A Recent Court of Appeals Case Contains a Lesson on Interpretation of Business Contracts

Author: Anne E. Braucher Date: 12/23/2010

Categories: Corporate and Business Law

You are a business person and you know what your contracts mean, right? A recent Maryland Court of Appeals case, Ocean Petroleum Company, Inc. v. Yanek, shows why that may not be the case. The Maryland rules of contract interpretation require courts in some situations to disregard what you may think is your best evidence – your own testimony along with the communications and documents you exchanged with your customer while you were negotiating that contract. Instead, courts must apply a standard that limits the inquiry to the language in the contract and what a “reasonable person” would think that language means. Before you and your customers execute another contract, read on.

Ocean Petroleum Company, Inc. (“Ocean”) leased property in Ocean City, Maryland owned by Dorothy Yanek and the Estate of Victor Yanek (the “Yaneks”). Ocean operated a convenience store on the property called the 85th Street Wine Rack. The lease had a 99-year term and allowed the tenant to buy the property from the Yaneks any time after April 1, 1996. The lease contained a three-tiered process for determining the purchase price. The landlord and tenant were first to attempt to negotiate the price themselves. If they could not reach an agreement, they were each to appoint a real estate appraiser. The two chosen appraisers were then to agree upon a purchase price that was equal to the “fair market value of the land only.” If those two appraisers could not agree upon a price, they were then to choose a third appraiser who would determine the fair market value of the land only and whose decision would be final.

When Ocean exercised its option to purchase the property in 2007, the parties could not agree upon a purchase price. Before they selected their two appraisers, however, they found they also could not agree upon what the contract meant by “fair market value of the land only.” Unable to do anything further, Ocean filed suit in order to have a court decide what the phrase meant. Ocean argued that the phrase meant the fair market value of the land as encumbered by the 99-year lease. The Yaneks argued that it meant the fair market value of the land unencumbered by the lease.

In the hands of the Court of Appeals, interpretation of the fair value phrase did not depend on what Ocean and the Yaneks thought or even what they said it meant. Instead, the court said “unless a contract’s language is ambiguous, we give effect to that language as written without concern for the subjective intent of the parties at the time they entered into the contract.” Ocean Petroleum Co., Inc. v. Yanek, 416 Md. 74, 86 (2010) (emphasis added). Accordingly, if the contract language is unambiguous, the court will limit itself to examining the language within the four corners of the document and considering that language from “the perspective of a reasonable person standing in the parties’ shoes at the time of the contract’s formation.”

Applying these rules to the lease at hand, the court decided that the phrase “fair market value of the land only” meant the value of the land unencumbered by the lease. The court said that a reasonable tenant, someone standing in Ocean’s shoes and relying on common sense, would understand that the option to purchase entitled him to purchase the property free of encumbrances, including his own lease. Conversely, a reasonable landlord, someone standing in the Yaneks’ shoes and relying on common sense, would understand that his obligation to sell terminated his right to receive income from the lease but enabled him to realize the property’s value as unencumbered. Id. In arriving at this conclusion, however, the court did not rely on evidence outside of the contract. The court did not refer to statements or testimony of the parties, communications between the parties, or other documents exchanged by the parties. It simply looked at what the contract itself said and determined what two reasonable people in the shoes of the landlord and tenant would have thought the phrase “fair market value of the land only” meant.

This case is instructive for business people whose relationships are governed by contracts. You should be wary of boilerplate contract forms or contracts you find on the Internet. Even if you know very well what you and your customer meant when you executed that contract, a court may disregard what you think is clear evidence of your intent – your own testimony, communications, and documents related to the contract. The applicable standard may not be what you and your customer meant by the terms of your contract, but what a reasonable person in your shoes would think the terms meant as they are written.

Before you send your contract to another customer, send it to a lawyer for review. You and your lawyer can discuss how best to define your terms so that you say exactly what you mean and leave nothing to chance. Your lawyer can also help you address other types of provisions that should or should not be in your contracts:

  • Attorneys’ fees. You do not intend to breach your contract, but what if the unexpected happens and your customer breaches? Does your contract state that your customer will pay your attorneys’ fees when you need to file suit to enforce the contract?
  • Arbitration. Arbitration may not always be the most time- and cost-effective way to settle a dispute. Does your contract require you to go to arbitration, or can you file your lawsuit in court?
  • Choice of law. Depending on the nature of your contract, some states’ law may be more favorable to you than others. Does your contract say which state’s law controls when you and your customer have a dispute?
  • Choice of venue. You are located in Maryland, but your customers can be located just about anywhere. Does your contract say where you must file a lawsuit arising from its terms?

These are just a few of the provisions you should consider. Take a moment in the new year to sit down with a lawyer and discuss your contracts. Do not leave it to the courts to tell you what they mean.