeLanis liken Hamblen County’s “flexible” approach to contract construction to the approach applied by the federal circuit, which explains why evidence of the parties’ conduct is so much more probative than dictionary definitions:

[T]o interpret disputed contract terms, “the context and intention [of the contracting parties] are more meaningful than the dictionary definition. ... Before an interpreting court can conclusively declare a contract ambiguous or unambiguous, it must consult the context in which the parties exchanged promises. Excluding [extrinsic] evidence ... because the contract terms are “unambiguous” on their face ignores the reality of the context in which the parties contracted. That context may well reveal that the terms of the contract are not, and never were, clear on their face. On the other hand, that context may well reveal that contract terms are, and have consistently been, unambiguous.

Steven W. Feldman & James A. DeLanis, Resolving Contractual Ambiguity in Tennessee: A Systematic Approach, 68 Tenn L. Rev. 73, 94–96, at 96, and n. 101 (2000) (quoting Metric Constructors, Inc. v. NASA, 169 F.3d 747, 752 (Fed. Cir. 1999)). See also Philadelphia Life Insurance Co. v. Daugherty, 132 S.W.2d 224, 227 (Tenn. Ct. App. 1939) (“Abstract rules should never be employed to defeat justice, when a reasonable interpretation of the language employed in a contract indicates the intention of the contracting parties.”)

Other Tennessee cases recognize how the rule of practical construction is exceptionally probative, because the rule recognizes that dispute and litigation often cause the parties to take stilted positions, whereas the parties’ conduct before any dispute and litigation arises is likely to present a more accurate and honest view of how the parties understood their agreement:

Evidence of the terms of an agreement is better afforded by the acts of the parties under it while harmonious and practical construction reflects their intention, than when subsequent differences have impelled them to resort to law, and one of them then seeks a construction at variance with the practical construction they have placed upon it of what was intended by its provisions.

Galleria Associates, L.P. v. Mogk, 34 S.W.3d 874, 876–77 (Tenn. Ct. App. 2000), citing McDowell v. Rambo, 21 Tenn. App. 448, 111 S.W.2d 892, 899 (1937) (citations omitted). Accord Williston, supra (“Litigants frequently assert an interpretation of a contract different from that suggested by their conduct or words during the course of their performance of the contract.”).

The rule of practical construction is thus like the surveillance video in a personal injury case that reveals the plaintiff’s actual physical abilities, which sometimes will be at odds with the plaintiff’s courtroom testimony. Practitioners on both sides of a dispute should consider how, through application of that rule, the parties’ conduct may inform the court’s interpretation of the contract.

Jason R. Scheiderer is a partner with Dentons US LLP, in Kansas City, Missouri. Michael Malone is an associate with Polsinelli in Nashville, Tennessee.

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