Remember Rainy Sky: The Commercially Sensible Interpretation Prevails

Every once in a while, an important decision comes along which should be put in your hip pocket so that it can be pulled out when needed.  Rainy Sky S.A. v. Kookmin Bank is such a decision.  In this decision, the U.K. Supreme Court (formerly the House of Lords) recently held that if there is a choice between interpretations of an agreement, the commercially sensible one should be adopted.

That principle may not be rocket science, but it is crucially important for two reasons.

First, the Supreme Court held this principle applies even if another interpretation is arguable.  The more commercially sensible interpretation will be selected whenever there is a contest over the meaning of a contract.

Second, this approach may make it more important to lay the groundwork for a sensible interpretation in the evidence.

Rainy Sky is an easy case to remember:  whenever the sky looks gloomy in a dispute, think of Rainy Sky!  It concerned a bond given by the Koomin Bank in relation to a shipbuilding construction contract.  The bond was given to protect the buyer in the event of the builder’s/seller’s default under the contract and obliged Koomin to pay “all such sums due to you under the Contract, between the buyer and the seller.”

The question was:   what “such sums” did the bond cover?  Did it cover only events such as the rejection by the buyer of the vessel, the cancellation or rescission of the contract by the buyer or the total loss of the vessel, all of which were specifically mentioned in the bond as events obliging the seller to repay the buyer?  Or did the bond also cover the insolvency of the seller?

In fact, the seller went bankrupt and failed to refund the advances paid by the buyer to the seller, and that event triggered Rainy Sky’s claim on the bond.  Rainy Sky asserted that the return of the advances was included as an obligation of Koomin under the bond.  Koomin asserted that the bond did not cover the seller’s insolvency, and that it covered only the specifically mentioned obligations of repayment contained in the construction contract.

The trial judge held that the bond covered the insolvency of the seller.  The Court of Appeal held that it did not, and that only the events of repayment specifically mentioned in the bond were covered by it. The UK Supreme Court restored the trial judgment.

The Supreme Court’s decision is a ringing endorsement of the reliability of commercial common sense as a touchstone to contract interpretation.  The Court adopted the following statement by the dissenting judge in the Court of Appeal:

“As the [trial] judge said, insolvency of the Builder was the situation for which the security of an advance payment bond was most likely to be needed….It defies commercial common sense to think that this, among all other such obligations, was the only one which the parties intended should not be secured.  Had the parties intended this surprising result I would have expected the contracts and the bonds to have spelt this out clearly but they do not do so.”

The Supreme Court re-iterated the principle stated by Lord Justice Hoffman in another case to the effect that “if the language is capable of more than one construction, it is not necessary to conclude that a particular construction would produce an absurd or irrational result before having regard to the commercial purpose of the agreement.”

The Court also referred to a previous decision of Lord Justice Longmore to the effect that “if a clause is capable of two meanings, it is quite possible that neither meaning will flout common sense, but that, in such a case, it is much more appropriate to adopt the more, rather than the less, commercial construction.”

The Supreme Court ended its judgment with the following statement:

“..the omission of the obligation to make such re-payment from the Bonds would flout common sense but it is not necessary to go so far…..of the two arguable constructions of paragraph (3) of the Bonds, the Buyers’ construction is to be preferred because it is consistent with the commercial purpose of the Bonds in a way in which the Bank’s construction is not.”

The court did not limit this principle to contracts in the nature of bonds and indemnities.  Rather, its pronouncement was clearly intended to relate to the general interpretation of contracts.  As such, it is of the highest persuasive authority in all common law countries.

The face of the judgment does not indicate that there was any expert or other evidence demonstrating the commercial common sense that the Supreme Court adopted.  So that sense of commercial reasonableness had to be derived from other sources.

In the Rainy Sky case, a primary source was the commercial skill and experience of the U.K. Supreme Court.  A court with that experience can make that judgment which other courts, even of high authority, may not be able to make if composed of judges who have not had extensive commercial experience.

If a judge or court does not have commercial experience, then that experience may have to be provided by expert or other testimony.  That circumstance may result in an unfortunate dispute between expert witnesses about what is “commercially sensible”.  That is a dispute which the Court of Appeal may have felt was undesirable.  The Court of Appeal also seemed unwilling to be the judge of what result amounted to commercial common sense when sophisticated parties had not themselves expressly stated that result in their contract.

In any event, we now have a judgment that we can rely upon for a crucial principle:  the commercially sensible interpretation of a contract prevails, even if another interpretation is arguable.

Construction Law  –  Interpretation of Building Contracts  –  Bonds:

Rainy Sky S.A. v. Kookmin Bank, [2011] UKSC 50

Thomas G. Heintzman O.C., Q.C.                                                                                                            December 3, 2011

www.heintzmanadr.com
www.constructionlawcanada.com

When and How is a Subcontractor Bound by its Tender in a Bid Depository System?

The process by which subcontractors’ tenders are accepted in a bid depository is fundamental to the efficacy of that system.  If that process does not effectively bind the subcontractors, then the subcontractors will be able to unilaterally withdraw their bids later.  The British Columbia Supreme Court addressed this issue in its recent decision in Civil Construction Co Ltd v. Advance Steel Structure Inc.

This case required the court to unscramble the “Contract A – Contract B” legal structure created by the Supreme Court of Canada in Ontario v. Ron Engineering & Construction (Eastern) Ltd, [1981] 1 SCR 111 and apply it to the relationship between a contractor and subcontractor.  In Ron Engineering, a distinctly Canadian legal structure was created for contracts between the owner and the contractor in a bid depository system.  Under that structure, there are two contracts which are potentially formed in such a bidding system. The first contract, Contract A, is the contract formed by the submission of a bid. That contract is a judge-made creation arising from the wording of a bid depository system. It is based upon and regulates the bid system itself and requires the bidding contractor to leave its price in place for the duration of the bid and requires the owner to award the contract only to a compliant bidder. The second contract, Contract B, is the ultimate construction contract which may be entered into if the bidder is successful.

That process is workable at the owner-contractor level but becomes more difficult to apply at the contractor-subcontractor level.  Nevertheless, in Naylor Group Inc. v. Ellis-Don Construction Ltd, [2001] 2 SCR 943, the Supreme Court held that the same structure applies to the relationship between a contractor and subcontractor when the subcontractor files a bid in a bid depository system and the contractor carries that bid in its bid to the owner.

What Binds a Subcontractor to a Bid?

In Naylor v. Ellis-Don, it was the contractor, Ellis-Don, which refused to award the subcontract to the subcontractor, Naylor, whose bid it carried in its bid to the owner.  So the dispute dealt with whether the contractor was in breach of its obligations, not whether the subcontractor was.  The Supreme Court held that, by carrying the subcontractor’s bid in its own bid, a Contract A was created between the parties which “required the successful prime contractor to subcontract to the firms carried in the absence of a reasonable objection.”  (My emphasis added).

In the Ontario Court of Appeal, the result was stated somewhat differently.  There the Court of Appeal said: “Thus, unless the successful prime contractor has a reasonable objection to the subcontractor it has proposed, the prime contractor must communicate its acceptance of the subcontractor’s bid.” (Again, my emphasis added, for comparison purposes).

In Civil Construction v. Advanced Steel, it was the subcontractor that refused to adhere to its bid.  And it said that its bid had not been accepted by the contractor.  In these uncharted waters, what is the right result under the Ron Engineering structure, or is the structure being bent so out of shape that it cannot apply?  What event binds the subcontractor to its bid, a communicated acceptance or the filing of the contractor’s bid?

Civil Construction was a bidder as the general contractor in a tender by the City of Richmond, British Columbia for the construction of a drainage pump station upgrade.  Advanced submitted an unsolicited bid dated June 10, 2009 to Civil Construction for the structural steel subcontract work.  In its bid, Advanced stated that its bid was “valid for acceptance for the next 30 days and valid for delivery within 90 days after acceptance”.  Civil incorporated Advanced’s bid into its own bid dated June 10, 2009 to the City of Richmond.

On July 10, 2009, Civil was advised by the City that it was the successful bidder.  Civil’s project manager testified that, on that same day, he called each of the subcontractors, including Advanced, to advise them that they were named as sub trades in its tender submission.  On July 13, 2009, the City wrote to Civil to formally award the general contract on the project to Civil, and Civil wrote to Advanced on the same day to award it the structural steel subcontract.

Advanced refused to enter into the subcontract for two reasons:

First, it said that Civil’s acceptance on July 13, 2009 of Advanced’s bid of June 10, 2009 was outside the 30 days stipulated in that bid.

Second, it said that Civil’s acceptance of its bid contained conditions not set forth in its bid, and therefore amounted to a counter-offer, which Advanced refused to accept.

Civil proceeded to hire another structural steel subcontractor and sued Advanced for the extra cost of that subcontract.

The Court rejected both of Advanced’s arguments

First, it held that the relevant acceptance by Civil of Advanced’s bid occurred on June 10, 2009. That acceptance occurred by reason of Civil including Advanced’s bid in Civil’s own bid to the owner.  By doing so, Civil created the Contract A with Advanced under the bid depository system.

Under that system, the B.C. Court held that Advanced’s bid was accepted by Civil under Contract A once that bid was submitted by Civil as part of its bid to the owner.  Relying on previous decisions in the Supreme Court of Canada and Alberta, the Court held as follows:

“[C]ontract A is formed when a subcontractor tenders in response to a general contractor’s invitation and the general contractor incorporates that bid as part of its tender to the owner. Under contract A a subcontractor may not withdraw its tender for a set period and must enter contract B upon acceptance of its bid, which is when the general contractor’s bid with the subcontractor’s tender included is accepted by the owner.

The general contractor’s obligation to a subcontractor under contract A arises once the general contractor chooses to carry the subcontractor’s bid in its tender to the owner.

In return for the subcontractor being bound by its bid, the general contractor, upon acceptance of its bid, which includes the subcontractor’s bid, is obliged to enter into a construction subcontract B with the subcontractor.”

The Court accordingly held that, since Civil had included Advanced’s bid in its own bid on June 10, 2009, the relevant acceptance had occurred within the 30 days set forth in Advanced’s bid.  In effect, the Court interpreted the words “valid for acceptance” in Advances’ bid as meaning “valid for acceptance for Contract A, not Contract B”.  The Court did not refer to any communication of that acceptance by Civil to Advanced, or any necessity for such a communication.

Second the Court also held that Civil’s purported addition of further work in the subcontract was not permissible under the Contract A system.  Therefore, Civil and Advanced were bound to enter into a Contract B that conformed to the bid, and the additional work specified by Civil was ineffective and Advanced was bound by a subcontract which did not include that additional work.  Accordingly, Advanced was liable in damages to Civil based upon that subcontact.

Two Disquieting Features:

While this decision is the common sense result of a bid depository system, it does have two disquieting features.

First, when the contractor includes the subcontractor’s bid in its tender to the owner, should the contractor be obliged to tell the subcontractor, at that time, that the latter’s bid is included in the contractor’s tender?

Normally, an acceptance only occurs when the acceptance is communicated to the offeror.  There could be many subcontractors who tender for the work.  If there is no communication from the contractor to the subcontractor when the contractor submits its bid, should the subcontractor be presumed to know that its bid is the one which has been accepted for inclusion in the general contractor’s bid?

As noted above, in Naylor v. Ellis-Don, the Ontario Court of Appeal said that the contractor “must communicate its acceptance of the subcontractor’s bid” to the subcontractor.  But what if it doesn’t?  Does that let the subcontractor off the hook?  And while the Supreme Court said in that case that Contract A “required the successful contractor to subcontract to the firm carried”, is the subcontractor similarly bound to proceed with the subcontract in the absence of an express and timely acceptance by the contractor?

The courts can, of course, create exceptions to the normal rule that an acceptance occurs when it is communicated to the offeror.  Those exceptions are based upon business efficacy and the presumed intent of the parties.  One such exception is the old rule that a posted acceptance is deemed to occur at the time of posting, not the time of receipt.

The Court Constructed a New Exception for Subcontractors

It appears that in the present case, the court constructed a new exception for subcontractors’ bids in the bid depository system.  According to this decision, the acceptance of a subcontractor’s bid for purposes of Contract A occurs when the contractor includes the subcontractor’s bid in its own bid, even though that is not communicated to the subcontractor.  The real question is whether that is a good rule, and if it is, whether the rule should be specifically set forth in the bid documents. Otherwise, it could be argued that the contractor should be required to notify the specific subcontractor whose bid has been included in the contractor’s bid to the owner, so that the subcontractor knows that its bid has been accepted for the purpose of Contract A.

For the moment, and based on this decision, contractors and subcontractors may proceed on the basis that if a subcontractor states a time for acceptance in its bid, then that statement will be taken to mean the time in which the contractor has to insert that bid into its own bid to the owner, that there is no need for the contractor to advise the subcontractor that that has occurred, and that it is up to the subcontractor to inquire, if it wishes to know, whether its bid has been included in the contractor’s bid.

Warning to Contractors:

The other question which is raised by this decision is whether a subcontractor can avoid this result by a more specific tender. Can the subcontractor specifically state in its bid that its offer of a construction contract (ie:  Contract B) must be accepted within a specific period of time, and a time period shorter than the contractor’s bid period?  In other words, could the subcontractor specifically state that its bid could only result in a construction contract if that construction contract is entered into within a specific period of time which is less than the bidding process allows?

The short answer is that such a bid is non-compliant with the bid depository system and Contract A under the Ron Engineering structure.  This answer follows from the requirement in Contract A that the subcontractor keep its bid open during the bid period and enter into Contract B on the terms set forth in the bid, that is, up to the time the contract is awarded and a reasonable time thereafter.  But if this is the right answer then contractors will have to be alert to ensure that any subcontractors’ bids they receive do not have such a short fuse in them, and if they do, to disqualify them from the bidding process.

Advanced may have intended to raise this question in the present case.  But the court did not answer the question by holding that Advanced’s bid was non-compliant with the terms of the bid.  Rather, it interpreted the word “valid for acceptance” in Advance’s bid to mean “valid for acceptance under Contract A”, and it arrived at that conclusion by reference to the bid depository system and Ron Engineering.  It will require a more specifically drafted subcontractor’s tender to raise the “non-compliant acceptance period” issue.

Construction Law – Subcontractors – Bid Depository System

Civil Construction Co Ltd v. Advance Steel Structure Inc., 2011 BCSC 1341

Thomas G. Heintzman O.C., Q.C.
November 13, 2011

www.heintzmanadr.com
www.constructionlawcanada.com

Restitutionary Payment May Be Ordered For An “Ineffective” Construction Contract

Owners and contractors should always avoid undertaking a project without a contract.  But if they do build the project without a contract, the British Columbia Court of Appeal has recently recognized in Infinity Steel Inc. v. B & C Steel Erectors Inc. that the party which received the benefit of the work or supplies must pay a fair amount to the party which provided them.

This may not be a novel proposition.  But what is novel is that the courts now recognize this situation as an “ineffective transaction” which falls within a discrete category of unjust enrichment.

Background Information:

Infinity made a tender bid to the general contactor, Bird Construction, for the supply and erection of the structural steel for the Search and Rescue Hanger at the Canadian Forces Base in Comox, British Columbia.  Infinity entered into discussions with B & C for that company to erect the steel.  The companies exchanged written documents which they thought constituted the contract, but each of them had a different view of the price and other elements of the contract. When the job was over 90% finished, Infinity terminated its relationship with B & C and had another erector finish the work.  Litigation ensued and it was Infinity’s position that, in determining the fair amount to be paid to B & C, the amount which it paid the replacement erector had to be taken into account.

The trial judge found that the parties had not agreed on the fundamental elements of the contract.  Accordingly, he was unable to order a contractual remedy, either by way of damages for breach of contract if a price for the contract had been agreed upon, or by way of contractual quantum meruit if no price had been agreed upon.  The judge held that a remedy in restitution was available in these circumstances and awarded compensation to B & C.  Infinity appealed arguing that the trial judge had not taken into consideration the amount that it had paid to complete the erection after B & C was no longer on the job.

There are two interesting aspects of the decision of the B.C. Court of Appeal which largely upheld the trial judge’s decision.

First, the Court of Appeal held that this situation constituted an “ineffective transaction” which, under a recent decision of the Supreme Court of Canada, was a distinct ground for restitutionary compensation.  It said: “[I]t is now firmly established that a claim alleging unjust retention of a benefit conferred in an ineffective transaction is a discrete category of the doctrine of unjust enrichment, which may attract a personal monetary remedy (Kerr v. Baranow, 2011 SCC 10 (CanLII), 2011 SCC 10 at para. 31) and that remedy must match, as best it can, the extent of the enrichment unjustly retained by the defendant (at para. 73)”.

Kerr v. Baranow was a family law case, not a construction law case.  That case was not about an ineffective contract and the statement at para 31 in the Supreme Court’s judgment had nothing to do with the merits of that case. The Supreme Court simply said, in a part of a sentence dealing generally with the circumstances in which a remedy in unjust enrichment may be ordered, that such a remedy could be awarded in a case of an “ineffective contract”.

Moreover, it is not clear from the decision in Kerr v. Baranow what amounts to an “ineffective transaction.”  One might have thought that the Supreme Court was thinking of dealings which are otherwise contracts but ineffective as contracts for legal reasons, such as the Statute of Frauds or lack of consideration.  When the parties simply fail to negotiate a contract, as happened in Infinity Steel v. B & C Steel Erectors, is this an “ineffective” transaction?  The B.C. Court of Appeal has held that it is.

While this result may come out of left field so far as construction law is concerned, it is a good one for that branch of the law.  It recognizes that an “ineffective transaction” constitutes a comprehensive classification to which the principles of unjust enrichment may be applied.  It should not matter whether the contract failed for legal or factual reasons.  If one party received a benefit, then the other party should pay for it.  Once the benefit is accepted, then the only question is the amount that the benefitted party should pay, and if the parties cannot agree on the amount, then the court will have to fix it.   For those propositions, we can now refer to this decision as authority.

The second interesting aspect of the Court of Appeal’s decision is its completely open-ended approach to assessing the appropriate compensation.  Again, taking a leaf from the decision in Kerr v. Baranow, the Court rejected any formulistic approach. The Court held that, once a trial judge rejects a contractual remedy and finds unjust enrichment, the trial judge’s task is “to determine what measure is appropriate to remedy the unjust enrichment in all the circumstances of the case. ….. in the light of Kerr, the appropriate measure for restitutionary quantum meruit is to be selected to meet the circumstances of the particular case.  Important factors will include but not be limited to, the course of dealings between the parties, any estimates obtained, the costs incurred, the scope of work, the actual work done, the market value of the services provided.”

These are sweeping considerations which will give the Court an unfettered power to award the amount of compensation that is fair in all the circumstances.

So far as the amount to which B & C was entitled for the work it had done, the Court of Appeal held that the trial judge had taken into account the cost of completion by the replacement contractor, and apart from a slight adjustment it upheld the award of the trial judge.

In the result, this decision of the British Columbia Court of Appeal provides a comprehensive basis for a court in Canada to assess equitable compensation if a construction contract is ineffective for any reason.

Construction law   –  Restitution   –   Quantum Meruit  –   Ineffective Transaction: 

Infinity Steel Inc. v. B & C Steel Erectors Inc., 2011 BCCA 215

Thomas G. Heintzman O.C., Q.C.                                                                                                   October 30, 2011

www.constructionlawcanada.com
www.heintzmanadr.com

A Contractor’s Construction Errors May Be Covered By A General Liability Policy

In two recent decisions, courts in Ontario and British Columbia have held that negligence during construction (or manufacturing) may be covered by general liability policies even though the damage is part of the construction (or the product sold):
California Kitchens & Bath Ltd. v. AXA Canada Inc. and Bulldog Bag Ltd. v. AXA Pacific Insurance Company

In these decisions, the courts have followed and applied the landmark decision of the Supreme Court of Canada in Progressive Homes Ltd. v Lombard General Insurance Company of Canada, [2010] 2 S.C.R. 245.  The Progressive Homes decision was discussed in my blog of January 16, 2011.

In Progressive Homes, the Supreme Court of Canada rejected the long-standing position of insurers that the claims by owners arising from the negligence in construction by contractors may not be covered by CGL insurance.

The insurance industry asserted that general liability insurance is not designed to be a performance bond and that if contractors wished to be insured against claims by owners for their own negligence during construction, then that would convert the insurance into a performance bond.

‘Plain Meaning’ In a CGL Policy Defined by Supreme Court

The Supreme Court looked at the plain meaning of the words in a CGL policy and held that, as long as the damages arose from an accident or other non-intended event, then the plain meaning of the policy applied, whether or not the damages arose from the contractor’s negligence and even though the damage was to part of the building constructed by the contractor.  The Supreme Court held that the insured was arguably covered by the policy, and therefore, Lombard had a duty to defend the contractor.

These principles have now been applied by the Ontario Superior Court in California Kitchens with respect to the duty to defend, and by the British Columbia Court of Appeal in Bulldog Bag with respect to the duty to indemnify.  In both cases, the courts were dealing with general liability policies issued by the AXA group of insurers.

In California Kitchens, the contractor was sued by a homeowner in respect of the mis-design and installation by the contractor of a kitchen in the plaintiff’s home.  The contractor asserted that AXA was obliged to defend it under a general liability policy.  The policy provided insurance for bodily injury and property damage.  ‘Occurrence” was defined to mean an “accident”.  The policy contained exclusions for the Named Insured’s work and for loss incurred by the Named Insured for the repair, replacement etc. of the Named Insured’s work because of known or suspected defects or deficiencies.

AXA argued that the policy did not include the defective design of the kitchen by the contractor, or otherwise the policy would become a performance bond.  This was the standard argument of CGL insurers before the Lombard decision.

The court held that the plaintiff’s claim for loss of use of the plaintiff’s home while the kitchen was being repaired was property damage under the policy.  The court rejected AXA’s argument that the claim was really a contract claim and was therefore not covered by the policy.

The Court said:

“If this argument prevailed, it would eliminate virtually all coverage.  What work is not performed pursuant to a contract?  It is the negligence in the performance of the work by California Kitchens that is the true nature of the claim.  There is no claim in contract in the pleading and no basis for questioning the true nature of the claim.”

The court also held that the “Named Insured’s work” exclusion did not apply because the claim asserted that the deficient work was performed by sub-contractors, not the Named Insured, the contractor.

In Bulldog Bag, Bulldog Bag sold bags to its customer Sure-Gro.  Sure-Gro used the bags to supply bagged soil to Canadian Tire.  The bags were printed by a printer for Bulldog.  Because of the defective printing, the printing became illegible.  Bulldog Bag compensated Sur-Gro for the cost of retrieving and re-bagging the soil being sold to Canadian Tire, and made a claim on its CGL policy for this loss.  Bulldog Bag did not make a claim for the cost of replacing its own bags.

The policy defined “Occurrence” as meaning “… property damage neither expected nor intended by the Insured”, which is a similar definition to “accidental” in the California Kitchens case.

The exclusions included property damage to “goods or products manufactured or sold by the Insured”; or “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”:   or loss of use of property that had not been physically injured or destroyed resulting from “a delay in or lack of performance by or on behalf of the Insured of any contract or agreement.”

The reasoning in the Progressive Homes case

The B.C. Court of Appeal applied the reasoning in Progressive Homes and held that there was coverage for Bulldog Bag’s claim and that the exclusions did not apply.  The court started with AXA’s concession that Bulldog Bag’s claim arose from “property damage” because Bulldog’s bags had been ‘injured’ by the faulty printing and Sure-Gro lost the use of them.  AXA also conceded that the faulty workmanship that resulted in the defective bags qualified as an “accident” or “occurrence” within the meaning of the policy.

However, AXA asserted that the costs of removing the soil from the defective packaging and disposing of that packaging fell within the exclusions in the policy.  It further asserted that the decision in Progressive Homes had not altered the basic nature of CGL policies, which did not include the costs arising from repairing or replacing the insured’s defective work and products.

The Appeal Court’s Decision

The Court of Appeal rejected AXA’s submissions. The Court held that the exceptions in the policy barred a claim for damage to Bulldog Bag’s own bags.  (In light of the California Kitchen case, one may question this conclusion since the damage was caused by Bulldog Bag’s sub-contractor, the printer, and not by Bulldog Bag itself).  However, the court held that the exclusions  did not bar a claim for compensation for the costs which Sure-Gro incurred in separating those bags from its products, repackaging the product in different bags, and salvaging the “old” product some months later.

The Court further held that, in any event, and even before Progressive Homes, the “own product” exclusion did not apply to loss incurred by the insured’s customer as a result of defects in the insured’s own product.  In addition, the Court held that the “own work and product” exception in this policy did not apply to resulting damage, but only to property damage to the goods supplied by the insured.

Progressive Homes Has Had a Profound Impact on General Liability Policies

These two decisions are the first evidence of the profound impact on general liability policies of the Progressive Homes decision of the Supreme Court of Canada.  The Supreme court’s decision has meant that the initial coverage of those policies will be read broadly, and may  possibly include damage from one part of a building or product to another, and damage arising from the insured’s fault.  As the decision in California Kitchens shows, those possibilities are very significant, and almost determinative, when it comes to the duty to defend since all the insured must show is the possibility that the claim falls within the policy.

The impact of the decision in Progressive Homes on the coverage for indemnity may be even more significant, as the Bullfrog Bag decision demonstrates.  By widening the potential interpretation of coverage, and narrowing the potential interpretation of the exceptions, the burden on the insurer is substantially increased.  As the drafter of the policy, the insurer will face the contra proferentem rule so far as initial coverage is concerned.  And if it relies on the exceptions, then the rule that exceptions must be narrowly construed will apply.

Once the Supreme Court held that CGL policies could apply to a contractor’s own negligence and could apply to damage from one part of a building or product to another, the whole ambit of a CGL policy was substantially clarified to the benefit of the insured.

Insurance policy – Contracts – Duty to Defend – Duty to Indemnify – Construction Law

California Kitchens & Bath Ltd. v. AXA Canada Inc., 2010 ONSC 6125;
Bulldog Bag Ltd. v. AXA Pacific Insurance Company, 2011 BCCA 178

Thomas G. Heintzman O.C., Q.C.                                                                                              October 6, 2011

www.heintzmanadr.com
www.constructionlawcanada.com

When Does The Negotiation End And The Limitation Period Begin For An Arbitration Claim?

Construction Law – Arbitration – Negotiations – Limitation Periods – Contract

An arbitration clause in a construction contract may be written in a way that encourages the parties to settle their differences by negotiation and agreement. But if the parties attempt to do so and fail, can one of the parties then say to the other: “Gotcha! The limitation period for your claim has now passed!” That is the issue which the Ontario Court of Appeal recently addressed in L-3 Communication Spar Aerospace Limited v. CAE Inc.

SPAR was awarded a contract to develop a hardware and software system. SPAR subcontracted some of the deliverables to CAE. SPAR was required to deliver data about those deliverables to CAE within a certain timetable. The subcontract said that if the data was not delivered within 90 days of that timetable “and the parties cannot agree to a price adjustment due to the delay….beyond the 90 days”, then CAE was relieved of its obligations under the subcontract “only to the extent that performance is not possible as a direct result of Spar to provide that information”. The subcontract then stated: “The price and other adjustments that are not agreed between the parties may be referred to arbitration” under the arbitration clause in the contract.

SPAR provided certain data to CAE, but CAE took the position that it was inadequate, and that SPAR should obtain further data from the vendors of the relevant software to SPAR. Spar refused to do so, and its refusal to do so was clear by November 2005. CAE proceeded to obtain the data from SPAR’s vendors. CAE’s evidence was that it had discussions with SPAR about settling the question of who would pay for the cost of obtaining that data.

When the cost and price issue was not settled by December 2008, CAE demanded payment for the cost of obtaining the data from SPAR’s suppliers. SPAR responded by stating that CAE’s demand was premature and that CAE was required to proceed by way of the arbitration. When CAE then delivered a Request to Arbitrate in January 2009, SPAR took the position that CAE’s arbitration claim was barred by the two year limitation period in Ontario. SPAR said that the limitation period commenced in November 2005 when SPAR unequivocally said that it would not obtain the data. SPAR commenced a court application for a declaration to that effect.

The Ontario Superior Court dismissed SPAR’s application and its decision was upheld by the Ontario Court of Appeal.

The Superior Court held that, under the wording of the subcontract, the right to arbitrate arose and the limitation period for CAE’s claim commenced, not from the date that SPAR said that it would not obtain the data, but from the date that the parties had failed to agree on a proper price adjustment. The Court held that that date was not until at least the fall of 2007, and accordingly the arbitration claim was commenced in time. The Court did not agree with CAE that the limitation period did not commence until CAE had full knowledge of the full costs of obtaining the data. But it did agree that the entitlement to arbitrate and the limitation period did not commence until “SPAR indicated its intentions to avoid any and all financial responsibility for the increased costs associated with procuring the data”.

The Court of Appeal agreed. It held that the commercially reasonable interpretation of the subcontract was that “a dispute over failure by SPAR to deliver information as required together with the cost consequences caused thereby is one that the parties were obliged to attempt to resolve between themselves. Failing agreement either party is entitled to take the dispute to arbitration.” Only then did the right to arbitrate arise and the limitation period commence running.

The Superior Court also found that, by its conduct, SPAR was estopped from asserting that the limitation period was running from November 2005. In light of its decision on the primary matter, the Ontario Court of Appeal did not deal with this issue.

Two comments can be made about this decision:

First, it is a welcome recognition of the duty to negotiate where such a duty is contained in the contract. Had the courts held that the limitation period started running from the time SPAR refused to obtain the data, the obligation to negotiate the price and costs dispute would have been effectively removed from the contract. When parties include an obligation to seek an agreement over those sorts of matters, then full recognition and effect should be given to that obligation. The only way to do so is to hold that the limitation period does not commence until that process is complete. That causes no hardship on either party, since either party can at any time state that negotiations are over and refuse to negotiate further.

Second, this decision is a reminder that it is the exception. It is the exception because most construction contracts do not contain an express duty to negotiate and attempt to agree on costs or other matters in dispute under the contract. Accordingly, in most instances it is dangerous for a party to continue to negotiate when, based upon the date of the other party’s alleged wrongful conduct or its discovery, a limitation period is looming. In most cases, the limitation period will have started to run and the party with the claim must protect its litigation rights, and then negotiate.

So there are two lessons to be learned:

First, when you are negotiating the contract and want to provide for an obligation to negotiate, expressly state that obligation in the contract and expressly state that any limitation period will only commence once the negotiations are complete.

Second, if you are in the midst of a contractual dispute and a limitation period is looming based on the date of the wrongful conduct or its discovery, then initiate the arbitration claim and negotiate later, unless you are very certain that the contract provides that the limitation period is not running in the meantime.

Construction Law  – Arbitration – Negotiations – Limitation Periods:

L-3 Communication Spar Aerospace Limited v. CAE Inc., 2010 ONSC 7133; 2011 ONCA 435 (CanLII)

Thomas G. Heintzman, O.C.,  Q.C.                                                                                           July 17, 2011
www.constructionlawcanada.com

The Duty To Defend: What Are The Indemnity Obligations In Construction Contracts?

Construction Law –  Insurance – Duty to Defend

A recent Ontario decision regarding the duty to defend against claims may have wide reaching implications for construction law even though the action did not involve a building contract.

In Cadillac Fairview v. Jamesway Construction, 2011, the Ontario Superior Court recently held that an indemnity obligation in a maintenance contract gave rise to a duty to defend the landlord.  This conclusion may apply to indemnity obligations in a building contract.

Jamesway entered into a contract with Cadillac Fairview to shovel the sidewalks and parking lot of a shopping centre owned by Cadillac Fairview, and to keep those premises free of ice and snow.  The contract contained an indemnity by Jamesway in favour of Cadillac Fairview, and an agreement by Jamesway to maintain CGL insurance in which Cadillac Fairview would be an unnamed insured.  Jamesway did take out such a policy.  So far as the reasons of the court disclose, the contract did not contain an agreement by Jamesway to defend Cadillac Fairview from any claim.

When Cadillac Fairview was sued arising from a slip and fall on the ice on the shopping centre, it brought an application against Jamesway and the CGL insurer to require those parties to defend Cadillac Fairview in the slip and fall action.  The Superior Court granted the application against Jamesway.

In arriving at its conclusion, the court referred to a number of cases involving insurers and an insurer’s duty to defend.  Relying on the reasoning in those cases, the court held that Jamesway had a duty to defend Cadillac Fairview.  The court held that the indemnity and the obligation to insure combined to create an obligation to defend.

The court referred to no cases in which an obligation to defend had been ordered against a non-insurer, nor any case in which such an order had been made against a non-insurer when the contract contained no express obligation to defend.  Rather, the court reasoned from the cases against insurers, and then concluded that the indemnity plus the duty to obtain insurance amounted to an agreement to defend.

The court dismissed the application against the CGL insurer, holding that there was no privity of contract between Cadillac Fairview and that insurer.

The implications of this decision for the construction industry are obvious.  Many construction contracts contain indemnities.  For example, Article 12.1 of the standard CCDC 2 Stipulated Price Contract contains indemnities between the owner and the contractor.  However, construction contracts do not usually contain an express obligation on either party to defend the other party in the event of litigation by a third party.  Even in an insurance setting, an obligation to defend will not necessarily be inferred if it is not expressly contained in the insurance contract.  Implying such a duty to defend into a maintenance or construction contract may well exceed the intentions of the parties.

Construction Law- Insurance- Duty to Defend: 

Cadillac Fairview v. Jamesway Construction, 2011 ONSC 2633 (CanLII)  https://bit.ly/kMm9gm

Thomas G. Heintzman O.C.,Q.C.                                                                                                                July 3, 2011

www.constructionlawcanada.com

Pay-When-Paid: When Is The Contractor Not Obliged To Pay The Subcontractor?

Construction Law  –  Building Contract  –  “Pay When Paid”

The Ontario Superior court recently wrestled with the issue of how to interpret and apply a “Pay When Paid” clause in a subcontract.

In 1473662 Ontario Limited v. Avgroup Consulting Services Limited, the Court appears to apply the traditional approach to this clause, but opened a door for subcontractors to avoid its severity.

Avgroup was the general contractor for a hotel construction project. The numbered company (which carried on business as “Dyson Electric”) was the electrical subcontractor.  Avgroup alleged that the parties had contracted pursuant to the CCDC subcontract, and that the contract contained a “Pay When Pay” clause which read:

“The Contractor shall pay the Subcontractor no later than thirty (30) days after the Submission Date or three (3) working days after the Contractor receives payment from the Owner, whichever is the later.”

However, that contract was never signed.  Dyson alleged that the contract was found in the invoices which it had submitted to Avgroup and which Avgroup had accepted as the basis for payment.  Those invoices did not contain a Pay When Paid clause.

The Court appeared to accept that the Pay When Paid clause in the form of CCDC contract relied upon by Avgroup was substantially similar to the clause in the contract which had been considered by the Ontario Court of Appeal in Timbro Developments Ltd. v. Grimsby Diesel Motors Inc (1988) 32 C.L.R. 32 (Ont. C.A.).  The clause in that case stated:  “Payments will be made not more than thirty (30) days after the submission date or ten (10) days after the certification or when we have been paid by the owner, whichever is the later.”

The Court of Appeal in Timbro held that such a clause was not just a payment-timing clause operating during the project, but entirely precluded the sub-contactor from recovering from the contractor in the event that the contractor was not paid by the owner.

The court in the present case evidently felt itself to be bound by the Timbro decision.  But the court held that there was a triable issue relating to whether the contract was in the form of the CCDC subcontract or in the form of the subcontractor’s invoices.  Accordingly, the court dismissed Dyson’s motion for summary judgment.

This decision highlights the need for the Supreme Court of Canada to review the Pay When Paid issue.  There is conflicting authority in Nova Scotia (Arnoldin Construction & Forms Ltd. v. Aslta Surety Co (1995), 19 C.L.R. (2d) 1 (N.S. C.A.)) and leave to appeal that decision was dismissed by the Supreme Court of Ontario.  Moreover, members of the construction industry, and the drafters of the CCDC subcontract, should clarify their intention about the meaning of a Pay When Paid clause.

The fundamental questions are these:  Who should bear the risk of the owner’s insolvency, the contractor or the subcontractor?

Why should the subcontractor, who has no dealings with the owner and no means of managing the risk of the owner’s insolvency, bear that risk rather than the contractor?  A subcontractor may reasonably be expected to bear the risk of the timing of the payments by the contractor during the project, but it is more difficult to understand why the subcontractor should bear the risk of the owner’s insolvency.

The same issue can, of course, arise in a sub-subcontract or a supply contract if that contract contains a Pay When Paid clause.  Here, the risk is the contractor’s insolvency.  Is it reasonable for the sub-subcontractor or supplier to the sub-contractor to bear the risk of the contractor’s insolvency when they have no dealings with the contractor?

These are questions which the courts and the construction industry need to carefully consider.

See Goldsmith and Heintzman, Canadian Building Contracts (4th ed), Chapter 4, part 2).

Construction Law – Building Contract – “Pay-when-Paid”: 

1473662 Ontario Limited v. Avgroup Consulting Services Limited, 2011 ONSC 2900 (CanLII)

Thomas G. Heintzman O.C., Q.C.                                                                               June 26, 2011

www.constructionlawcanada.com

What Is The Role Of Owners and Contractors In The Application Of Trust Funds?

Construction Law – Construction Liens – Trust Fund Provisions

The Ontario Court of Appeal has recently considered some interesting issues relating to the trust fund provisions of the Construction Lien Act of Ontario.  In Colautti Construction Ltd. v. Ashcroft Development Inc, the Court provided some useful guidance about the roles of owners and contractors in the application of trust funds. The Court also held that those provisions cannot be enforced by the owner, but only by the subcontractors or suppliers for whose benefit the provisions were enacted.

Ashcroft was the developer of residential and commercial real estate.  Colautti contracted with Ashcroft to provide services in relation to the construction of basements, municipal services and roads under seven different contracts.  Colautti also provided services for Ashcroft in relation to the projects under certain older contracts.  During the early stages of the projects, each time Ashcroft paid Colautti, it told Colautti which invoices of Colautti it was paying.  But later in the projects, Ashcroft refused to advise which invoices it was paying and for which contacts or projects, even though Colautti made repeated inquiries.  Colautti applied some of the monies it received against the oldest contracts.  Ashcroft later objected to the application of the funds by Colautti, alleging that Colautti had been paid on the seven contracts that it was suing under, if the payments were applied as Ashcroft maintained they should be.

The court held that Colauttii had acted properly in the application of the payments, particularly in the absence of any contemporary advice from Ashcroft about which invoices it was paying. The court applied two principles.

First, a contractor has an obligation to make reasonable inquiries of the debtor, to determine which invoices are being paid by the debtor. The court held that Colautti had fulfilled this obligation.

Second, absent an allocation of a payment by the debtor, the creditor can make the allocation. The court applied the words of the House of Lords in Cory Brothers & Co. v. Owners of the Turkish Steamship “Mecca”, [1897] A.C. 286, at p. 293:

“When a debtor is making a payment to his creditor he may appropriate the money as he pleases, and the creditor must apply it accordingly. If the debtor does not make any appropriation at the time when he makes the payment the right of application devolves on the creditor.”

Accordingly, the court held that Colautti acted reasonably in making the application of the funds it received from Ashcroft, in the absence of advice to the contrary from Ashcroft. The court confirmed that the trust fund obligations of the Act did require Colautti to apply the payments it received to the related projects. But having made reasonable inquiries and receiving no advice from the owner about the matter, Colautti was entitled to make the allocation of the payments to the various contracts relating to the projects, including the older contracts.

The court then dealt with Ashcroft’s claim that Colautti had breached the trust fund provisions of the Act. Ashcroft said that, at each time that Colautti received payments, Colautti had obligations to subcontractors under the seven contracts, and it was obliged to pay those subcontractors at that time. Ashcroft claimed a right to have its payments to Colautti re-allocated to those subcontractors, and particularly the subcontractors on the seven projects in question and not the older projects.

The court held that Ashcroft had no standing to enforce the trust fund provisions in this fashion. The court said that only subcontractors and other parties for whose benefit the trust fund provisions had been enacted could enforce those provisions:

“Simply put, standing to complain of a s. 8 breach of trust is limited to those
“who stand in direct privity with the contractor and who are owed amounts by the contractor”….. The protected class of creditors are those “down the chain” from the trustee of the s. 8(1) trust fund. The Developers, as owners of the Projects, do not come within that class.”

This decision is a welcome clarification of the trust fund provisions.  Those provisions are some of the most important parts of the Construction Lien Act.  They provide very substantial protection for contractors, subcontractors and suppliers. Clearly the Ontario Court of Appeal was concerned that an owner could effectively undermine those provisions or use them for a purpose for which they were not intended. The court was not prepared to allow an owner to refuse to allocate funds paid by it and then complain later about the contractor’s allocation of them. Nor was it prepared to allow the owner to use the trust fund provisions for its benefit in that re-allocation effort.

Construction Law – Construction Liens – Trust Fund Provisions:

Colautti Construction Ltd. v. Ashcroft Development Inc., 2011 ONCA 359 (CanLII)

Thomas G. Heintzman, O.C., Q.C.                                                                                               June 19, 2011
www.constructionlawcanada.com

Can A Condition In An Invitation To Tender Be Illegal?

Construction Law – Tenders – Illegality

Can a condition in an invitation to tender a construction contract be illegal?  This is a question upon which construction law is largely silent.  But the Court of Appeal of Quebec has held that a condition of tender may be unlawful. This is not a recent decision, but it is not well known outside Quebec.  The importance of the issue of illegality makes it a suitable subject for this blog.

In Société de developpement de la Baie James v. Compagnie de construction et de developpement Cris Ltée, the contractors contested standing terms which James Bay Development Society inserted into its invitations to tender.  Those terms (sub-sections 3.1 and 3.3) excluded any bid from a contractor who had commenced proceedings against, or was the defendant in proceedings commenced by, James Bay Development Society.  The Court of Appeal held that this condition was illegal as being contrary to public order.

The Court of Appeal held that Section 3.3 was contrary to the principle of the rule of law.  That principle is now incorporated into the Canadian Charter of Rights and Freedoms.  A principle element of the rule of law is access to the courts. While the law of contract is based upon the liberty to enter into any contract that the parties may agree to, there are limits to that liberty, and one limit, in Quebec, is public order. Any contractual provision which contravenes political public order is an absolute nullity.  While the parties can agree in their contract to waive certain rights, they cannot do so with respect to matters which are oppressive to the extent of being contrary to public order.

In addition, the Court of Appeal noted that sub-section 3.1 of the standing terms permitted the Bay James Development Society to accept, in its discretion, a non-compliant bid.  However, the provincial law governing the tenders stipulated that a non-conforming bid was required to be automatically rejected.  Accordingly, the Court of Appeal held that, on this additional ground, sub-section 3.1 of the standing terms was invalid.

This decision is a reminder of the need to review the terms of any invitation to tender from an overall standpoint, including its legality.  In the case of any governmental body, the Charter of Rights and Freedoms, and other statutes, regulations or bylaws applicable to that body, may be relevant.  Those considerations and the James Bay decision, may not be applicable if the owner issuing the invitation to tender is not a public body.  But there may be other conditions of legality which apply to the tender.

See Goldsmith and Heintzman on Canadian Building Contracts (4th ed.), Chapter 1, Section 2(d).

Construction Law – Tenders – Illegality: 

Société de developpement de la Baie James v. Compangnie de construction et de developpement Cris Ltée, (2001), 16 C.L.R. (3d) 26 (Que. C.A.)

Thomas G. Heintzman                                                                                                                                                 June 5, 2011

www.constructionlaw.com 

Is A Site Visit A Material Condition To A Tender?

Construction Law – Tenders – Site Visit – Materiality

An invitation to tender may contain many conditions, some of which are more or less material to the ultimate submitted tender.  Is a requirement that the contractor attend a site visit a material condition of the tender?  In Admiral Roofing v. School District 57 (Board of Education), the British Columbia Supreme Court said Yes, and held that a missed site visit eliminated the contractor from the bidding process.

The District School Board issued an invitation to tender for re-roofing of two buildings. The invitation contained a term stating that a “mandatory” site visit was being held at 8 am on a certain date, that registration at the site visit was required and that “failure to attend and register will lead to the non-acceptance of the tender by the owner.”

The President of Admiral Roofing arrived 15 minutes late at the first site.  After the representatives of the School District had moved to the second site, he joined the group making the site visit.  He was asked by the School District representatives whether he wished them to go back with him to the first site, and he declined stating that he would visit that site himself later.  He was told later that day that Admiral Roofing’s bid would not be accepted.   Nevertheless, he went back to the first site and then submitted the tender. The School Board did not open that tender.

The contractor and the School Board brought an application to determine whether Admiral Roofing’s tender was non-compliant so that the School District was unable to accept it.  The British Columbia Supreme Court held that it was.

The contractor argued that it substantially complied with the site visit requirement by attending part of the site tour, signing its name and returning later to the first site.  The court held that the word “attend” required the attendance at the two locations and at the mandatory site tour starting at 8 am.  The Court held that the words “failure to attend and register will lead to the non-acceptance of the tender by the owner” made this mandatory requirement sufficiently clear.

The Court also held that this failure by the contractor could not be waived by the owner under the tender condition entitling the owner to waive “irregularities … of a minor or technical nature.”  While arriving late by five minutes might have been technical if the School District’s site team had still been there, there was no discretion to waive the actual first site visit itself.

The Court quoted from another case in which it was held that a defect is material if it “undermines fairness of the competition or the process of tendering …impacts the cost of the bid or the performance of contract B …or creates a risk of action by other (complaint) bidders.”

The Court applied a “restrictive interpretation” to the discretion clause, which approach has been held necessary “in order to respect the mandatory requirements of the instructions to tenderers and to protect the tendering process.”  Applying that approach, the Court held that there was no discretion to accept the bid.

This approach places a very narrow limit on the owner’s discretion to accept non-compliant bids, from two aspects.

First, it treats procedural irregularities in the same way as substantive irregularities.  It may be argued that the procedural necessity to attend a site meeting is of a different order or nature than the actual contents of the bid or timing of its delivery.  The former cannot impact the content of the bid itself or the constructed project.  Nor does a missed site visit appear to unfairly impact other bidders who are required to deliver their bids on time.  A site meeting seems to be very much for the benefit of the bidder, and to the extent that it has any value to the owner, that value would seem to be one that the owner should be entitled to waive.

Second, the Court’s interpretation appears to place an inordinate importance on the threat of a claim by another contractor.  The late attendance at the site meeting does not seem to materially interfere with the other ingredients referred to by the Court:  the fairness of the competition, the process of tendering, the cost of the bid, or the performance of Contract B.   Rather, reading between the lines, the threat of an action by another bidder that makes the “defect” material.  That approach may be inappropriate for two reasons.

First, in this case, the parties apparently made the application to the court immediately, and before the tender were completed.  So the court was in a position to deal with the legality of the bid before claims were made by other contractors.

Second, the threat of litigation should not, by itself, be relevant to the materiality of the defect of default.  Otherwise, the other contractor will always “hold the hammer” and the owner’s discretion to accept a bid with a non-material defect will virtually disappear.

See Goldsmith and Heintzman, Canadian Building Contracts ((4th ed.), Chapter 1, Part 1(f).

Construction Law – Tenders-Site Visit – Materiality:

Admiral Roofing v. School District 57 (Board of Education), 2010 BCSC 1394

Thomas G. Heintzman                                                                                                  May 29, 2011

www.constructionlawcanada.com