Canada: Termination Of Contracts In Challenging Economic Times

Given the current state of the economy, businesses are scrutinizing existing and potential transactions very closely. Existing or potential contracts, which seemed economic even a few short months ago, may not seem as valuable now and there is a reasonable expectation that there will be increased litigation dealing with termination of contracts especially in the oil and gas sector. Such decisions can occur in various contexts including with pending mergers and acquisitions, service agreements and other existing contracts. Whether a contracting party has the right to terminate a contract is fact specific and case law varies based on a number of factors to consider. Some considerations include the following:

  • The recent Supreme Court of Canada (SCC) decision in Bhasin v. Hrynew recognized a common law duty that applies to all contracts to act honestly in the performance of contractual obligations. The case also held that, in carrying out the performance of a contract, a contracting party should have appropriate regard to the legitimate contractual interests of the opposing party. While that common law duty does not attract the obligations of a fiduciary nor does it engage duties of loyalty, the principles enunciated by the court should be borne in mind in considering the circumstances under which a termination may occur.
  • Another recent case by the SCC in Sattva Capital Corp v. Creston Moly Corp. confirmed that the court can have regard to the surrounding circumstances or "factual matrix" in interpreting the terms of a contract, which is nothing particularly new although the court's recent treatment of that analysis was instructive. While the SCC held that the factual matrix can be relied upon in the interpretive process, such surrounding circumstances cannot be used to deviate from the actual words used in a contract. The SCC was also clear that its commentary in allowing the introduction of surrounding circumstances did not preclude the operation of the parol evidence rule, which prohibits the admission of evidence outside the words of the written contract that would add to, subtract from, vary or contradict the terms of a contract that has been wholly reduced to writing. As a result, looking at the existing words of a contract may not always provide a clear picture of when a contract can be terminated and under what circumstances.
  • A body of case law has developed concerning the ability of a party to terminate a contract in the context of a material adverse change (MAC), which may be defined in different ways in different contracts. To the extent that a triggering event and processes are clearly set out in a MAC clause, it is critical to follow that process precisely, failing which it may create potential defences. To the extent that such MAC clauses and related triggering events are not clearly drafted, it may invite the court to examine the surrounding circumstances involved. That said, the Alberta Court of Appeal in Vallieres v. Vozniak recently held that in dealing with a standard form contract, delving into surrounding circumstances is often not necessary. Accordingly, whether a contract is a standard form industry agreement may also have some bearing on termination rights.
  • The termination of a contract may also depend on whether a party is ready, willing and able to perform that contract, particularly when that termination relates to a "time is of the essence" clause (TIOTE Clause). Generally speaking, a TIOTE Clause provides that if one party is late in performing its obligations under the contract, then the other party may terminate the contract. However, there are defences against such a termination. Specifically, where the other party is late in its performance, a party can only terminate a contract if it was ready, willing and able to perform the contract itself (see Bowlen v. Digger Excavating (1983) Ltd. at paragraph 13).
  • Another important risk factor is the prospect of punitive damages being awarded against parties that intentionally breach their contracts. There may be situations where parties view the benefit of terminating a contract as greater than their exposure to damages for such a breach. Termination in these circumstances may attract punitive damages against such parties (see Rookes v. Barnard (1964)).

In sum, the termination of a contract can be a complex process with potentially significant consequences to the parties involved. In the midst of the current economic landscape, more parties may be looking to terminate contracts that have depreciated in value. Nevertheless, it is well-advised to seek legal advice prior to terminating a contract to ensure that any proposed termination is conducted properly and that the anticipated legal consequences of the termination are understood.

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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