No Way Out: A Review of the Supreme Court of Canada’s Recent Treatment of Exculpatory Clauses

By Nadia Somani

In the December 2010 decision of Tercon Contractors Ltd. v. British Columbia (Transportation and Highways)1 , the Supreme Court of Canada unanimously agreed that it was time to lay to rest the doctrine of fundamental breach in the context of exclusion or limitation of liability clauses. This decision, though set in the context of a tender contract, has wide ranging implications for contract law generally, as it finally signals an end to a source of long-standing difficulty the Canadian courts have had with the application of the doctrine in the context of exclusion clauses. Given the significance of this decision, the following article discusses the origins of the doctrine of fundamental breach, its treatment by the Court in the Tercon decision and the implications for contracting parties going forward.

Origin of the Doctrine

The doctrine of fundamental breach traces its roots back to the United Kingdom with Lord Denning being its reputed founder. As originally formulated, the doctrine of fundamental breach provided that “where a breach of contract constituted a radical or fundamental departure from the obligations set out in the contract, an exculpatory clause that would otherwise have insulated the party in breach from liability would not have that effect.”2  Lord Denning was of the view that this doctrine should be applied as a rule of law regardless of the parties’ intentions relating to liability. That is, if a party was in fundamental breach of its contractual obligations, such party should not, as a rule of law, be entitled to rely on an exclusion clause which limits or excludes its liability. However, this approach was later rejected by both the English and Canadian common law courts in favour of a rule of construction. Unfortunately, the difficulties with the application of the doctrine remained, as the construction approach was inconsistently applied and, on a more general level, some courts struggled with the appropriateness of the doctrine itself.

While many of the central issues surrounding the doctrine became moot in the U.K. following the enactment by Parliament of the Unfair Contracts Terms Act 1977, which invalidated exclusion clauses in certain consumer contracts and standard forms, no similar statute was enacted in Canada. Consequently, the doctrine continued to evolve in our common law but had, by no means, become a settled area of law. The current decision of the Supreme Court in the Tercon case seems however to have resolved the issues surrounding the doctrine once and for all by unanimously agreeing to lay it to rest at least in the context of limitation of liability cases.

The Court’s Decision in Tercon

In this case, the Court was called upon to consider the question of whether an exculpatory clause could be enforced by the defendant party who was claimed to have fundamentally breached a contract. Briefly stated, the facts of this case are as follows:  

In 2000, the Province of British Columbia issued a request for expressions of interest for designing and building a highway. Six companies made submissions for such request. Shortly thereafter, the province informed those six companies that it was going to design the highway itself and that it would instead be seeking a request for proposals for the highway’s construction. The province further advised that only the original six proponents were eligible to submit a proposal.

Brentwood, being one of the original six proponents, was unable to submit a competitive bid on its own because it did not have certain expertise that was necessary for the construction project in question. To deal with the issue, Brentwood approached EAC, a company that had such expertise, with a proposition to team up so that if Brentwood’s bid was successful, EAC and Brentwood would undertake the project as joint venturers. Since EAC was not an original proponent and therefore an ineligible bidder pursuant to the terms of the RFP, Brentwood submitted a bid in its own name but with EAC listed as a major member of the team. This structuring of the bid allowed Brentwood to submit a highly competitive proposal, which resulted in Brentwood being awarded the job. Tercon was the second runner up.

Based on the foregoing, Tercon sued the province for damages “alleging that the Ministry had considered and accepted an ineligible bid and that, but for that breach, it would have been awarded the contract.”  As the RFP itself contained a limitation clause which limited the liability to the province arising from a proponent’s participation in the RFP, the province asserted that even if it were in breach, the limitation clause operated to bar recovery by Tercon entirely.

Tercon, in turn, argued that the exclusion clause could not be relied upon by the province because the province had fundamentally breached the terms of the RFP by accepting a bid from an ineligible bidder. Relying on past cases, Tercon argued that where a fundamental breach of a contract has occurred, an exculpatory clause could not be used as a shield by the breaching party.

While Tercon’s arguments were successful at the trial level, they were rejected by the Court of Appeal. Accordingly, Tercon appealed to the Supreme Court of Canada where it was met with a more favourable outcome but one which had much more far reaching implications for contracting parties generally.

Interestingly, although the Court unanimously agreed that the doctrine of fundamental breach had no impact on the analysis, the Court was divided on the issue of whether the exclusion clause barred recovery on the basis of the facts of this case.

In considering the issues and the application of fundamental breach, both the majority and dissent stated that the time has come to lay the doctrine of fundamental breach to rest as it applies to exclusionary and limitation of liability clauses. The approach that should instead be followed in interpreting these clauses involves three stages of analysis:

(1) The court must determine, as a matter of interpretation, whether the exclusion clause even applies to the circumstances established in evidence. This will depend on the Court’s assessment of the intention of the parties as expressed in the contract. If the exclusion clause does not apply, there is obviously no need to proceed any further.

(2) If the exclusion clause does apply, the court must then consider whether the exclusion clause was unconscionable at the time the contract was made, “as might arise from situations of unequal bargaining power between the parties” This second issue is said to deal with contract formation and not breach.

(3) If the exclusion clause is held to be valid and applicable, the court must then determine whether it should nevertheless refuse to enforce the valid exclusion clause because of the existence 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 the contracts.

Based on this analytical framework, the majority of the Court held that the exclusion clause did not apply because it did not cover the breach in question and accordingly Tercon was entitled to recover. The dissent however stated that the clause did cover the province’s breach and that there were no overriding public policy concerns which would allow the Court to refuse to enforce the provision.  

Implications Going Forward

What’s clear from the Tercon decision is that the doctrine of fundamental breach as applied in the context of exclusionary clauses will be an escape hatch that can only be used by non-breaching parties in the most extreme of cases. The Supreme Court was very clear in sending the message that, where there is no inequality of bargaining power, the courts should leave the bargains struck by parties undisturbed and should only intervene in those special cases where there is a clear and overriding public policy to do so and one which would trump the public policy relating to freedom of contract. Accordingly, it is incumbent upon contracting parties to draft these clauses with precision so as to truly reflect their intentions to ensure that allocation of risk in the event of a breach–fundamental or otherwise–is adequately addressed in the contract at issue.

The content of this article is intended to provide general information for the reader and is not intended as advice or an opinion to be relied upon in relation to any particular circumstance. For specific applications of the law to a particular set of circumstances, the reader should seek professional advice.

Nadia Somani practices in the areas of corporate finance, securities and corporate law with McLean & Kerr LLP, a law firm based in Toronto. 

1.Tercon Contractors Ltd. v. British Columbia (Transportation and Highways), 2010 SCC 4, [2010] 1 SCR 69.

2. John D. McCamus, Essentials of Canadian Law: The Law of Contracts (Toronto: Irwin Law, 2005) at 754.