Overview

The Ontario Court of Appeal’s decision in Iroquois Falls Power Corporation v Ontario Electricity Financial Corporation² (“Iroquois Falls”) suggests that the bar for successfully appealing findings of contractual interpretation may be at its highest in the context of certain energy supply contracts. The decision also raises questions with respect to how adjudicators may apply the Supreme Court of Canada’s landmark decision in Sattva v Creston Moly³ (“Sattva”) to other forms of contracts in the energy sector.

Background

In Iroquois Falls, certain non-utility generators (“NUGs”) challenged the Ontario Electricity Financial Corporation’s (“OEFC’s”) calculation of amounts payable under their long-term power supply contracts (“Power Purchase Agreements”, or “PPAs”).⁴ The PPAs contained an annual price adjustment index based on rates charged to (what was then) Ontario Hydro’s Direct Industrial Customers. Hence the rate upon which the price adjustment index was based was referred to in the PPAs as the “Direct Customer Rate” or “DCR.”⁵ The DCR, including any variations therein, were reflected in the price adjustment index, which was in turn used to calculate the annual payments to the NUGs under the PPAs.⁶

With the late 1990’s restructuring of Ontario Hydro and the introduction of the Ontario wholesale electricity market, the DCR became obsolete.⁷ Various stakeholders, including the parties in Iroquois Falls, set out to find an appropriate replacement for the DCR.⁸ That stakeholder initiative resulted in, among other things, a Working Paper in June 2002 (the “Working Paper”) which proposed a new price adjustment index based on “Total Market Costs” (“TMC”).⁹  More specifically, TMC was the aggregate of several individual costs, including Global Adjustment (“GA”)¹⁰, associated with the production, delivery and use of electricity to a proxy customer with 100% firm load factor at a specified voltage.¹¹ TMC was incorporated into the PPAs by way of Term Sheets heavily negotiated and agreed to by the parties in 2003 (“Term Sheets”).¹² Fundamental to the agreement surrounding the Term Sheets was that TMC was to replace and replicate DCR to the fullest extent possible.¹³

The advent of Ontario Regulation 429/04, commonly referred to as the “GA Reallocation Regulation”, in 2004 reapportioned GA costs so as to decrease the overall GA costs among Class A customers¹⁴ and increase them among Class B consumers¹⁵. Hydro One¹⁶ subsequently assumed, for the purpose of calculating the price adjustment index based on TMC, that the proxy customer was a Class A consumer. This had the effect of reducing GA as a variable in the price adjustment index calculation under the PPAs, ultimately reducing the amounts payable to the NUGs.¹⁷

In Iroquois Falls, the NUGs argued that the reapportionment of GA costs between Class A and Class B consumers under the GA Reallocation Regulation caused GA to no longer comprise one of the components of TMC, as the GA changes did not pertain to the direct or indirect costs associated with the production or delivery of electricity.¹⁸  The OEFC, in response, took the position that TMC had been defined to reflect the price of electricity to certain customers, and that therefore the newly applicable definition of GA still fell within its ambit.¹⁹ The application judge favored the NUGs’ interpretation of the meaning of TMC, and found in their favour.

The OEFC appealed to the Ontario Court of Appeal on three grounds. First, the application judge determined the application on a basis other than what either of the parties had argued.²⁰  Second, the application judge made several findings of fact that were either unsupported by the evidence or were otherwise based on a misapprehension of the evidence.²¹ Third, the application judge erred in his interpretation of certain provisions of the PPAs.²²

The Court of Appeal rejected the first ground of appeal, finding that the application judge did not decide the application on an issue not raised by the NUGs.²³ The appellate court also rejected the second ground of appeal, finding that the application judge’s findings were supported by the evidence and did not reveal any material misapprehension of the evidence.²⁴ With respect to the third ground of appeal, the Court of Appeal found that all but one of the contractual misinterpretations alleged by the OEFC raised a question of law alone (and all others were questions of mixed fact and law). In particular, the OEFC argued that the application judge erroneously implied a term into the PPAs by requiring that TMC reflect costs as allocated on a pro rata consumption basis.²⁵ The Court of Appeal nevertheless rejected this argument by finding that the application judge did not in fact imply a term into the definition of TMC.²⁶

With respect to the remainder of the OEFC`s allegations of contractual misinterpretation, the appellate court found that they did not demonstrate that the application judge misapplied a legal principle, i.e. failed to read the PPAs (as amended by the Term Sheets) as a whole or give the contractual terms their ordinary and grammatical meaning. Rather, the appellant essentially took issue merely with the way the application judge interpreted the relevant provisions.²⁷

As such, the Court of Appeal held that the majority of the contractual interpretation issues raised by the OEFC were actually questions of mixed fact and law. Because the OEFC had presented them as questions of law, no arguments were offered as to if or how the alleged contractual misinterpretations met the requisite threshold of palpable and overriding errors of law.²⁸  The OEFC`s appeals were dismissed.²⁹

Treatment of contractual interpretation by appellate courts

In its reasons for rejecting the OEFC`s challenge to the application judge’s interpretation of TMC, the appeal court considered the applicable standards of review for each of questions of law and questions of mixed fact and law, as set out in Sattva.³⁰

Sattva clarified that issues of contractual interpretation may raise (i) questions of law alone to be reviewed by an appellate court on a “correctness” standard, or (ii) questions of fact or of mixed fact and law, to be reviewed by an appellate court on a more stringent “palpable and overriding error” standard of review.³¹ Because questions of law alone elicit a lower standard of review, appellants will often seek to frame their respective grounds for appeal as questions of law. Sattva cautioned that appellate courts should, however, exercise care before determining that a proposed ground of appeal has been properly characterized as a question of law.³²  Heeding this caution, the appellate court in Iroquois Falls found that the OEFC’s challenges to the application judge’s interpretation of TMC, framed as questions of law, were more properly characterized as questions of mixed fact and law.³³

As the Court of Appeal in Iroquois Falls cited from Sattva, a central purpose for applying a higher standard of review to questions of fact, and of mixed fact and law, is to limit the intervention of appellate courts in cases where the issue has limited precedential value beyond the litigating parties.³⁴ Indeed, given that contractual interpretation will involve particular words of the agreement in dispute between the parties, Sattva effectively limits cases where questions of contractual interpretation will be deemed questions of law to those where there has been a demonstrable application of an incorrect principle, a failure to consider a required element of a legal test, a failure to consider a relevant factor, or the like.³⁵

But it is a rare occurrence where a case demonstrates that the trier of fact has applied an incorrect principle, failed to consider a required element of a legal test, or failed to consider a relevant factor in the manner contemplated by Sattva. Oftentimes the mere reference to the correct legal principle in the underlying decision will be sufficient to demonstrate to an appellate court that the trier of fact did not incorrectly fail to consider or apply that legal principle. For example, in Sattva, the appellant argued that the arbitrator made an error in law in interpreting the term “market price” in the contract between the parties.³⁶ More particularly, the appellant in Sattva argued that in failing to consider the term “market price” in relation to the “maximum amount” proviso in the associated capital markets policy document, the arbitrator failed to interpret “market price” in the context of the agreement as a whole (and as such, failed to apply that interpretive legal principle). There, the mere fact that the arbitrator made reference to the maximum amount proviso was sufficient for the Supreme Court of Canada to find that the arbitrator did not fail to consider the agreement as a whole.³⁷ This in spite of the Supreme Court’s acknowledgment that “the arbitrator provided no express indication that he considered how the “maximum amount” proviso interacted with the Market Price definition.”³⁸  The Supreme Court of Canada instead found that “such consideration is implicit in his decision.”³⁹

Similarly, in Iroquois Falls, the OEFC tried to argue that the application judge failed to properly consider all of the relevant provisions in the Term Sheets as a whole when interpreting the critical word “cost” in the definition of TMC.⁴⁰ The thrust of the OEFC`s argument was that the application judge should have relied on the specific wording used in the various parts of the Term Sheets, such as the definition of TMC, and that the application judge failed to address these provisions when interpreting the word “cost” to mean the cost of producing and distributing electricity to consumers instead of as the price of electricity to purchasers.⁴¹

Yet the Court of Appeal described the OEFC`s argument as follows:

For example, [the OEFC] maintains that the application judge wrongly defined the word “cost” …. These arguments are not the stuff from which questions of law are made. They raise questions of mixed fact and law, if not pure questions of fact. One example makes my point. The appellant submits that while the word “cost” may refer to cost to the seller or cost to the purchaser, the phrase “market cost” must refer to cost to the purchaser. Clearly, there is no “extricable” question of law in this argument.⁴²

Further, to the extent the definition of TMC could not be ascertained within the four corners of the PPAs (together with the Term Sheets), the OEFC argued that the application judge erred in not properly considering the surrounding circumstances of the Working Paper including the description of DCR therein.⁴³ As in Sattva, consideration of other parts of the Working Paper was sufficient for the Court of Appeal to find that the application judge properly satisfied the legal principle of considering the relevant surrounding circumstances, even though the application judge did not expressly address or explain how the Working Paper provisions raised by the OEFC influenced or impacted the arbitral award.⁴⁴

Misapplication of legal principles as questions of law

While the Court of Appeal in Iroquois Falls acknowledged that an “extricable question of law” could be extracted from a challenge to an interpretation of a contractual term⁴⁵, its dismissal of the OEFC`s appeals underscores the practical challenges of successfully doing so. For example, Sattva clarified the legal principle that 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.”⁴⁶  Given this guidance, appellants are compelled to rely on the factual matrix at hand to demonstrate that a misapplication of the legal principle has occurred.

Yet, as exhibited in Iroquois Falls, it is almost always the case that the only way to demonstrate that a trier of fact has failed to consider all the relevant surrounding circumstances such as other relevant documentary provisions, and that therefore there is an appealable question of law, is to point to the way in which the other provisions are relevant and were not applied or misapplied in the factual circumstances at hand. As such, many appellants, like the OEFC in Iroquois Falls, inevitably find themselves stuck within the confines of the post-Sattva paradigm where arguments of contractual misinterpretation are deemed to raise questions of mixed fact and law, rather than of law alone, and therefore subject to a palpable and overriding error standard of review.

Appellants framing their challenge to an interpretation of a contractual term as a question of law should therefore be prepared to contend with the increasingly crystalizing precedent in which appellate courts will presume that the decision maker properly applied relevant principles of legal interpretation where it can be shown that the decision maker at least made reference to them.

This is so even though it seems incorrect to find, for example, that the mere reference to a related provision is tantamount to giving consideration to that related provision by explaining how it informs the interpretation of the disputed provision, which is surely what is required by the legal principle that a contract be read as a whole. That is, without expressly setting out how the surrounding and relevant documentary provisions have been interpreted, including how those interpretations influenced or impacted the ultimate decision, it is arguable that an adjudicator has not properly applied the legal principle of reading the contract as a whole consistent with the surrounding circumstances known to the parties at the time. This is precisely what the OEFC attempted, but failed, to demonstrate in Iroquois Falls. Would-be appellants should take note.

Concluding remarks

The Court of Appeal in Iroquois Falls showed considerable deference to the application judge`s findings with respect to contractual interpretation. In doing so, the appellate court emphasized that the PPAs (and Term Sheets) “were the product of extensive and careful negotiations and consultations among sophisticated commercial entities” with a “longstanding and ongoing relationship in a unique market place.”⁴⁷  It further emphasized that the contested definition of TMC had to be considered “in the context of the extensive and detailed discussions and negotiations that produced” it, and that it would be “difficult to imagine an exercise in contractual interpretation that would be more fact-specific” or “that could have less precedential value” than this one.⁴⁸  Given such caveats, and in light of the jurisprudence on the division of responsibilities between trial and appellate courts as espoused in Sattva⁴⁹, it is not surprising that the appellate court in Iroquois Falls was highly deferential to the findings of the underlying application judge with respect to matters of contractual interpretation.

But the Court of Appeal also noted that the strong reasons for such deference will not apply in every case of contractual interpretation, citing its 2015 decision in MacDonald v Chicago Title Insurance Company of Canada (“MacDonald”).⁵⁰ In MacDonald, the Court of Appeal held that, notwithstanding Sattva, the higher standard of review of palpable and overriding error did not apply in the case of standard form insurance contracts.⁵¹ Standard form insurance contracts, the appellate court explained, have more general applicability than some other forms of agreement, and are not genuinely negotiated by the parties.⁵²  Therefore the Court of Appeal held that the Sattva reasons for using a palpable and overriding error standard of review did not apply to standard form contracts, and that it was instead more appropriate to apply a correctness standard of review.⁵³

Ontario has a number of standard form energy supply contracts. It remains to be seen, then, how appellate courts will apply Sattva to disputes arising from such contracts. That is, it is unclear whether appellate courts will render findings more akin to MacDonald or otherwise to Iroquois Falls, on the spectrum of interpretive deference for standard form energy supply contracts. Likewise, it is unclear how courts will treat the interpretation of a term used in a negotiated contract which could have a precedential impact on the interpretation of the same term used in standard form contracts, or the interpretation of the term in the context of a tailored energy supply contract where that same term is widely used in other agreements between other parties.⁵⁴ Creating an interpretive precedent for a term in an energy supply contract could also have significant implications for the public ratepayers and therefore have ramifications beyond the litigating parties.

What is clear is that due to the oftentimes dense and technical nature of energy supply contracts, it is difficult for energy industry litigants to frame alleged misapplications of legal principles independent from the factual matrix at hand. Moreover, industry contracts are also often the product of lengthy and detailed stakeholder initiatives. As such, energy industry litigants are especially vulnerable to having possible grounds for appeal classified by appellate courts as questions of fact alone or questions of mixed fact and law, post-Sattva. This requires industry appellants and their respective lawyers to always be prepared, even if in the form of alternative arguments, to meet a higher palpable and overriding error standard of review, as is demonstrated by the decision in Iroquois Falls.

1. Reena Goyal and James Hunter are counsel at the Independent Electricity System Operator (“IESO”) in Ontario. The views expressed in this article are those of the authors alone, and do not necessarily represent those of the IESO.
2. Iroquois Falls Power Corporation v Ontario Electricity Financial Corporation, 2016 ONCA 271 [Iroquois Falls].
3. Sattva Capital Corp v Creston Moly Corp, 2014 SCC 53 [Sattva].
4. Iroquois Falls, supra note 2 at paras 1-2.
5. Ibid at para 18.
6. Ibid.
7. Ibid at paras 23-24.
8. Ibid at para 25.
9. Ibid.
10. Ibid at para 34.
11. Ibid at para 26.
12. Ibid at para 28.
13. Ibid at para 25.
14. Generally speaking, Class A consumers are defined under the GA Reallocation Regulation as those LDC-connected consumers that exceed an average monthly hourly demand in excess of 5MW for the applicable 12-month base period. (This initiative was expanded in 2015 to include customers with a peak demand greater than 3MW but less than 5MW, so long as they have one of the requisite classifications under the North American Industry Classification System (NAICS)).
15. Generally speaking, Class B consumers are defined under the GA Reallocation Regulation as those LDC-connected consumers who are not Class A consumers, i.e. who have an average monthly hourly demand of less than 5MW for the applicable 12-month base period.
16. Through OEFC`s consultant Navigant Consulting Inc.
17. Iroquois Falls, supra note 2 at para 35.
18. Ibid at para 2.
19. Ibid at para 3.
20. Ibid at para 5.
21. Ibid at para 6.
22. Ibid at para 7.
23. Ibid at para 10.
24. Ibid.
25. Ibid at para 106.
26. Ibid at para 110.
27. Ibid at paras 103-104.
28. Ibid at para 105.
29. Ibid at paras 120-121.
30. Ibid at para 93.
31. Ibid.
32. Sattva, supra note 3 at para 54.
33. Iroquois Falls, supra note 2 at para 105.
34. Ibid at para 96 (citing Sattva, supra note 3 at para 50).
35. Ibid at para 100 (citing Sattva, supra note 3 at para 53).
36. Sattva, supra note 3 at para 64.
37. Ibid at para 65.
38. Ibid at para 83 (emphasis added).
39. Ibid at para 83.
40. Supra note 2 at para 104.
41. Ibid at paras 45, 69.
42. Ibid at para 103.
43. Ibid at paras 82-83.
44. Ibid at para 104.
45. Ibid at para 103.
46. Sattva, supra note 3 at para 47 (emphasis added).
47. Iroquois Falls, supra note 2 at para 98.
48. Ibid at para 99.
49. Sattva, supra note 3 at paras 51-52.
50. MacDonald v Chicago Title Insurance Company of Canada, 2015 ONCA 842 [MacDonald]; Iroquois Falls, supra note 2 at para 97.
51. MacDonald, supra note 50 at para 35.
52. Ibid at paras 33-37.
53. Ibid at para 41.
54. For instance, interpreting “cost” to exclude the price of electricity to purchasers could arguably have significant ramifications to the interpretation of other long-term energy supply contracts procured on behalf of the Province.