Canada: SCC Eliminates Doctrine Of Fundamental Breach In Contract Law; Tercon Decision Strongly Endorses Upholding Exclusion Of Liability Clauses Absent Proof Of An "Overriding" Public Policy To The Contrary

In a procurement decision that will have a wide-ranging and significant impact on all types of contractual disputes, the Supreme Court of Canada (SCC) has "laid to rest" the doctrine of fundamental breach in Canadian contract law. Under that doctrine, an innocent party could stop performing its obligations under a contract if the other party had committed a breach that was so "fundamental" that it denied the innocent party of "substantially the whole" of the contract's benefit. Even if the contract contained a clear and express "exclusion clause" limiting liability, a fundamental breach allowed a court to refuse to enforce this clause, thereby enabling the innocent party to sue for damages that would have otherwise been excluded.

In a ringing endorsement of freedom of contract, the SCC has both eliminated the "fundamental breach" jargon and narrowly curtailed the circumstances in which a party can escape the application of a valid exclusion clause "or other contractual terms" limiting liability. As long as the language of the exclusion clause covers the circumstances in issue and the clause was not unconscionable at the time that the contract was formed, a party will be bound by the clause unless they can establish "an overriding public policy" that "outweighs the very strong public interest in enforcement of contracts". Only then will a court exercise its "narrow jurisdiction" to deviate from the contractual bargain struck by the parties.

The case, Tercon Contractors Ltd. v. British Columbia (Transportation and Highways), 2010 SCC 4, arose in the context of a request for proposal (RFP) process initiated by the Ministry of Transportation and Highways of British Columbia to build a highway in northern BC. Only six bidders, including the appellant Tercon Contractors Ltd. and another construction company, Brentwood Enterprises Ltd., were eligible to submit a response to the RFP. Unable to submit a competitive bid on its own, Brentwood teamed up with another construction company and submitted a bid that was "in substance" a joint venture between Brentwood and its partner. The problem was that the partner was not eligible to participate in the RFP, and the Province "took active steps to obscure the reality" that the joint venture bid was in "material non-compliance" with its own RFP process. Ultimately, the Province awarded the contract to Brentwood on the basis of its joint venture bid. Tercon, the runner-up, sued for breach of the contract it formed with the Province through the RFP process. At issue was the exclusion clause contained in the RFP, which stated in part that Proponent shall have any claim for compensation of any kind whatsoever, as a result of participating in this RFP, and by submitting a Proposal each Proponent shall be deemed to have agreed that it has no claim.

Justice Cromwell, writing for a majority of the SCC, allowed the appeal and restored the trial judge's conclusion that this exclusion clause did not prevent Tercon from recovering compensation from the Province for selecting Brentwood's joint venture bid. Justice Cromwell found that the exclusion clause did not apply to Tercon's claim for compensation because the exclusion clause only covered those claims arising "as a result of participating in [the] RFP", not to claims arising from the participation of other, ineligible bidders. Justice Cromwell found that the exclusion clause was not broad enough to limit the Province's liability, both in respect of allowing the ineligible bidder to bid and for breaching the implied duty of fairness that the Province owed to Tercon and all other eligible bidders. The drafter of the clause would no doubt disagree with Justice Cromwell on this point – but those who draft such clauses are put on notice by the Tercon decision that in the absence of the "fundamental breach" escape hatch, the terms of exclusion clauses may be subject to increasingly strict and imaginative scrutiny on the question whether they cover the contractual breach at issue.

The SCC was unanimous in rejecting the doctrine of fundamental breach as a basis on which Tercon could avoid the exclusion clause and recover compensation from the Province. Justice Binnie, writing for the Court on the analytical approach that should be followed when considering the enforceability of an exclusion clause, reiterated that "[t]here is nothing inherently unreasonable about exclusion clauses". Noting the difficulty with categorizing a breach of contract as "fundamental" (so as to allow an innocent party to escape an otherwise valid exclusion clause), Justice Binnie discarded the "fundamental breach" lexicon, writing that

...the principle is that a court has no discretion to refuse to enforce a valid and applicable contractual exclusion clause unless the [party seeking to avoid the exclusion clause] can point to some paramount consideration of public policy sufficient to override the public interest in freedom of contract and defeat what would otherwise be the contractual rights of the parties.

Going forward, a party to a contract will no longer be able to argue that it can circumvent a valid and applicable exclusion of liability clause on the basis of an alleged "fundamental breach" of the contract by the other party. Only if the party seeking to avoid such a clause can identify some "paramount consideration of public policy" or, as Justice Binnie later terms it, "an overriding public policy" that outweighs the very strong interest in enforcing contracts and their terms, will the court oblige this request. Notably, while the focus of Justice Binnie's analytic framework pertains to exclusion clauses, he suggests that this category may also include "other contractual terms", potentially signalling that other valid and applicable contractual provisions that limit parties' rights under a contract may be subject to the same analysis as pure exclusion of liability clauses.

This analysis is summarized by Justice Binnie as involving three enquiries. The first is whether the exclusion clause applies to the conduct in question – an issue that requires a court to examine the exclusion clause in the context of the contract as a whole and the commercial context of the agreement. If the clause does apply, a secondary enquiry is whether the clause is valid, in the sense that it is not unconscionable between the parties. What matters here is whether circumstances such as unequal bargaining power existed at the time that the contract was formed, not the current state of affairs between the parties. Finally, if the exclusion clause applies and is valid, the last enquiry is whether the court should refuse to enforce it. In Justice Binnie's words, a court has "no discretion" not to enforce such a clause, unless persuaded by the party seeking to avoid it of a "paramount" or "overriding" public policy consideration.

The elimination of the "fundamental breach" terminology in contract law resolves the difficulty often encountered in ascertaining whether a breach of contract is truly "fundamental". More broadly, the SCC's decision solidifies the enforceability of clear and express exclusion clauses and other provisions that limit liability under a contract. Given the "very strong public interest in enforcement of contracts" affirmed by the SCC and the "narrow jurisdiction" that courts have to override this freedom of contract on public policy grounds, it appears that that the cases in which an otherwise valid and applicable exclusion clause will not be enforced will be few and far between.

Parties entering into contracts in the procurement context or otherwise must continue to be mindful of the scope of clauses that limit liability. In particular, sophisticated parties that agree to broad limitation of liability clauses must be aware that absent some compelling public policy reason, the bargain they strike in their contract will likely be enforced.

Mark Gelowitz is a partner in the firm's Litigation Department. Roger Gilott is a partner in the Construction and Infrastructure Group at Osler and has significant expertise in construction litigation, arbitration and dispute resolution proceedings. Paul Ivanoff is a partner in Osler's Litigation Department and is a member of the firm's Construction & Infrastructure Specialty Group. Ian Matthews is an associate in the Litigation Department of the firm's Toronto office.

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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