Who Is A Successor To A Contract?

Most commercial agreements contain a clause stating that the contract is binding upon and for the benefit of “successors.”  For example, Article 10.1 of the CCDC Cost Plus Contract states that the contract “shall enure to the benefit of and be binding on…successors”.

What does the word “successors” mean?  Who are “successors”?  Do those who enter into the contract know who the successors are?

Recently, the Ontario Court of Appeal considered this issue in Brown v. Belleville (City).  I dealt with that case in an article last week. In that article I was concerned with whether inaction could amount to acceptance of a repudiation of a contract.

Factual Background

 Let’s remind ourselves of the facts in Brown v. Belleville. In 1953, a municipality signed an agreement with a farmer under which the municipality agreed to maintain and repair a storm sewer drainage system that it had constructed on and near the farmer’s lands. Six years later, the municipality stopped maintaining and repairing the drainage system.  Over the next 50 years, the original municipality and successor municipality clearly and repeatedly repudiated the agreement.

The lands were sold from owner to owner and each owner unsuccessfully sought to have the municipality repair and maintain the drainage system.  Finally, in 2011 the then owners of the lands, the Browns, sued the municipality for breach of contract. The municipality, the Town of Belleville, defended the action on a number of grounds.  It said that the limitation period had expired because the Browns or their predecessors had long ago accepted the municipalities’ repudiation of contract. The trial judge and the Court of Appeal rejected that position. I dealt with that issue last week.

Belleville also said that the Browns had no standing to sue because they were third parties to the 1953 agreement, and that contract law does not entitle third parties to enforce agreements. Belleville also said that the Browns were not “successors” of the original farmer who entered into the agreement.  That agreement said:

“THIS INDENTURE Shall inure to the benefit of and be binding upon the parties hereto and their respective heirs, administrators, successors and assigns.”

The agreement was never registered against the title to the land.  The City said that the agreement was never assigned or otherwise transferred to the plaintiffs or the other owners of the land after the original farmer who entered into the agreement.  The City asserted that the Browns were third parties to the original agreement and did not fall within any of the accepted  category of persons who could enforce the agreement.

Court of Appeal Decision  

 The Court of Appeal held that, on its face, the contract created a category of persons who could enforce the contract as parties to the contract, namely, successors of the owner who entered into the agreement. In that sense, the Browns did not have to demonstrate the application of the “third party beneficiary rule”. They were effectively parties as much as the original party.

The court stated it this way:

“…the broad and unqualified language of the enurement clause constitutes an express stipulation by the contracting parties that they intended the benefit of the Agreement to be shared by future owners of Mr. Sills’s lands, as his successors or assigns or by way of inheritance.  The  language  of  the  enurement  clause  unequivocally  confirms  that  the contracting parties intended and agreed that the benefit of the Agreement would extend to an aggregation or class of persons that includes successor  landowner of Mr. Sills.   On the admitted findings of the motion judge, the Browns are Mr. Sills’s successors.   In this sense, the Browns are not strangers or ‘third parties’ to the Agreement.   Rather, they step into Mr. Sills’s shoes and have standing to enfore the Agreement as against the City as if they were the original covantee(s) to the Agreement…given the intention of the contracting parties stipulated in the Agreement under the enurement clause, I conclude that ‘relaxing’ the doctrine of privity in this  case  does  not frustrate  the  reasonable expectations of  the  parties  at the  time the Agreement was formed.  To the contrary, it gives effect to them.”

Belleville relied upon a 1980 decision of the Supreme Court of Canada in Greenwood Shopping Plaza. It said that that decision precluded the Browns from relying on the 1953 agreement to which they were not a party. The Court of Appeal held that, in light of more recent decisions of the Supreme Court, the Greenwood case had been largely over-ruled. In any event, having regard to the enurement clause, the prohibition against third party enforcement of the agreement had little or no application.  If necessary, the court said that it would apply the exceptions to the rule prohibiting third party enforcement of a contract and allow the Browns to enforce the drainage agreement when they so clearly fell within the category of persons who were intended to have its benefit.

The Court of Appeal considered one further objection of Belleville, namely, that the Browns were using the 1953 agreement as a sword – to bring an action and positively enforce rights – rather than as a shield – or as a defence. In the modern cases in the Supreme Court recognizing the rights of third parties to rely on contract they had not signed, those third parties were asserting the contract as a defence.

The Court of Appeal held that this distinction made no difference in the presence of the enurement clause:

 “I recognize  that London Drugs and Fraser River were cases where the third-party beneficiaries sought to rely, by way of defence, on the benefit of the contractual provisions at issue  to resist  claims  brought  against them – they  were not  seeking to  enforce  the affirmative benefit of the relevant contractual provisions….. Nonetheless, it is my view that the Browns’ status as the successors of the original covenantee under  the Agreement affords  them the  right  to seek to  enforce  the original covenantor’s contractual obligations, as against the original covenantor.   In effect, for the purpose of enforcement of the Agreement, the Browns are Mr. Sills and the City is Thurlow.  Further, insofar  as  the performance  of  the  City’s  obligations under  the Agreement are concerned, there is a clear identity of interest between Mr. Sills and the Browns.   As Mr. Sills’s successors, the Browns stood ready to comply with the activity required of them under the Agreement- the provision of access  to their lands.    In all these circumstances, the application of the principled exception to the privity rule advances the interests of justice.” (emphasis added

Analysis

 The Brown v. Belleville decision answers one of the issues arising from “successor” clauses. Based on that decision, a person falling within the clause does not have to worry about the old rule that contract law does not recognize the rights of third parties.  If the contact has an enurement clause in favour of or binding on successors, then successors are parties to the contract as much as the original parties.

The next issue is:  who are successors? Clearly, based on Brown v. Belleville, a later owner of the same land that is affected by the agreement is a successor. But what about a tenant, or subtenant, of that later owner? If that tenant has exclusive possession of the affected property, and is the person who is really affected by a breach of the agreement, is that person a successor? What about the owner of other interests in the land such as owners of easements or mortgagees?

The issue becomes even more complicated when one considers building contracts.  If the main contract between the owner and the contractor states that it is binding on the “successors” of the contractor, does that word include a subcontractor?  What if the owner has given a covenant in the main contract that affects the electrical work and the contractor subcontracts the entire electrical work to an electrical subcontractor?  Is the electrical subcontractor the “successor” of the contractor?  Why not?

If the contractor assigned the electrical part of the main contract to the electrical subcontractor (if it were permitted to do so), then the enurement clause would likely apply because that clause would likely be expressed to include assignees. If the clause includes both successors and assigns, then the word “successors” must be given a wider meaning than “assisgns”, but who does it include?

A further issue is this:  if the enurement clause is also expressed to be binding on successors, then third parties may find themselves bound by obligations under the contract even though they never signed the contract. In fact, a good test as to whether the contract enures to the benefit of a third party may be whether it should be binding on that party.  Clearly, the Browns were willing to be bound by the 1953 agreement and allow Belleville access to their land to repair and maintain the drainage system, so it was not difficult to find that the Browns were successors. Similarly, a subtenant or mortgagee of the Brown’s property would be willing to grant such access, so they may well be successors.

But what parties would be willing to be bound by the contractor’s building contract with an owner?  Would a subcontractor or supplier?  Likely not, especially if that includes the payment obligations. Often the subcontract will state that the main contract is incorporated into the subcontract, but at least one line of authority holds that some of the terms of the main contract (such as arbitration, insurance and guarantee clauses) are not incorporated into the subcontract unless that intention is specifically set forth in the subcontract.

Now that the Ontario Court of Appeal has held that successors may enforce a contract if there is an enurement clause in the contract to that effect, the clause may be more powerful and dangerous than it was previously.  This may be a good reason for the meaning of “successors” to be defined in the contract. The parties may mean that it includes only the successors by virtue of corporate or bankruptcy law. If so, they can say that. But they may mean it to have a broader meaning, such as a successor in title. Again, they can say that.  If they do not, then they will leave it up to the court to decide who is bound by or may rely upon the contract.

See Heintzman and Goldsmith on Canadian Building Contracts, 4th ed., chapter 1, part 2

Brown v. Belleville (City), 2013 ONCA 148  

Construction law  –  Enforcement  –  Third Parties  –  Breach of Contract

Thomas G. Heintzman O.C., Q.C., FCIArb                                                         March 29, 2013

 www..heintzmanadr.com

www.constructionlawcanada.com

 

Does A Mediation Agreement Suspend The Limitation Period Or The Period To Set Down A Lien For Trial?

An agreement to mediate is often found in arbitration and building contracts. Yet, the impact of mediation upon court or arbitral proceedings is uncertain. Does an agreement to mediate mean that, until the mediation occurs, there is no cause of action and therefore there is no entitlement to commence arbitration or an action?  In that case, the limitation period would be effectively extended. In L-3 Communication Spar Aerospace Limited v. CAE Inc., 2010 ONSC 7133, 2011 ONCA 435, the Ontario Court of Appeal held that, until a contractual obligation to negotiate a compromise had been fulfilled or terminated, no cause of action arose and the limitation period was not running.   

Or is an agreement to mediate simply not enforceable because an agreement to negotiate is not enforceable? If this is the case, then the limitation period is running and either party can ignore the mediation agreement and go to court or commence arbitration. The Ontario Court of Appeal so held in Federation Insurance Co. of Canada v. Markel Insurance Co of Canada, 2012 ONCA 218.

The uncertainty about the enforceability of mediation agreements creates real dangers for those engaged in dispute resolution under arbitration and building contracts. Fortunately, in Ontario there may be at least a partial solution in section 11 (“section 11”) of the Limitations Act, 2002 of Ontario (“Limitations Act”). This solution is often forgotten but in the recent decision in Tribury v. Sandro, the court held that a mediation agreement, once made, does effectively stop the limitation period from running.

However, there are other dangers arising from mediation agreements and limitation and procedural periods.  The Tribury decision did not expressly determine whether the mediation agreement would suspend the limitation period even if it was not an enforceable agreement to mediate.  In addition, section 11 only applies to limitation periods prescribed under the Limitations Act.  Thus, in Tribury, the court did not apply section 11 to the two year period for setting a lien action down for trial under section 37 of the Construction Lien Act (“section 37”).  What is the effect of mediations on all the other procedural and limitation sections found in Ontario statutes?

Section 11(1) states as follows:

“ If a person with a claim and a person against whom a claim is made have agreed to have an independent third party resolve the claim or assist them in resolving it, the limitation periods established by sections 4 and 15 do not run from the date the agreement is made until,

(a) the date the claim is resolved;

(b) the date the attempted resolution process is terminated; or

(c) the date a party terminates or withdraws from the agreement.”

Background

Tribury was the general contractor on a construction project for Laurentian University.  Sandro was the structural steel subcontractor and Edward was Sandro’s structural steel consultant.  The project started in 2006 and ground to a halt in June 2007 due to the alleged failure of certain steel connections. Apparently, all parties accepted that the claims between the parties were “discovered” in June 2007 for the purposes of the Limitations Act. As will be seen later, one of the issues in the motions in question was whether some of the subsequent proceedings were brought within the basic two year limitation period set out in section 4 of the Ontario Limitations Act or, in effect, by June 2009.

In October 2008, Sandro commenced a construction lien claim against Tribury and Laurentian. The other issue in the motions in question was whether Sandro had set that lien claim down for trial within two years of that date as required by section 37 of the Construction Lien Act, or, in effect, by October 2010.

In December 2008, Tribury counterclaimed in Sandro’s lien action.  In April 2009, Tribury started its own action which was substantially the same as its counterclaim in Sandro’s lien action. While Tribury agreed to withdraw that counterclaim, the order dismissing the counterclaim was not made until November 2010.

The Mediation

In March 2009, Sandro suggested mediation to all parties. In April 2009, counsel for all the parties participated in a conference call and all the parties, with the exception of one party, agreed to participate in mediation. That agreement was confirmed by a letter from Tribury which suggested the names of mediators, proposed deadlines for the mediation briefs and confirmed the parties’ tentative consent to a cost sharing for the mediator’s fees. In July, 2009, Sandro delivered its mediation brief to Edward. In March, 2010 the parties chose a mediator. In August, 2010, a mediation date in November 2010, was scheduled.  On November 10, 2010, counsel for Edward advised the other parties that Edward was not prepared to mediate the “Sandro remediation costs”, namely the remediation costs which Sandro itself had incurred and was now claiming against Edward (as opposed to remediation claims being asserted by others against Sandro which Sandro claimed over against Edward). The mediation was cancelled.

The Impugned Proceedings

On December 3, 2010, Sandro issued a new Statement of Claim against Edward. On December 6, 2010, in Tribury’s 2009 action Sandro served a Statement of Defence, Crossclaim (against Edward) and Counterclaim (against Tribury).

The Motions

Edward then brought a motion to dismiss the December 2010 action and cross claim against it on the ground that the limitation period had expired.

Tribury bought a motion to dismiss Sandro’s lien action on the ground that it had not been set down within the two years period set forth in Section 37 of the Construction Lien Act. Section 37 requires that, within two years of the lien action that perfected the lien, an order must be made for the trial of an action in which the lien may be enforced, or an action in which the lien may be enforced must be set down for trial.  Otherwise, the lien action must be dismissed.

Tibury also sought an order dismissing Sandro’s December 2010 counterclaim on the basis that, by December 2010, the limitation period had expired for that counterclaim to be brought.

The Decision

1.      Section 11

So far as Sandro’s December 2010 claim and cross claim against Edward and its December 2010 counterclaim against Tribury, the Court held that the limitation period for commencing those claims was extended during the whole period from April 2009 to November 2010, and had not expired by the time that Sandro’s December 2010 claim, cross claim and counterclaim were commenced, by virtue of the mediation and the effect of section 11 of the Limitations Act.

First, the Court held that an agreement under section 11 did not have to specify that the limitation period was suspended until the conclusion of the mediation.  The suspension of the limitation period was effected by section 11 itself, without the parties having to say so. Their agreement to mediate, not any words agreeing to a suspension of the limitation period, caused the suspension.

The Court distinguished section 23(3) from section 11 of the Limitations Act. Sub-section 23(3) is the general provision allowing parties to agree to suspend or extend the limitation period.  That sub-section depends, for it to be activated, on the parties’ agreement to do exactly that, namely, suspend or extend the limitation period.  In contract, section 11 depends, for it to be activated, upon the parties’ agreement to mediate. If there is an agreement to mediate, it is section 11 which then suspends the limitation period. The Court said:

Edward has not convinced me that the agreement referred to in section 11 of the Limitations Act requires specific language suspending or extending applicable limitation periods for its efficacy. In my view, what is required is an agreement which is entered into after a dispute has arisen whereby the parties agree to have a third party assist in resolving the dispute, nothing more. In the case before the court, the parties entered into an agreement to mediate in response to a dispute which had arisen among them. They have therefore met the requisite test.

Whether there was an agreement to mediate was disputed. After reviewing the evidence, The Court held there was an agreement to mediate and that it included the Sandro remediation costs.  The Court found as follows:

The correspondence between the parties confirms their mutual intention to mediate the issues which arose following the failure of the steel connectors and I find that all parties decided to mediate these issues on the understanding that all outstanding damages issues would be mediated. Although the confirming letter did not specify which issues were to comprise the subject of the mediation, the agreement was open ended and not restricted in scope. There was a stated requirement in the letter confirming the mediation that both Sandro and Tribury submit damages briefs and there is no evidence that the parties intended that only some of the issues resulting from the failure of the steel connectors were to be mediated.

2.       Section 37

So far as Sandro’s lien claim, the Ontario Superior Court exercised its discretion to permit that claim to proceed as an ordinary contract claim, and struck out the lien itself on the ground that the action had not been set down within the two year period set forth in section 37. In so deciding, it did not consider whether the mediation, and section 11 of the Limitations Act, could extend the time set forth in section 37. Since section 11 only refers to limitation periods in the Limitation Act, the Court presumably thought that it was self-evident that section 11 did not apply to section 37.

Discussion

There is good news (with a condition), bad news and two warnings arising from this decision.

First the conditional good news.  If parties who are involved in a dispute agree to mediate, they thereby suspend the limitation period under section 11.  This is a power that is often forgotten. The parties are not necessarily faced with a “do or die” alternative between commencing the proceeding on the one hand, or mediating and potentially letting the limitation period run out on the other hand.  By reason of section 11, they are protected against the running of the limitation period by a proper mediation agreement.

The condition to the good news is this. In Tribury the Court held that the mediation agreement suspended the limitation period without inquiring whether the mediation agreement was an enforceable mediation agreement, so far as the obligation to mediate is concerned. That is, the Court did not consider whether the mediation agreement contained enough details to make it an enforceable agreement to mediate. There are many recent cases, particularly in the United Kingdom, holding that an agreement to mediate is not enforceable unless that agreement contains sufficient procedural details.

One explanation of the Tribury decision could be that it is not essential that mediation agreement be enforceable as such for it to activate section 11: a           mediation agreement is enforceable to suspend the limitation period by virtue of section 11, even if it does not compel the parties to mediate.

Another explanation is that this issue was simply not considered, and that it is open for another court to conclude that, unless the mediation agreement contains sufficient details, it does not activate section 11.

Second, the bad news. Sections 11 and 23 only refer to limitation periods contained in the Limitations Act. They do not refer to limitation periods in any other Act, including the Construction Lien Act.  For this reason, the parties cannot rely on sections 11 or 23 to extend by agreement the limitation periods for the commencement of a lien action or the statutory period for setting a lien action down for trial.

Nor do sections 11 or 23 apply to limitation periods, or periods for taking steps, in other statutes.  For example, the Arbitration Act, 1991 of Ontario contains a number of limitation periods. Section 52(1) of that Act says that limitation period for an arbitral claim is the same limitation period as for an action. So presumably, sections 11 and 23 should apply to arbitral claims.  Section 47of the Arbitration Act, 1991 establishes a 30 day period for commencing an appeal from an award or an application to set aside an award. Section 52(3) establishes a 2 year period for enforcing an award. Section 3 says that the contracting parties may agree to vary or exclude any provision of the Act, except certain specific mandatory sections.  Sections 47, 52 and 53 are not among the mandatory sections.  So the parties should be able to vary the limitation periods set forth in those sections.

Article 34(3) of the Model Law attached to the Ontario International Commercial Arbitration Act (“ICAA”) establishes a three month period for bringing an application to set aside an international commercial arbitral award.  Article 52(3) establishes a two year limitation period for commencing an application to enforce the award. The ICAA and the Model Law do not contain any express power to grant relief from, or contract out of, those articles.  While the two year enforcement period seems to be based on the two year general limitation period in the Limitations Act, it appears that the parties can vary the latter but not the former, unless a court were to find that parties can generally contract out of the ICAA .

Third –  two warnings:

First, the mediation agreement should be carefully documented. An exchange of correspondence should not be relied upon as that exchange may be subject to dispute and interpretation.  The dispute or disputes that fall within the mediation agreement should be specified. In the present case, Sandro was fortunate that the exchange of correspondence was interpreted by the Court to include all the issues between all the parties.

Second, in a construction lien action, attention should be paid to intersecting limitation and procedural periods, some of which may not be suspended by a mediation agreement. The same warning applies to any action or arbitration involving statutory limitation periods or periods for taking steps which could result in the proceeding being dismissed if not taken. In the present case, Sandro may have thought that the mediation agreement suspended all periods for taking procedural steps.  But it didn’t. It didn’t suspend the two year period for setting the lien action down for trial.

See Heintzman and Goldsmith on Canadian Building Contracts, 4th ed., Chapter 6, introduction, and Chapter 10, part 6.

Tribury v. Sandro, 2013 ONSC 658

Construction Law  –   Building Contracts   –   Construction and Builders Liens  – Arbitration  –  Mediation  –  Limitation Periods

Thomas G. Heintzman O.C., Q.C., FCIArb                                                                                                                     February 24, 2013

www.heintzmanadr.com

www.constructionlawcanada.com    

Can Silence Amount To A Fraudulent Misrepresentation?

The Ontario Court of Appeal recently dealt with the issue of what sort of representations amount to fraud, and what representations survive an “entire agreements” clause. In Iatomasi v. Conciatori, the Court of Appeal held that when, during the pre-contractual negotiations for the sale of a building , a vendor delivers plans to a purchaser, there is no implied representation that the building was built according to the plans.  The court held, however, that the vendor is liable in fraudulent misrepresentation for statements that there had never been problems with the basement of the house, notwithstanding  the “entire agreements” clause. The court awarded damages.

Factual Background

During the negotiations for the purchase of a home, the vendor represented to the purchasers that there had never been a problem with respect to water leaking in the basement. The trial judge found that the vendor knew that there had been a history of water problems in the basement. During the negotiations, the owner gave the purchasers the plans for the house.  The trial judge found that, in doing so, the vendor effectively represented that the building had been built in accordance with those drawings, and that this representation was untrue.  The contract of purchase and sale of the home contained a provision stating that the contract was the entire agreement between the parties.

Decision of the Court of Appeal

The Court of Appeal held that the vendor was liable to the purchasers for fraudulent misrepresentation arising from the first express statement, but not for the second implied representation and reversed the trial judge’s decision on the second point.

As to the first representation, that there were no basement water problems, the Court of Appeal made no mention of the “entire agreement” clause.  The court appears to assume that the clause would not apply to representations, or if it did, it would not apply to fraudulent misrepresentations.

As to the second representation, that the handing over of the plans effectively amounted an implied representation that the house was built in accordance with those plans, the Court of Appeal held that since the plans were provided to the purchaser in the “context of arm’s length negotiations”, a finding that this conduct amounted to an “implied representation as to the accuracy of those plans was unreasonable.”   Again, no mention was made by the court of the entire agreement clause in the part of its decision dealing with this issue.

Based on the first express misrepresentation, the Court of Appeal held the vendor liable for fraudulent misrepresentation.

The Court of Appeal upheld the approach to the award of damages adopted by the trial judge. The trial judge concluded that the purchasers’ damages were the difference between the price paid for the property and the actual value of the property at the time of the sale, and that that difference was equal to the cost of remedying the problems relating to the misrepresentations. Or, as the Court of Appeal said, “the difference between the actual value of a house with a leaking basement and the price paid was equal to the costs of the repairs needed to fix the existing leakage-related problems.”

Having found that the vendor was liable only for the express representation regarding the non-leaky basement, not the implied representation about the compliance with the plans, the Court of Appeal discounted the damages to award only the costs associated with repairing the first problem.

Comments

The most interesting aspect of this decision is the conclusion by the Court of Appeal that the handing over of plans does not amount to an implied representation that the building was built in accordance with those plans. The decision will likely be relied upon in the future for the proposition that silence does not amount to fraud,  and that when something like plans or specifications are delivered during the negotiation of  a contract, that conduct does not amount to a representation, or at least not a fraudulent representation.

There could, however, be a number of bases for this conclusion.  One basis could be the “entire agreements” clause, even though it was not mentioned in the court’s decision on this point. If this is so, then the Court of Appeal’s decision is only applicable if the contract in issue has an “entire agreements” clause.

If it was the “entire agreements” clause which led to this result, then the question is: Why? Would the clause apply because the implied representation was really a warranty –that is, an agreement – that the plans had been used to build the house, and the “entire agreements” clause eliminated the effect of such an agreement?

Or did the “entire agreements” clause apply to the implied statement as a representation, not an agreement.  If this is the case, then the further question would be: does the clause apply to innocent, negligent, or any (including fraudulent) misrepresentations?  This question is not answered by the Court of Appeal’s decision since the “entire agreement” clause was not part of its reasoning.

Another basis for the court’s decision may be that the delivery of plans during the negotiations for the purchase and sale of a property cannot, without more, amount in law to an implied representation that the plans were used to build the building. Indeed, the Court of Appeal said that the trial judge’s conclusion that the handing over of the plans did amount to such a representation was “unreasonable.” If this is so, then this decision opens up a wide scope for the delivery of all sorts of relevant materials during the negotiation of a contract without responsibility for the accuracy of those materials. If the Court of Appeal’s decision is strictly applied, then parties to the negotiation of a building contract must obtain specific representations about the accuracy and the past use of those materials.

This decision will also be relied upon by those asserting that entire agreement clauses can never apply to fraudulent misrepresentations, at least in Ontario. While that seems to be the necessary result of the decision, there is no reasoning in the decision to that effect and the issue may have to be addressed in subsequent decisions. It seems intuitively obvious that an entire agreements clause cannot apply to fraud.  But whether such a representation is a collateral warranty which must be treated as such and subject to the “entire agreements” clause, or is simply outside that clause on the grounds of fraud, is not entirely clear in law.

See Heintzman and Goldsmith, Canadian Building Contracts (4th ed.), Chapter 6 Part 4(b)(i) and Chapter 6 Part 2(b)(i)(c) and (ii)(c)

Iatomasi v. Conciatori, 2012 ONCA 913

Construction Law  –  Fraudulent Misrepresentation  –  Exclusion and Limitation Clauses  

Thomas G. Heintzman O.C., Q.C. FCIArb                                                                                                            February 3, 2013

www.heintzmanadr.com

www.constructionlawcanada.com

What Does A CGL Policy Cover After Progressive Homes?

A:        OVERVIEW

The decision of the Supreme Court of Canada in Progressive Homes Ltd. v. Lombard General Insurance Co of Canada[1]  is a seminal decision with respect to the application of CGL policies to the construction industry.  While the immediate effect of the decision was with respect to the insurer’s duty to defend the insured, in the course of its decision the Supreme Court implicitly rejected some of the long-standing positions of insurers about the ambit of the a commercial general insurance policy, particularly as the policy applies to construction projects.

In an article in the recent edition of Skylines, the CBA National Construction Section’s publication, the Progressive Homes decision has been well reviewed by Andrew Heal, particularly from the aspect of the insurer’s duty to defend the insured.  In this article, I will dig deeper into three indemnity coverage issues with which the Supreme Court was dealing in Progressive Homes. Those issues are:

  1. Whether the events in question gave rise to an “accident” under the CGL policy;
  2. Whether damage to property arising from damage to other parts of the property amounted to “property damage” under a CGL policy;
  3. Whether the damage was excluded because it related to work performed by the insured.

I will then consider the decision of the British Columbia Court of Appeal in Bulldog Bag Ltd. v. AXA Pacific Insurance Company, 2011 BCCA 178 (CanLII).  That decision appears to be the first by a Canadian court which analyzes and applies the Progressive Homes decision to the substantive indemnity coverage of a CGL policy.

A CGL provides coverage for liability arising from “bodily injury” or “property damage”, but the discussion in this paper only relates to property damage coverage. Coverage for property damage arises if two conditions are satisfied.

First there must be property damage. Property damage is usually defined to include three elements: physical injury to tangible property, including resulting loss of use of that property, or loss of use of tangible property that is not physically injured.

Second, there must be an event giving rise to coverage.  That event is usually described in the policy as an “occurrence” or an “accident”.

B: ELEMENTS OF THE DECISION IN PROGRESSIVE HOMES

1.      Accident or Occurrence

Canadian case law has debated the meaning and scope of these words.  The debate has circulated around whether negligence or a result of negligence is included within the word “accident”.  The modern origins of this debate in Canada are found in the 1952 decision of the Supreme Court of Canada in Andrews & George Co. v. Canadian Indemnity Co.[2]  In that decision, Justice Rand wrote one of the judgments, and he expressly excluded the results of negligence from the concept of “accident”:

“To treat mistaken action of that nature as an “accident” would render the word superfluous.  What is meant is something out of the ordinary or the likely, something fortuitous, unusual an unexpected, not in the ordinary course, guarded against….what [the parties] did not aim at were direct and unexpected damages from the daily risks which it was part of their business of production and sale to face and eliminate.”

Justices Kerwin and Estey did not agree and stated the matter this way:

“..the defective condition was unsuspected and undesired and, therefore, there was an accident which caused the damage to “property to others.”

     In 1975, the Supreme Court of Canada returned to the subject in Strait Towing Ltd v. Washington Iron Works (sub nom. Canadian Indemnity Co v. Walkem Machinery & Equipment Ltd. [3] In his judgment for the court, Justice Pigeon specifically stated that Justice Rand’s statement about “the meaning of the word “accident” clearly does not form part of the ratio decidendi”. He dismissed the same conclusion of the Manitoba Court of Appeal, from which the appeal was taken. He said:

“With respect, this is a wholly erroneous view of the meaning of the word “accident” in a comprehensive business liability policy. On that basis, the insured would be denied recovery if the occurrence is the result of a calculated risk or of a dangerous operation. Such a construction of the word “accident” is contrary to the very principle of insurance which is protection against mishaps, risks and dangers….in everyday use, the word [accident] is applied as Halsbury says in the passage quoted, to any un-looked for mishap or occurrence….in construing the word “accident” in this policy, one should bear in mind that negligence is by far the most frequent source of exceptional liability which a businessman has to contend with. Therefore, a policy which wouldn’t cover liability due to negligence could not properly be called comprehensive.” (emphasis added)

            In 1976, in Pickford & Black Ltd. v Canadian General Insurance Co.[4] the Supreme Court quoted with approval from the judgment Justice Pigeon In Walkem Machinery, saying that “any unlooked for mishap or occurrence.. is the proper test” and that the damage due to shifting of cargo during shipment was due to an accident even if the shifting of the cargo arose in turn from the negligent storage by the stevedores at the time of loading.

In 1978 in Mutual of Omaha Insurance Co. v. Stats,[5] the Supreme Court of Canada expressly held that the word “accident” included “the negligence of the actor whose activities are being considered” because to “exclude from the word “accident” any act which involved negligence would be to exclude the very largest portion of the risks insured against.”

In 2003, in Martin v. American International Assurance Life Co.,[6] the Supreme Court of Canada considered the meaning of the word “accident” in the context of an insurance policy covering death through “accidental” means. It adopted its decisions in Stats and Justice Pigeon’s judgment in Walkem Machinery, holding that:

 “death is not non-accidental merely because the insured could have prevented death by taking greater care, or that a mishap was reasonably foreseeable in the sense used in tort law. Nor does a death that is unintended become “non-accidental merely because that person was engaged in a dangerous or risky activity….the jurisprudence assigns a generous meaning to “accidental” in the absence of language to the contrary in the insurance policy.”

In Progressive Homes, Lombard argued that, in the context of a building, the damage was not accidental. It asserted as follows:

“Lombard argues that when a building is constructed in a defective manner, the end result is a defective building, not an accident. It relies on case law that, in its view, supports its argument that faulty workmanship is not an accident … It relies on Ryan J.A.’s conclusion, in the court below, that this interpretation would offend the assumption that insurance provides for fortuitous contingent risk. Lombard argues that interpreting accident to include defective workmanship would convert CGL policies into performance bonds. In my opinion, these general propositions advanced by Lombard do not hold upon closer examination.”

      Speaking for the court, Justice Rothstein held that whether the workmanship in question led to an accident depended on the specific facts of the case. But there was nothing to prevent faulty workmanship from falling within that word.  He said:

 “I, therefore, cannot agree with Lombard’s view that faulty workmanship is never an accident. This Court’s jurisprudence shows that there is no categorical bar to concluding in any particular case that defective workmanship is an accident. In Canadian Indemnity Co. v. Walkem Machinery& Equipment Ltd., 1975 CanLII 141 (SCC), [1976] 1 S.C.R. 309, at pp. 315-17, the Court found that the negligent repair of a crane constituted an accident. Therefore, I see no impediment to concluding the same in the present case, unless of course it is not supported by the specific language of the policy.”  (emphasis added)

 Justice Rothstein also rejected Lombard’s submission that so interpreting the word “accident” would eliminate the concept of fortuity in the CGL policy.  He said:

 “I cannot agree with Justice Ryan’s conclusion that such an interpretation offends the assumption that insurance provides for fortuitous contingent risk. Fortuity is built into the definition of “accident” itself as the insured is required to show that the damage was “neither expected nor intended from the standpoint of the Insured”. This definition is consistent with this Court’s core understanding of “accident”: “an unlooked-for mishap or an untoward event which is not expected or designed” …When an event is unlooked for, unexpected or not intended by the insured, it is fortuitous. This is a requirement of coverage; therefore, it cannot be said that this offends any basic assumption of insurance law.”

 Finally, Justice Rothstein rejected Lombard’s submission that so interpreting the word “accident” would convert the CGL policy into a performance bond:

 “I am not persuaded by Lombard’s argument that equating faulty workmanship to an accident will convert CGL policies into performance bonds. There seems to be a fairly significant difference between a performance bond and the CGL policies at issue in this case: a performance bond ensures that a work is brought to completion ….whereas the CGL policies in this case only cover damage to the insured’s own work once completed. In other words, the CGL policy picks up where the performance bond leaves off and provides coverage once the work is completed.”

 Justice Rothstein accordingly concluded that:

 “Accident” should be given the plain meaning prescribed to it in the policies and should apply when an event causes property damage neither expected nor intended by the insured. According to the definition, the accident need not be a sudden event. An accident can result from continuous or repeated exposure to conditions.”

 Since the pleading against Progressive Homes did not allege intentional conduct but rather negligence, then the claim fell within the coverage provided by the policy.  Accordingly a duty to defend arose.

While the decision in Progressive Homes resulted in the duty to defend being found, it was an essential part of the logic in arriving at that decision, and therefore part of the ratio decidendi of the decision, that the word “accident” includes the result of negligent conduct.  Accordingly, it appears that this issue is settled for similarly worded CGL policies under the law of Canada.

2.      Damage to Property arising from another part of the Property

             Lombard argued that the damage to one part of a building from another part of the same building did not amount to “property damage” but only to economic loss.  This submission was based on the distinction in tort law between property damage and economic loss.  Lombard asserted that the consequential property damage in this case was economic, not property, damage. The Supreme Court did not accept this submission and declined to bring principles of tort law into insurance contract law.  Justice Rothstein said:

 “I cannot agree with Lombard’s interpretation of “property damage”. The focus of insurance policy interpretation should first and foremost be on the language of the policy at issue. General principles of tort law are no substitute for the language of the policy. I see no limitation to third-party property in the definition of “property damage”. Nor is the plain and ordinary meaning of the phrase “property damage” limited to damage to another person’s property….I would construe the definition of “property damage”, according to the plain language of the definition, to include damage to any tangible property. I do not agree with Lombard that the damage must be to third-party property. There is no such restriction in the definition.” (emphasis added)

  Interestingly, Justice Rothstein also relied upon the exclusion for “work performed” in arriving at this conclusion:

 “The plain meaning of “property damage” is consistent with reading the policy as a whole. Qualifying the meaning of “property damage” to mean third-party property would leave little or no work for the “work performed” exclusion (discussed in more detail below). Lombard argues that the exclusion clauses do not create coverage. This is true. But reading the insurance policy as a whole is not the same as conjuring up coverage when there was none in the first place. Consistency with the exclusion clauses is a further indicator that the plain meaning of “property damage” is the definition intended by the parties.”

     Finally, and even though it was not argued in the appeal, Justice Rothstein held that “defective property” could constitute “property damage”. Again, he reached this conclusion based not only on the plain meaning of those words but also by reference to an exclusion:

       “While this point was not contested and nothing turns on it in this appeal, it is not obvious to me that defective property cannot also be “property damage”. In particular, it may be open to argument that a defect could not amount to a “physical injury”, especially where the harm to the property is “physical” in the sense that it is visible or apparent…Moreover, where a defect renders the property entirely useless it may be arguable that defective property may be covered under “loss of use”, the second portion of the definition of “property damage”….. not barring defective property from the definition of “property damage” at the outset gives meaning to the exclusion clauses discussed below. Specifically, the second version of the policies expressly excludes coverage for defects. This would be redundant if defects were excluded from “property damage” at the outset. While perfect mutual exclusivity in an insurance contract is not required, this redundancy supports the view that the definition of “property damage” may not categorically exclude defective property.” (emphasis added)

      Again, while the final decision was that Lombard had a duty to defend, it was a necessary step in the court’s reasoning that damage to other property on or in the same site or building due to other property on the same site or building fell within the policy.  Accordingly, this matter should now be settled under Canadian law for CGL policies with the same wording.

3.    The “Work Performed” Exclusions

(a)   Work performed by the Contractor or Subcontractor

Exclusions with respect to “work performed” are common in CGL policies. They are also expressed in different ways in different policies, and in the Progressive Homes case, there were two different forms of “work performed” exclusions.

In the first version of the policy the original “work performed” exclusion was modified by what was called a General Liability Broad Form Extension Endorsement.  The original policy excluded “property damage to work performed by or on behalf of the Named Insured arising out of the work or any portion thereof, or out of materials, parts or equipment furnished in connection therewith”.  That clause was replaced by clause (Z) in the Broad Form Extension Endorsement, which excluded “property damage to work performed by the Named Insured arising out of the work or any portion thereof, or out of materials, parts or equipment furnished in connection therewith.”

Justice Rothstein found that the clause (Z) exclusion did not apply to property damage caused by a subcontractor, or to the subcontractors work, whether caused by the subcontractor, another subcontractor or the insured contractor.  He reasoned as follows:

 “The clause (Z) exclusion is limited to work performed by the insured. Unlike the clause that it replaced, it does not apply to work performed on behalf of the insured. The plain language is unambiguous and only excludes damage caused by Progressive to its own completed work.

     Justice Rothstein said that he would have arrived at the same result by the application of the contra proferentem principle, especially since the insured would have expected different coverage from different wording.

(b)   The Particular Part of the Work exclusion

The “work performed” exclusion relied upon by Lombard in another policy excluded:

 Property damage’ to ‘that particular part of your work’ arising out of it or any part of it and included in the ‘products – completed operations hazard. (emphasis added)

 Justice Rothstein noted the words “particular part of your work” and said:

 “Unlike the standard form version of the “work performed” exclusion (clause (i)) reproduced above, this version expressly contemplates the division of the insured’s work into its component parts by the use of the phrase “that particular part of your work”…This means that coverage for repairing defective components would be excluded, while coverage for resulting damage would not… Again, I find there is a possibility of coverage under the second version of the policy. It will have to be determined at trial which “particular parts” of the work caused the damage. Repairs to those defective parts will be excluded from coverage under this version, regardless of whether they were the result of Progressive’s own work or the work of subcontractors. If, as Lombard alleges, the buildings are wholly defective, then the exclusion will apply and Lombard will not have to indemnify Progressive.” (emphasis added)

      Once again, this logic was a necessary step in the court’s finding that there was a duty to defend.  Accordingly, under similar language in CGL policies, a“work performed” exclusion should not exclude property damage arising from damage caused to one part of the work by defective components in another part.

C;        APPLICATION OF PROGRESSIVE HOMES IN BULLDOG BAG

              (a)   What is the binding effect of the Progressive Homes decision?

       The broad scope of an insurer’s duty to defend adopted by the Supreme Court of Canada in Progressive Homes has been picked up and applied in numerous lower court decisions in Canada.  Important as that duty is, the fundamental importance of Progressive Homes relates to the indemnity coverage provided by a CGL policy.  After that decision was released, the question remained: would lower courts consider that Progressive Homes was only a decision about the duty to defend, and everything else was obiter?

As stated above, in my view the Supreme Court’s decision about the duty to defend was necessarily based upon its decision regarding indemnity coverage.  So, its decision regarding the coverage in a CGL policy should be considered as part of the ratio decidendi of the decision, and therefore binding on lower courts.  Would lower courts see it this way?

The decision of the British Columbia Court of Appeal in Bulldog Bag Ltd. v. AXA Pacific Insurance Company, 2011 BCCA 178 (CanLII) appears to be the only decision so far which has directly considered and applied the Progressive Homes decision to the substantive coverage of a CGL policy. In doing so, the B.C. Court of appeal resoundingly recognized that the Supreme Court’s decision in Progressive Homes had fundamentally changed the law relating to the coverage in a CGL policy.  In the very first paragraph of the Court of Appeal’s decision, it said:

 “In its recent decision in Progressive … the Supreme Court of Canada reversed a line of insurance cases that had taken a narrow view of the scope of coverage under commercial and general liability (“CGL”) policies commonly used in Canada and the U.S…..the Court determined that “property damage” in such policies is not limited to damage to “third-party property” and can include damage from part of a building to another part, previously regarded as irrecoverable “pure economic loss” (para. 36); that the term “accident” may, depending on the facts of each case, include the consequences of defective workmanship (paras. 39, 46); and that, again depending on context, the “own product/work” exclusion is to be construed narrowly or contra proferentem, such that it may be limited to damage caused by the insured to its own work and not extend to “resulting damage”. (emphasis added)

           (b)   Background facts of  Bulldog Bag

Bulldog manufactured plastic packaging and sold it to Sure-Gro, with emblem and other printing on it in accordance with Sure-Gro’s instructions. Sure-Gro used the packaging for manure and soil products which it sold to Canadian Tire. The ink later came off the packaging, so Bulldog had to supply new packaging and Sure-Gro had to retrieve, re-package re-deliver the manure and soil products to Canadian Tire.  Bulldog paid Sure-Gro’s claim against it for about $824,000 and sought recovery from its CGL insurer. Bulldog conceded that about $86,000 was the cost of the initially defective bags and did not seek coverage for that amount. So its net insurance claim was about $732,000. Reversing the trial judge’s decision, which was based on the case law prior to Progressive Homes, the Court of Appeal held that Bulldog’s claim was covered under its CGL policy.

Because of the decision in Progressive Homes, AXA reversed its position at trial and now conceded that Bulldog’s claim fell within the initial coverage in the policy.  AXA conceded that so far as the scope of “property damage” it was no longer necessary to show damage to third party property, that the faulty workmanship that resulted in the defective bags qualifies as an “accident” or “occurrence” under the CGL policy, and that the failure of the ink was neither expected nor intended and resulted in “property damage”.

          (c)    The reasons and effect of the Bulldog Bag decision

As a result, the major impact of the decision in Progressive Homes was conceded by the insurer and did not form part of the reasoning of the B.C. Court of Appeal.  For this reason, I suppose, it is possible for another insurer to contest these implications of the Progressive Homes decision. But since those concessions formed a central basis for the reasoning in the Bulldog Bag case, and since the B.C. Court of Appeal clearly announced in the opening paragraph of its decision that Progressive Homes had change the law, it would seem very difficult for another CGL insurer to argue to the contrary.

Instead, AXA argued that the exclusion clause in the policy applied.  That clause read as follows:

This insurance does not apply under Insuring Agreement 1(c) to claims for property damage to:

(a) goods or products manufactured or sold by the Insured; or

(b) work done by or on behalf of the Insured where the cause of the occurrence is a defect in such work, but this exclusion shall only apply to that part of such work that is defective. (emphasis added)

     AXA acknowledged that para. (b) did not apply, since it dealt with “work done” and not “goods or products”. However, it argued that the proviso in para. (b) did not appear in clause (a) and was not an apt proviso for para. (a) since that paragraph did not refer to “work”, but rather to “goods or products”.)

AXA also argued that while the Progressive Homes had changed the law regarding the interpretation of CGL policies, it had not changed the basic principle in the earlier cases to the effect that those policies “are not intended to pay the costs associated with repairing or replacing the insured’s defective work and products.”

The Court of Appeal disagreed.  It said:

“Bearing in mind that exclusion clauses are to be read narrowly and in a manner consistent with the parties’ reasonable expectations, I find that the clause operates to exclude claims for damage to Bulldog’s bags, including loss of use thereof, but cannot be extended to compensation for Sure-Gro’s costs separating those bags from its products, repackaging in different bags, and salvaging the “old” product some months later. To deny coverage would, as Mr. Ward suggested, be a ‘perversion’ of Progressive Homes.”

     The Court of Appeal also pointed out that, even prior to Progressive Homes, the “own product” exclusion had been held not to apply to “loss incurred by the insured’s customer as a result of defects in the insured’s own product.”

Finally, the Court of Appeal held that its conclusion was supported by the reference in Progressive Homes to one of the “work performed” exclusions in that case.  Referring to paragraph 68 of the decision in Progressive Homes, the Court of Appeal said:

“At para. 68, the Court ruled that this clause excluded only “coverage for defective property” and that “Coverage would remain for resulting damage.” As Bulldog notes, the language of clause 6(a) in the case at bar is even more favourable to the insured than the foregoing version of the exclusion in Progressive Homes –here, the clause does not purport to exclude coverage for “claims that flow from” the plaintiff’s defective work or work product, and excludes only coverage for property damage to goods supplied by the insured.” (emphasis added)

       Finally, AXA argued that Bulldog’s claim was not covered due to a clause which excluded “claims arising from loss of use of tangible property that has not been physically injured or destroyed.”   The Court of Appeal held that the product that “remained stuck to the plastic of the defective bags was “physically injured or destroyed”, at least in the sense that it had ceased to be useable for its intended purpose.”

D:        CONCLUSION

            Now that one Canadian Court of Appeal has considered and applied the Progressive Homes decision to the indemnity coverage under a CGL policy, it is safe to predict that other courts will do so as well.  In the result, a fundamental change in the scope of CGL policies has occurred.  The change is at two levels.

First, at the conceptual level:

  1. The policy will be interpreted in accordance with the plain meaning of the words in the policy, and contra proferentem in the event of ambiguity.
  2. No longer will pre-conceptions or in terrorem arguments be applied.  Such arguments, that by so interpreting the policy it will be turned into a performance bond or another type of insurance, will not be given weight.   Rather, the court will apply the plain words of the policy.
  3. If the common meaning of those words provides coverage, then the policy will apply unless the insurer demonstrates that an exclusion applies.

Second, at the level of the particular coverage:

  1.   If the policy covers damage arising from an “accident” or “occurrence” then the policy will cover damage arising from the insured’s negligence unless that coverage is specifically excluded.
  2. If the policy excludes damage to the insured’s own work, the policy will cover damage to other property, even if arising from the insured’s own work, again unless coverage for that damage is specifically excluded.
  3. If the policy excludes damage arising from damage performed by the insured contractor, it will not exclude damage arising from work performed by a subcontractor or others.
  4. If the policy excludes damage to a particular part of the work, it will not exclude damage to other parts of the work, even if caused by the damage to the excluded portion of the work.
  5.  The coverage in the policy for “damage” will be read widely and will apply to damage arising from a defective product or to a product if it is rendered unfit for its intended use.

Each of these latter conclusions are sensible since, as Justice Rothstein effectively held in Progressive Homes, the plain meaning of the words in question (“accident”, “damage”, “by”, “part” etc.) may include the event or loss in question.  If the insurer wished to unambiguously provide otherwise, it should do so expressly.

Thomas G. Heintzman O.C., Q.C., FCIArb                                                                                        September 26, 2012

2012 CBA National Construction Law Conference:  September 28-29 St. John’s Newfound

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www.constructionlawcanada.com

          


[1]  [2010] 2 SCR 245; [2] [1953] SCR 19; [3] [1976] 1 SCR 309;[4] [1977] 1 SCR 261;[5] [1978] 2 SCR 1113; [6] [2003] 1 SCR 158;

Is The Owner Liable For Delaying The Commencement Of The Building Project?

Time is money on a building project. And the obligation of the owner and the contractor to proceed expeditiously with the project may be one of the most important aspects of their relationship.

But what if the owner delays in notifying the contractor of the award, or in signing the building contract?  Can the owner be liable, even if the contract has not yet been signed?  In Bre-Ex Limited v. Hamilton (City), the Ontario Superior Court has recently answered Yes to these questions.  In the process, that court also provided a smorgasbord of answers to many questions arising from a construction claim.

The Background

In the fall of 2001, the City of Hamilton issued a call for tenders for the construction of a new leachate collection system at a landfill site located within its boundaries.  The tender documents stated that a binding contract would exist upon the acceptance of the tender by City council, that the listed documents would constitute the contract between the parties and that the signing of a contract would be a formality. The tender documents also stated that the work would not proceed without the City’s acceptance of the bidder’s methodology and that the “specifications” included “all written and printed descriptions or instructions pertaining to the method and manner of performing the work…”  The tender documents also stated that the City “will require that work commence immediately following the award of the Contract and will require the work to be completed by approximately the end of July, 2002”

Bre-Ex submitted a tender which provided for a methodology that was quite different than the methodology proposed by other bidders.

The tenders were opened on November 6, 2001 and Bre-Ex’s tender was the lowest. Before any contract was awarded, Bre-Ex advised the City that it would be undertaking the work during the winter months, although that statement was not contained in its formal tender. Before awarding the contract, the City and its consultants reviewed Bre-Ex’s methodology and accepted it.

On December 11, 2001, City council accepted Bre-Ex’s bid and authorized the award of a contract to it.  On January 6, 2002, the time expired for Bre-Ex’s tender to remain open.  The City did not advise Bre-Ex of the award of the tender to it until January 24, 2002.  The parties disagreed about whether Bre-Ex’s methodology should form part of the formal contract, Bre-Ex insisting that it did and the City asserting that it did not.  These matters were not sorted out until March 2002 when the City agreed to insert Bre-Ex’s methodology into the formal contract.  Bre-Ex signed the contract on April 12, 2002 and the City signed it on June 12, 2002.

As a result of these delays, Bre-Ex largely lost the ability to perform work during the winter of 2002, and it was forced to do much of the work during the winter of 2003.  It filed a delay claim with the City.

In these circumstances, the Superior Court held that the City was in breach of the building contract arising from the City’s acceptance of Bre-Ex’s tender.  In arriving at this conclusion, the court found as follows:

  1. The City’s failure to advise Bre-ex of the award of the contract from January 6, 2002 to January 24, 2002 was a breach of contract.  As a result of the tender documents, it was reasonable for the contractor to understand that its work was to commence on January 6, 2002 (being the date that its tender expired) if it was awarded the contract.  Moreover, it was reasonable for the bidders to assume that, if the City accepted a tender within the tender period, the City would forthwith advise the successful bidder so that it could marshal the documents and its forces in order to start work on January 6, 2002.
  2. The City was in breach of contract by failing to sign the formal contract until June 2002.  In particular, the City was wrong to assert that the methodology set forth in Bre-Ex’s bid should not be part of the contract.  It was only when the City agreed to put that methodology into the contract that the contract was finally signed.

Contractor’s Tender Methodology Became A Contract Specification

The court’s conclusion on this latter point is instructive.  The court held that the necessary result of the tender documents was that the contractor’s methodology was a “specification” included in the building contract.  This conclusion followed from the working of the tender document, and in particular the statements that:

    • the definition of “specification” included all documents pertaining to the method of performing the work;
    • the work could not proceed without the City’s acceptance of the contractor’s methodology;
    • the City had clearly accepted Bre-ex’s methodology in awarding it the contract; and
    • the subsequent execution of the Contract Documents was a formality.

This conclusion that the methodology in Bre-Ex’s tender became a “specification” is an important one for construction law.  It demonstrates that definitions used in standard form construction contracts and tender documents can include more than just the documents that the parties attach to their “formal” contract.  The tender process itself may well make documents delivered by the contractor during that process part of the contract, as “specifications”.

Owner’s Contractual Obligation To Commence The Project With Dispatch

The court then concluded that the delays by the City breached an implied obligation to perform its contractual duties within a reasonable time.  The Court quoted from Heintzman and Goldsmith on Canadian Building Contracts to the effect that what is a reasonable time for the performance of contractual duties must be decided in light of the “specific work and conditions and the general circumstances in which the contract was entered into”.

In its tender documents, the City had stated that the work was to commence immediately after the award of the contract and was to be completed by approximately July of 2002.  In these circumstances, the Court held that the City breached its implied duty to proceed with the contract with reasonable dispatch by its delay in advising Bre-Ex of the award of the contract and by its delay in executing the contract, all of which caused Bre-Ex to lose the ability to perform the work in the winter of 2002.

The Building Contract Arises From The Tender Process Itself

This conclusion followed from the fact that there were two contracts between the City and Bre-Ex, one relating to the tender itself (known in Canadian law as Contract A), and the other being the building contract arising from the City’s acceptance of Bre-Ex’s bid on December 11, 2001 (known in Canadian law as Contract B).  The City’s duty to proceed with reasonable dispatch might arise from both contracts, but it certainly arose from the building contract, Contract B.  As both parties acknowledged, that contract arose on December 11, 2001 when the City accepted Bre-Ex’s bid.  Accordingly, the implied duty to act with reasonable dispatch arose from that contract.  It did not require the execution of the formal contract in June 2002 for that duty to come into existence.

This conclusion is also an important one for construction law.  The owner’s duty not to delay the project does not just arise during the project.  That duty applies to the commencement of the project.  And it applies even before the execution of the “formal” contract if, as is usually the case for a true tender, the building contract arises from the tender process itself.

Damages awarded to Bre-Ex

The final interesting aspect of this case is the wide scope of the damage relief that was awarded to Bre-Ex.  It was awarded damages for: loss of revenue due to a decline in profit for the first quarter of 2002, fuel and labour escalation costs, refinancing costs, and loss arising from sale of equipment and required rental of replacement equipment.

Important Conclusions

The Bre-Ex decision is a very useful case to consult when allegations of owner’s delay are raised.  The decision reminds us that, when an invitation to tender provides, as it usually does, that a contract arises from the acceptance of the tender, then a building contract is immediately formed.  That contract may well include the methodology or systems proposed by the bidding contractor, as part of the specifications of the contract.  And it will require both parties not to delay pending the execution of a formal contract, but to proceed with reasonable and immediate dispatch.

See Heintzman and Goldsmith on Canadian Building Contracts (3rd ed.) at Chapter 5, part 1(b)

Bre-Ex Limited v. Hamilton (City), 2012 ONSC 147

Construction Law   –   Tenders   –   Implied Duties   –   Performance

Thomas G. Heintzman O.C., Q.C., FCIArb                                                               July 26, 2012

www.heintzmanadr.com

www.constructionlawcanada.com

 

Incorporation By Reference In Building Contracts

Incorporation by reference in building contracts

By Thomas G. Heintzman and Julie Parla1

A common clause in a building contract is one which incorporates the terms of another contract or document into the building contract in issue. The effect of such a clause is referred to as “Incorporation by Reference”. These clauses are common in building contracts because the various contracts necessary for a building project are often cross-referenced and their performance are inter-related.

Thus, the main contract between the owner and the general contractor is inter-related with the subcontract between the contractor and the sub-contractor. The tender or other pre-contractual documents are inter-related to the contracts later entered into. The payment or performance bonds are related to the contracts for which they provide financial guarantees. The contracts between the consultants are related to the building contracts themselves. To a great extent, all of these contracts are part of the same package. Whether the object is to save drafting time or to ensure absolute consistency, or laziness, one of these contracts may state that the terms of another document or contract are incorporated into it.

While an Incorporation by Reference clause may provide a useful correlation of one contract to a second contract, they also open up dangers when the clauses are arguably unsuitable for inclusion in the second contract. This paper will examine the circumstances in which Incorporation by Reference clauses have been used and the potential problems they raise.

Uses of Incorporation by Reference Clauses

Incorporation by Reference clauses have been used in a wide variety of circumstances in building contracts. Here are some of the circumstances in which they have been used and applied:

  • (a)  Specifications:  A specification list prepared by the owner was incorporated by reference into the contract ultimately entered into with the contractor, rather than attaching a specification list physically to the actual contract.2
  •  
  • (b)  Specific work and Best Practices:  A term in the main contract specifying the work to be carried out and stating the obligation to use “best trace practices” was incorporated by reference into the subcontract.3 In another case, the measurement and price to be paid for concrete work in the main contract was incorporated into the subcontract.4
  •  
  • (c)  Force Majeure and Claim period:  A force majeure clause and a clause stating the period in which a claim must be made, contained in the main contract, was incorporated by reference into the sub-contract.5
  •  
  • (d)  Profit Sharing:  A contractor’s obligation in the main contract to pay the owner 75% of savings from the contract price was enforceable against the bonding company. While there was no Incorporation by Reference clause in the bond, the Ontario Court of Appeal applied principles that related both to Incorporation by Reference and to contractual interpretation.6
  •  
  • (e)  Tender Conditions – GST:  The term of a tender, requiring the tender price to include GST, was incorporated into the contract ultimately entered into.7
  •  
  • (f)  Performance Bond:  A provision in the main contract requiring the contractor to post a performance and materials bond for 50% of the contract price was incorporated into the subcontract and precluded the contractor from requiring the subcontractor to post a 100% bond.8
  •  
  • (g)  Letter of Intent:  A letter of intent was incorporated by reference into the subsequent contract, thereby creating contractual representations.9

On the other hand, Incorporation by Reference clauses have not been applied in many cases to incorporate the provisions of another contract or document. Thus,

  • (a)  Liquidated Damages: A liquidated damages clause in the main contract was not incorporated by reference into the sub-contract.10 A bond which contained a clause incorporating the building contract between the owner and the contractor was held not to impose on the surety the obligation to pay the liquidated damages referred to in the building contract between the owner and the contractor.11
  •  
  • (b)  Lien Security:  The obligation to post security for lien claims contained in the main contract was held not to be incorporated into the subcontract.12
  •  
  • (c)  Guarantee Period:  A two-year guarantee given by the contractor to the owner in the main contract was not incorporated by reference into the subcontract.13
  •  
  • (d)  Insurance:  An obligation to obtain insurance was not incorporated into the subcontract because, although there was an Incorporation by Reference clause in that subcontract, there had been no main contract in fact entered into.14
  •  
  • (e)  Inconsistency:  A Term in a building contract was not incorporated into a bond because it was inconsistent with the limited liability of the surety stated in the Bond.15
  •  
  • (f)  Additional Terms:  The subcontractor understood that the main contract between the owner and contractor was the standard CCDC 2 contract. In fact the owner and contractor negotiated additional terms which were unknown to the subcontractor. It was held that those additional terms were not incorporated by reference into the subcontract.16
  •  
  • (g)  Dispute Resolution:  In Canada, courts have generally held that an arbitration clause in the main contract is not incorporated by reference into the subcontract without specific incorporation.17

The courts in other common law jurisdictions have also considered the incorporation of arbitration clauses from one contract to another. Their decisions illustrate the nuances of this practice, especially when those clauses affect rights and obligations outside of the project work per se. The incorporation by reference of arbitration clauses from one contract to another has been the subject of a number of cases in the United Kingdom and Australia.18 The general trend is that an arbitration clause in one contract is only incorporated into the other contract if the arbitration clause in the first contract is specifically referred to in the second agreement. This rule is sometimes referred to as the “rule in Aughton” after the decision in Aughton Ltd. v. M.F. Kent Services Ltd.19 The rule was effectively applied 100 years ago by the House of Lords in TW Thomas & Co. Ltd v. Portsea Steamship Co Ltd (The Portsmouth).20 While the rule is more or less settled in the UK, there are cases in which the rule was not applied on the particular facts.21

Two commentators have recently reviewed the law in the UK and Australia. Their view is that, in Australia, the pendulum is swinging from requiring express reference to an arbitration clause in order to validly uphold an incorporation by reference, to more flexibility allowing arbitration clauses to be incorporated by general reference to a contract which contains an arbitration clause, provided doing so can be supported on a proper construction of the contract. This shift is generally credited to a more pro-arbitration policy of the courts, and may provide insight as to the direction other common law jurisdictions will ultimately take.22

Incorporation by reference of arbitration clauses may also be subject to the governing arbitration statute. Thus, the UNCITRAL Model Law, which is incorporated into the various provincial and federal statutes applicable to international commercial arbitrations23, states as follows:

“The reference in a contract to any document containing an arbitration clause constitutes an arbitration agreement in writing, provided that the reference is such as to make that clause part of the contract.” (underlining added)

It is arguable that the proviso to this provision was intended to require specific reference to the arbitration clause in the other contract before incorporation of it into the second contract occurs. But the opinions of commentators and the decided cases do not necessarily demonstrate this point of view.24

In light of these apparently inconsistent decisions, one might wonder why any subcontractor would agree to an Incorporation by Reference clause in the subcontract. Since the provisions of the main contract are drafted to suit the circumstances of the owner and the contractor, there is every reason for the subcontractor not to agree, holus bolus, to the terms of the main contract being incorporated into the subcontract. This is especially so where the main contract may contain provisions such as liquidated damages, an arbitration clause and other specific provisions with respect to security, insurance and removal of liens which may be wholly suitable to the owner and contractor, but totally unsuitable to the subcontractor.

Some examples from the cases referred to above make this point clear. For example, in Q.Q.R. Mechanical Contracting Ltd. v. Panther Controls Ltd., the contractor had given the owner a specific two-year guarantee. There does not seem to be much reason why the subcontractor should be bound by that guarantee. In Litchfield Bulldozing Ltd. v. PCL Construction Ltd., the owner was a municipality. While a municipality may need a specific force majeure clause, it is not evident that the same force majeure clause is suitable to the subcontract.

Similarly, in Niagara Structural Steel v. LaFlamme, the liquidated damages clause stated a specific per diem amount which was based upon the owner’s particular circumstances and was set to cover the owner’s supervisory cost. Those costs would have no bearing upon the costs incurred by the contractor or subcontractor. In the result, that liquidated damages clause had no relationship to the subcontract. Similarly, in Lac La Ronge Indian Band v. Dallas Contracting Ltd., a bond was interpreted as not including on obligation upon the surety to pay the liquidated damages due by the contractor under its contract with the owner, because that obligation was contrary to the specific terms of the bond.

There may be a total disconnect between the necessity and rationale for terms in the main contract as opposed to the necessity or rationale for the same terms in the subcontract.

Nevertheless, standard form contracts in the Canadian building industry continue to contain Incorporation by Reference clauses. General condition 3.7.1 of the CCDC 2 Stipulated Price Contract between the owner and the contractor requires the contractor to “incorporate the terms and conditions of the Contract Documents into all contracts or written agreements with subcontractors and suppliers.” The wisdom of this requirement is questionable particularly when, as noted above, courts have found that the Incorporation by Reference will not necessarily occur even in the presence of such a clause.25

In these circumstances, it seems more advisable for the Incorporation by Reference clause to state that “the following provisions of the Contract Documents are to be incorporated into the subcontracts”, and then list them specifically, rather than incorporating each and every portion of the Contract Documents into the subcontract. This is particularly so in circumstances where the owner and the contractor have negotiated provisions which are peculiar to their relationship and which may have no place in the subcontract document.

Application of Contract Interpretation Principles

It should be kept in mind that the determination by the Courts of when a term will be found to have been incorporated by reference, will be subject to the general principles of contract interpretation as applicable to any contract.

First and foremost the court will look to the words of the contract, understood with reference to the “factual matrix”, that is, the circumstances and context surrounding contract formation.26 The factual matrix will include the purpose of the second contract to the overall project, in informing how to interpret the agreement.

Second, determining the intention of the parties is an objective exercise; the court does not look to the subjective intent of the parties, but rather presumes that the parties intended the legal consequences of their words.27

Third, the contract must be interpreted as a whole, such that meaning is given to all of the terms agreed to between the parties, without conflict.28

Finally, the contract is to be interpreted consistent with “sound commercial principles and good business sense” and in a way that is commercially reasonable.29

These principles guide how a court may treat terms incorporated into a contract by reference. So, for example, the court will look first to the words that the parties have used, and the subjective intent of one party to incorporate all terms of the incorporated contract (or to not do so) will not be determinative in interpreting what was intended to be incorporated. As discussed below, if a term makes little sense in governing the relationship between the parties who incorporate another contract, it may be inapplicable for failing to result in being commercially reasonable – for example an onerous liquidated damages term as applied to a relatively discrete subcontract, the value of which is far less than the purported liability, may be found to be inapplicable. Where the express terms of the contract appear to be in conflict with the terms of the contract purported to be incorporated, the incorporated terms may also fail to apply.

An Attempt to Draw General Principles

So long as Incorporation by Reference clauses are included in building contracts, can we derive any principles from the case law? To the extent that it is possible to do so, the following are general principles which, in our view, should be applied by the courts, based upon the decided cases, and the principles of contract interpretation:

1.   Incorporation by Reference will only occur if the objective intention of the parties was to incorporate one document into another. While this principle is sometimes stated to be based on the subjective intention of the parties, that approach is contrary to the fundamental principle of contract law that intention is to be objectively determined.30 The mere existence of Incorporation by Reference clause in a subcontract will not demonstrate such an objective intention in relation to matters which do not concern the coordination and undertaking of the physical work.

2.   Some of objective circumstances which may arguably demonstrate an objective intention not to include terms of one contract into another were discussed in the Dynatec Mining deicison, being: lengthy negotiation of the latter contract during which the terms proposed to be incorporated were never discussed; an entire agreement clause in the latter contract; and a comprehensive scheme (such as a dispute resolution procedure) in the latter contract which does not mention or is inconsistent with the term in the other contract (such as an agreement to arbitrate).

3.   Conflict between the provisions in the latter contract and the term sought to be imported from the other contract will in all likelihood preclude incorporation. In fact, the latter contract may directly address this conflict issue. Thus, the subcontract may well state, and should state, that if there is any conflict between the subcontract and the main contract, then the provisions of the subcontract apply.

4.   A conflict does not require an absolute conflict in wording. Indeed, the failure to provide for the matter in, say, the subcontract may itself preclude the importation of a term from the main contract, because to do so would be in conflict with the subcontract.

5.   If the parties are in a direct relationship with each other, then Incorporation by Reference will be more sustainable. Hence, if it is a question of incorporating a letter of intent or the terms of a tender into the contract which is ultimately made by the same parties who exchanged the letter of intent or participated in the tender, or incorporating the terms of a contract into a performance or payment bond relating to that contract, then a court will be much more likely to hold that the Incorporation by Reference clause is effective to bring all of the material portion of the other document into the contract.31

6.  The obligation in the main contract in respect of the actual physical work to be undertaken will likely be incorporated into the subcontract by virtue of the Incorporation by Reference clause.32 The courts view the purpose of an Incorporation by Reference clause in a subcontract to be for co-ordinating the prosecution of the actual physical project, and not for the purposes of subjecting the subcontractor to the same insurance, dispute resolution and similar regimes adopted by the owner and the contractor, absent the clear intention by the contractor and subcontractor to import into their contract the terms of the main contract.

For this reason, terms relating to liquidated damages, the obligation to obtain insurance, the provision for security for lien in the main contract will not likely be incorporated into the subcontract in the absence of a specifically articulated intention to do so.

7.   Similarly, arbitration clauses and other clauses relating to dispute resolution will not usually be imported from the main contract into the subcontract by virtue of a general Incorporation by Reference clause in the latter contract. However, the general principles of interpretation and the facts of the particular case may result in a general incorporation clause having that effect. Consideration must also be given to the specific arbitral statute governing the contract because it may favour or contradict such incorporation. In addition, the trend toward a more arbitration-friendly approach by courts may increase the likelihood of such general incorporation in the future.

Conclusion

Even though standard form building contracts contain Incorporation by Reference clauses, courts may not find that such incorporation has actually occurred. Incorporation by Reference will more likely be found to occur if the parties are in a direct relationship with each other or engaged in the preparation of, or exchanged, both documents, or if the document sought to be incorporated relates to the physical construction of the project. Otherwise, terms such as arbitration clauses, lien security, insurance and liquidated damages clauses will not likely be imported from one contractual regime into another. The interpretation of the contract as a whole, being the contract and the terms Incorporated by Reference, will be subject to the established principles of contract interpretation.

In these circumstances, the drafters of standard building contract might well revisit the Incorporation by Reference clauses contained in those contracts, and particularly in main contracts and subcontracts, and encourage the parties to direct their minds to which specific provisions of one contract they wish to be incorporated into the other contract.

[This article first appeared in Skylines – Newsletter of the CBA National Construction Law Section – July 2012]


  • 1 Thomas G. Heintzman OC, QC, FCIArb is counsel and Julie Parla is a partner in the Toronto office of McCarthy Tétrault LLP.
  • 2 Pozzebon v. Lamantea, 1988 Carswell Ont. 759 at para. 4
  • 3 Kor-Ban Inc. v. Pigott Construction Ltd. (1993), 11 C.L.R. (2d) 160 at para 529(Ont. S.C.J.)
  • 4 Online Constructors Ltd. v. Speers Construction Inc. 2011 CarswellAlta 104 at paras 17-20.
  • 5 Litchfield Bulldozing Ltd. v. PCL Construction Ltd. (1985) 14 C.L.R. 287(B.C. Co. Ct.)
  • 6 Whitby Landmark Developments Inc. v. Mollenhauer Construction Ltd., (2003) 26 C.L.R. (3d) 161 at para. 9-16 (Ont. C.A.)
  • 7 Ecozone Engineering Ltd. v. Grand Falls – Windsor (Town) (1995), 30 C.L.R. (2d) 277, (2000) 5 C.L.R. (3d) 55 (N.L.C.A.)
  • 8 Schaible Electric Ltd. v. Melloul – Blaney Construction Inc. (2005) 45 C.L.R. (3d) 41 (Ont. C.A.)
  • 9 Foundation Co. of Canada Ltd. v. United Green Growers Ltd. (1997), 33 C.L.R. (2d) 159 at para. 27 (B.C.C.A.)
  • 10 Niagara Structural Steel v. LaFlamme (1985), 14 C.L.R. 70 at para 28-32; aff’d (1987) 58 O.R. (2d) 773 (C.A.)
  • 11 Lac La Ronge Indian Band v. Dallas Contracting Ltd. (2004), 35 C.L.R. (3d) 236 at para 70, 82-95 (Sask. C.A.)
  • 12 1510610 Ontario Inc. v. Man-Shield (NOW) Construction Inc., 2010 Carswell Ont. 1395
  • 13 Q.Q.R. Mechanical Contracting Ltd. v. Panther Controls Ltd. (2005), 40 C.L.R. (3d) 154 at para 16-31 (Alta. Q.B.)
  • 14 529198 Alberta Ltd. v. Thibeault Masonry Ltd. (2001), 19 C.L.R. (3d) 63 (Alta. Q.B.)
  • 15 Lac La Rouge Indian Band v. Dallas Construction Ltd., (2004) 35 C.L.R. (3d) 236 (Sask. C.A.)
  • 16 Daiwood Construction Co. v. Wright Schuchart Construction Ltd. (1992), 3 C.L.R. (2d) 144.
  • 17 Dynatec Mining Ltd. v. PCL Civil Constructors (Canada) Inc. (1995), 25 C.L.R. (2d) 259 (Ont. Gen. Div.); Sunny Corner Enterprises Inc. v. Dustex Corp., (2011), 1 C.L.R. (4th) 281 (N.S.C.A.)
  • 18 Rebecca James and Michael Schoenberg, “Incorporating an Arbitration Clause “By Reference”: Reconciling Model Law Article VII and Australian Common Law in Light of Recent Developments”, (2011) 77 Arbitration, Issue I, 84. (“James and Schoenberg”)
  • 19 (1991), 57 B.L.R. 1; 31 Con. L.R. 60 CA.
  • 20 [1912] A.C. 1 HL.
  • 21 Modern Buildings (Waltes) Ltd. v. Limmer & Trinidad Co. Ltd. [ 1975], 1 W.L.R. 1281; [1975] 2 All E.R. 549 CA; Owners of the Annefield v. Owners of Cargo Lately Laden on Board the Annefieldl, [1971] P. 168; [1971] 2W.L.R. 320 CA
  • 22 James and Schoenberg, above.
  • 23 See, for instance, the Ontario International Commercial Arbitration Act, R.S.O. 1990, c. I.9, Article 7(2) of the Model Law attached to that Act The domestic Ontario Act, the Arbitration Act, 1991 ,S.O. 1991, c. 17 does not contain a provision that directly deals with incorporation by reference of an arbitration clause from one contract or document into a second contract. Section 5(1) does say that an arbitration agreement “may be an independent agreement or part of another agreement”.
  • 24 See James and Schoenberg, above, at footnotes 15 and 16.
  • 25 Dynatec Mining Ltd. v. PCL Civil Constructors (Canada) Inc., (1996), 25 C.L.R. (2d) 259; Daiwood Construction Co. v. Wright Schuchart Construction Ltd. (1992), 3 C.L.R. (2d) 144.
  • 26 SimEx Inc. v. IMAX Corp., [2005] O.J. No. 5389 (Ont. C.A.) at para. 23
  • 27 Eli Lilly & Co. v. Novopharm Ltd., [1998] 2 S.C.R. 129 at para. 56; SimEx, supra at para. 23; Drumbrell v. Regional Group of Cos. 2007 CarswellOn 407 (Ont. C.A.) at paras. 48-51.
  • 28 Ventas, Inc. v. Sunrise Senior Living Real Estate Investment Trust (2007), 85 O.R. (3d) 254 at para. 24; 3869130 Canada Inc. v. I.C.B. Distribution Inc. (2008) ONCA 396 (Canlii) at para. 31.
  • 29 Ibid.
  • 30 Heintzman and Goldsmith on Canadian Building Contracts, Chapter 1, Part 1(b)
  • 31 Foundation Co. of Canada v. United Green Growers Ltd. (1997), 33 C.L.R. (2d) 159 (B.C.C.A.); Pozzebon v. Lamantea, 1988 Carswell Ont. 759 at para. 4; Whitby Landmark Developments Inc. v. Mollenhauer Construction Ltd., (2003) 26 C.L.R. (3d) 161 (Ont. C.A.)
  • 32 Dynatec Mining Ltd. v. PCL Civil Constructors (Canada) Inc., (1996), 25 C.L.R. (2d) 259; Kor-ban Inc v. Pigott Construction Ltd, 1993 Carswell Ont. 825 at para 529.

www.constructionlawcanada.com                                                                                                                               July 25, 2012

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Decision Holding That Demolition Is Not An Improvement Is Reversed

In my article dated December 11, 2011, I reported on a decision of the British Columbia Supreme Court holding that demolition is not an “improvement” for the purposes of the B.C. Builders Lien Act (the Act).  That decision has since been reversed by the B.C. Court of Appeal.  It was not reversed on the merits, but only on the basis that the B.C. Supreme Court did not have jurisdiction to make the order:  West Fraser Mills. Ltd v. BKB Construction Ltd

The Facts of the Case

As my earlier article reported, BKB and its subcontractor had filed builders’ liens against West Fraser’s property when they were not paid in full for their work in removing machinery from the property.  West Fraser had shut down its paper mill in Kitimat, B.C. and sold the paper machinery separately from the land.   Under the agreement by which West Fraser sold the machinery, the buyer was obliged to remove the equipment.  The buyer hired BKB to remove the machinery and BKB hired a subcontractor to assist in the removal.  BKB and its subcontractor were not paid in full by the buyer and so filed their builder’s liens.

The B.C. Supreme Court held that the removal of the machinery was not an improvement of the land.   Demolition work may be an improvement, it said, if undertaken as part of a project to create an altered structure, but work to preserve the value of removed or salvaged material which does not benefit the landowner qua landowner is not an improvement within the Act.

The B.C. Court of Appeal reversed this decision on the basis that the court had no jurisdiction to strike out the lien under sections 24 and 25 of the Act.  The Court of Appeal held that those sections were not intended to permit the court to rule on the merits of the liens or to grant summary judgment on the merits.  West Fraser did not contend that the lien was filed out of time or against the wrong property or had been satisfied by payment or litigated to conclusion.  Indeed, a lien action had not even been commenced.

The only provision in those sections under which the lien could be struck out was section 25(2) (b) on a showing that the lien claim was scandalous, frivolous or vexatious.  The Court of Appeal held that this test could not be met because it was at least arguable that the liens were valid, and not plain and obvious that they were invalid.  These sections could not be used to determine whether the liens had been proven, which is what the Supreme Court judge had done.

In the Court of Appeal, BKB argued that West Fraser had refused to produce the documents which might show the reason why West Fraser sold the equipment separately from the land, and had the equipment removed.  Those documents might show, BKB argued, that the removal work was an improvement to the land, having regard to West Fraser’s future  intended use of the building and the land.  The Court of Appeal said that this argument had “some merit.”

As a result, the issue of whether demolition can be an “improvement” under the Act has not yet been determined.  The B.C. Court of Appeal’s decision appears to support the conclusion that, at least in some circumstances, it can.  As in all things, the first chapter was not the end of the story, and we will have to wait for the next episode.

 Construction Law   –  Construction Liens  –   Removal of Equipment  –   Power of the Court to Strike Lien

West Fraser Mills. Ltd v. BKB Construction Ltd., 2012 BCCA 89

 Thomas G. Heintzman O.C., Q.C., FCIArb                                                                                                             April 4, 2012

www.heintzmanadr.com

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Can A Contractor Use Its Own Mistakes To Withdraw Its Bid?

A contractors’ worst nightmare is making a mistake in a tender and being stuck with a low bid.  The next worse nightmare is submitting a winning bid but one which contains errors which arguably make the bid non-compliant.

What happens when both occur?  Can the contractor get out of its low bid by its own errors?  That is the issue that the Manitoba Court of Queen’s Bench recently dealt with in Manitoba Eastern Star Chalet Inc. v. Dominion Construction Co Inc.

The Supreme Court of Canada has revolutionized the law of tender by its Contract A/Contract B regime for tenders.  Under that regime, Contract A is the contract formed by the contractor submitting a tender in response to the owner’s invitation to tender, and Contract B is the subsequent construction contract awarded by the owner.  Contract A converts what appear to be unilateral acts in the tender process into an enforceable contract.

The courts will typically imply terms into Contract A.  Thus, the owner will generally have an implied duty not to accept a non-compliant bid absent a term in the invitation to tender to the contrary.  The contractor will have a duty not to withdraw its bid during the period stated in the invitation for the owner to accept a bid.

But what happens when the contractor’s bid is allegedly non-compliant due to the contractor’s own faulty bid, and the contractor wants to withdraw it because it is seriously underpriced?  Can the contractor do so?  The Manitoba Queen’s Bench has said No, unless the non-compliance is clear from the face of the bid.  In its decision, the Court has provided an extensive and useful analysis of the law on this subject.

The Background

Dominion was one of three bidders on an extension to a seniors housing complex being constructed by Manitoba Eastern Star Chalet.  Dominion’s bid was more than $600,000 under the next bid on a project worth about $2.5 to $3 million, or about 25% under the next bidder.

When it was notified that its bid was accepted, Dominion sought to withdraw the bid on two grounds.

First, that it had failed to provide a resolution of its board of directors authorizing the signatory to the bid to sign it.

Second, that its bid failed to refer to Structural Addendum #4 included in the tender documents.

Dominion said that these items were required by the invitation to tender, and therefore its bid was non-compliant and incapable of acceptance by the owner.  Admittedly, it was Dominion’s own fault that these items were omitted, but Dominion maintained that the Contract A regime applicable to tenders precluded the owner from accepting its bid.

The trial judge rejected Dominion’s position.  In the course of his reasons, he examined the Contract A/Contract B law, all the way from the 1981 decision of the Supreme Court of Canada in Ron Engineering up to its 2007 decision in Double N Earthmovers.   The trial judge agreed that, unless the invitation to tender states otherwise, Contract A requires the owner to only accept a compliant bid.  Therefore, if Dominion’s bid was truly non-compliant under Contract A, then the owner could not accept it and Dominion could withdraw it, even if that non-compliance was entirely due to Dominion’s fault.

The trial judge noted that an attempt by a contractor to withdraw its bid based on non-compliance due to its own fault gives rise to “mischief” which “effectively reward[s] a bidder who has made a mistake in its bid, but then can utilize its non-compliance for the purposes of not honouring a contract.”  Nevertheless, the court held that logic and previously decided cases led to the conclusion that a contractor can do exactly that, if the circumstances permit it to do so.

However, the court held that the circumstances did not permit Dominion to withdraw its bid.  As to Structural Addendum #4, the court held that it was effectively included in Dominion’s bid, when the whole bid was properly read.  In the alternative, the order of precedence in the contract documents overcame any error arising from the absence of this addendum.

In addition, the amount of the cost of this addendum was insignificant in relation to the total cost of the project.  In the result, Dominion’s bid was substantially compliant with the invitation to tender with respect to this issue.

As to the failure of Dominion to file with its tender a corporate resolution authorizing the signatory to sign the bid, the court found that Dominion had never done so in any bid, even when the invitation to tender required such a resolution.  The person signing the bid for Dominion had authority to sign the bid and that person intended to sign and submit the tender on behalf of Dominion.  Dominion’s corporate seal was affixed to the tender. The Instructions to Bidders stated that a non-compliant bid could be accepted at the discretion of the owner.  Even giving that discretion a narrow scope, the trial judge held that the non-compliance was not substantial and fell within the owner’s discretion to accept it.

The trial judge also found that the amount by which Dominion’s bid was less than the next bid was not a matter which ought to have alerted the owner to any non-compliance or other reason not to accept the bid.  Any mathematical error in Dominion’s bid was not apparent on the face of the bid.  The trial judge held that “the divergence in the bid numbers did not raise the need for an investigation into the reasons, nor was there a duty to do so”.

At the end of the reasons, the trial judge returned to the issue of whether Dominion was entitled to rely on its own fault to escape its bid.  As noted above, early in the reasons, the trial judge held that, based on logic and previously case law, a contractor should be able to do so.  But at the end of the reasons, the trial judge said:

“If there is any error in my analysis or my findings, I am satisfied that such an error would be sufficiently small that it is incumbent on the court to protect the integrity of the tendering process by not allowing Dominion to point to these alleged incidents of non-compliance to resile itself from a bid which it fully intended when it was submitted to be compliant, to be binding, and to be accepted.”

This statement is strong evidence of the inclination of courts to ensure that the tendering process is not undermined by the faulty and unfair conduct of either the owner or the bidders.  If a bidder asserts that it may escape the consequences of its own faulty bid due to non-compliance, then the court will scrutinize the alleged non-compliance very, very carefully.  The court will place a high burden on the bidder to demonstrate that the non-compliance is so material and substantial as to be a true non-compliance and one not falling within the discretion of the owner to accept non-compliant bids, however that discretion is expressed in the tender documents.

This decision is useful in three other respects:

First, it contains a very helpful collection of the cases that deal with whether a contractor has a right to withdraw from its own faulty bid due to non-compliance.

Second, it addresses two circumstances in which this court held that the non-compliance was not substantial: failure to include reference to drawings (and the impact of the contractual order-of-preference provision on that failure), and the failure to provide a corporate resolution authorizing the execution of the bid.  Anyone dealing with circumstances like these may look to this case for assistance.

Third, the decision effectively assumes, or holds albeit in obiter in the final result, that a bidding contractor may withdraw such a bid.  It is, accordingly, an important update on that principle.

This decision does not address the situation that might arise if the contractor purposefully or recklessly puts a material non-compliant term into its bid, to protect itself from a possible mistake in its bid and hoping to negotiate around that non-compliance if it is awarded the contract. Whether a contractor would ever be so reckless as to do so is another matter.  Whether a contractor could rely on that sort of non-compliance will await another day.

Tenders  –  Non-Compliance  –  Withdrawal of Bid

Manitoba Eastern Star Chalet Inc. v. Dominion Construction Co Inc., 2011 MBQB 320.

Thomas G. Heintzman O.C., Q.C.                                                                                  January 25, 2012

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Does A Tender Give Rise To Liability For Negligent Misrepresentation Or Bad Faith?

Can an informal tender process which is not part of a bid depository system give rise to liability for negligent misrepresentation?

Can it give rise to liability for bad faith conduct?

In Oz Optics Limited v. Timbercom, Inc., the Ontario Court of Appeal recently answered Yes to the first question, and after agonizing over the second question, decided not to answer it.

The Background

Timbercom issued a purchase order to Oz for the purchase on consignment of manual optical products.  Those products were part of the equipment to be supplied by Timbercom to Lockheed Martin for installation into fighter aircraft.  Because Oz did not sign the purchase order the Court held that there was not a contract between the parties and dismissed Oz’s claim for payment for manual optical products not used by Timbercom.

Timbercom and Oz also had discussions about the supply by Oz of automated optical products to be similarly supplied by Timbercom to Lockheed Martin.  Timbercom repeatedly told Oz that Oz was the sole supplier and there was no competitive supplier.

Unknown to Oz, Timbercom obtained a competitive bid from another supplier.  Timbercom advised the competitor that its price was higher than another competitor’s price (being Oz), so the competitor reduced its price.  Timbercom gave no such competitive “heads-up” to Oz. Then, when Timbercom submitted the two bids to Lockheed Martin, it marked up Os’s bid by 72% but only marked up the competitor’s bid by 42%.  Lockheed Martin accepted the competitor’s bid, but its employee testified at trial that, had Oz’s bid been the only one, Oz’s bid would have been successful.

The Court of Appeal for Ontario held that Tibercom was liable to Oz for negligent misrepresentation.  The Court agreed with the trial judge that there was a special relationship between the parties concerning the statements made by Timbercom to Oz.  Timbercom’s statement that Oz was the sole supplier was a negligent misrepresentation, if not nearly fraudulent, the Court held.  The evidence established that Oz had relied upon that statement to its detriment, and that if Oz had been aware of a competitive bid, it would have acted differently by changing its delivery schedule which was the only element in its bid that was less advantageous than the competitor’s.

In view of its finding of liability for negligent misrepresentation, the Court of Appeal declined to decide whether Timbercom could be liable under a self-standing duty of good faith.  Such liability could arguably result from an inferred contract based on the whole process.  The Court noted that the process was not a bid depository system and therefore did not necessarily result in the Contract A – Contract B regime recognized by the Supreme Court of Canada in Ontario v. Ron Engineering, [1981] 1 SCR 111 and M.J.B. Enterprises Ltd v. Defense Construction (1951), [1999] 1 SCR 619.  Accordingly, a duty of good faith arising from a Contract A relating to the bidding process itself did not necessarily arise.

The Court of Appeal also noted that, in view of Martel Building Ltd v. Canada, [2000] 2 SCR 860 and similar cases, the pre-contractual negotiations leading to a tender does not create a general duty of care.  However, the Court said that, if a subcontractor is told that it is the sole supplier, then there is arguably a stronger basis to infer a duty of good faith when “the bidder is unknowingly considered a bidder among many.”

Having explored the legal and policy grounds for and against the existence of a duty of good faith in these circumstances, the Court of Appeal declined to decide the issue.  The finding of negligent misrepresentation was, in its view, a sufficient basis to dispose of the appeal.

Moreover, the Court was of the view that the torts of negligent misrepresentation and fraud are available to address misconduct during an informal bidding process.  Only if and when those torts were not sufficient to deal with liability should a court embark upon the difficult task of deciding if a self-standing duty of good faith arises in the circumstances of the particular tender.

This decision addresses one issue arising from informal tenders but leaves a big question mark around the other.  The Court of Appeal has held that, when an owner or contractor engages in a tender process and makes specific statements during the tender process, a special relationship exists between the parties and those statements can lead to liability for negligent misrepresentation or fraud.  So care must be taken about any statement contained in a call for tenders.  The person issuing the tender may try to avoid the special relationship by stating in the tender that there is no such relationship, but it is unlikely that exclusionary language will avoid liability particularly for fraudulent misrepresentations.

Unanswered Questions

The unanswered questions are whether there is any need for a duty of good faith in an informal tender situation, and if there is, what the basis of that duty would be.  The need for a duty of good faith could exist in at least two situations:

First, if the plaintiff’s claim does not result from something stated by the party letting the tender, then the torts of negligent misrepresentation and fraud will not be available.  But if there has been no statement by that party, what other circumstance could properly give rise to a claim by the plaintiff, especially if there is no duty of care during the pre-tender process?

Second, the plaintiff may recover damages on a more favourable basis under contract law than tort law.  If so, the plaintiff may wish to recover damages for breach of an implied contractual duty of good faith and not for negligent misrepresentation.

If there is a need for the duty of good faith, what is its legal foundation?  Does any tender, no matter how informal, result in an inferred contract?  If so what are its terms?  An obligation on the parties to deal with each other in good faith cannot be the only term.  Would the court have to invent all the other terms, such as an obligation of the bidder to leave its bid open for some specified period, and if so what period, or the obligation of the party calling for the bid to accept only a complaint tender, and if so, complaint with what?  The uncertainties surrounding the proposed contract seem daunting.

The specific circumstances of the particular case will determine all these factors.  In one situation, the circumstances may arguably give rise to a special relationship even absent a specific misrepresentation; in another, no such circumstances may exist.  In one situation, the dealings between the parties may be sufficiently clear that a Contract A relating to the bidding process may be inferred; in another case, the uncertainty of those dealings may preclude the existence of a Contract A.

In any event, we have heard the alarm bell, but not heard the last word, on the duty of good faith in informal tenders.

Construction Law  –  Tenders   –  Negligent Misrepresentation  –  Duty of Good Faith

Oz Optics Limited v. Timbercom, Inc., 2011 ONCA 714

Thomas G. Heintzman O.C., Q.C.                                                                                              December 28, 2011

www.heintzmanadr.com
www.constructionlawcanada.com

Does The Removal Of Equipment Amount To An Improvement For Lien Purposes?

Update:  The decision of the BC Supreme Court in West Fraser Mills Ltd. v. BKB Construction Inc., referred to in this article has since been reversed by the BC Court of Appeal.  Please see my blog of April 7, 2012.  The decision of the BC Supreme Court may still be relevant if and when that court finally considers whether demolition amounts to an “improvement” under the BC Builders Lien Act.

An important issue for construction and builders liens is whether destroying or removing land, structure and equipment qualifies as an “improvement.”  Why shouldn’t it, if it benefits the owner?  After all, the land itself couldn’t care less.  It is the benefit to the owner of the land that an “improvement” is all about.

In West Fraser Mills Ltd. v. BKB Construction Inc., the British Columbia Supreme Court recently applied the traditional approach to this issue and held that the removal of equipment was not an improvement and did not give rise to a builders lien.  This decision is noteworthy in itself, but it also raises the question of whether the result would be different under a recent amendment to Ontario Construction Lien Act which specifically deals with the installation of equipment.

The Background

West Fraser shut down its paper mill in Kitimat, B.C.   It then sold the paper machinery separately from the land.  It did so, as the court found, in order to enhance the total proceeds that it received from the land and machinery although the removal of machinery lowered the value of the land.

Under the agreement by which West Fraser sold the machinery, the buyer was obliged to remove the equipment.  The buyer hired BKB to remove the machinery and BKB hired a subcontractor to assist it in the removal.  BKB and its subcontractor were not paid in full by the buyer and filed a builders’ lien against West Fraser’s property.

The B.C. Supreme Court found that West Fraser was an “owner” under the B.C. Builders Lien Act since West Fraser held an estate or interest in the land and, through its sales contract with the buyer, had knowledge of and had given its consent to the work of removing the machinery.  In addition, the removal of the machinery directly benefitted West Fraser by enabling the sale of the machinery to occur on terms advantageous to it.

The Court also held that BKB and its subcontractor were both “subcontractors” under the Act. It said that:

“The Act does not require a direct contractual relationship between the respondents and West Fraser for liens to arise.  Additionally, it does not require contractual relationships between BKB or [its subcontractor] and any person engaged directly by West Fraser.”

However, the Court held that the removal of the machinery was not an improvement of the land.  Demolition work may be an improvement, it said, if undertaken as part of a project to create an altered structure, but work to preserve the value of removed or salvaged material which does not benefit the landowner qua landowner is not an improvement within the Act.

The Court held that the removal of the machinery fell into the latter category.  The land or buildings were not improved by the removal of the machinery nor was the removal incidental to a project to improve the land.

This decision is noteworthy on two accounts.

First, it is surprising that the court found that the value of the land was not improved by the removal of the machinery.  Surely the abandoned paper mill machinery detracted from the value of the land.  Otherwise, why did West Fraser require the buyer to remove it, and to do so at the buyer’s cost?  If the lien claimant proved that the market value of the land was increased by the removal of the machinery, would the result have been the same?

Second, would the result have been different under other provincial lien Acts?  Thus, the Ontario Construction Lien Act was amended in 2010 to broaden the definition of “improvement” to include “the installation of industrial, mechanical, electrical or other equipment on the land.”  Under the Ontario Act, the definition of “improvement” already included  the demolition or removal of any building, structure or works on the land.  The 2010 amendment was apparently intended to reverse the 2007 decision in Kennedy Electric Ltd. v. Rumble Automation Inc. (which, interestingly was not cited in the West Fraser decision).  In Kennedy Electric, the Ontario Court of Appeal held that the installation of large assembly-line equipment for the manufacture of truck frames was not an “improvement.”

By logic, the amendment to the Ontario Act should apply to the removal as much as the installation of equipment, but does it?  Is the equipment “building, structure and works on the land”?  It could be argued that it is not, because if it is, then there was no need to amend the Act in 2010, since the words “building, structure and works on the land” were already in the Act, and it was amended for the very reason that those words did not include “equipment.”  The part of the definition of “improvement” which refers to demotion or removal was not also amended to refer to “equipment”.

If the argument (that the installation of the equipment is within the Act but the removal is not) was successful, it would be unfortunate because the legislative purpose behind including the equipment seems so obviously applicable to the removal.  But making legislative intent clear is a challenge.

Construction Law  –  Construction Liens  –   Removal of Equipment:

West Fraser Mills Ltd. v. BKB Construction Inc. 2011 BCSC 1460

Thomas G. Heintzman O.C., Q.C.                                                                      December 4, 2011

www.heintzmanadr.com
www.constructionlawcanada.com