It is not uncommon for construction contracts, in Canada and abroad, to contain both a limitation of liability clause and a contractual right of set-off. It is an issue of some uncertainty, however, as to which clause should be applied first in circumstances where both are engaged – an ambiguity of some importance, insofar as it can drastically alter the ultimate amount of damages payable.
Fortunately, further guidance has been provided by the Civil Division of the Court of Appeal in England in Topalsson GmbH v Rolls-Royce Motor Cars Limited, [2024] EWCA Civ 1330 ("Topalsson GmbH"). In its reasoning, the Court provided takeaways that could be relevant to Canadian practitioners, including the proper interpretation of liability cap provisions, and the rationale for set-off applying after such contractual liability caps are applied. Below, we review the case and consider the relevance of this decision for Canadian practitioners.
Factual Background
Rolls-Royce Motor Cars Limited ("Rolls-Royce") engaged Topalsson GmbH ("Topalsson") to design, build, implement, and maintain digital visualization software in October 2019 (the"Agreement") that would allow customers to see renderings of vehicles they were considering for purchase. However, due to delays and disputes between the parties, Rolls-Royce purported to terminate the Agreement in April 2020.
Topalsson commenced proceedings against Rolls-Royce in the High Court of Justice. Rolls-Royce defended the claims, counterclaiming for losses allegedly arising out of the termination.
The High Court of Justice Decision
At trial, the High Court of Justice held in relevant part that:
- Topalsson failed to comply with a revised project schedule;
- Topalsson was primarily responsible for the project delays; and
- as a result, Rolls-Royce validly terminated the Agreement with Topalsson.
Consequently, the trial judge found that Topalsson owed Rolls-Royce €7,962,323 in damages, which was reduced by €794,759 based on the amount owed by Rolls-Royce to Topalsson, for a net total of €7,167,564. Next, the trial judge applied the contractual liability cap of €5 million to the net total, awarding Rolls-Royce €5 million in damages, along with contractual interest.
In that regard, the trial judge applied the set-off before the contractual liability cap, based on the express terms of the Agreement. By contrast, Topalsson had argued that the calculation of set-off to establish the net sum due should be carried out after applying the liability cap. In support of its position, Topalsson relied on Lord Denning's decision in The Tojo Maru (No.1),[1969] 2 Lloyd's Rep 193 ("Tojo Maru").
In Tojo Maru, Lord Denning gave the example of a laundromat having a clause limiting their liability to 10s for articles that were lost or damaged. If the laundromat washed many articles in one week, charging £2, but lost a shirt worth £3 the next week, Lord Denning concluded that the laundromat ought to be paid £2 for the work done, while limiting its liability to 10s. The customer, having agreed to the clause, should not be able to claim set-off of £3 against the £2. Otherwise, the agreed-upon clause could be rendered useless by a clever customer.
In Lord Denning's view, equity in such a case would not require a set-off of the £3 against the £2, but only of the 10s against the £2.
However, in Topalsson GmbH, the trial judge disagreed, distinguishing Lord Denning's laundromat example based on the limitation of liability being on a "per article" basis, whereas in the case at hand, the liability cap was applicable to the "total liability" of either party to the other.
The Court of Appeal
Topalsson appealed to the Court of Appeal, arguing, in part, that the trial judge was wrong in applying set-off before the liability cap, as she should have instead applied set-off after applying the liability cap. The major issue for the Court of Appeal to determine (at least for the purpose of this case comment) was whether the contractual liability cap should apply before or after the calculation of set-off.
Topalsson's Position
Topalsson argued that the contractual liability cap should apply separately to Rolls-Royce's liability to Topalsson, and to Topalsson's liability to Rolls-Royce. This interpretation of the cap would fix Topalsson's liability to Rolls-Royce at €5 million, while Rolls-Royce's liability to Topallson would be fixed at €794,759. Once the cap had been applied to each party's liability, then the set-off of €794,759 would be deducted from the €5 million payable to Rolls-Royce, resulting in a sum of just over €4.2 million being owed to Rolls-Royce rather than €5 million plus interest.
In essence, Topalsson argued that the calculation of set-off to establish the net sum due should be carried out after the application of the contractual liability cap. This was based on three points.
First, clause 20 of the Agreement referred to the "total" liability of either party to the other (in other words, the gross total of liability), not "net" liability once all claims and cross-claims had been taken into account:
20. Liability
Subject to clause [20.1], the total liability of either Party to the other under this Agreement shall be limited in aggregate for all claims no matter how arising to the amount of €5m (five million euros). [emphasis added]
Clause 20.1 carved out exceptions to this limitation of liability in relation to death, personal injury, breaching confidentiality, and breaching third party intellectual property rights.
Second, Topalsson submitted that the set-off should apply after the liability cap as a matter of commercial common sense, as otherwise, Rolls-Royce could be in a better position as a result of its failure to pay the Charges otherwise due under the Agreement. In Topalsson's submission, the trial judge's interpretation allowed Rolls-Royce to take advantage of its own wrongdoing by withholding payments, and then, on termination, recovering €5 million while keeping payments it otherwise should have paid.
Finally, Topalsson submitted that its interpretation was supported by the jurisprudence. While the trial judge distinguished Lord Denning's decision in Tojo Maru from this case as the liability cap was expressed on a "per article" rather than "total liability" basis, Topalsson claimed that in Tojo Maru, Lord Denning was considering a single aggregate cap on liability for all relevant losses, and the "per article" cap was only an illustrative example.
Instead, Topalsson argued that Lord Denning's logic in Tojo Maru applied. After all, if Topalsson's liability were to be set-off before application of the cap, the effect would be to limit Topalsson's liability to €5 million plus whatever sums were otherwise due to Topalsson that Rolls-Royce had chosen to withhold, rather than limiting Topalsson's liability to the agreed-upon cap of €5 million.
Rolls-Royce's Position
Conversely, Rolls-Royce argued that the set-off should apply before the liability cap. This was for two reasons.
First, Rolls-Royce claimed that reference to "total liability" in clause 20 referred to the aggregate for all claims, no matter how they arose. This was wide enough to include claims, cross-claims, and counterclaims, such that the "total liability of either party to the other" was to be determined with the end goal of establishing who owed what to whom. Rights of set-off were part of the process of establishing "total liability", so only after set-off was complete could the cap be applied.
Second, Rolls-Royce argued that the approach taken by the trial judge was consistent with the United Kingdom's common law approach to the assessment of damages, which is based on a "net loss" basis (i.e. to reflect the loss suffered by the claimant after accounting for any benefits or cost savings that result from the wrongful act).
The Court of Appeal's Decision
The Court of Appeal disagreed with the trial judge's approach to clause 20, preferring Topalsson's position on the interpretation of "total" liability. Nothing in clause 20 suggested that the cap only applied once the net financial position between the parties had been calculated. If that was what the parties intended, the Court explained that the clause could have stated "net" liability – but it did not.
As well, the "total liability of either party to the other" suggested that the cap had to be applied to Topalsson's liability to Rolls-Royce, and to Rolls-Royce's liability to Topalsson. These words assumed the calculation of two separate liabilities, where each liability was subject to the cap. Thus, the cap would be applied to Topalsson's liability to Rolls-Royce of over €7 million, reducing liability to €5 million, while Rolls-Royce's liability to Topalsson would be unaffected as it was under the €5 million cap. Both these liability figures would then be netted off, resulting in roughly €4.2 million being owed to Rolls-Royce.
The Court of Appeal found that the cap must apply to the financial position across the Agreement as a whole, as it accorded with commercial common sense. Otherwise, it would be possible for Rolls-Royce to circumvent the effect of the €5 million cap.
In agreeing with Topalsson, the Court of Appeal also found that this potential circumvention of the cap was what Lord Denning had in mind in Tojo Maru. Whether Lord Denning's laundromat example dealt with a cap that was on a "per article" basis was of no importance because ultimately, Lord Denning was considering an aggregate cap for all relevant losses suffered.
Thus, in the Court of Appeal's view, the laundromat example was designed to demonstrate that, should the claim for set-off be taken into account before application of the cap, the result could be manipulated such that the party with a right to set-off could avoid the consequences of the cap altogether. The central flaw in Rolls-Royce's construction of the interplay between set-off and the liability cap was that if set-off was applied before the cap, the cap could become potentially meaningless.
The Court of Appeal also disagreed with Rolls-Royce's argument concerning the common law entitlement to the "net loss" approach for assessing damages. On this point, the Court remarked that a contractual cap could at least potentially be a denial of both parties' common law rights. As a commercial limit designed to promote certainty, such a cap was a blunt instrument which could ride roughshod over what might otherwise be obvious rights and obligations.
Rolls-Royce also argued that calculating set-off after the liability cap ran the risk of double-counting because the sums payable by Rolls-Royce to Topalsson for work carried out before termination and not otherwise paid would be deducted twice. However, the Court of Appeal held that, whether or not there was double-counting in this case was of no importance as either way, the liability cap of €5 million would have limited Topalsson's liability to Rolls-Royce at €5 million.
Thus, Topalsson was successful in its appeal on the sequencing of calculating set-off and liability caps.
Commentary
Notwithstanding that Topalsson GmbH is an English case, it nevertheless provides useful guidance for how a Canadian court might consider a similar issue, given the paucity of Canadian case law on the relationship between liability caps and set-off rights. In that regard, this lack of case law may be somewhat surprising given that it is not uncommon for both provisions to be found in construction contracts. Of the same token, the proper interpretation of this inter-relationship can have important ramifications regarding the final amount due to a party.
That being said, it is important to emphasize that the result in Topalsson GmbH appears to have been driven primarily by the specific language at issue in the applicable contract, and that the Court of Appeal was consequently not stating any general proposition as to how these two provisions interact. In arriving at its decision, the Court of Appeal stressed that Clause 20 referred to the total liability of either party to the other, rather than the net liability. It was this choice of words that resulted in the liability cap being applied before set-off.
On the other hand, however, even this conclusion was not an unambiguous one, insofar as it was disputed between the parties as to what the word "total" meant in the circumstances; for its part, Rolls-Royce argued that "total" referred to the aggregate of all claims, no matter how arising, such that set-off was actually part of determining "total" liability. Accordingly, Topalsson GmbH might be read even more narrowly as confined to the specific phrasing, and specific interpretation of the relevant word in question. It is not necessarily difficult to envision a different circumstance in which a court would agree with the latter interpretation of "total".
In that regard, the Court arguably gave somewhat short shrift to Rolls-Royce's reliance on the common law treatment of damages, insofar as it summarily observed that the liability cap ousted the parties common law rights in that regard, and that this was designed to promote commercial certainty.1 On the one hand, Ontario courts regularly allow for the ousting of common law rights to bring claims,2 and to limit or exclude liability.3 On the other hand, however, it is well-established in certain areas of law – such as exclusion clauses – that the ousting of common law, contractual, or statutory rights must be clear and unequivocal.4 As a result, it is unclear how such an argument might be addressed in Ontario if the clause in question was arguably less than unequivocal.
Ultimately, we will have to await further consideration of this issue from Canadian courts in order to seek more directly applicable guidance. In the meantime, parties would be well advised to remain mindful when including contractual liability caps and set-off provisions in their contracts, and to be clear as to the order of operations between the two should the situation arise.
Footnotes
1. Topalsson GmbH v Rolls-Royce Motor Cars Limited, [2024] EWCA Civ 1330 at paras 33 and 39.
2. Todd Brothers Contracting Limited v Algonquin Highlands (Township), 2015 ONCA 737 at paras 2-3 and 6.
3. 2708266 Ontario Inc v The City of Toronto, 2022 ONSC 6315 at para 128. Also see 2708266 Ontario Inc v The City of Toronto, 2023 ONSC 383 at paras 34 and 36.
4. Tercon Contractors Ltd v British Columbia (Transportation and Highways), 2010 SCC 4at para 71; Earthco Soil Mixtures Inc v Pine Valley Enterprises Inc, 2024 SCC 20at para 98. We have written about Earthco here.
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