Doctrine of Fundamental Breach "laid to rest" by Supreme Court of Canada: Tercon Contractors Ltd. v. British Columbia

The Supreme Court of Canada just released its decision in Tercon Contractors Ltd. v. British Columbia (Transportation and Highways), 2010 SCC 4. The Court agreed on the appropriate framework of analysis and that the doctrine of fundamental breach should finally be “laid to rest.” However, the Court was divided 5-4 on the applicability of the exclusion clause to the facts. See Shaunna Mireau’s lead-in at slaw.ca here.

Cromwell, J. for the majority writes,

[61] The trial judge held that as a matter of construction, the clause did not bar recovery for the breaches she had found. The clause, in her view, was ambiguous and, applying the contra proferentem principle, she resolved the ambiguity in Tercon’s favour. She also found that the Province’s breach was fundamental and that it was not fair or reasonable to enforce the exclusion clause in light of the nature of the Province’s breach. The Province contends that the judge erred both with respect to the construction of the clause and her application of the doctrine of fundamental breach.

[62] On the issue of fundamental breach in relation to exclusion clauses, my view is that the time has come to lay this doctrine to rest, as Dickson C.J. was inclined to do more than 20 years ago: Hunter Engineering Co. v. Syncrude Canada Ltd., [1989] 1 S.C.R. 426, at p. 462. I agree with the analytical approach that should be followed when tackling an issue relating to the applicability of an exclusion clause set out by my colleague Binnie J. However, I respectfully do not agree with him on the question of the proper interpretation of the clause in issue here. In my view, the clause does not exclude Tercon’s claim for damages, and even if I am wrong about that, the clause is at best ambiguous and should be construed contra proferentem as the trial judge held. As a result of my conclusion on the interpretation issue, I do not have to go on to apply the rest of the analytical framework set out by Binnie J.

[64] The key principle of contractual interpretation here is that the words of one provision must not be read in isolation but should be considered in harmony with the rest of the contract and in light of its purposes and commercial context. The approach adopted by the Court in M.J.B. is instructive. The Court had to interpret a privilege clause, which is somewhat analogous to the exclusion clause in issue here. The privilege clause provided that the lowest or any tender would not necessarily be accepted, and the issue was whether this barred a claim based on breach of an implied term that the owner would accept only compliant bids. In interpreting the privilege clause, the Court looked at its text in light of the contract as a whole, its purposes and commercial context. As Iacobucci J. said, at para. 44, “the privilege clause is only one term of Contract A and must be read in harmony with the rest of the tender documents. To do otherwise would undermine the rest of the agreement between the parties.” …

Binnie, J. in dissent, similarly notes:

[117] As Duff C.J. recognized, freedom of contract will often, but not always, trump other societal values. The residual power of a court to decline enforcement exists but, in the interest of certainty and stability of contractual relations, it will rarely be exercised. Duff C.J. adopted the view that public policy “should be invoked only in clear cases in which the harm to the public is substantially incontestable, and does not depend upon the idiosyncratic inferences of a few judicial minds” (p. 7). While he was referring to public policy considerations pertaining to the nature of the entire contract, I accept that there may be well-accepted public policy considerations that relate directly to the nature of the breach, and thus trigger the court’s narrow jurisdiction to give relief against an exclusion clause.
[118] There are cases where the exercise of what Professor Waddams calls the “ultimate power” to refuse to enforce a contract may be justified, even in the commercial context. Freedom of contract, like any freedom, may be abused. Take the case of the milk supplier who adulterates its baby formula with a toxic compound to increase its profitability at the cost of sick or dead babies. In China, such people were shot. In Canada, should the courts give effect to a contractual clause excluding civil liability in such a situation? I do not think so. Then there are the people, also fortunately resident elsewhere, who recklessly sold toxic cooking oil to unsuspecting consumers, creating a public health crisis of enormous magnitude. Should the courts enforce an exclusion clause to eliminate contractual liability for the resulting losses in such circumstances? The answer is no, but the contract breaker’s conduct need not rise to the level of criminality or fraud to justify a finding of abuse.

[120] Conduct approaching serious criminality or egregious fraud are but examples of well-accepted and “substantially incontestable” considerations of public policy that may override the countervailing public policy that favours freedom of contract. Where this type of misconduct is reflected in the breach of contract, all of the circumstances should be examined very carefully by the court. Such misconduct may disable the defendant from hiding behind the exclusion clause. But a plaintiff who seeks to avoid the effect of an exclusion clause must identify the overriding public policy that it says outweighs the public interest in the enforcement of the contract. In the present case, for the reasons discussed below, I do not believe Tercon has identified a relevant public policy that fulfills this requirement.
[121] The present state of the law, in summary, requires a series of enquiries to be addressed when a plaintiff seeks to escape the effect of an exclusion clause or other contractual terms to which it had previously agreed.

[122] The first issue, of course, is whether as a matter of interpretation the exclusion clause even applies to the circumstances established in evidence. This will depend on the Court’s assessment of the intention of the parties as expressed in the contract. If the exclusion clause does not apply, there is obviously no need to proceed further with this analysis. If the exclusion clause applies, the second issue is whether the exclusion clause was unconscionable at the time the contract was made, “as might arise from situations of unequal bargaining power between the parties” (Hunter, at p. 462). This second issue has to do with contract formation, not breach.

[123] If the exclusion clause is held to be valid and applicable, the Court may undertake a third enquiry, namely whether the Court should nevertheless refuse to enforce the valid exclusion clause because of the existence of an overriding public policy, proof of which lies on the party seeking to avoid enforcement of the clause, that outweighs the very strong public interest in the enforcement of contracts.

International Sales Law Implications

In circumstances where provincial sales legislation applies to a contractual dispute, the doctrine of fundamental breach is spent. However, what if the United Nations Convention on Contracts for the International Sale of Goods Act, 1980 (CISG) (as implemented in Canada by the International Sale of Goods Contracts Convention Act , S.C. 1991, c. 13 and incorporated into legislation by all Canadian provinces and territories) applies to the dispute? Unlike most provincial sale of goods legislation (e.g. The Ontario Sale of Goods Act, R.S.O. 1990, s.S.1), there is no a priori classification of terms of the contract into warranties and conditions. Rather, the consequences of a breach of either party’s obligations are, with few exceptions, determined by the gravity of the breach, that is, by whether or not it amounts to a “fundamental breach”: Art. 25 CISG, Art. 49(1) CISG and Art. 64(1) CISG.

Article 25 CISG is a key article because the remedies of the buyer and seller under the CISG turn on the character of the breach involved. Generally speaking, if the breach is fundamental the injured party is entitled to avoid the contract; if it is not, the party’s remedy is to claim in damages although in some circumstances, an order for specific performance may be appropriate. See arts. 49 and 64.

The common law rules are different since the sale of goods acts generally resorts to a classification system based upon warranties and conditions with respect to the implied terms of title, description, merchantability, fitness and sale by sample. (cf. Art. 8 CISG for treatment of standard terms and conditions)

Article 26 CISG speaks to “Avoidance” in the sense of repudiation or rescission for cause. “Avoidance” is generally used in Anglo-Canadian law in the context of contracts induced by the misrepresentation or other misconduct of one of the parties rather than to describe the remedy available for breach of a contractual obligation. The terminology used is likely a distinction without a difference, or, put another way, form over content. There may be circumstances when, at common law, the aggrieved party may have no option but to treat the contract as void or voidable: for example, where the other party has become bankrupt or, in the case of a sale of specific goods, the goods have been destroyed due to the seller’s fault. In such cases the injured party would not be electing a remedy and any notice requirement would be non-sensical. Moreover, there is no practical difference since no formality is required when giving notice of avoidance under Art. 27 CISG.

J.W. Carter in “Party Autonomy and Statutory Regulation: Sale of Goods”6 Journal of Contract Law, North Ryde NSW, Australia (1993) 93-122 offers the following meaning of fundamental breach under the CISG:

“The concept of fundamental breach is central both to avoidance (by either party) and to rejection. It has been rightly pointed out that the Convention does not employ the words ‘fundamental breach’ to deal with exclusion clauses.[36] Moreover, the reference to foresight of the consequences, based on a provision in ULIS, is expressed somewhat differently to the common law, since it appears to be no defence to a promisor under the common law to say that the consequences of the breach are more fundamental than anticipated.[37] [page 101]

 

Two further points must, however, be kept firmly in mind when considering the impact of the Convention on domestic law. First, if courts were to treat the common law concept of fundamental breach as being adopted in the Convention, avoidance for fundamental breach would hardly ever be an available remedy. No American court would take this view. How will courts in Australia and Canada interpret the concept? It must surely have been the intention to introduce a concept which would allow avoidance in a wider range of circumstances than exist under the sale of goods legislation in relation to intermediate terms.[38] Secondly, the concept of fundamental breach does not rely on a prior classification of the term breached as being an intermediate term. It therefore also applies to terms which would, under the sale of goods legislation, be conditions.[39] This means that, subject to what is said below about ‘intention’, the right of termination for ‘minor’ breach of a term classified as a condition has been removed from international sale of goods transactions governed by the Convention. For example, where there is a breach of the duty under Art 35(1) of the Convention, to supply goods which are of the ‘quantity, quality and description required by the contract and which are contained or packaged in the manner required by the contract’, the buyer’s right of avoidance depends on proof of fundamental breach. Failure of the seller to deliver goods which are as ‘fit for the purposes for which goods of the same description would ordinarily be used’,[40] does not of itself confer a right of avoidance.”

See also, CISG-AC Opinion no 5  which defines “fundamental breach” in the following terms:

4.1 A fundamental breach of contract giving the buyer the right to avoid the contract or to ask for substitute goods presupposes that the defect has a serious importance to the buyer. In considering avoidance, one has to take into account whether the buyer can be required to retain the goods because he can be adequately compensated by damages or a price reduction. The substantiality of the detriment to the buyer may be ascertained by having regard to the terms of the contract, the purpose for which the goods are bought and finally, by the question of whether it is possible to remedy the defect. In any case, the question of time has to be given due consideration.

Finally, Art. 51(2) CISG provides the buyer is only entitled to completely avoid the contract, if the seller’s breach amounts to a fundamental breach of the entire contract.

 

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