Chapter 5. Interpretation of Contracts

• Interpretation of contracts is the process of determining the exact meaning of any terms or phrases used in a contract between two parties.

• Since a contract is in the nature of law as between the parties and their successors in interest, its interpretation entails a legal issue.

Interpretation

• Meaning of language is ascertained

Reformation

• To express or to conform to the real intentions of the parties

Laws, in general, as aid to interpretation of contracts.

• Modification by parties of rules of interpretation - The parties are free to accept these rules as written, to alter them where necessary or appropriate, or to comply with them to the fullest degree permitted by law or in accordance with their nature.

• Acceptance by parties of the rules - If nothing is expressed to the contrary, these suppletory norms and legal models must be assumed to have been accepted

• Natural and accidental elements of contract - When the parties don't express anything to the contrary, the natural parts of the contract are assumed to be accepted, and the accidental elements are excluded if the parties haven't made any specific provisions for them.

• Intent of the law - It is a fundamental principle that the court should look for the legislative intent in the law's provisions before attempting to interpret them. As it is never within the legislative intent, the law should never be interpreted in a way that leads to injustice.

• Retroactivity of the law - It is a well-established principle that laws do not apply retroactively unless specifically stated to do so. Only laws in effect at the time the contract was signed apply to the said particular transaction.

• Law of place where contract entered into - Lex locus contractus doctrine holds that a contract's nature, validity, obligation, and interpretation are generally governed by the law of the location in which it is made or entered into. Even though the place where the contract was made and the place where it must be performed are different, this has historically been the rule.

• It is a fundamental principle in contract interpretation that if a contract's words are unambiguous and demonstrate the parties' purpose, that meaning should be taken literally. Any other intention of the contracting parties that is contrary to the plain meaning cannot be inferred by the court.

ILLUSTRATION:

Miko and Ei entered into a contract of sale of a parcel of land belonging to Ei with a fair value of five million pesos (₱5,000,000.00) It is clearly stated that Ei is the vendor while Miko is the vendee.

EXPLANATION:

The terms of the contract are clear and it does not appear from the circumstances that the intention of the parties is contrary to the literal meaning of said terms.

In the event that the terms of a contract is ambiguous, the judge has a duty to take into account the parties' current relationships as well as the overall contract's tenor, purpose, and circumstances.

ILLUSTRATION: 

Albedo and Mona signed a document for a Contract of Lease. Although Mona is listed as the lessee and Albedo is referred to as the lessor in the agreement, possession and ownership of the land are transferred to Mona. Mona registered the property in her name after receiving the title from Albedo. Mona offered to buy the land in a letter to Albedo before the contract's start date.

EXPLANATION: By their actions, the parties have made it very clear that they intend to transfer ownership of the property to Mona. Consequently, the deal should be seen as a sale.

Special intent over general intent.

Although the phrases or words used in the contract or agreement may be general, the interpretation should NEVER depart from the parties' intentions. According to the circumstances, that purpose should be specified.

This rule is in place because it must be presumed that the parties' intentions are clear when they make remarks about a specific matter in their communication. 

General terms in contracts may be difficult to understand if they are diverse and have various meanings to the parties who agreed.

     EXAMPLE:

A sold his condo to B "including all the furniture therein.” 

The term "all" should not be interpreted to include A's car, which is distinct and different to furniture. 

Interpretation of stipulation with several meanings.

When an agreement is open to multiple meanings, the one that is most effective should be utilized. Therefore, the interpretation that results in a contract being valid or effective is the one that is justified by the rule mentioned in Article 1373, whereas the interpretation that results in a contract being illegal or meaningless is not.

    EXAMPLE:

A sold his horse to B, named “Olaf”. Incidentally, there are two horses with the name "Olaf". However, one of them has had his leg amputated. The horse will compete in horse races.

In order to make the contract effective, the sale should be made in regard to a horse that can compete in horse races without having one of its legs amputated.

Interpretation of various stipulations of a contract.

A contract must be interpreted in its completeness, and the parties' intentions should be inferred from the entire document rather than from specific words, phrases, or clauses.

    EXAMPLE:

B rented A's condo. According to the terms of the agreement, B was not allowed to sublease the property without A's prior written permission. Another clause therein stated that, if B breaks this condition, he must pay 5,000 in additional rent each month. The property was subleased by B without A's permission.

A has the power to kick B out? No, specifically in light of the clause specifying the fine for breaking the condition.

Interpretation of words with different significations.

Any words are to be understood in the manner that is most in line with the nature and object of the contract if it is capable of more than one meaning.  

   EXAMPLE:

X rented an area to Y so he could install a billboard for her business. The contract of a rental stipulates that X may end the agreement if a “building” is constructed on an adjacent property that is tall enough to block the view of X’s billboard. A building that blocked the view of X’s billboard had been placed on the area of an adjacent property.

Considering the nature and object of the contract, it is reasonable to interpret the term "building" as used in this context to encompass the blocking of billboards.

Resort to usage or custom as aid in interpretation.

This article explains the effect of usage or custom of the place. To explain the idea of the parties in the contract regarding such usage or custom, it is required to know whether the contract was entered into with the intention of receiving it.

To make it comprehensible, the custom from that place must be used to avoid confusion or to make it clearer in the contract.

     EXAMPLE:

1.  A performed services to B, but the contract did not specify how much compensation was to be given.

In this case, the amount must be determined by the rate customarily paid in the place where the services were rendered. (Arroyo vs. Azur, 76 Phil. 493.)

2. C made a contract with D within "Salad," and in Palawan, where the contract was made, Fruit salad was more regularly cooked than Caesar Salad. The phrase "salad" should be interpreted as Fruit Salad.

It is just reasonable not to favor the party who started the confusion in the contract, contract drafters must be extremely careful and mindful in the words they choose to use. The terms should be straightforward and should remove any doubt as to the parties' true intentions.

Illustration:

The College of Business and Accountancy entered into a contract with the government for the air conditioning of classrooms and buildings. The CBA wants air conditioning in every classroom, but they haven't been particularly clear about what they want. The contractor explained that, according to their understanding, it solely refers to the chosen classrooms. Word ambiguity can lead to problems and misunderstandings. 

The problem is determining how to effectively communicate the meaning of a word with multiple interpretations that was used in the contract?

In this case, the contractor should be in favor of the interpretation because they were not to blame for the confusion. The CBA must be clear regarding how to comply with the directions they provide. Anything that might be favorable to the party in whose favor the provision was made and to the person who does not lead to misunderstanding.

If Articles 1370 to 1377 cannot apply, this article will be considered as the last resort.

Gratuitous Contract 

• doubt refers to incidental circumstances (Art.1350) 

• least transmission of rights and interest

Examples:

Alex gave his yacht to Ariel. Their contract was not clear if it is a commodatum or donation.

Their contract should be presumed as a mere commodatum because it would transmit a lesser rights than a donation since Alex retained his ownership of the yacht.

Onerous Contract

• doubt shall be settled in favor of the greatest reciprocity of interests.

Examples:

In January first Jade borrowed from Kat P200,000 with a 10% interest. The term of their contract was not clear if the loan is payable on the first half of the year or at the end of the year.

It must be assumed that the period that they agreed upon is at the end of the year which results in a greater reciprocity of interest. Jade could use the money for the whole year while on the other hand Kat could earn interest for one year instead of half year.

Principal Object of the Contract

• Intention of the parties are unknown

• Contract should be null and void

Examples:

Danica buys Daniel's car. Daniel has multiple cars. It is not clear which car is intended by the parties to be sold.

As a result, the contract shall be null and void and it is as if the parties have not entered into any contract at all.

These are the classifications of defective contracts:

1. Rescissible contracts

• could be rescinded by economic injury or damage to one of the parties or third person.

2. Voidable or annullable contracts

• valid until annulled unless there has been ratification

3. Unenforceable contracts

• cannot be sued upon or enforced unless they are ratified.

4. Void or inexistent contracts

• absolutely null and void