'Fundamental breach' doctrine dead for exclusion clauses
Courts should not override valid contractual clauses limiting a defendant's liability except in "rare" cases where there are "paramount" public policy grounds to do so, the Supreme Court has ruled.

In a Feb.12 holding which will apply in diverse commercial contexts, including construction industry procurement cases, the top court unanimously ruled there "is nothing inherently unreasonable about exclusion clauses," and also pronounced dead the much criticized doctrine of "fundamental breach" in relation to such exclusion clauses: Tercon Contractors Ltd. V. B.C. Transportation and Highways.

The doctrine of fundamental breach was a rule of law that operated independently of the parties' intention in circumstances where the defendant so egregiously breached the contract as to deny the plaintiff substantially the whole of its benefit under the contract. In such a case, the defendant could still be liable for the consequences of its "fundamental" breach even if the parties excluded liability by clear and express language.

However, the Supreme Court's recent decision effectively narrows the discretion of courts to refuse to enforce exclusion of liability clauses because the defendant has breached the to those "rare" cases where the "very strong" public policy in favour of the freedom to contract is outweighed by countervailing societal values that seek to curb abuses of the freedom to contract. Thus, in principle, courts may no longer override valid exclusion clauses, merely because they view them to operate unfairly or unreasonably in light of the defendant's breach of the contract, commented Glen Boswall of Vancouver's Clark Wilson.

"The big conclusion of the case...is that there nothing inherently wrong with a comprehensive limitation of liability clause in a request for proposal (RFP)," Boswall told The Lawyers Weekly. "The only thing that will override clear contract terms are fraud-level behaviour," serious criminality, or some other behaviour that is manifestly contrary to public policy. In the wake of Tercon, he predicted, lawyers will "sharpen up their drafting on exclusion/limitation of liability clauses."

He added that decision's result-a majority of the court refused to enforce the exclusion clause in an RFP-also suggests that courts will still strive to somehow achieve "fairness" between contracting parties, notwithstanding the existence of exclusion clauses and the death of the fundamental breach doctrine.

"If your behaviour is patently unfair, it's an unwritten rule that the courts are going to look at the rules with a microscope and see if they can find a legitimate way in the rules to create justice," Boswall observed. "It sounds kind of airy-fairy, but [the warning is] 'Don't behave egregiously.'"

Chris Armstrong of West Vancouver's McLean & Armstrong, co-counsel with Brian McLean for the appellant Tercon Contractors Ltd., told The Lawyers Weekly via e-mail "we are obviously satisfied with the result, but the court may be split philosophically on the issue of whether public policy in favour of freedom of contract should prevail over the public policy in favour of fair and equal tendering system. The result is a decision which clearly puts fundamental breach to bed, but does not provide any direction in relation to the ability to exclude liability for fairness in a tendering contract. There will be much reading between the lines of this decision and the issue will likely land again on the lap of the SCC sometime in the future."

Edward Gouge, counsel for the respondent B.C. Ministry of the Attorney General, agreed the court has "significantly limited the power of the courts to refuse to give effect to exclusion clauses according to their terms."

Gouge told The Lawyers Weekly the judgement raises some issues likely to be litigated in the future. "The court affirmed, without much discussion, the idea that, in a tendering context, the owner owes a duty of fairness to the bidders. The duty of fairness appears to an implied term of Contract 'A'," Gouge said via e-mail. "It is clear from the Tercon judgement that the duty of fairness can be limited or eliminated by a suitably-crafted exclusion clause. What is not yet clear is the ambit of the duty if not expressly limited or excluded. In many cases, fairness is in the eye of the beholder."

The decision is important because all nine of the Supreme Court's judges argeed to jettison the doctrine of fundamental breach, and endorsed as well Justice Ian Binnie’s new three-step framework for analyzing if, and when, judges can intervene, at the plaintiff's behest, to override liability limitation clauses or other contractual terms to which the plaintiff previously agreed.

However, the judges split 5-4 on the result (Justices Binnie, Rosalie Abella, Marshall Rothstein and Chief Justice Beverly McLachlin dissented).

Led by Justice Thomas Cromwell, the majority ruled that a broadly worded exclusion clause in an RFP that was issued by B.C.'s Ministry of Transportation and Highways in 2001, did not relieve the Ministry of liability for its subsequent breach of its own RFP rules by picking an ineligible bidder.

The decision is a victory for the appellant Tercon Contractors, which lost the contract to build a $35-million highway in northern B.C. The majority restored the trail judge's $3.5 million lost profit award to Tercon.

The fundamental breach doctrine-promoted by Lord Denning in the 1950s-has been interpreted over the years by some judges as giving courts a broad discretion not to enforce valid exclusion of liability clauses where it would not be "fair or reasonable" to do so in light of a defendant's "fundamental" breach of the contract.

"On this occasion we should again attempt to shit the coffin on the jargon associated with 'fundamental breach,'" Justice Binnie wrote for the whole court on this issue: "Categorizing a contract breach as 'fundamental' or 'immense' or 'colossal' is not particularly helpful," he explained. "Rather, the principle is that a court has no discretion to refuse to enforce a valid and applicable contractual exclusion clause unless the plaintiff…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."

Justice Binnie said judges who are asked by the plaintiff to refuse to enforce liability limitation clauses "or other contractual terms to which" the plaintiff previously agreed must conduct three "inquiries."

First the court must determine whether the exclusion clause even applies in the circumstances, based on the clause's wording. Second, if the exclusion clause does apply, is the clause valid? That is, was it created in unconscionable circumstances at the time the contract was formed-perhaps because the parties had unequal bargaining power?

Third, if the clause is both applicable and valid, the court may nevertheless refuse to enforce it "because 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 contract," Justice Binnie wrote.

"Conduct approaching serious criminality or egregious frauds 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," Justice Binnie said. “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 that it says outweighs the public interest in the enforcement of the contract."

Justice Binnie noted that freedom of contract, like any freedom, may be abused. He citied the example of a milk supplier that adulterates its baby formula with a toxic compound to increase its profit, at the expense of sick or dead babies. "In China, such people were shot," he observed. "In Canada, should the courts give effect to a contractual clause excluding civil liability in such a situation? I do not think so."

However, in Tercon's case, the majority concluded that the Ministry was liable for breaching the express eligibility terms for bidders in its tender documents, as well as its implied duty of fairness to bidders, despite a broad exclusion clause in the RFP which barred claims for compensation by bidders "as a result of participating" in the RFP.

Justice Cromwell held, as a matter of contract construction, that this wording did not effectively limit the province's liability. "Tercon's claim is not barred by the exclusion clause because the clause only applies to claims arising 'as a result of participating in [the] RFP,' not to claims resulting from the participation of other, ineligible parties," reasoned Justice Cromwell. "Moreover, the words of this exclusion, in my view, are not effective to limit liability for breach of the Province's implied duty of fairness to bidders."

The trial judge found that the province knowingly gave the tender to a bidder engaged in a joint venture with an ineligible company, and that the province acted "egregiously" by ensuring that the ineligible true bidder was not disclosed to the other bidders.

The minority agreed with the majority that the Ministry clearly breached the contractual rules of the RFP process. However, Justice Binnie decried the majority's “strained and artificial interpretation” of the exclusion clause "in order, indirectly and obliquely, to avoid the impact of what may seem to the majority ex post facto to have been an unfair and unreasonable clause."

The minority argued that Tercon clearly "participated" in the RFP by submitting a proposal for consideration, within the meaning of the exclusion clause. Moreover, that exclusion clause was enforceable, the minority held. They reasoned the clause was not unconscionable since there was no imbalance of bargaining power when Tercon, a sophisticated, experienced and large contractor, agreed to it. The Ministry's "misconduct" did not rise to the level where public policy would justify depriving the Ministry of the exclusion of compensation clause freely agreed to by Tercon in the contract, the minority urged.

"While the Ministry's conduct was in breach of Contract A, that conduct was not so extreme as to engage some overriding and paramount public interest in curbing contractual abuse," Justice Binnie concluded.

He noted that if enough contractors refuse to participate in tendering processes which include a limitation, or exclusion, of remedies for breach of tendering rules, "the Ministry would be forced to change its approach. So long as contractors are willing to bid on such terms, I do not think it is the court's job to rescue them from the consequences of their decision to do so. Tercon's loss of anticipated profit is a paper loss. In my view, its claim is barred by the terms of the contract it agreed to."

Twenty-one years ago, Supreme Court Chief Justice Brian Dickson argued that the fundamental breach doctrine should be "laid to rest" because of the "host of difficulties" it presented, including figuring out what amounts to a "fundamental" breach.

Chief Justice Dickson urged that exclusion clauses should only be set aside if they were created under unconscionable circumstances. But over the years other judges have suggested that a court retains residual discretion to refuse to enforce an exclusion clause where enforcing it would be unfair, unreasonable or otherwise contrary to public policy, reasons "which seemingly confer on courts a very broad after-the-fact discretion," Justice Binnie observed.

Source: Schmitz, C., "'Fundamental breach' doctrine dead for exclusion clauses" The Lawyers Weekly (March 5th, 2010).
Marc Koplowitz Associates
"...the lawyer's greatest weapon is clarity, and its whetstone is succinctness"
- Judge Prettyman
390 Bay Street, Suite 2900
Toronto, Ontario M5H 2Y2
Tel: 416-368-1100
Fax: 416-368-1998
1000 Finch Avenue West, Suite 600
Toronto, Ontario M3J 2V5
Tel: 416-667-8000
Fax: 416-667-8004