Contracts

California law on interpreting disputed contracts isn't what many lawyers think it is - and the same goes for deeds, wills, and other written instruments.

Who is vested with the power to say what a contract means? Is it a question of law for the trial judge? Or does a jury get to make the call?

Any attorney who thinks a bright-line rule will leap out of Witkin's treatises to end the discussion is in for a surprise. Indeed, the real answer to these questions is "it depends," because the factors governing who interprets a contract can prove vexing.

Such determinations are no esoteric exercise for a law school seminar; they have real-world consequences. The prospect of a jury interpreting a complex agreement is enough to make any transactional lawyer's hands tremble. Advocates and clients also have reason for trepidation, especially in cases where emotional or equitable factors might overwhelm deliberations in the jury room. Fortunes may turn on a lay jury's interpretation of a complex contract that transactional lawyers negotiated over the course of months. In City of Hope v. Genentech, Inc. (43 Cal. 4th 375 (2008)), for example, the jury returned a verdict of $300 million in compensatory damages. And when contract interpretation is a question of fact for the jury, appellate review typically is so deferential as to be virtually nonexistent.

Key Precedent
So what factors determine when a jury will decide what a contract means?

The seminal case is Parsons v. Bristol Development Co. (62 Cal. 2d 861 (1965)), in which the California Supreme Court established several black-letter rules. These have been reaffirmed many times, but often they are misunderstood by trial lawyers and judges.

- If there is no extrinsic evidence (that is, if the contract is to be interpreted strictly from the face of the instrument), interpretation is a question of law for the court.

- If such a decision is appealed, the appellate court reviews the contract interpretation issue de novo, with no deference to the trial court.

- The same rules apply if there is uncontested extrinsic evidence: Interpretation is a question of law, and it is reviewed de novo on appeal.

- In cases of undisputed extrinsic evidence, review is de novo even if there are disputes over the inferences that should be drawn from it.

- Contract interpretation becomes a question of fact for a jury to resolve when there are material conflicts in the extrinsic evidence - such as disputes over what was said during contract negotiations, what was done after contracting but before the dispute arose, or the relevant custom and practice in the industry. (See Parsons, 62 Cal. 2d at 865.)

The last of these rules has proved to be the real troublemaker. Indeed, litigators can count on a fierce pretrial fight over whether there are material extrinsic fact disputes that convert the contract interpretation into a jury question.

If the trial court correctly applies these rules, many - perhaps most - contract interpretation disputes will present questions of law that the trial judge decides and the appellate court redetermines de novo. This could mean that the contract's meaning can be resolved on a motion for summary judgment; if not, it should be resolved by the trial court in time to instruct the jury as to the contract's meaning.

Factual Disputes
If material extrinsic fact disputes do make contract interpretation a question of fact, then things start to get complicated, especially if the case is to go before a jury. In many cases - City of Hope was one of them - a lay jury will be required to apply the very contract-interpretation principles that trial lawyers labor to master during their law school years. For this reason, the approved jury instructions include some general principles of contract interpretation. (See CACI Inst. 314320.) Just reading these instructions and thinking about what jurors in a complex contract interpretation case will make of them is unsettling.

Unless the trial court requires the jury to fill out a special verdict form, the contract interpretation may be subsumed into a general verdict on the contract cause of action. This was the case in City of Hope, where a lay jury interpreted an ambiguous, complex commercial agreement and returned a nine-figure verdict.

Of course, such verdicts can be appealed. But when the jury has been given the task of interpreting the contract, case law shows that the appellant faces a steep uphill climb. Indeed, one court noted that where "the interpretation of the contract turns upon the credibility of conflicting extrinsic evidence which was properly admitted at trial, an appellate court will uphold any reasonable construction of the contract by the trial court." (Morey v. Vannucci, 64 Cal. App. 4th 904, 913 (1998).) No standard of review is more deferential. Under that standard, it is hard to conceive of any appellate tribunal overturning a jury's interpretation.

Trial counsel who understand the foregoing rules have a powerful tool for getting a question of contract interpretation resolved by a jury rather than by the trial judge or an appellate court. Such a tactic will, of course, ordinarily be attractive to the side whose contract interpretation is the least plausible: Counsel with the legally weaker interpretation will argue that there are material extrinsic fact disputes that merit jury determination. For example, there may be a dispute about material discussions during contract negotiation, or a question about the post-contracting conduct of the parties. In other cases, expert testimony about industry custom and practice might be disputed. Skilled counsel will focus on one or more of these kinds of fact disputes to defeat summary judgment and, ultimately, present the issue of contract interpretation to the jury.

To the extent a jury is allowed to interpret a contract - and an appellate court is bound to uphold the jury's interpretation unless it is completely unreasonable - the law injects a high degree of unpredictability into commercial contractual relationships: As a practical matter, a lay jury will have the last word as to the meaning of a contract that a lawyer negotiated and wrote.

A Procedural Alternative
In the City of Hope case cited above, appellant Genentech tried to avoid this predicament by arguing that the trial court should have used another procedure: letting the jury resolve the extrinsic fact disputes (using a special verdict form), after which the trial judge interprets the contract. (See Med. Operations Mgmt., Inc. v. Nat'l Health Labs., Inc., 176 Cal. App. 3d 886 (1986).)

This dual procedure takes advantage of the distinct institutional competencies of both the trial judge and the lay jury: The jury resolves the historical fact disputes, and the trial judge then applies established interpretative principles to the contract language in light of the facts found by the jury. If such a case is appealed, the reviewing court would apply the familiar "any substantial evidence" standard to the facts, but would review the contract interpretation de novo.

However, the California Supreme Court held in City of Hope that this dual procedure was optional, and its use a matter of trial court discretion (City of Hope, 43 Cal. 4th at 450-452 (2008)). Indeed, the trial judge in City of Hope rejected the idea without explanation, and his ruling was upheld.

Appellant Genentech did not seek review of the case-specific question of whether the jury's contract interpretation was unreasonable. As noted, decisions such as Morey v. Vannucci have held that when the jury has interpreted the contract because of a material extrinsic fact dispute, the appellate court will "uphold any reasonable construction of the contract by the trial court." (64 Cal. App. 4th at 913.) The question of whether the court of appeal correctly applied that standard to the particular circumstances of City of Hope would not have met the Supreme Court's criteria for discretionary review.

But is the Morey standard correct? To be sure, the appellate court will apply the highly deferential "any substantial evidence" standard to the jury's resolution of factual disputes. And unless the trial court has used the Medical Operations Management special verdict procedure, the appellate court must assume that the jury resolved all material factual disputes in the prevailing party's favor. (See Whiteley v. Philip Morris, Inc., 117 Cal. App. 4th at 635, 642 & n.3.) But does it follow that the appellate court must also "uphold any reasonable construction of the contract" given by a lay jury?

Maybe not. Appellate courts are quite accustomed to describing the facts favorable to the verdict and judgment. In this context, then, the reviewing tribunal could craft its opinion based on the most favorable view of the disputed facts - both the historical facts (who said and did what) and any disputed extrinsic facts (such as industry custom and practice). Yet there is no requirement that the jury's interpretation of the contract itself receive comparable deference. Presumably, the appellate court could take the facts determined by the jury (that is, facts favorable to the prevailing party) and then independently review the issue of contract interpretation as a matter of law.

Recent Authority
A recent ruling endorses this methodology, albeit in an analogous context and without disapproving Morey. In Haworth v. Superior Court (50 Cal. 4th 372 (2010)), the issue was whether a former trial judge, sitting as a neutral arbitrator, had failed to disclose a matter that could cause a reasonable person to question his impartiality. The trial court held that the arbitrator should have made the disclosure. The California Supreme Court eventually ruled that disclosure was not required. Part of its opinion addresses the standard of review, holding that the appellate court should determine the disqualification issue de novo, after giving deferential effect to the trial court's resolution of disputed facts.

The supreme court considered the issue to involve "a mixed question of law and fact." (50 Cal. 4th at 384.) The court explained: "[I]n most instances, mixed questions of fact and law are reviewed de novo - with some exceptions, such as when the applicable legal standard provides for a 'strictly factual test, such as state of mind.' " The court further noted that "usually the application of law to fact will require the consideration of legal concepts and involve the exercise of judgment about the values underlying legal principles." (50 Cal. 4th at 385.)

In light of the court's statement that appellate review of mixed questions of law and fact is de novo "in most instances," the deferential standard endorsed by decisions such as Morey v. Vannucci appears open to question.

The Need for Certainty
Further appellate consideration of this issue is urgently needed. When commercial parties enter into contracts, their goal is to have the terms of their relationship determined by their voluntary agreement. They seek certainty and predictability.

Contract ambiguities are common because the fallibility of scriveners prevents negotiators from reaching the utopia of clear and certain contract drafting. But if the parties know that their contract will be interpreted by a trained and experienced judge applying established legal principles, they most certainly will feel more secure than if their fate lies in the hands of a lay jury.

Juries are good at determining disputes over historical facts - Who said what? Who did what? - and perhaps also at resolving competing claims of an industry's custom and practice. But contract interpretation involves many subtle legal principles and techniques. (See 1 Witkin, Summary of Cal. Law, Contracts §§ 741-758 (10th Ed. 2005).) Juries have no special expertise for that role.

Until the courts harmonize these conflicting lines of cases, the party with the weaker contract interpretation argument has every incentive to create and exploit an extrinsic fact dispute and push for jury interpretation of the contract. Knowing that, what can lawyers - both transactional attorneys as well as litigators - do to protect their clients?

Contract Language
Counsel who draft contracts should consider inserting language specifying that contract interpretation disputes will be resolved through arbitration by an experienced neutral. As an alternative, a clause could require that contract interpretation disputes be resolved by a judicial referee, which effectively waives a jury trial. (See Cal. Code Civ. Proc. § 638; Grafton Partners LP v. Superior Court, 36 Cal. 4th 944 (2005).)

Counsel might also include a provision acknowledging the City of Hope decision and agreeing that in the event of litigation over interpretation of the contract, the parties will jointly request that the court not allow the jury to interpret the contract and, further, that if extrinsic facts are disputed, the court will submit them to the jury by special interrogatory before interpreting the contract as a matter of law.

However, if the jury was allowed to interpret the contract at trial, counsel should characterize the disputed contractual issues as mixed questions of law and fact in post-trial motions and in appellate briefing. The briefs should urge the appellate court to follow Haworth by deferring to the jury's presumed findings of fact (that is, by assuming - as appellate courts regularly do - that the jury resolved each fact dispute in favor of the party who prevailed) but affording de novo review to the legal issue of contract interpretation.

Given the complexities surrounding this issue, perhaps the most cogent bit of advice to lawyers is that they draft a contract that is so clear that anyone can understand it - including a lay person who may wind up sitting on a jury.

Jerome B. Falk Jr. is a partner at Howard Rice Nemerovski Canady Falk & Rabkin in San Francisco and a certified appellate specialist.

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