Canada: Tercon and its Effect on Exclusion and Limitation of Liability Clauses

The Supreme Court of Canada's (SCC) judgment in Tercon Contractors Ltd. v. British Columbia (Transportation and Highways) (2010) has been described as putting to rest the doctrine of fundamental breach. Many court watchers would argue that that doctrine was effectively abolished in Canada by the SCC's decision in Hunter Engineering Co. v. Syncrude Canada Ltd., handed down more than 20 years before the decision in Tercon. Thus, it is somewhat surprising to see the amount of ink that has been spilled on this aspect of Tercon.

Before dealing with other aspects of the SCC's decision in Tercon, it is important to be clear about the scope of the doctrine of fundamental breach. The doctrine started with a 1956 judgment of the English Court of Appeal. The court in Tercon described the doctrine this way:

...where the defendant had so egregiously breached the contract so as to deny the plaintiff substantially the whole of its benefit ... the innocent party was excused from further performance but the defendant could still be held liable for the consequences of its "fundamental breach" even if the parties had excluded liability by clear and express language.

In Hunter, the court unanimously agreed that the doctrine was no longer the law of Canada. However, that did not mean that exclusion or limitation of liability clauses would always be enforced by a court. The court in Hunter was divided on the circumstances in which a court should refuse to give effect to an exclusion or a limitation of liability clause. Some members opted for an unconscionability test, while others favoured unreasonableness and public policy tests. The court in Tercon resolved this difference of opinion by favouring an unconscionability exception to enforcement of an exclusion or limitation of liability clause. The court went on to hold that even if an exclusion exception or limitation of liability clause were not unconscionability vis-à-vis the parties, it may nevertheless be unenforceable if the court concludes that it is contrary to public policy.

Although the court was unanimous on these aspects of Tercon, the court was split 5-4 on the interpretation of the exclusion clause in Tercon. The majority held that the clause did not apply, while the minority held that the clause did protect British Columbia from its breach of the RFP.

It is interesting to note that of all the judges who heard this case, seven (the three members of the Court of Appeal and the four dissenting judges in the SCC) decided that the clause applied in the circumstances, while six judges (the trial judges and five judges in the SCC) held that it did not. Only the trial judge, in obiter, held the clause to be unconscionable. None of the other 12 judges who heard the case found the clause to be unconscionable, although the four minority judges in the SCC held that the clause was not unconscionable.

The judgment also raises the question of what types of clauses will be subject to the unconscionability test. Put another way, will courts consider an entire agreement clause to be an exclusion or limitation of liability clause? Will a threshold or a cap on damages be considered such a clause? Are exclusion of implied warranty clauses subject to the unconscionability standard? These are just some of the questions that are likely to arise in the future.

As for the test to be used to determine if an exclusion or limitation of liability is unconscionable, neither the majority nor the minority in Tercon set out what the test should be. The majority found that the clause did not apply and, therefore, did not have to deal with whether the clause was unconscionable. The minority found the clause did apply, but found no inequality of bargaining power. Presumably, on that basis, the minority concluded that the clause was not unconscionable.

Tercon has been hailed for putting the final nail in the coffin of the doctrine of fundamental breach, a result supposedly achieved in effect by the court in Hunter in 1989 and another case in 1999. It is true that Tercon also probably makes it difficult to argue that an exclusion or limitation of liability clause is unconscionable in an agreement between sophisticated commercial parties.

On the other hand, the adoption of unconscionability still leaves a real risk that a court will refuse to give effect to such clauses in many consumer contracts. Therefore, on a going-forward basis, the test for unconscionability becomes crucial for businesses dealing with consumers.

In Titus v. William F. Cooke Enterprises Inc. (2007) MacPherson J. adopted the four-part test applied in an earlier Alberta Court of Appeal decision:

  1. a grossly unfair and improvident transaction;
  2. the victim's lack of independent legal advice or other suitable advice;
  3. an overwhelming imbalance in bargaining power caused by victim's ignorance of business, illiteracy, ignorance of the language of the bargain, blindness, deafness, illness, senility, or similar disability; and
  4. the other party's knowingly taking advantage of this vulnerability.

Yet, in Birch v. Union of Taxation Employers, Local 70030 (a 2008 penalty clause case), the court used the two-part test employed in another decision while at the same time acknowledging that "[t]here does not appear to be a single articulation of a test applicable to all situations. This is not surprising given that the doctrine of unconscionability has been applied in a wide variety of cases." (para. 41).

The SCC itself has dealt with unconscionability in a few cases. In one decision, the court held that a special test for unconscionability should be used in the matrimonial context. It is certainly conceivable that the SCC, in a subsequent decision, will have to determine the test for unconscionability in the case of exclusion or limitation of liability clauses.

The introduction of the doctrine of public policy into the analysis introduces another element of uncertainty, unless the court narrowly circumscribes the concept of public policy in this context.

The fact that the nine members of the court in Tercon were divided on the interpretation of the clause highlights what has always been an important battleground in the enforceability of exclusion and limitation of liability clauses — how broadly or how narrowly should such clauses be interpreted. The division in Tercon underscores the need for absolute clarity in the drafting of such clauses, even if clear language will be a hard sell. After all, what contracting party wants to focus the other party's attention on what little it has actually gained from the contract? Put another way, the emphasis on clear language may well result in perfection being the enemy of the good.

Exclusion Clauses in Québec

Despite some overlap between the approaches of the Civil law of Québec and Canadian common law, the SCC decision in Tercon will not likely have a significant impact upon the law of Québec governing exclusion or limitation of liability clauses.

The SCC decision in Glengoil Steamship Co. v. Pilkington established that exclusion of liability clauses are valid in principle and not contrary to public order under the law of Québec. The validity of exclusion clauses derives from the principle of freedom of contract, rather than an express provision in the Civil Code of Lower Canada in force at the time of the Glengoil decision or in the current Civil Code of Québec (CCQ).

As in Canadian common law jurisdictions, exclusion of liability clauses are restrictively interpreted under the law of Québec. The intention to limit or exclude liability must be clearly expressed and the clause will only be applied according to its terms. An ambiguity in the clause will be interpreted against the interests of the person invoking the clause and may cause it to be without effect.

As with any other contractual provision, the consent to an exclusion of liability clause must be freely given. Article 1475 CCQ specifies that notices excluding or limiting liability, such as those posted in parking lots, are valid only if the party invoking the notice establishes that the other party was aware of its existence at the time the contract was formed.

Exclusion and limitation of liability clauses can only apply to contractual liability. Article 1458 CCQ prevents the parties to a contract from invoking an extra-contractual liability regime to the extent that the potential claim is covered by a contractual regime.

The law of Québec restricts the validity of exclusion and limitation of liability clauses through specific rules related to the seriousness of the misconduct, the nature of the damages or the class of contractual activity. The most generally applicable restriction on exclusion clauses is found in Article 1474 CCQ. This provision prohibits the exclusion or limitation of liability for injury caused through intentional or gross fault. Gross fault is defined as a fault that demonstrates "gross recklessness, gross carelessness or gross negligence." This aspect of Article 1474 CCQ clearly indicates that the law of Québec distinguishes between negligence and gross negligence. The notion of intentional fault under Québec law appears to include an intention to cause harm, as well as a deliberate refusal to perform a contractual obligation whether harm is intended or not.

In addition, Article 1474 CCQ expressly prohibits any exclusion or limitation of liability for bodily or moral injury. The restrictions imposed by this article apply to all types of contracts.

Québec law also restricts exclusion and limitation of liability clauses in order to protect certain parties in the context of particular types of contracts. Section 10 of the Québec Consumer Protection Act states that any stipulation whereby a merchant is liberated from the consequences of his own act or act of his representative is prohibited. It is not possible to derogate from the statute by private agreement and, in particular, a consumer cannot waive any rights granted under the statute unless provided in it.

Under the Québec regime governing the contract of sale, a buyer can exercise recourses for latent defects in the item purchased against his immediate seller and, as an exception to the principle of privity of contract, against a distributor, supplier and manufacturer in the chain of title. As described in a recent SCC decision, manufacturers and professional sellers are presumed to know of latent defects existing at the time of sale. The result of the presumption of knowledge is that an exclusion clause as regards liability for latent defects is valid only if the seller or manufacturer can rebut the presumption of knowledge, thereby of avoiding fraud or an intentional fault and the application of the rule in Article 1474 CCQ Rebuttal of the presumption knowledge requires demonstrating that the seller of manufacturer could not have reasonably discovered the defect despite taking all necessary production precautions.

The CCQ also states that exclusion clauses favouring a lessor in a residential lease, carrier in a contract of transport and an employer as regards termination of employment are without effect.

The analogue to fundamental breach plays a role in Québec law in two circumstances. First, Article 1604 CCQ indicates that the recourses for termination of a contract for breach is not available if the breach is "of minor importance." The provision applies "notwithstanding any stipulation to the contrary." Second, Article 1437 CCQ states that an abusive clause in a consumer contract or contract of adhesion is null, or the obligation arising from it may be reduced. The provision indicates that a clause is abusive in particular where it so departs from the fundamental obligations arising from the rules normally governing the contract that it changes the nature of the contract. Article 1437 CCQ has been applied to invalidate an exclusion clause where breach of the primary obligation under the contract deprives it of its essential effects.

While the scope and effect of exclusion and the limitation of liability clauses is in part a matter of contract interpretation under Québec law, restrictions on the validity of exclusion clauses result from codified rules regarding the seriousness of the misconduct, nature of the damages or nature of the contract. Fundamental breach, until recently the central element in the regulation of exclusion clauses in Canadian common law, plays a relatively minor role in this area in Québec.

Further, unconscionability and public policy, given important status by Tercon, are subsumed in the law of Québec by the specific codal and statutory restrictions of general or limited application. Under the law of Québec, in addition to the issue of interpretation, the primary battleground with regard to the validity of exclusion clauses in a commercial context will be whether the breach results from an intentional or gross fault, an issue that is not directly addressed in Tercon.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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