Standard Form Contracts Are To Be Reviewed On A Standard Of Correctness: Supreme Court Of Canada

In, Ledcor Construction Ltd. v. Northbridge Indemnity Insurance Co, 2016 SCC 37, the Supreme Court of Canada has held that the interpretation of a standard form contract is a matter of law alone, and not a matter of mixed fact and law. Accordingly, it is not sufficient for a judge to arrive at a reasonable interpretation of a standard form contract: the interpretation must be correct or it may be set aside by an appellate court.

In this respect, the Supreme Court has decided that a different standard of review applies to standard form contracts than for contracts generally. In Sattva Capital Corp. v. Creston Moly Corp., 2014 SCC 53, [2014] 2 S.C.R. 633, the Supreme Court held that a decision of an arbitrator interpreting a contract amounted to a matter of mixed fact and law, and not just a question of law. Accordingly, the Supreme Court held that the B.C. Court of Appeal had no jurisdiction to grant leave to appeal on a matter of law from a decision of a trial court upholding the arbitral award.

So, in Canada there are two kinds of contract which involve two different kinds of contractual interpretation:

General contracts; The interpretation of these contracts amounts to a question of mixed fact and law. Appellate courts will show great defence to a trial judge’s decision interpreting the contract.

Standard form contracts: The interpretation of these contracts amounts to a question of law alone. Appellate courts may reverse the trial judge’s decision if that decision is not correct.

For those involved in arbitration, the question is whether these two standards will be imported into the review of arbitral decisions.

The Supreme Court’s decision in Ledcor v. Northbridge also contains an extremely important ruling with respect to the exclusion for faulty workmanship contained in most Builders’ Risk insurance policies. This aspect of the decision was discussed by me in an article dated September 17, 2016. The present article addresses the “standard of review” issue.

Background

As discussed in my previous article, the Ledcor v. Northbridge case arose from damage done to the windows of a building under construction. Before the project was completed, the owner hired cleaners to clean the windows. The clearers used improper tools and methods and scratched the windows. The windows had to be replaced and the building’s owner and the general contractor claimed the replacement cost under the Builders’ Risk insurance policy covering the project. The insurers denied coverage, asserting that the claim fell within the policy’s exclusion for the “cost of making good faulty workmanship”.

The Alberta trial judge held that the clause was ambiguous and applied the contra proferentem rule to find that the claim was not excluded. The Alberta Court of Appeal reversed the trial judge’s decision. It concluded that the damage to the windows was excluded because it was directly caused by the intentional scraping and wiping motions involved in the cleaners’ work.

Accordingly, the appeal before the Supreme Court of Canada involved the application of two sets of principles.

First, the principles relating to the interpretation of contracts – in this case, an insurance contract.

Second, the principles to be applied to an appellate court’s review of a lower court’s decision interpreting a contract. It is this second aspect of the Supreme Court’s decision which is notable because the court applied a different standard of review than it had very recently pronounced in Sattva.

The Sattva Decision

In Sattva, the Supreme Court held that the interpretation of a contract is a question of mixed fact and law. Because a contract is negotiated in a factual setting, the interpretation of the contract is not just a matter of examining the words of the contract, but also examining the facts which gave rise to the contract.

Under s. 31(2) of the British Columbia Arbitration Act, the arbitrator’s award could only be appealed if the appeal raised “questions of law”. The judge of the B.C. trial division dismissed the appeal from the arbitral award, holding that the interpretation of the contract by the arbitrator raised a question of mixed fact and law, not a question of law. The Supreme Court agreed with that view. Accordingly, the Supreme Court held that the B.C. Court of Appeal erred in hearing the appeal since there was no question of law properly before the Court of Appeal over which that court had jurisdiction.

The Ledcor decision

In Ledcor, the majority of the Supreme Court held that the reasons for its decision in Sattva do not apply to the interpretation of a standard form contract, for several reasons.

First, there is no relevant factual matrix in which a standard form is signed. A standard form contract is prepared by one party and presented to the other side on a “take it or leave it” basis, with little or no negotiation between the parties. In the absence of a relevant factual matrix that could influence the proper interpretation of the contract, the interpretation should be characterized as a matter of law.

Second, the interpretation of a standard form contract applies to all users of that contract. The contract cannot have a different meaning for some parties than for others. For this additional reason, the interpretation of the contract should be seen as a matter of law. This is particularly so for insurance contracts which are usually prepared as “standard form policies” and are provided by the insurer to the insured without negotiation, except as to the amount of the premium.

Third, a standard of correctness properly sorts out the responsibilities of trial judges and appellate courts. The function of trial judges is to make factual finding. The function of appellate courts is to decide legal principles that will be applied by and to society at large, and not just those who are parties to the immediate dispute. In this setting, it is more appropriate that the review by an appellate court of a trial judge’s interpretation of a standard form contract be conducted on a standard of correctness. As the majority said, “ensuring consistency in the law and reforming the law” is the function of appellate courts.   By “selecting one interpretation over the other as correct” the appellate court provides “certainty and predictability.” For all these reasons, there is one correct interpretation of a standard form contract, and if the trial judge does not come to the correct conclusion, then the appellate court may set it aside.

Justice Cromwell dissented. In his view, all contracts have a factual matrix. Even standard form contracts involve surrounding facts, including the market, industry or setting in which they exist, their purpose, the parties’ reasonable expectations and commercial reality, etc. For this reason, there is not a sufficient generality associated with a standard form contract to turn its interpretation into a question of law.

Discussion

There are a number of interesting aspects to the Ledcor decision.

First, one may ask whether it is a practical or commercially sensible to differentiate between general contracts and standard form contracts. What if the contract is partly standard form and partly negotiated? Does the “correctness standard apply to part of the contract, or part of the judge’s decision, but not to the balance? Can the two parts be separated?

Second, what amounts to a “standard form contract” for the purposes of Ledcor? This is an important issue in the construction industry. “Standard form” construction contracts, such as the CCDC contracts prepared by the Canadian Construction Document Committee, are not prepared by one party or one side of the industry and presented to the other on a “take it or leave it” basis. Rather, they are prepared by the consensus of the participants on all sides of the construction industry. Are these contracts “standard form contracts” within Ledcor?

Third, does the Ledcor decision apply to the review of arbitration awards involving standard form contracts? The Ledcor decision involved appellate review of a trial court decision, and the majority of the Supreme Court decided that that review should have been conducted on a correctness standard. One of the factors in its decision was the relationship between trial judges and appellate courts which, in the Supreme Court’s view, supported a correctness standard of review. In Sattva, the original decision being reviewed was an arbitral award that was appealed to the superior court. The Supreme Court ultimately decided that appellate review of the superior court’s decision did not involve a pure question of law, but a question of mixed fact and law. Does the fact that Sattva originally involved an arbitration decision and Ledcor originally involved a court decision make a difference? And if an arbitrator is dealing with a standard form contract, as opposed to a negotiated contract, does that make a difference?

Some provincial arbitration statutes allow the parties to appeal an arbitral award on a question of law, sometimes by agreement of the parties or with the court’s leave. Sattva involved such a statute, and the Supreme Court of Canada held that leave to appeal the trial court’s decision reviewing the arbitral award should not have been granted under the B.C. arbitration statute since the interpretation of the contract in question did not involve a question of law, but rather a question of mixed fact and law. If the contract had been a standard form contract, would the interpretation of the contract now be a matter of law under Ledcor?

In addition, are the roles of a judge and arbitrator in interpreting a contract, and is the relationship of a judge and arbitrator to an appellate court, the same? Is the arbitrator, even though selected by the parties and selected because of his or her expertise and knowledge of the industry, bound to approach the interpretation of the contract in exactly the same way as a judge?

In the net result, is a decision of an arbitrator under a CCDC contract reviewable by a court on a standard of correctness? If so, the “hands off” approach of courts toward arbitration, which has been the trend in arbitration law over the last twenty years, may be changed by Ledcor.

See Heintzman and Goldsmith on Canadian Building Contracts (5th ed.), chapter 11, part 11.

Ledcor Construction Ltd. v. Northbridge Indemnity Insurance Co, 2016 SCC 37

Contracts – interpretation of contracts – standard of review – questions of law and mixed fact and law

Thomas G. Heintzman O.C., Q.C., FCIArb                             October 10, 2016

www.heintzmanadr.com

www.constructionlawcanada.com

When Does The Limitation Period Start When A Party Repudiates A Contract?

You might think that there is one answer to this question. But in Pickering Square Inc. v. Trillium College Inc., the Court of Appeal for Ontario recently reminded us that there are two answers, depending on whether the innocent party accepts the repudiation or not. If the repudiation is accepted, then the contract comes to an end and the limitation period starts to run for all claims under the contract. But if the innocent party does not accept the repudiation, then the contract continues and the repudiation may well constitute a continuing breach of contract. If that is so, then for each day of non-performance, the limitation period runs from that day.

Background

Pickering was the lessor and Trillium was the lessee under a lease of space in a shopping centre. In the lease, Trillium agreed to pay rent, to occupy the premises and to continuously operate its business as a vocational college, and to restore the premises at the expiry of the lease. Trillium gave notice to Pickering that it was vacating the premises and did so in December 2007. In June 2008, Pickering sued the appellant for rent arrears and payment under the lease for its failure to occupy the premises and to conduct its business continuously. The suit was settled in August 2008 and Trillium agreed to resume occupation of the leased premises. Trillium paid the rent for the remainder of the lease but it did not re-occupy the premises, did not conduct its business in those premises, and did not restore the premises at the end of the lease ended. After the lease expired, Pickering sued Trillium for breach of the lease.

Trillium brought a motion for summary judgment, arguing that Pickering’s claim was brought outside the two-year limitation period under s. 4 of the Ontario Limitations Act, 2002. The motion judge held that Trillium’s breach of the covenant to occupy the premises and operate its business continuously was of a continuing nature, such that each day of the breach gave rise to a fresh cause of action. As a result, only the claim relating to the breach occurring more than two years prior to commencement of the action ­­was barred by the Limitations Act, 2002.

The motion judge also held that Pickering’s claim for damages for breach of the covenant to restore the premises was not time barred. The obligation to restore arose when the lease expired on May 31, 2011, and Pickering’s action in February 16, 2012 was brought within two years of that date. .

The Appeal

Trillium argued that its breach of the covenant to operate its business continuously was complete on October 1, 2008, the first day it failed to resume occupation of the leased premises and operate its business. It submitted that each subsequent day that it failed to operate its business was not a separate breach and that each day of non-occupation did not give rise to a separate cause of action; rather, each such day constituted an instance of additional damages. Trillium submitted that a continuing breach of contract requires a succession or repetition of separate acts. In this case, it argued, there was a single act with continuing consequences and consequently, Pickering’s claim became statute-barred on October 1, 2010, two years after October 1, 2008 when Trillium failed to resume occupation and conduct its business, and long before Pickering commenced its action in February 2012.

The Ontario Court of Appeal rejected this submission. In doing so, the court differentiated between a repudiation of a contract which is accepted, in which case the contract comes to an end, and a repudiation of contract which is not accepted, in which case the contract remains in force. In the latter situation, the continuing failure of the repudiating party may amount to a continuing breach of contract. In that latter situation, the limitation period applies to each day of continuing breach. The limitation period expires on a rolling basis, so that once two years passes from a particular day then the limitation period for that day expires, but it has not yet expired for successive days and breaches.

The Ontario Court of Appeal explained the repudiation principle as follows:

“The election to cancel a contract as a result of a serious breach or repudiation brings a contract to an end and relieves the parties of any further obligations under it. The contract is not void ab initio: the innocent party may sue for damages for breach of the contract….By contrast, if the innocent party elects to affirm the contract despite the serious breach or repudiation, the contract remains in effect and the parties are required to perform their obligations under it. The innocent party retains the right to sue for past and future breaches…Pickering elected not to cancel the lease following Trillium’s October 1, 2008 breach. It affirmed the lease and, as a result, the parties were required to perform their obligations under it as they fell due….Trillium could have resumed performance of its obligations at any time prior to the end of the term of the lease by carrying on its business at the leased premises in accordance with the terms of the covenant. Had it done so, Pickering would have been required to accept Trillium’s performance and would have been unable to terminate the lease in the absence of a further serious breach or repudiation. Trillium would have been liable for damages from the date of its October 1, 2008 breach until the date it resumed the performance of its covenant obligations, but would not have incurred liability for breach of the lease beyond that date. Trillium chose not to resume its obligations at any point prior to the expiry of the lease.”

The Ontario Court of Appeal then explained the applicable limitations principle:

“In these circumstances, when did the two-year limitation period begin to run? It is clear that a cause of action accrues once damage has been incurred, even if the nature or the extent of the damages is not known….But accrual of a cause of action is not determinative for limitation purposes in the context of a continuing breach of contract and an election by the innocent party to affirm the contract. The motion judge properly concluded that a fresh cause of action accrued every day that breach continued – every day that Trillium failed to carry on its business in accordance with the covenant……The accrual of fresh causes of action has consequences for the innocent party as well as the party in breach of the contract. It sets the clock running for a new two-year limitation period. Pickering’s election to affirm rather than cancel the lease does not have the effect of postponing the date for discovery of the breach until expiry of the lease…..The limitation period in this case applied on a “rolling” basis……The two-year limitation period commenced each day a fresh cause of action accrued and ran two years from that date. Thus, Pickering was entitled to claim damages for breach of the covenant for the period going back two years from the commencement of its action on February 16, 2012 – the period that ran from February 16, 2010 until the lease expired on May 31, 2011.”

The Court of Appeal also upheld Pickering’s claim for repairs to be done at the end of the lease. Pickering was only claiming for breach of this covenant at the end of the lease, and not before. According, the limitation period for that breach arose in May 2011 when the lease expired, not in October 2008 when Trillium failed to resume occupation.

Discussion

This decision is a useful reminder of the distinction between an accepted and unaccepted repudiation of contract. The former brings the contract to an end. The latter does not, and as such has been described as something “writ upon water”. The fact that the contract remains in place is obviously important for the ongoing performance of the contract, as the obligation of performance remains in place on both sides of the contract. But as importantly, the limitation period continues to apply, on a rolling basis, to the breaches that occur after the unaccepted repudiation. And the Court of Appeal has held in this case that it does not require separate and positive acts by the defaulting party to occur for there to be continuing breaches of the contract. Rather, the failure to act and the omission of performance amount to continuing breaches of the contract.

There may be other implications of an unaccepted repudiation of the contract. It is not just the obligation of performance that continues. In addition, the parties remain entitled to exercise positive rights under the contract. Also, the performance of contracts with subcontractors and consultants, and the coverage and reporting obligations under insurance contacts and bonds, may be affected.

See Heintzman and Goldsmith on Canadian Building Contracts, 5th ed., chapter 8 part 8(b) and chapter 9 part 3.  

Pickering Square Inc. v. Trillium College Inc., 2016 ONCA 179

Contracts – repudiation – non-acceptance of repudiation – limitation period

Thomas G. Heintzman O.C., Q.C., FCIArb                                                 April 17, 2016  

www.heintzmanadr.com

www.constructionlawcanada.com

The Supreme Court Of Canada Proclaims 10 Rules For The Interpretation Of Contracts And The Review Of Arbitration Awards

The Supreme Court of Canada’s recent decision in Sattva Capital Corp. v. Creston Moly Corp. is a remarkable document. It is more than a judicial decision. It is literally a textbook or checklist for the interpretation of contracts and the review of arbitration decisions.

Background

First, the context. Creston agreed to pay Sattva a finder’s fee in relation to its acquisition of a mining property.  The parties agreed that Sattva was entitled to a finder’s fee of US$1.5 million and was entitled to be paid this fee in shares of Creston. They disagreed on which date should be used to price the shares and therefore the number of shares to which S was entitled.  S argued that the share price was to be fixed on one date, and therefore it was entitled to about 11,460,000 shares priced at $0.15.  C claimed that the proper date was the date when the compensation was payable, that the agreement’s “maximum amount” proviso prevented S from receiving shares valued at more than US$1.5 million on that date and therefore that S should receive approximately 2,454,000 shares priced at $0.70.  The parties agreed to arbitrate their dispute under the B.C. Arbitration Act.

The arbitrator found in favour of Sattva.  Creston was denied leave to appeal on the basis that the issue was not a question of law.  The Court of Appeal reversed that decision and granted C’s application for leave to appeal, finding that the arbitrator’s failure to address the meaning of the agreement’s “maximum amount” proviso raised a question of law, and remitted the matter to the superior court.

The superior court judge then dismissed C’s appeal from the arbitrator, holding that the arbitrator’s interpretation of the agreement was correct.  The Court of Appeal allowed C’s appeal, finding that the arbitrator reached an absurd result.  The Court of Appeal also held that the superior court judge was bound by the Court of Appeal’s prior decision. S appealed to the Supreme Court of Canada which re-instated the decisions of the arbitrator and the superior court judge.

Decision of the Supreme Court of Canada

Here are the major pronouncements in the Supreme Court’s decision. They are not listed in the decision in this way but they appear to be the major grounds for the decision.

  1. A contract should be interpreted in light of the surrounding circumstances.

The Supreme Court held that a contract should be interpreted in light of all the surrounding circumstance. Moreover, doing so does not contradict the parol evidence rule. The court said:

“The parol evidence rule does not apply to preclude evidence of the surrounding circumstances. Such evidence is consistent with the objectives of finality and certainty because it is used as an interpretive aid for determining the meaning of the written words chosen by the parties, not to change or overrule the meaning of those words.”

  1. The interpretation of a contract is a question of mixed fact and law, not a question of law.

The Supreme Court held that, except in the “rare” instances in which an “extricable question of law” can be found, the interpretation of a contract is a matter of mixed fact and law, not a matter of law. The court acknowledged that historically, the determination of the rights and obligations under a contract was considered a question of law. However, Justice Rothstein, speaking for the unanimous court, said that rule should no longer apply:

“I am of the opinion that the historical approach should be abandoned.Contractual interpretation involves issues of mixed fact and law as it is an exercise in which the principles of contractual interpretation are applied to the words of the written contract, considered in light of the factual matrix.”

Justice Rothstein said that it “may be possible to identify an extricable question of law from within what was initially characterized as a question of mixed fact and law” but that “courts should be cautious in identifying extricable questions of law in disputes over contractual interpretation.”

  1. Leave cannot be granted to appeal the interpretation of a contract by an arbitral tribunal award if the test for granting leave is “a question of law”

Under the arbitration statutes of most provinces, leave to appeal from the arbitrator’s award can be granted if there is a question of law involved. A strong argument can be made that the whole regime relating to appeals from arbitral awards was premised on the historical assumption that the interpretation of a contract was a matter of law. In Sattva, the Supreme Court held that an interpretation of a contract does not raise a question of law, and so it held that leave to appeal should not have been granted in this case. So in the future, and except in rare instances, a court may no longer grant leave to appeal to determine if the arbitrator was correct in his or her interpretation of the contract.

This decision goes affects much more than applications for leave to appeal. It affects any legal regime relating to the interpretation of a contract. For example, if the parties agree to an appeal on a point of law – and most of the provincial and territorial arbitration statutes allow the parties to do so – now such an agreement will not allow an appeal concerning the interpretation of the agreement.

Accordingly, this decision will require that parties proposing to enter into an arbitration agreement re-think how they express in their agreement the rights of appeal from the arbitral decision. If they intend that the interpretation of the contract by the arbitral tribunal is to be appealable, then it is no longer sufficient for them to provide for an appeal on a question of law. They must now provide for an appeal on a question of mixed fact and law.

In addition, many provincial and territorial arbitration statutes – including British Columbia’s – do not allow the parties to agree to an appeal from an arbitral decision on a question of mixed fact and law, only on a question of law. Under this decision of the Supreme Court of Canada, none of those statutes will now allow the parties to include a review of the interpretation of a contract as a ground of appeal. A whole subject of contract law has potentially been removed from the court’s review.

  1. The test for leave to appeal is “arguable merit”

The Supreme Court of Canada held that the test for a superior court to apply when considering an application to appeal from an arbitral award is “arguable merit.” The test may be described in many different ways using different words, but they come down to these two words.

This test is met if “the issue raised by the applicant cannot be dismissed through a preliminary examination of the question of law. In order to decide whether the award should be set aside, a more thorough examination is necessary and that examination is appropriately conducted by the court hearing the appeal once leave is granted.” In the case of legal issues, “the appropriate threshold ….is whether it has arguable merit, meaning that the issue raised by the applicant cannot be dismissed through a preliminary examination of the question of law.”

  1. The court has a residual discretion not to grant leave to appeal

Even if the court considers that the appeal has arguable merit, the Supreme Court of Canada has confirmed that the court has a residual discretion not to grant leave to appeal. Discretionary factors to consider in a leave application include:

o   the conduct of the parties

o   existence of alternative remedies

o   undue delay and

o   the urgent need for a final answer.

However, “courts should exercise such discretion with caution.” If the court finds an error of law and a potential miscarriage of justice, then the discretionary factors “must be weighed carefully before an otherwise eligible appeal is rejected on discretionary grounds.” There should be no double-counting of the relevant factors. For example, “respect for the forum of arbitration chosen by the parties is a consideration that animates the legislation itself and can be seen in the high threshold to obtain leave…Recognition that arbitration is often chosen as a means to obtain a fast and final resolution tailor-made for the issues is already reflected in the urgent need for a final answer.” So this factor should not be counted again in exercising a residual discretion not to grant leave to appeal.

In considering misconduct in relation to this residual discretion, the court said that the misconduct of a party need not be directly relevant to the question of law in issue in the appeal.

  1. The exercise of discretion should be reviewed by an appellate court with deference

The Supreme Court held that a discretionary decision by the court considering an application for leave to appeal from an arbitral award should be reviewed by another court with deference. An appellate court “should not be interfered with merely because an appellate court would have exercised the discretion differently… An appellate court is only justified in interfering with a lower court judge’s exercise of discretion if that judge misdirected himself or if his decision is so clearly wrong as to amount to an injustice.”

  1. The review of an arbitral decision is not by way of judicial review applicable to administrative tribunals

The Supreme Court drew an important distinction between the review of an arbitral decision by a superior court under the statutes applicable to commercial arbitrations, and a review of the decision of an administrative tribunal by way of judicial review. Arbitral review is not judicial review in the latter sense. Appellate review of arbitral awards “takes place under a tightly defined regime specifically tailored to the objectives of commercial arbitrations and is different from judicial review of a decision of a statutory tribunal.” As the court pointed out, “for the most part, parties engage in arbitration by mutual choice, not by way of a statutory process. Additionally, unlike statutory tribunals, the parties to the arbitration select the number and identity of the arbitrators.” Furthermore, in the arbitration statutes of some provinces and territories (like British Columbia, but unlike the arbitration statutes in many other provinces and territories), the court is prohibited from reviewing an arbitral tribunal’s factual findings. However, in the judicial review of administrative tribunals, a prohibition against the review of an administrative tribunal’s factual findings “signals deference” under the Supreme Court’s decision in Dunsmuir v. New Brunswick, [2008] 1 S.C.R. 190.

  1.    The Dunsmuir test may be helpful to the review of arbitral awards

The Supreme Court did find, however, that the standard of review developed for administrative tribunals may be relevant or useful to the appeal or review of arbitral awards. The court said the two systems of review are:

“analogous in some respects. Both involve a court reviewing the decision of a non-judicial decision-maker. Additionally, as expertise is a factor in judicial review, it is a factor in commercial arbitrations: where parties choose their own decision-maker, it may be presumed that such decision-makers are chosen either based on their expertise in the area which is the subject of dispute or are otherwise qualified in a manner that is acceptable to the parties. For these reasons, aspects of the Dunsmuirframework are helpful in determining the appropriate standard of review to apply in the case of commercial arbitration awards.”

In applying the Dunsmuirtest, the Supreme Court said the following:

“In the context of commercial arbitration, where appeals are restricted to questions of law, the standard of review will be reasonableness unless the question is one that would attract the correctness standard, such as constitutional questions or questions of law of central importance to the legal system as a whole and outside the adjudicator’s expertise …The question at issue here, whether the arbitrator interpreted the Agreement as a whole, does not fall into one of those categories. The relevant portions of the Dunsmuiranalysis point to a standard of review of reasonableness in this case.”

  1.    The Court may supplement the reasons of the arbitral tribunal

The Supreme Court of Canada held that, in considering an application for leave to appeal from an arbitral award, the court may supplement the award by its own analysis before undermining the award by finding it deficient. The court quoted from its decision in Newfoundland and Labrador Nurses’ Union v. Newfoundland and Labrador (Treasury Board), [2011] 3 S.C.R. 708:

“even if the reasons in fact given do not seem wholly adequate to support the decision, the court must first seek to supplement them before it seeks to subvert them. For if it is right that among the reasons for deference are the appointment of the tribunal and not the court as the front line adjudicator, the tribunal’s proximity to the dispute, its expertise, etc, then it is also the case that its decision should be presumed to be correct even if its reasons are in some respects defective.” (underling in both decisions)

The Supreme Court proceeded to supplement the decision of the arbitral tribunal by its own reasoning. Having done so, it concluded that the interpretation of the contract by the arbitral tribunal award met the reasonableness standard and upheld the award.

10.   The Leave to Appeal decision is not binding in subsequent hearings

The B.C. Court of Appeal had held that its previous decision granting leave to appeal, and the factual findings in that decision, were binding on the superior court judge and on itself during the subsequent hearings. The Supreme Court held that this was wrong:

“A court considering whether leave should be granted is not adjudicating the merits of the case… A leave court decides only whether the matter warrants granting leave, not whether the appeal will be successful…. This is true even where the determination of whether to grant leave involves, as in this case, a preliminary consideration of the question of law at issue. A grant of leave cannot bind or limit the powers of the court hearing the actual appeal.”

Discussion

This decision has a profound impact on the interpretation of contracts and the appeal and review of arbitral decisions. Some time is required to reflect upon and absorb the decision. The following comments are only a first stab at its full implications.

The decision apparently reduces the authority of the superior court to review arbitral decisions in two respects.

First, it reduces the grounds upon which an existing arbitration agreement may give rise to appellate review: except in rare instances, no leave to appeal on a matter of law may be granted to review the correctness of the interpretation of a contract by an arbitral tribunal, and an agreement providing for an appeal on a matter of law will not encompass such a review.

Second, it reduces the ability of parties to future arbitration agreements to agree on appellate review of the correctness of the interpretation of a contract by an arbitral tribunal; if the applicable arbitration statute does not permit the parties to agree to an appeal on a question of mixed fact and law, then no such appellate review appears possible.

The decision also provides guidance on the practice which applies to applications for leave to appeal from arbitral awards. This guidance particularly applies to the scope of the court’s discretion, the impact of a party’s improper conduct upon the exercise that discretion, the non-binding effect of the leave to appeal decision and the scope of the reviewing court’s entitlement to supplement the reasoning contained in the award. So while the leave to appeal door may have been partially closed by this decision, to the extent that the door is still open the decision clarifies and to some extent broadens the court’s powers to deal with the application.

Sattva v. Creston goes into the first drawer of the Contract and Arbitration tool boxes with a big red sticker on it.

Sattva Capital Corp. v. Creston Moly Corp., 2014 SCC 53

Contracts – Interpretation of Contracts – Arbitration – Appeal and Review of Arbitral Awards

Discretion – Standard of Review

Thomas G. Heintzman O.C., Q.C., FCIArb                                                     August 10, 2014

www.heintzmanadr.com

www.constructionlawcanada.com

When Is A Commercial Arbitration Decision Unreasonable?

Canadian courts will generally over-rule a decision of a domestic arbitral tribunal only if the decision is “unreasonable.”  What does this word mean? Is the standard of “unreasonableness” different in a commercial arbitration than, say, in a labour or employment arbitration?  If the arbitral award is found to fall within the bounds of reasonableness by the judge who hears the motion to over-rule it, how can an appellate court then say that the decision is “unreasonable”?

These questions are raised by the recent decision of the Newfoundland and Labrador Court of Appeal in St. John’s (City) v. Newfoundland Power Inc.  The Court of Appeal allowed an appeal and set aside the decision of the arbitral tribunal under a long term power lease, even though the judge who first heard the motion to set aside the arbitral decision upheld the decision as reasonable.  When one judge had found that the arbitral decision was reasonable, how did the Court of Appeal arrive at the decision that it was unreasonable?

Background

The arbitration arose under a long term lease between the City of St. John’s and Newfoundland Power. The lease was for the use of the Mobile River.  Clause 1 of the lease permitted the City to terminate the lease upon:

“payment to the Company of the value of all works and erections constructed or provided by the Company within and without the Mobile River watershed subsequent to the date of this Lease for the primary purpose of developing the waters of Mobile provided such works and erections are in use by the Company for that primary purpose at the time notice of termination of the Lease is given by the Council and also at the time of termination of the said Lease…” (emphasis added)

The meaning of the underlined words was the source of the contention. Newfoundland Power said that they meant that, on termination of the lease, the City was required to pay for the on-going value of its operating business in the Mobile River watershed as the time of the termination, including the value that it derived from the use of the river which it leased from the City.  The City said that, on termination of the lease, it was only required to pay for the physical works and erections which Newfoundland Power had constructed and nothing more.

The lease had been previously amended to delete the words “aggregate cost of works and erections … less depreciation” and replace them with the words “value of all works and erections … in use.”

The Arbitral Decision

The majority of the arbitral tribunal decided in favour of Newfoundland Power and held that the City was obliged to pay the full amount of the value of Newfoundland Power’s business in the Mobile River watershed.

The majority held that this interpretation followed from the concluding words of clause 1 of the Lease. Those words contained a proviso which referred to another right of the City under section 29 of the governing statute (the St. John’s Street Railway Act), namely, the right to purchase the assets and business of Newfoundland Power.  Under that right, the City was obliged to pay for the “value of the said undertaking, plant, property, assets and rights of the Company.”

The majority held that the reason for the reference to section 29 of the Act within clause 1 was to provide guidance to the appraisers in making valuation when the City terminated the lease.  The majority stated that “the wording of Clause 1 of the Lease as amended ties the termination process to the concepts expressed in Section 29 of the St. John’s Street Railway Act”.  Accordingly, the majority of the arbitral tribunal concluded that, upon termination of Newfoundland Power’s rights, (rather than the purchase of Newfoundland Power’s business),  the valuation of Newfoundland Power’s undertaking must take into account the “assets” and “rights” of the Company as they were explicitly referred to in section 29.

With respect to the meaning of the word “value” in the lease, the majority of the arbitral tribunal referred to dictionary meanings and concluded that the ordinary meaning of “value” did not mean “depreciated cost”.  The majority referred to the fact that clause 1 of the lease had been amended to remove the words “aggregate cost of works and erections… less depreciation” and had replaced those words with the words “value of all works and erections”.  From this amendment, the majority concluded that the appraisal process would be incorrectly conducted if it applied “cost less depreciation”.  Due to the amendment, the word “value” could not mean “cost less depreciation.”

Privative Clauses

In the present case, two privative clauses applied to the decision of the arbitral tribunal.  One was contained in clause 1 of the lease itself. That clause stated that “the award of any two such arbitrators shall be final and binding between the parties”.  The other was in section 36 of the Arbitration Act, RSNL 1990, c. A-14 which states that “the award made by arbitrators or an umpire is final and binding on the parties and persons claiming under them.”

Standard of Review 

 Newfoundland and Labrador has not adopted the Uniform Law Conference’s Uniform Arbitration Act.  That Uniform Act provides for a right of appeal if leave is granted by the provincial superior court from a decision of an arbitral tribunal.  The Uniform Act has been adopted in most of the Canadian provinces, but not in Newfoundland and Labrador.  Therefore, the only remedy to overturn the decision of an arbitral tribunal in Newfoundland and Labrador is an application for judicial review.

Both the judge hearing the original application and the Court of Appeal held that the proper standard of judicial review was set forth in the decision of the Supreme Court of Canada in Dunsmuir v. New Brunswick, [2008] 1 S.C.R. 190.  Under Dunsmuir, there are only two standards of judicial review: correctness and reasonableness. There are two steps in determining which standard of review applies. The first step in the Dunsmuir analysis is to determine whether the courts have already established an appropriate standard of review for the particular tribunal whose decision was being reviewed. Both courts agreed that no appropriate standard of judicial review had been established for this arbitral tribunal.

The next step in the Dunsmuir analysis is the “contextual analysis” in which the following factors are considered:

(1) the presence or absence of a privative clause;

(2) the purposes of the tribunal;

(3) the nature of the question at issue; and

(4) the expertise of the tribunal.

The Court of Appeal agreed with the application judge that when these factors were applied to the arbitral tribunal in the present case, the proper standard of review was reasonableness. That is, the arbitral decision should only be set aside if it was unreasonable.

The Court of Appeal then considered how the reasonableness standard should be applied. It referred to the decision of the Supreme Court of Canada in Newfoundland and Labrador Nurses’ Union v. Newfoundland and Labrador (Treasury Board), [2011] 3 S.C.R. 708.  It held that this decision had clarified that the adequacy of reasons is not a “stand-alone basis for quashing a decision.”  Courts are not required, as it said, to “undertake two discrete analyses – one for the reasons and a separate one for the result.”  The Court of Appeal noted Justice Abella’s statement in the Newfoundland and Labrador Nurses’ Union decision that:

 “even if the reasons in fact given do not seem wholly adequate to support the decision, the court must first seek to supplement them before it seeks to subvert them. For if it is right that among the reasons for deference are the appointment of the tribunal and not the court as the front line adjudicator, the tribunal’s proximity to the dispute, its expertise, etc, then it is also the case that its decision should be presumed to be correct even if its reasons are in some respects defective.”

 The Newfoundland and Labrador Court of Appeal then stated its duty in applying the Dunsmuir test as follows:

 “This Court must therefore determine whether the reasons meet the standard of justification, transparency and intelligibility’.  Even if the reasoning is in some respects flawed, this Court must determine whether the outcome is acceptable as being defensible in respect of the facts and the law by examining any alternative arguments which could have been made.” (emphasis added)

 Decision of the Court of Appeal

 The Court of Appeal said the following in starting its analysis:

 “In this case, however, I am satisfied that the majority made a number of errors in its reasoning process which led to a result that is not reasonable and supportable given the wording of the lease and the context in which it was negotiated.  The outcome is not defensible as a possible, acceptable outcome, given the commercial context in which the lease was to be interpreted and applied.”

 The Court of Appeal held that the majority of the arbitral tribunal had made two fundamental errors in the interpretation of clause 1 of the lease. The first error arose from the majority applying the valuation provision relating to the purchase of the business of Newfoundland Power.  That provision had no application when the valuation related to the termination of the lease.

The Court of Appeal said:

 “What was to be valued varied significantly depending on whether the City acquired the electrical generating plant by purchase pursuant to section 29 or by termination of the lease.  If the City terminated the lease after forty-seven years it had to pay the value of the “works and erections … in use”.  If the City exercised its right to purchase the Company as a going concern under section 29 of the St. John’s Street Railway Act, which it could do during the forty-seven year term of the Lease, it had to pay the value of the “undertaking, plant, property, assets and rights”….

 Intuitively, the different bases of valuation make sense.  If the City terminated the lease, Newfoundland Power would no longer have the right to use the water or the land on which the works and erections sat.  In other words, its franchise would be terminated….

 Here, Newfoundland Power and the City entered into a lease from the City with an express right of termination after forty-seven years upon three years notice with a compensation formula in favor of Newfoundland Power limited to the value of works and erections in use at the end of the lease to be valued by three arbitrators.  There would be no other compensation based on a going concern or otherwise because of the express language set out in the amended clause 1 of the lease dated, October 21, 1949…..

 The majority’s holding that the closing portion of clause 1 supported the contention that the valuation which occurs on the termination of the lease must be consistent with the valuation that occurs upon the City exercising its rights under section 29 was unsupportable and unreasonable and ignores the specific nature of the franchise rights granted by the City to Newfoundland Power.”

The Court of Appeal also held that the majority of the arbitral tribunal had erred in its interpretation of the word “value.”  It effectively said that the majority had ignored the fact that what was to be valued was “the works and erections in use”, not the business. It said:

 “The words “works and erections” generally refer to physical assets, a fact noted by the minority arbitrator.  While the addition of the words “in use” could connote an intention that the City would be taking over an operating facility, read in the context of the discussion above, it is clear that the words “in use” did not intend to transform the valuation from one including only physical assets into one including all associated rights and intangible property.  Their inclusion was meant only to identify which physical assets are to be valued, i.e. only those which are in use.

 This interpretation is commercially sensible.  Presumably, the words “in use” were added so that structures which were no longer necessary or functioning for the purpose of electrical power generation, would not be included in the assessment of value.  Newfoundland Power is to be paid for the value of only those physical assets which it was using to generate electrical power at the time of notice and termination. These are the only structures of value that it is losing upon termination of the lease.

 The Court of Appeal held that the majority of the arbitral tribunal had erred by relying so heavily on the changed definition of “value” in the lease.  In the court’s view, the amendment inserted into the lease “one method of valuation with the broader concept of ‘value’, which included as a possible interpretation the original method of valuation….The effect of the amendment, from a stand point of reasonableness, would appear to be intended to give greater flexibility to the arbitrators in determining which method of valuation is appropriate upon termination of the lease of those works and erections that are in use and are to be valued.”

The Court of Appeal then considered what result flowed from its conclusions, particularly in light of the finding by the application judge to the contrary.  It said the following:

 “The errors identified in the reasoning process of the majority of the arbitrators led to a decision which is unreasonable and unsupportable based upon the wording of the lease and the context in which the agreement was made.  Therefore, the applications judge erred by finding that the decision of the majority was reasonable and within the range of possible outcomes.”

 The Court of Appeal accordingly allowed the appeal and referred the matter back to the arbitral tribunal to be determined in accordance with the analysis in the Court of Appeal’s decision.

Discussion

This decision appears to reflect a tendency by the courts to review commercial agreements on a stricter basis than other agreements.  In the case of commercial agreements, the courts have at their disposal long-standing and well known principles of contractual interpretation.  When the arbitral decision offends one or more of those principles, then a court can conclude that the decision is “unreasonable”.

Two of the best known principles of contractual interpretation are the rule prohibiting reference to irrelevant considerations and the parole evidence rule.  Once the Court of Appeal concluded that the valuation principles applicable to the purchase of Newfoundland Power’s business were irrelevant to the valuation arising from the termination of the lease, then it was almost inevitable that it would conclude that the arbitral decision was unreasonable.  When, in addition, the court concluded that the prior versions of clause 1 were not helpful in arriving at the proper  interpretation of that clause, then its inclination to interfere was likely greater.  The only expertise brought by the arbitral tribunal to the process of interpreting the lease was legal expertise, and the court, which is comfortable with interpreting commercial agreements and rightly considers itself expert in doing so, undoubtedly felt that it should have little reluctance in setting the tribunal’s award aside.

This decision will be of interest to those involved in disputes involving the interpretation of construction and procurement agreements.  Those disputes often involve loaded words such as “value” and the dispute may revolve around whether certain factors are relevant or irrelevant in the interpretation process, or whether the negotiations or prior drafts of the agreement should be looked at. If one party to a construction dispute believes that the arbitration tribunal got the interpretation wrong, then the decision in St. John’s v. Newfoundland Power will be a useful decision in support of an application for judicial review.

Another view of this decision may be that courts are far too ready to set aside arbitral decisions.  Those with this view will see this decision as exactly the kind of case in which the court improperly intervened on a valuation matter that was at the heart of what the arbitral tribunal was asked to decide.

As a footnote to this decision, one could consider how it would have been decided if the arbitration in question was an international commercial arbitration, not a domestic arbitration, and the Model Law attached to the International Commercial Arbitration Act of Newfoundland and Labrador had applied. That Act is similar to the many provincial statutes which adopt the UNCITRAL Model Law across Canada.  Article 34 of the Model Law states the grounds upon which there may be recourse against an arbitral decision. Those grounds include:

  • incapacity by a party
  • invalidity of the agreement
  • lack of notice
  • the arbitral tribunal deciding a dispute or matter falling outside the terms of the arbitration agreement
  • the wrong composition of the tribunal or
  • the determination by the tribunal of a matter which is incapable of being arbitrated, or contrary to public policy.

None of those grounds appear to include an error of law made by an international commercial arbitration tribunal within its prima facie jurisdiction. If that is so, then this decision highlights the wider authority that international commercial arbitration tribunals have than domestic tribunals.  It also highlights the broader supervisory authority that provincial superior courts have over domestic arbitrations than over international commercial arbitration tribunals.  The Model Law appears to contemplate that international commercial arbitration tribunals may make errors of law within their jurisdiction and that Law gives the courts no express authority to set aside such errors.  This being the case, it may be doubtful that the Dunsmuir analysis has any application to international commercial arbitration.

With respect to domestic arbitration tribunals, however, Canadian law contemplates that provincial superior courts have authority to set aside errors of law made by domestic arbitration tribunals based upon the standards of “correctness” and “reasonableness” stated in Dunsmuir. If the decision in St. John’s v. Newfoundland Power tends to show that the courts apply a higher degree of scrutiny to legal error by commercial than to other types of arbitration, then it may be ironical that that there is no judicial review for error of law made in international commercial arbitrations.

See Heintzman and Goldsmith on Canadian Building Contracts, 4th ed, chapter 10

St. John’s (City) v. Newfoundland Power Inc., 2013 NLCA 21

Arbitration  –  Standard of Review  –  Error of Law  –  Reasonableness  –  Contracts  -Interpretation

Thomas G. Heintzman O.C., Q.C., FCIArb                                                                                         August 1, 2013

www.heintzmanadr.com

www.constructionlawcanada.com

 

When Is A Building Contract A Joint Venture?

A difficult issue that may arise between contractors and subcontractors is the nature of their contractual relationship.  Are they:  independent contractors; or partners; or joint venturers; or employees one of the other?

In WCI Waste Conversion Inc. v. ADI International Inc, The Prince Edward Island Court of Appeal recently considered whether a contractor and subcontractor were actually in a joint venture relationship.  The decision is an important one as the majority and minority of the court approached the issue in a different way.

The Court also considered questions relating to the obligations of good faith, fiduciary duty and repudiation on a construction project.  The decision provides a useful insight into those issues as they apply to a construction project.

Those issues will be addressed in my next blog, but for now, let’s consider the question of when parties to a construction project may be in a joint venture.

The Background

In June 2000, a PEI Crown Corporation, Island Waste Management Corporation (“IWMC”), issued a Request for Proposals for the design, construction and operation of a central composting facility to serve the province of Prince Edward Island.  WCI approached ADI about making a proposal together.  The two companies submitted a Pre-Qualification Submission which was expressly made by those companies “in association” and as a “team”.  The ultimate Proposal was submitted in March 2001 by ADI and it stated that it was prepared by both companies.  In July 2001, IWMC awarded the contract to ADI, with WCI shown as a sub-contractor.

In May 2001, ADI and WCI entered into a Memorandum of Understanding (“MOU”).  They entered into a further MOU in August 2001 after the contract had been awarded by IWMC to ADI.  The key provision of the August MOU stated as follows:

It is agreed that ADI will be the prime contracting party, with WCI engaged as a sub-contractor.  ADI will provide the bonding and insurances as stipulated by the RFP. However, it is agreed that the actual working relationship will be based on the general principles of a joint venture agreement as summarized below.

In their correspondence with each other, ACI and WCI frequently referred to the bid as being “joint” and to the relationship as being a “joint venture”, but ADI insisted throughout that it was the prime contractor and carried the associated rights and risks.

Construction of the project was substantially completed by October 2002.  During the construction, the relationship between ADI and WCI deteriorated and ADI terminated the contract with WCI.

The Sub-Contract or Joint Venture Issue

The trial judge found that the contract between the parties included the two MOUs and the correspondence between the parties, at least so far as determining the relationship between the parties.  He held that, for the purposes of the relationship with IWMC, the parties were in a contractor-sub-contractor relationship, but between themselves they were parties to a joint venture relationship.

The  majority of the PEI Court of Appeal affirmed this finding.  A number of features of its reasoning are important.

First, the majority held that ADI could not rely on evidence outside the MOU to contradict the statement in the MOU that the relationship between the parties was a joint venture.

Second, the majority held that it was not necessary that WCI have an expectation of profit from the prime contract with IWMC for there to be a joint venture between the parties.  Even though WCI was only entitled to a fixed payment from ADI, and ADI was entitled to all the upside and subject to the downside of that prime contract, the parties were still entitled to call their agreement a joint venture agreement and thereby impose duties upon themselves consistent with a joint venture.

Third, the majority held that contractors and subcontractors are entitled to contract between themselves as joint venturers, and to contract with the owner on the basis that only one of them is the contractor and the other is a subcontractor.  The majority distinguished the case of Design Services v. R, [2008] 1SCR 737 in which a subcontractor asserted that it was in a contractual relationship with the owner based upon it really being part of a joint venture with the contractor.  The majority of the PEI Court of Appeal said that, in Design Services, the owner had issued no contract at all to the contractor but had issued the contract to another bidder:

“Canada awarded no construction contract to the contractor, Olympic.  Olympic didn’t enter into a subcontract with Design Services.  In the present case, WCI’s claim is between the contracting parties, inter se, where terms have been agreed and expressed by the parties.”

The minority judge disagreed.  As to the clause in the MOU stating the parties’ relationship, the minority judge held that there was an inconsistency between the first and third sentences and that “the court was obligated to find an interpretation which would give meaning to both provisions that create the inconsistency.”

The minority judge then turned to the actual responsibilities and the actual entitlements to payment and profits to determine whether the relationship was really one of joint venture or one of contractor-subcontractor.  He found that ADI entered into a fixed price contract with IWMC in which WCI had no entitlement to profit, and that WCI entered into a fixed price contract for WCI to be paid a fixed price.  There was no sharing in profits under either arrangement.  ADI and WCI had separate activities for which they were responsible.  Each party entered into separate sub-contracts.  Neither party was vulnerable to the other.  In short, all the ingredients of the relationship indicated that there was no joint venture and that the parties were independent contractors.  According to the minority judge, the statement about a joint venture in the MOU:

“meant they would work in close cooperation with each other to carry out their specialized duties as contractor and subcontractor…. Reliance on joint venture was for purposes of facilitating the proper functioning of their working relationship as contractor and subcontractor…there is nothing in their contractual arrangements which would indicate they agreed to enter into a joint venture….The statement standing by itself in the contract did not make their legal relationship that of parties to a joint venture.”

This disagreement between the majority and minority reveals a fundamentally different approach to determining the legal relationship between the parties.

The majority held that, if the parties state in their agreement that they are joint venturers, then the court will hold them to that statement.

The minority held that the court may go behind that statement, at least if the parties also state that they have a contractor-subcontractor relationship so far as the owner is concerned; and the court may determine if the relationship between the parties is really one of joint venture and if it is not, then the parties’ statement about joint venture may be over-ridden.

This difference in opinion raises a number of questions:

First, if the parties wish to have a joint venture relationship between themselves, but also wish one of them to be the prime contractor and the other to be the subcontractor, can they legally do so?  If they can, how do they do so to ensure that the relationship is not disputed later?

The wording used by the parties in the key provision of the MOU seems as clear as possible, namely, that the parties wanted a joint venture arrangement between them, but recognized that one of them would be contractor and the other sub-contractor so far as the owner was concerned.  How could they have more clearly stated that intention?  Would it have been better to leave out reference to the “actual working relationship” being “based on” a joint venture agreement, and instead say that the “real legal relationship between the parties is that of joint venture”?   Or with this judicial precedent, can we now proceed on the basis that the words in this contract are sufficient in the future to create a joint venture between a contractor and subcontractor?

Second, which approach is better?  Should courts accept the parties’ statement as it is?  Or should they inquire into the actual relationship to see if it is one of joint venture?  In the employment setting, courts often determine whether the relationship is really one of employment or one of independent contractors, but there are real public policy reasons for doing so.  When the parties say that they are partners, should the court go behind that statement to see if they really are?  If they say that they have entered into a joint venture agreement, are there good public policy reasons for the court to go behind that statement?

These thoughts are enough for the moment.  In the next blog we will consider the approach of the PEI Court of Appeal to the following important issues:

…when do parties to a construction project owe duties of good faith or fiduciary duties to each other?

…and what misconduct on a construction project will be considered to be sufficiently serious that it amounts to repudiation entitling the other party to terminate the contract?

A very meaty decision indeed!

See Heintzman and Goldsmith on Canadian Building Contracts, 4th ed, Chapter 7, part 1.

WCI v. ADI, 2011 PECA 14 (CanLII)

 Construction Law   –   Contractors and Subcontractors   –   Joint Venture

Thomas G. Heintzman O.C., Q.C.                                                                  January 7, 2012

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