RECENT DEVELOPMENTS
IN CONTRACT LAW
Margaret Grottenthaler
Stikeman Elliott
Toronto, Canada
February 4, 2002
With special thanks to Raj Nijjar and Andrew Cunningham for their assistance.
© Stikeman Elliott 2002
TABLE OF CONTENTS
1 INTRODUCTION....................................................................................................................................1
2 CONTRACT FORMATION THROUGH THE INTERNET AND EXTRANETS........................1
2.1 Introductory comments..................................................................................................................1
2.2 Canadian courts’ approach to new technologies........................................................................2
2.3 E-commerce legislation in Canada................................................................................................2
2.3.1 Introductory comments .................................................................................................................2
2.3.2 Progress of the legislation ..............................................................................................................3
2.3.3 Enforceability of electronic contracts established...........................................................................3
2.3.4 Offer and acceptance......................................................................................................................4
2.3.5 Writing requirements ....................................................................................................................5
2.3.6 Signatures......................................................................................................................................5
2.3.7 Time and place of offer and acceptance ..........................................................................................7
2.4 Common law contract-formation principles ...............................................................................9
2.4.1 Introduction...................................................................................................................................9
2.4.2 Notice of the material terms of the contract...................................................................................9
3 THIRD PARTY BENEFICIARIES.......................................................................................................10
3.1 Introductory comments................................................................................................................10
3.1.1 The rule in Beswick’s case............................................................................................................10
3.1.2 Traditional ways around the rule ................................................................................................11
3.2 Relaxing the doctrine of privity...................................................................................................11
3.2.1 Introduction.................................................................................................................................11
3.2.2 London Drugs: focusing on the clause.........................................................................................12
3.2.3 Silva: focusing on the relationship between the parties ...............................................................14
3.2.4 Fraser River: Further extension of the exceptions to privity .......................................................15
3.2.5 Shield or sword? ..........................................................................................................................18
3.3 The U.K. Contracts (Rights of Third Parties) Act, 1999 ................................................................20
3.4 Implications of recent developments for drafting contracts ...................................................21
4 DUTY TO NEGOTIATE IN GOOD FAITH .....................................................................................22
4.1 Introductory comments................................................................................................................22
4.2 Recent cases....................................................................................................................................23
4.2.1 Introduction.................................................................................................................................23
4.2.2 Martel Building ...........................................................................................................................23
4.2.3 Cornell Engineering ....................................................................................................................25
4.2.4 Big Quill Resources: other legal principles used to achieve the same end ...................................27
4.2.5 Dofasco.........................................................................................................................................28
5 DAMAGES ..............................................................................................................................................28
5.1 Blake: restitution of profits ordered even where innocent party not harmed by breach.....28
5.1.1 The law prior to Blake ..................................................................................................................28
5.1.2 Facts.............................................................................................................................................29
5.1.3 Holding ........................................................................................................................................30
5.1.4 Comment......................................................................................................................................30
5.2 Other possible implications of Blake ...........................................................................................31
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6 NON-COMPETITION AGREEMENTS ............................................................................................32
6.1 Lyons v. Multari ..............................................................................................................................32
6.1.1 Facts.............................................................................................................................................32
6.1.2 Ruling ..........................................................................................................................................32
6.2 Drafting employment contracts in light of Lyons......................................................................34
7 RECTIFICATION...................................................................................................................................35
7.1 Introductory comments................................................................................................................35
7.2 Applying the rectification remedy in tax cases.........................................................................35
7.2.1 Re Juliar .......................................................................................................................................35
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Recent Developments in Contract Law
1
INTRODUCTION
Developments in the law of contract that significantly affect the negotiation and
formation of major business agreements are few and far between. In a business
context, a contract generally requires only the basic elements of offer, acceptance,
intention to contract and consideration, and these are rarely the subject of disputes
or radical legal developments. Nevertheless, there have been several developments
in the past few years of interest to transactions lawyers:
Contract law has come into the cyber-age with the passage across Canada of
legislation regarding on-line contracting. (Section 2)
That stalwart principle of privity of contract has started to crumble (Section 3).
Courts have re-affirmed that no duty to negotiate in good faith arises in the context
of negotiating ordinary business contracts. (Section 4)
An important House of Lords decision required a party who had breached a contract
without harming the other party to disgorge his profits. (Section 5)
The Ontario Court of Appeal has severely restricted the effectiveness of noncompetition clauses in employment contracts. (Section 6)
There has been a surprising decision from the Ontario Court of Appeal with respect
to the rectification of contracts. (Section 7)
2
CONTRACT FORMATION THROUGH THE INTERNET AND EXTRANETS
2.1
Introductory comments
Increasing acceptance and use of deal site extranets may soon make it commonplace
to close deals in cyberspace. Transactions lawyers should therefore keep an eye on
developments in the law of internet contract formation even though their effects are
for the moment largely restricted to e-commerce and online business-to-business
contracts.
2
2.2
Canadian courts’ approach to new technologies
Reliance on judges to create legal certainty with respect to new commercial
developments is typically unsatisfying, given the inevitable lag time between the
development and its consideration by a court—if indeed it is ever considered by a
court. One may nevertheless take comfort in the traditional willingness of Canadian
courts to adapt contract law principles to technologies such as the telephone, the
telex, the fax machine1 and, most recently, electronic forms of communication. In
Rudder v. Microsoft Corp.2 (1999), the Ontario Superior Court enforced a exclusive
jurisdiction clause contained in an electronic agreement, stating that a failure to
enforce electronic agreements “would lead to chaos in the marketplace, render
ineffectual electronic commerce and undermine the integrity of any agreement
entered into through this medium.”3
While the legislative developments discussed in Section 2.3 below have superseded
the common law in certain respects, there are still some issues that are not covered
by statute. I return to these in Section 2.4 below.
2.3
E-commerce legislation in Canada
2.3.1
Introductory comments
As we all know, however, parties to novel or untested types of transactions are not
always entirely reassured by our optimistic assertions that the courts will probably
not interfere with them. Happily, while we cannot yet provide them with certainty,
the void in the common law has been filled to a certain extent by new provincial ecommerce legislation that has been passed or proposed in all ten provinces4. This
Re Rolling and Willann Investments Ltd. (1989), 70 O.R. (2d) 578 (Ontario C.A.) and Beatty v. First Exploration Fund
1987 and Company, L.P. (1988), 25 B.C.L.R. (2d) 377 (British Columbia S.C.) at 395, where Hinds J. stated, “The
conduct of business has for many years been enhanced by technological improvements in communications.
Those improvements should not be rejected automatically when attempts are made to apply them to matters
involving the law. They should be considered and, unless there are compelling reasons for rejection, they should
be encouraged, applied and approved.”
2 Rudder v. Microsoft Corp. (1999), 47 C.C.L.T. (2d) 168, 2 C.P.R. 474 (Ontario S.C.J.).
3 Rudder, note 2 above, ¶16.
4 The federal Personal Information Protection and Electronic Documents Act, S.C. 2000, c. 5 (“PIPEDA”) sets out a
legislative scheme by which electronic data can satisfy writing requirements under federal laws that do not
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highly significant legislative development is discussed below, followed by some
further thoughts on the state of the common law in this area.
2.3.2
Progress of the legislation
Legislation governing the electronic formation of contracts was enacted in 2000 or
2001 in British Columbia,5 Manitoba,6 New Brunswick,7 Nova Scotia,8 Ontario,9
Prince Edward Island,10 Quebec,11 Saskatchewan,12 and the Yukon13. In the
remaining provinces (Alberta14 and Newfoundland15) bills are currently making
their way through the legislative process. Every province but Quebec has modelled
its e-commerce legislation on the Uniform Law Conference of Canada’s Uniform
Electronic Commerce Act (the “Uniform Act”).16 The Uniform Act was in turn
designed to implement the principles of the United Nations Model Law on
Electronic Commerce, adopted by the U.N. General Assembly in November 1996.17
2.3.3
Enforceability of electronic contracts established
Provincial e-commerce legislation has been drafted to be “media neutral”,
recognizing electronic communications, documents, contracts and signatures as
functionally equivalent to their written or printed counterparts.18 It clearly
expressly permit the use of electronic media. Under Canadian constitutional law, however, contracting between
private parties falls within the exclusive jurisdiction of provincial governments. Hence, this section only
discusses the relevant provisions of the provincial legislation.
5 Electronic Transactions Act, S.B.C. 2001, c. 10.
6 Electronic Commerce and Information, Consumer Protection Amendment and Manitoba Evidence Amendment Act, S.M.
2000, c. 32.
7 Electronic Transactions Act, S.N.B. 2001 (chapter number not yet assigned).
8 Electronic Commerce Act, S.N.S. 2000, c. 26.
9 Electronic Commerce Act, S.O. 2000, c. 17.
10 Electronic Data Transmission Act, S.P.E.I. 1997, c. 63.
11 An Act to establish a legal framework for information technology, S.Q. 2001, c. 32.
12 Electronic Information and Documents Act, S.S. 2000, E-7.22.
13 Electronic Commerce Act, Yukon O.I.C. 2000/29.
14 Bill 21, Electronic Transactions Act, (third reading, November 25, 2001).
15 Bill 35, An Act to Facilitate Electronic Commerce By Removing Barriers to the Use of Electronic Communication (first
reading, November 19, 2001).
16 See <http://www.ulcc.ca>. See John D. Gregory, “Canadian Electronic Commerce Legislation” (IT.Can/Law
Society of Upper Canada, Second Annual IT Law Spring Training Program, April 2001).
17 <http://www.uncitral.org>.
18 The legal recognition of the functional equivalency of electronic data is particularly important in the context of
legislative requirements for “written” agreements or “signatures”. This is discussed in further detail below.
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establishes that the legal effect or enforceability of a contract will not be denied
simply because one or more of its elements is in electronic form.
The legislation provides some general guidance on how to translate the traditional
elements of contract law—offer and acceptance, signatures, etc.—into an electronic
context.
2.3.4
Offer and acceptance
The legislation clearly allows offers and acceptances to be communicated
electronically. An example is Ontario’s Electronic Commerce Act, which states that an
offer, the acceptance of an offer, or any other matter that is material to the formation
or operation of a contract may be expressed:
by means of electronic information or an electronic document, or
by an act that is intended to result in electronic communication, such as touching or
clicking on an appropriate icon or other place on a computer screen or speaking.
This leaves a great deal of scope to design a process for electronic closings. The
legislation does not impose any particular requirement that the process for
communicating offers and acceptances meet any standards of reliability or
authenticity.19 It is up to the parties to deal with these issues in designing their
process.
The legislation makes it clear that an electronic communication meeting these
criteria will be effective. Should the parties not want this form of communication to
constitute an offer or an acceptance, they should specifically agree during the course
of negotiations that electronic communication of the acceptance of the final
documentation will not constitute effective communication of the final offer or
acceptance of that offer.
19 Section 23(2) of Manitoba’s Electronic Commerce and Information Act does stipulate that where a right is to be
granted or an obligation is to be acquired by one person and no other and there is a legal requirement that the
document be in writing, the requirement may only be satisfied by the use of electronic documents if a standard
of reliability is met that considers all the circumstances, including the purpose for which the right or obligation
was conveyed and any relevant agreement.
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2.3.5
Writing requirements
The business transactions in which we have typically been involved rarely give us
pause to consider the legal requirement that a contract be in writing in order to be
enforceable, given that all the agreements are in writing (many times over in fact!).
As these transactions begin to take advantage of the possibilities of electronic
contracting, however, this requirement will take on greater significance in the
business context. The Statute of Frauds20 is still relevant to many types of contracts
that can be involved in a major business transaction, including certain guarantees,
contracts that may not be performed within one year21 and sale of goods. Without
the legislation, if such a contract was in an electronic format, it may not meet the
Statute’s requirement that it be evidenced by a memorandum “in writing.”
However, the electronic commerce legislation has solved that problem by providing
that any legal requirement that a contract be in writing is satisfied by an electronic
contract.
2.3.6
Signatures
LEGAL SIGNIFICANCE
In most business transactions, a signature traditionally indicates the intention to be
bound by the terms of an agreement. Such an intention is among the basic
requirements for forming a valid contract. Even in the digital age, it seems
reasonable to assume that parties will continue to require some form of electronic
signature to indicate final and formal offer and acceptance of the agreements.
Moreover, a signature is legally required in certain cases: for example, in contracts
subject to consumer protection legislation, to the Sale of Goods Act or the Statute of
Frauds (such as guarantees).
R.S.O. 1990, c. S-19.
This particular class of contract was removed from the types of contract that are required to be in writing in
Ontario, but the point is still relevant in certain other provinces.
20
21
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ELECTRONIC SIGNATURES PERMITTED UNDER THE NEW LEGISLATION
The provincial e-commerce legislation provides that electronic signatures can have
the functional equivalence of signatures on paper.22 This provision applies where
there is a legal requirement of a signature. Therefore, it does not apply to the typical
situation where there is no statutory or other formal signature requirement.23
WHAT COUNTS AS AN ELECTRONIC SIGNATURE LEFT UNCERTAIN
Most provincial e-commerce legislation is similar to Ontario’s in defining “electronic
signature” as “electronic information that a person creates or adopts in order to sign
a document and that is in, attached to, or associated with the document.” However,
the provincial acts do not set standards for the reliability of electronic signatures.
Therefore it is not clear at this stage whether pre-printed names on an electronic
version of a document or a signature automatically appended to an electronic
message would count as a signature under the new legislation. In contrast, a secure
digital signature could be considered analogous to an ink-stamped signature and
therefore acceptable.24 Recent developments in digital technology have greatly
enhanced the security and reliability of these cyber-signatures.
Most of the provincial acts provide that regulations can be promulgated to impose
some particular degree of reliability should it be required. Presumably, the general
common law evidentiary requirements would still apply to an electronic signature,
namely the need to prove that it was signed by the person it purported to be signed
by and that the person had authority (actual or ostensible). (Manitoba’s statute,
however, does require that any requirement that something be in writing, including
an electronic signature, must meet a reliability standard that takes into account all
22 See, for example, the Ontario Act, n. 9, above, s. 11. The corresponding section in the Uniform Act (see n. 16
above) is s. 10.
23 It might apply, for example, where the parties had agreed in pre-closing documents that signatures were
required.
24 Industry Canada has indicated the federal government’s desire to facilitate commercial transactions on the
Internet. In its analysis of electronic signatures, it states that an electronic signature will be considered
trustworthy where reliable technology such as digital signature technology is used, combined with a reliable
certification authority. For more information see http://e-com.ic.gc.ca/english/641.html
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the circumstances under which the agreement was made. It remains to be seen what
difficulties this will cause.)
2.3.7
Time and place of offer and acceptance
SIGNIFICANCE IN A BUSINESS LAW CONTEXT
Occasionally it is important to know when an offer or acceptance of an offer has
been made. Deadlines might be imposed in pre-closing documents, for example.
Where a document is entered into may also be important because the law of that
place may be the governing law on the issue of due execution and delivery. Where a
contract is made can also be a factor in determining the governing law for the
interpretation and formation of the agreement where there is no express governing
law (but in a major negotiated transaction it is rarely the case that there is no express
governing law). The provincial electronic commerce legislation includes rules that
assist in making these determinations.
UNDER THE COMMON LAW
By way of background, Canadian courts generally apply the following common law
principles when determining when and where a contract is formed.
Under the instantaneous communication rule, contracts formed by means of
instantaneous communication are made when and where the offeror receives notice
of the acceptance.
Under the mailbox rule, contracts formed by correspondence are made when and
where the acceptance is sent. This rule applies to mailed or delivered acceptances.
Canadian courts have not decided whether contracts formed over the Internet
(either through email or automatically by clicking on a website) are governed by the
“instantaneous communication rule” or by the “mailbox rule”. Some guidance is
given by a recent case that applied the instantaneous communications rule to
communication by fax. In Eastern Power Ltd. v. Azienda Communale Energia &
Ambiente25 the Ontario Court of Appeal based its decision on the fact that fax
25
Eastern Power Ltd. v. Azienda Commulale Energia & Ambiente (1999), 178 D.L.R. (4th) 409 (Ont. C.A.), leave to
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communications are more like face to face communications than postal
communications. Thus, it would appear that where both parties indicate a
willingness to use (and do in fact use) a medium that facilitates virtually
instantaneous communication, such as fax machines or the Internet, to form a
contract, the instantaneous communication rule should apply.
UNDER THE NEW LEGISLATION
The e-commerce legislation provides rules for determining when an electronic
document is sent and received, but does not specifically say whether the mailbox
rule or the instantaneous communication rule applies. Here is what the Ontario Act
says about “when”—first with respect to sending and secondly with respect to
receipt:
22. (1) Electronic information or an electronic document is sent when it
enters an information system outside the sender’s control or, if the sender
and the addressee use the same information system,26 when it becomes
capable of being retrieved and processed by the addressee.
(2) Subsection (1) applies unless the parties agree otherwise.
(3) Electronic information or an electronic document is presumed to be
received by the addressee,
(a) if the addressee has designated or uses an information system for
the purpose of receiving information or documents of the type sent,
when it enters that information system and becomes capable of being
retrieved and processed by the addressee; or
(b) if the addressee has not designated or does not use an information
system for the purpose of receiving information or documents of the
type sent, when the addressee becomes aware of the information or
document in the addressee’s information system and it becomes
capable of being retrieved and processed by the addressee.
The substance of these rules would suggest that the instantaneous communication
rule is the more appropriate one to apply at least where an information system is
used or designated (e.g. an extranet) or where the contract provides for email
communication. The mailbox rule might apply in other situations.
appeal denied (2000), 259 N.R. 198n (S.C.C.).
26 “Information system” is not a defined term.
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In addition to dealing with the “when” the Ontario Act also deals with the “where”
of the sending or receipt.
20. (4) Electronic information or an electronic document is deemed to be sent
from the sender’s place of business and received at the addressee’s place of
business.
(5) Subsection (4) applies unless the parties agree otherwise.
(6) If the sender or the addressee has more than one place of business, the
place of business for the purposes of subsection (4) is the one with the closest
relationship to the underlying transaction to which the electronic information
or document relates or, if there is no underlying transaction, the person’s
principal place of business.
The implication is that where the instantaneous communication rule applies the
contract will be formed where the offeror has its place of business. Where the
mailbox rule applies, it is likely found at the place where the offeree has its place of
business. Of course, the difficulty in applying any of these rules whether in the
electronic or non-electronic context to major types of transactions is that it is not
always easy to determine who is the offeree and who is the offeror.
2.4
Common law contract-formation principles
2.4.1
Introduction
While the electronic contracts legislation deals with the formalities of offer and
acceptance and signatures, in other respects the formation of electronic contracts will
continue to be governed by the common law. The instantaneous communication vs.
mailbox rule question is one such issue, and there are others that might arise and
have perhaps have a different spin in the electronic context.
2.4.2
Notice of the material terms of the contract
Rudder v. Microsoft raised a question about the type of notice that had to be given
with respect to the terms of the contract.27 Mr. Justice Winkler of the Ontario
Superior Court of Justice decided that where an offer clearly indicates that a certain
27
Rudder v. Microsoft, note 2 above.
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action will constitute acceptance—such as clicking on an “I Agree” icon—the action
will be held to constitute acceptance. This point is now addressed by the legislation
as described in 2.3.4 above.
However, the Court in Rudder also noted that to constitute a valid offer, the
communication must include all of the material terms of the contract with
reasonable specificity to permit these terms to be ascertained. The court dismissed
the argument that terms not immediately apparent on a screen containing an
electronic contract could be considered “fine print” simply because one had to
“scroll down” to see the whole contract. It was held that the terms of an electronic
contract need not be simultaneously visible on the computer monitor any more than
a contract printed on paper has to be printed on a single page. The Court held,
incidentally, that “fine print” means much the same thing in electronic contracting
as it does in any other kind: tiny type or egregious legalese.
3
THIRD PARTY BENEFICIARIES
3.1
Introductory comments
3.1.1
The rule in Beswick’s case
Those of us who were regular attendees of our first year contracts courses no doubt
have been long familiar with the common law third party beneficiary rule as a result
of the memorable case of Peter Beswick, that scoundrel nephew who refused to
make good on his contractual promise, upon buying his uncle’s business, to pay an
annuity to his uncle’s widow upon his death.28 Because she was not a party to the
contract, the widow had no ability to sue on the contract in her own right and was
able to assert her rights only because she happened also to be the executor of the
husband’s will and stood in his shoes. As executor, however, she (i.e. the estate)
suffered nominal damages at most. To get around the problem, the court ordered
specific performance. That is not always going to be an option, however, and even if
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a party to the contract could sue to enforce the breach of a promise in favour of a
third party, problems may arise with respect to proof of damages or perhaps in
motivating the party to sue on the third party’s behalf.
3.1.2
Traditional ways around the rule
We do not usually want third parties to have the right to sue under the contracts we
draft. But there are some exceptions. Probably the best example is a right of
indemnification in favour of directors, officers and employees or limitations of
liability that benefit these same persons. In such cases, we rely upon clever devices
such as the declaration of a trust with the trust promise being the contractual
promise which we want the third party to be able to enforce (in this case indirectly
through the trustee) or the establishment of an agency relationship. Then there are
situations where you want obligations to be performed in favour of subsidiary
companies within a corporate group but do not necessarily want them to be full
parties to the agreement. Procurement contracts are an example. Typically in these
situations you will have a master agreement with one corporate entity that allows
subsidiaries to order product. Without some other mechanism to create a direct
contractual relationship with the subsidiaries (which are awkward to design and
implement), the subsidiaries would not have any right to sue for breach of an
obligation to deliver a product to them even though they are the person suffering
damage. In any of these situations it would certainly be beneficial to be able to create
rights that a third party could enforce directly.
3.2
Relaxing the doctrine of privity
3.2.1
Introduction
The principle that a third party beneficiary has no standing to sue on the contract
has been subjected to criticism from judges in England29, Canada30 and
Beswick v. Beswick, [1968] A.C. 58 (H.L.).
See Woodar Investment Development Ltd. v. Wimpey Construction U.K. Ltd., [1980] 1 W.L.R. 277 (H.L.) at 291, per
Lord Salmon.
30 London Drugs Ltd. v. Kuehne & Nagel International Ltd., [1992] 3 S.C.R. 299 at 418-426, per Iaccobucci J.
28
29
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Australia.31Third party beneficiaries under contracts governed by U.S. law,32 the law
of a number of Commonwealth jurisdictions, including the province of New
Brunswick,33 and most recently, the United Kingdom,34 have the ability to sue
directly given the abolishment of the privity rule in these jurisdictions.
In common law Canada, apart from New Brunswick, the general rule of privity
survives. However, the force of the rule has been undermined by two decisions of
the Supreme Court of Canada, London Drugs Ltd. v. Kuehne & Nagel International
Ltd.,35 and more recently, Fraser River Pile & Dredge Ltd. v. Can-Dive Services Ltd.36 In
these rulings, the Court did not purport to overrule the general privity of contract
doctrine, stating instead that it was recognizing an exception specific to the
circumstances of each case. When these cases are examined closely, however, it
emerges that there is an arguable case that the Court did much more.
3.2.2
London Drugs: focusing on the clause
FACTS
While London Drugs dates all the way back to 1992, it is worth reviewing here
because it established the context for more recent developments. The case asked
whether employees of a contracting business corporation could directly enforce the
corporation’s limitation of liability clause as a defence against their own negligence.
The facts were as follows: the plaintiff had delivered a transformer to a warehouse
company for storage pursuant to the terms and conditions of a standard form
contract. The contract had included a limitation of liability clause limiting the
warehouseman’s liability on any one package to $40. With full knowledge and
understanding of this clause, the plaintiff had chosen not to obtain additional
insurance from the warehouse company, arranging instead for its own all-risk
Trident General Insurance Co. Ltd v. McNiece Bros. Pty. Ltd. (1988), 165 C.L.R. 107 at 116-24, per Mason C.J.
See M. Eisenberg, “Third Party Beneficiaries” (1992), 92 Col. L. Rev. 1358.
33 Law Reform Act, S.N.B. 1993, c. L-1.2, s.4.
34 Contracts (Rights of Third Parties) Act, 1999 (U.K.), c. 31. See discussion in Section 3.3, below.
35 See note 30, above.
36 Fraser River Pile & Dredge Ltd. v. Can-Dive Services Ltd. (1999), 176 D.L.R. (4th) 257 (S.C.C.).
31
32
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coverage. When the defendant employees had moved the transformer in an unsafe
way, it had toppled over, causing extensive damage. The plaintiff had sued the
warehousing company and the employees for damages for breach of contract and
negligence. At issue was whether the employees could claim the benefit of their
employer’s contractual limitation of liability clause.
RULING
The Supreme Court of Canada held that employees should be entitled to benefit
from a limitation of liability provision in a contract between their employer and the
plaintiff if both of the following requirements are satisfied:
The clause must, either expressly or impliedly, extend its benefits to the employees
seeking to rely on it.
The employee or employees seeking the benefit of the clause must have been acting
in the course of their employment and must have been performing the very services
provided for in the contract when the loss occurred.
The Court held that the employees were not complete strangers to the clause, but
were unexpressed or implicit third party beneficiaries with respect to it. In making
this determination, the Court took into account the nature of the relationship
between the employees and their employer, the identity of interest with respect to
contractual obligations, the fact that the plaintiff knew that employees would be
involved in performing the contractual obligations and the absence of a clear
indication in the contract to the contrary. The term “warehouseman” was extended
to cover them.
COMMENT
The Court was swayed by the policy arguments and decided that the doctrine of
privity should not stand in the way of commercial reality and justice. It believed that
a contrary result would create uncertainty and require excessive expenditures on
insurance by defeating the allocations of risk specifically made by the contracting
parties and the reasonable expectations of everyone involved, including the
employees.
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3.2.3
Silva: focusing on the relationship between the parties
FACTS
The Ontario Court of Appeal recently applied the London Drugs exception in
extending the benefit of a waiver of subrogation in an insurance contract to a third
party. In Tony and Jim’s Holdings Ltd. v. Silva, the Ontario Court of Appeal
interestingly allowed the defendant to benefit from the clause even where it was not
entirely clear on the wording that this particular third party was contemplated as or
intended to be a beneficiary of the waiver.37 An insurance policy had been issued to
the landlord of a pizza parlour. The relevant lease did not contain an express
covenant to insure, but it did provide that the tenant would pay insurance
premiums. The insurance company conceded that it could not sue the tenant (which
was a corporation)38 but went after the defendant Norman instead. Norman, the
tenant’s principal, had negligently caused the fire. The insurance company argued
that he could not benefit from the landlord’s obligation to insure because he was not
a party to the lease.
RULING
Norman advanced a number of arguments, some of which were that the corporate
veil between him and the corporate tenant should be lifted. While it refused to
ignore the separate existence of the corporation, the Court nevertheless accepted that
the close identity of interest between Norman and the corporate tenant was
sufficient to extend the benefit of the landlord’s implied covenant to insure to
Norman. The identity of interest arose because the landlord would have understood
that the tenant could only be negligent through the acts of its individual agents.
Also, a strict application of the doctrine of privity in this case would have effectively
allowed the insurer to circumvent the waiver of subrogation to which it had agreed.
Tony and Jim’s Holdings Ltd. v. Silva (1999), 170 D.L.R. (4th) 193 (Ont. C.A.).
It agreed because of the well-established principle, accepted here by the Court, that the risk of loss by fire
passes to the landlord when the lease requires the tenant to pay fire insurance premiums even in the absence of
an express covenant to insure. No benefit would flow to the tenant from its promise to insure if the insurance did
not protect it from its own negligence.
37
38
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The policy stated that the insurer waived all rights of subrogation against any
corporation, firm, individual or other interest with respect to which insurance is
provided by the policy. The Court admitted that this language was “certainly not the
clearest,” but stated that where fire coverage is extended to leased premises for fire
caused by the negligence of anyone, the scope of this waiver can reasonably be
interpreted to extend to the tenant who, in the words of the clause has an interest
with respect to which insurance is provided by the policy and that this must be wide
enough to include those individuals through which the corporate tenant must
necessarily act.
COMMENT
The interesting thing about this case is the extent to which the Court examined the
issue by considering the lease and the relationship between the landlord and the
tenant, as opposed to focusing primarily on the wording of the policy itself. Another
interesting point is that in London Drugs (and Fraser River, discussed below) the
Supreme Court of Canada made a point of saying that the contract must clearly
extend the benefit to the third party. It could hardly be said in this case that the
intention to extend the benefit of this clause to the employee of the tenant was clear.
3.2.4
Fraser River: Further extension of the exceptions to privity
FACTS
Fraser River continued the Supreme Court of Canada’s slow march toward abolition
of the privity rule. Similar to the Silva case it dealt with a waiver of subrogation
rights in an insurance policy. Fraser owned a barge that it sometimes chartered to
companies like Can-Dive. Fraser’s insurance contract contained a waiver of the
insurance company’s subrogation rights with respect to charterers of the barge. CanDive chartered the barge and it sank. The insurer paid out to Fraser. But then Fraser
agreed to waive its waiver, allowing the insurer to go after Can-Dive.
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RULING
While again the Supreme Court made only a limited exception to the privity rule, it
did open the door to judges in subsequent cases extending the exceptions further.
Iacobucci J. stated that the privity rule must be reformed to reflect commercial
realities, but added that courts could not take on this task themselves: a complete
overhaul of a common law rule should be left to Parliament (as has happened with
the privity rule in the U.K.—see below). What the Supreme Court can do is to
introduce incremental change where it is appropriate. This is what began to happen
with the London Drugs decision, where a “principled exception” was made.
Iacobucci J. took the position that the ruling in London Drugs was the basis for a
more general relaxation of privity, a process that in future will be governed by two
“critical and cumulative factors” that can be expressed in question form as follows:
Did the parties to the contract intend the relevant provision to confer a benefit on the
third party seeking to rely on the contractual provision?
Were the activities performed by this third party the very activities contemplated as
coming within the scope of the contract in general or the provision in particular,
again as determined by reference to the intention of the parties?
On a plain reading of the waiver of subrogation clause it clearly applied to CanDive. The owner’s argument was not, however, that Can-Dive did not come within
the scope of the clause, but that only the owner could enforce it on Can-Dive’s
behalf. The court rejected this argument.
The owner then argued that its agreement with the insurer to delete the waiver of
subrogation was effective. The court noted that it was a significant concern in
relaxing the doctrine of privity that it would restrict the freedom of contract that
could result if the interests of a third-party beneficiary must be taken into account by
the parties to the initial agreement before any adjustment to the contract could
occur.
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However, in this case the parties had tried to alter the agreement after the point at
which Can-Dive’s defence had materialized. Iacobucci J. wrote at paragraphs 36 and
37:
Having contracted in favour of Can-Dive as within the class of potential
third-party beneficiaries, Fraser River and the insurers cannot revoke
unilaterally Can-Dive’s rights once they have developed into an actual
benefit. At the point at which Can-Dive’s rights crystallized, it became for all
intents and purpose a party to the initial contract for the limited purposes of
relying on the waiver of subrogation clause. Any subsequent alteration of the
waiver provision is subject to further negotiation and agreement among all of
the parties involved, including Can-Dive.
[N]othing in these reasons concerning the ability of the initial parties to
amend contractual provisions subsequently should be taken as applying
other than to the limited situation of a third-party’s seeking to rely on a
benefit conferred by the contract to defend against an action initiated by one
of the parties, and only then in circumstances where the inchoate contractual
right has crystallized prior to any purported amendment. Within this narrow
exception, however, the doctrine of privity presents no obstacle to contractual
rights conferred on third-party beneficiaries.
Iacobucci J. declined to distinguish Fraser River from London Drugs, on the ground
that in the latter the third-party beneficiary employees were performing services
under the very contract that contained the liability limitation, unlike Can-Dive,
which acted under a separate contract with Fraser.
COMMENT
What is important, according to the second part of Iacobucci J.’s test, is whether the
purported third-party beneficiary is involved in the very activity contemplated by
the contract containing the provision upon which he or she seeks to rely. This
reasoning in the decision should extend easily to waiver of subrogation clauses in
guarantees and perhaps to agreements such as subordination agreements.
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3.2.5
Shield or sword?
THE ISSUE
The court in both London Drugs and Fraser River made a point of stating that the
exceptions to the privity doctrine would allow a party to rely on a clause as a shield
and not as a sword. This limitation was confirmed in a couple of recent cases, but
probably should not be seen as a bar in all cases.
PARWINN DEVELOPMENTS
In Parwinn Developments Ltd. v. 375069 Alberta Ltd.39 the plaintiff real estate broker
and his personal real estate company sought to recover real estate commissions. The
clause providing for the payment of commission was in the contract between the
vendor and the purchaser of the property and it provided that the vendor would
pay the commissions to the “Agent”. The Agent within the meaning of the clause
was actually another real estate broker, not the plaintiff. The plaintiff’s claim did not
meet either of the two criteria set out by the Supreme Court of Canada. There was
no evidence that the clause was intended to extend to the plaintiffs. The court also
agreed that the plaintiffs were trying to use the clause to create rights, and not as a
defence, and this was not permitted under the recognized exception.
RDA FILM DISTRIBUTION
In RDA Film Distribution Inc. v. British Columbia Trade Development Corp.40 the
plaintiff companies, RDA Film Distribution Inc. (“Distribution”) and a related
company, RS II Productions Inc. (“Production”), had been incorporated for the
purpose of producing, marketing and distributing feature films. The defendant
(“B.C. Trade”) was an agent of the provincial government whose purpose was to
facilitate the export of goods and services. The Plaintiffs secured a bank loan to
finance the films and B.C. Trade entered into a contract with Distribution to
guarantee a substantial portion of the loan. The contract provided that B.C. Trade
39
40
Parwinn Developments Ltd. v. 375069 Alberta Ltd. (2000), 259 A.R. 137, 30 R.P.R. (3d) 74 (Alberta Q.B.).
RDA Film Distribution Inc. v. British Columbia Trade Development Corp. (2000), 83 B.C.L.R. (3d) 302 (British
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would receive a charge over distribution rights in foreign markets. B.C. Trade
subsequently repudiated the contract on the ground the Plaintiffs failed to provide
adequate security. The trial judge allowed Distribution to recover damages, but held
that although the Plaintiffs acted as a group enterprise, Production could not recover
on the basis of B.C. Trade’s breach of its contract with Distribution.
The B.C. Court of Appeal dismissed Production’s appeal, holding that privity of
contract was to be extended only in very limited circumstances. The Court made
much of sword-shield distinction, noting that in both London Drugs and Fraser River
the defendants had been permitted to rely on a contractual term only as a defence
against a possible liability. Although acknowledging that it is sometimes fortuitous
whether a particular party is a defendant in need of a shield or a plaintiff seeking a
sword, the Court noted that different considerations, in terms of mutuality and
fairness, usually apply to the two situations. For example, the Court pointed out that
in London Drugs it was not unfair for the defendant’s employees to rely on the
contract in defence to the plaintiff’s action, while it might well have been unfair to
allow those same employees to sue London Drugs for a breach of contract. In the
present case, the Court reasoned that it would be unfair to allow Production to sue
B.C. Trade under the guarantee agreement, unless B.C. Trade could also sue
Production for a breach on its part. Yet it is unlikely that B.C. Trade would be
allowed to do so because it would be argued that if it had been intended that
Production could be liable, B.C. Trade should have insisted on receiving
Production’s contractual promise.
In spite of the Court’s suggestion that the principled exception to the privity rule
does not give a third party enforceable claims (as opposed to defences), it also
appears that the Court’s reasoning is specific to the context of particular facts that
militated against relaxing the rule. Specifically, the Court noted that the separate
incorporation of Distribution and Production was evidence that the each acted as
Columbia C.A.).
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principal in the transaction, rather than as agent-principal. In addition, permitting
Production to recover in the present circumstances would have allowed the
possibility of double recovery against both B.C. Trade and Distribution, because the
trial judge had found that Production had a right of recovery against Distribution
under the Distribution Agreement between them.
COMMENT
It should also be noted that the two factors emphasized as most important in London
Drugs and Fraser River did not mention a sword vs. shield distinction. Accordingly, I
believe that the Court’s decisions do leave open the very real possibility for a
relaxation of the doctrine in certain limited types of rights, such as rights of
indemnity or enforcement of promises made specifically to a particular third party
or within a class.
3.3
The U.K. Contracts (Rights of Third Parties) Act, 1999
Rather than wait for the slow and meticulous judicial reform of the privity rule, the
United Kingdom has enacted legislation to achieve that purpose. The Contracts
(Rights of Third Parties) Act, 1999 has partially abolished the rule of privity by
allowing for the enforcement of contracts by third parties if the contract expressly so
provides or a term of the contract confers a benefit on the third party. While this is
not a development of Canadian contract law, it is still interesting to look at it briefly,
for a couple of reasons. First, if you make a contract subject to U.K. law, you could
take advantage of this legislation. Assuming the bona fides of the choice of law, this
would seem to be a purely contract law issue which would be a matter for the
chosen law. (Similarly with respect to any other jurisdiction without a privity rule.)
Secondly, a few of the terms in the legislation suggest some caveats that you may
want to take into account in drafting terms such as indemnities and other third party
beneficiary covenants.
Under Section 1, persons who are not a party to a contract (“third party”) may
enforce a term of the contract in their own right if (a) the contract expressly provides
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that the third party may or (b) the term purports to confer a benefit on the third
party. This is not unlike the requirement set out in London Drugs and Fraser River.
The Act also deals with the extent to which those rights conferred on third parties
may be amended without the consent of the third party. Section 2(1) limits the
ability of parties to vary or rescind the contract without the third party’s consent.
The limitation applies only where at least one of the following is the case:
The third party has communicated his assent to the term to the promisor.
The promisor is aware that the third party has relied on the term.
The promisor can reasonably be expected to have foreseen that the third party would
rely on the term and the third party has in fact relied on it.
The Act allows the parties to further limit the right of the benefited third parties to
consent to amendments by including express terms qualifying or ousting the
consent rights (s. 2(3)).
3.4
Implications of recent developments for drafting contracts
The following principles can be drawn from the recent developments in this area.
It’s fairly clear under Canadian common law that a limitation of liability or a waiver
of a right (such as a subrogation right) drafted in favour of a third party would be
enforceable directly by the third party assuming that the two basic criteria of London
Drugs and Fraser River were met.
It’s not yet the case that an indemnity or other obligation undertaken in favour of a
third party could be enforced directly based on this principle since it would require
reliance on the right as creating a claim and not merely a defence, but very good
arguments could be made in favour of extending the privity exception to specific
obligations.
If the contract confers benefits in favour of a third party, then the parties will be
constrained in their ability to amend those terms unless the contract provides
otherwise. In Fraser River, for example, the Supreme Court held that the parties could
not amend the contract without the third party’s consent once those rights had
“crystallized. ” The U.K. legislation also suggests that once it knows of or relies on
the right, the third party will have a right of consent with respect to any proposed
amendment to it, unless the contract says otherwise.
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What I think this means for us as drafters is that we could and should do the
following:
In any case where a contract confers a benefit on third parties, expressly build in
what rights the parties will have to amend the term (e.g. the scope of the indemnity
or the parties to be indemnified) without the consent of the benefited third parties. If
you do not, the parties may be constrained as to the changes they can make.
Presumably in many cases you would want to preclude any right to consent at all at
least until the right became enforceable.
Draft the clause as though the law did recognize the right as directly enforceable by
the third party. It probably will be if the parties intend it to be and make that
intention clear. That way your third parties may indeed get all the benefits of being
direct parties.
Continue to use the trust and agency concepts as backstops in the event that the
court does not recognize the direct right of action.
Expressly state that the contract does not confer rights on third parties other than for
those specific clauses that you do want third parties to be able to enforce.
4
DUTY TO NEGOTIATE IN GOOD FAITH
4.1
Introductory comments
It is not uncommon for parties to be happily negotiating towards an agreement,
having settled all of the major terms, when one gets cold feet for one reason or
another. The reason could have to do with the transaction itself: for example, the
principal of your client could decide (for amorphous reasons, perhaps) that he does
not trust the principal of the other party. Or it might be something unrelated, such
as a change in the economic climate or a change in corporate direction or policy. It
could even be that a better deal with another party has materialized. In these
circumstances we are often asked by our clients whether they have any obligation to
proceed with negotiations or to sign the agreement. Another slightly different sort of
situation that can come up in the course of negotiations occurs when your client
learns of some fact or circumstance that might be relevant to the other party’s
decision to go ahead and asks your advice as to whether it has to be disclosed to the
other party.
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In each of these situations, a number of legal issues can arise (e.g. misrepresentation,
whether in fact an agreement has been arrived at). Assuming, however, that there is
no concluded agreement, no need to correct a prior representation, etc., the ultimate
question will be whether there is an obligation to negotiate in good faith. If there
were such an obligation, it could require disclosure of relevant information or the
continuation of negotiations. So, is there any such obligation?
4.2
Recent cases
4.2.1
Introduction
While there are many examples of good faith obligations arising during a
contractual relationship, the existing case law certainly does not support the
application of such a general principle in the pre-contract stage. A number of recent
cases confirming that general proposition are worth noting.
4.2.2
Martel Building
FACTS
While the recent decision of the Supreme Court of Canada in R. v. Martel Building
Ltd.41 did not deal directly with this question, it strongly suggests that Canadian law
should not recognize such a duty. Martel was landlord to the Atomic Energy
Control Board (AECB). As the lease was about to expire, the Department of Public
Works entered into negotiations with Martel, indicating that it was interested in
renewing, but then later deciding to put the lease out for tender. There was no
question that the Department had not been up-front with Martel at various points
about its plans. In any event, Martel tendered what turned out to be the low bid.
However, the RFP contained a privilege clause stating that the Department reserved
the right to add various “fit-up” costs to the bids. The RFP also stated that AECB
required “contiguous” space. When the Department’s estimate of the fit-up costs,
41
R. v. Martel Building Ltd., [2000] 2 S.C.R. 860.
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including the cost of making Martel’s space contiguous, was added to the bids,
Martel’s bid came out second-lowest and it lost the tender.
Martel’s claim related both to the way in which the Department conducted the
negotiations for renewal of the lease and how it prepared and assessed the bids. In
terms of the negotiations for the lease renewal, Martel alleged that the Department
was negligent in not providing adequate information about its bargaining position
or its readiness to conclude a renewal of the lease. It had shown casual contempt
and minimal courtesy to Martel (cancelling appointments, imposing impossible
deadlines etc.). The action was framed in tort (that is, as a negligence claim).
HOLDING
With respect to the lease renewal, the court recognized that although its claim was
not framed as such, Martel seemed to be asserting a general duty to bargain in good
faith. Since the breach of such a duty was alleged in the Federal Court, but not
before the Supreme Court, the court held that whether contractual negotiations are
to be subject to a duty of good faith was a question for another time. Although the
court stated that a duty to bargain in good faith has not yet been recognized in
Canadian law, the court’s discussion regarding whether or not to extend the tort of
negligence to include negotiations sheds some light on how the court would
approach the issue. With respect to the lease renewals, the court held that a prima
facie duty of care existed based on the parties’ pre-existing landlord-tenant
relationship and the intent to negotiate a lease renewal. The court acknowledged
that although a set of facts could exist where a duty of care may arise in commercial
negotiations, there were strong policy reasons against recognizing a duty of care in
this case. Unlike most cases where the policy analysis focuses on potential for
liability in an indeterminate amount to an indeterminate class, this case focused on
other policy reasons. Among the reasons was that tort law should not be used as an
insurance policy against failure to conduct appropriate due diligence or as a hedge
against unsuccessful negotiations. Also, hard bargaining is economically and
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socially useful. The court held that it would defeat the essence of negotiations and
hobble the marketplace to extend a duty of care to the conduct of negotiations and to
label a party’s failure to disclose its bottom line, its motives or its final position as
negligent. This conclusion would of necessity force the disclosure of privately
acquired information and the dissipation of any competitive advantage derived
from it, all of which is incompatible with the activity of negotiating and bargaining.
COMMENT
This case will give no comfort to the supporters of a duty to negotiate in good faith,
rejected or disregarded in both lower courts in Martel and not pursued in the
Supreme Court, though nevertheless expressly noted. However, the reasons given
by the Supreme Court for rejecting any closely resembling duty of care in tort seems
equally destructive of any implied good faith duty during negotiations.
4.2.3
Cornell Engineering
INTRODUCTORY COMMENTS
Following roughly the same analysis as in Martel the Ontario Court of Appeal
recently held in 987011 Ontario Ltd. v. Cornell Engineering Company Ltd42 that one
party to a potential employment contract had no obligation to point out a rather
beneficial termination compensation provision he had included in the draft contract
to his potential employer, again supporting the view that in the absence of a
fiduciary relationship or duty of care in tort, no obligation to make positive
disclosures that might be relevant to the other party exists.
FACTS
The facts were a little convoluted. Stevens and Bimboga owned 51% and 49% of
Cornell, an engineering firm. Stevens, age 70, was a family friend of the much
younger engineer Macdonald. When Bimboga wanted out of Cornell, Macdonald
expressed a strong interest in working for Cornell. Stevens then suggested that he
42 987011 Ontario Ltd. v. Cornell Engineering Co. Ltd. (2001), 198 D.L.R. (4th) 615 (Ontario C.A.), reversing (1998), 41
B.L.R. (2d) 219 (Ontario Gen. Div.). Leave to appeal denied, [2001] S.C.C.A. No. 315.
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buy Bimboga’s share. Before negotiations for the purchase of Bimboga’s share were
completed, Macdonald and Cornell agreed to an employment contract. This contract
did not contain a termination clause. Cornell’s accountant then advised that it would
be mutually beneficial if Macdonald provided his services through his numbered
company. Stevens asked Macdonald to prepare the agreement. Macdonald did so by
using a precedent he found and typing a few new clauses onto address labels and
sticking them over clauses in the precedent that were not appropriate. One of the
new clauses was a termination clause under which Macdonald would receive twice
the remuneration that he had been paid to date should the purchase of Bimboga’s
shares fall through for any reason. When Macdonald handed him the eleven page
contract, Stevens ignored his advice to read it, looked at the first couple of pages and
signed. The purchase of Bimboga’s shares fell through after Bimboga played a long
cat-and-mouse game, in which Stevens participated, repeatedly changing his mind
about selling, raising his price, changing his mind again, and so on. Macdonald then
sought to enforce the agreement.
HOLDING AT TRIAL
The trial judge held that there was no fiduciary relationship but that there was a
duty of good faith to point out the clause because Stevens had the right to expect
that the personal services agreement would contain no important provisions that
were not already in the agreed-to employment contract. The trial judge recognized
that there needed to be a “special relationship” to create a good-faith obligation like
this and found it in the “mentor-mentee” and nearly “father-son” relationship
between Stevens and Macdonald. On the basis of this the court ordered rectification
of the contract to delete the beneficial termination clause.
HOLDING ON APPEAL
Madam Justice Weiler, for the Court of Appeal, agreed that the question was
whether there was a special relationship. That relationship must be such as to have
entitled Stevens to rely on Macdonald. The “indicia” of such a relationship are those
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set out in Prof. Paul Finn’s 1989 article “The Fiduciary Principle”43, which Weiler J.A.
summarized, at paragraph 35, as “dependence, influence, vulnerability, trust and
confidence.” Here, Stevens, an experienced businessman, was Macdonald’s mentor,
not the other way around. Furthermore, the court noted that since the expectations
of the parties at the time a contract was signed can be determined with reference to
their later conduct, Stevens’ participation in Bimboga’s negotiation ploys did not
suggest that he had much regard for Macdonald’s interests and therefore he could
not expect Macdonald to have regard for his. The trial judge’s decision to apply the
doctrine of rectification was held to have been unjustifiable given that the parties
had not discussed a termination provision and therefore could not have been said to
have had a common understanding, prior to signing the contract, of what that
provision would say.
4.2.4
Big Quill Resources: other legal principles used to achieve the same end
FACTS
While no generally applicable duty to bargain in good faith is likely to be
recognized, courts are still free to apply other more traditional contract or tort
principles to pre-contractual conduct that constitutes sharp practice. Big Quill
Resources Inc. v. Potash Corporation of Saskatchewan44 is a recent example. The plaintiff
bought feed-stock from the defendant under a contract that defined the price as an
average of the defendant’s costs. In the initial agreement, the costs that were to be
used in the formula were defined as including only provincial sales taxes. When the
agreement was up for amendment, the word “sales” was removed from the crucial
clause by the president of the defendant without specific notice to anyone else at the
defendant company (or to the defendant’s counsel) or to the plaintiff. When the
plaintiff discovered what had happened and that it was now expected to pay a
significantly higher price than it had anticipated, it sought to have the amended
Paul Finn, “The Fiduciary Principle,” Equity, Fiduciaries and Trusts, T.G. Youdan, ed. (Toronto: Carswell, 1989).
Big Quill Resources v. Potash Corp. of Saskatchewan, [2000] 10 W.W.R. 465 (Saskatchewan Q.B), aff’d (2001), 203
Sask. R. 298 (Saskatchewan C.A.).
43
44
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agreement rectified on the basis of the contract principle of mistake—the agreement
was a long-term agreement—and damages were for the amount that it had overpaid before the mistake was discovered.
HOLDING
The plaintiff’s claim succeeded at the trial court level on the basis that the plaintiff
had made a “unilateral mistake” and the agreement was rectified by re-inserting the
word “sales” into the agreement. A claim for punitive damages was dismissed. The
decision was appealed. The Saskatchewan Court of Appeal dismissed the appeal
and held that the facts supported the trial judge’s finding of unilateral mistake,
entitling the respondent to an order for rectification and a payment of monies
overpaid under the agreement as rectified.
4.2.5
Dofasco
An example in the tort context is NBD Bank v. Dofasco45, which imposed liability on
an officer of a borrower for the tort of misrepresentation when he misrepresented
the causes of his company’s current financial woes in order to induce the lender to
advance funds.
5
DAMAGES
5.1
Blake: restitution of profits ordered even where innocent party not harmed by breach
5.1.1
The law prior to Blake
There tend not to be many significant developments in the law of damages for
breach of contract. The basic principles have been established since Hadley v.
Baxendale.46 However, in Attorney-General v. Blake and Jonathan Cape Ltd. (2000),47 the
House of Lords set out a very important new principle with respect to the measure
of damages for breach of contract. The law lords considered the issue of whether a
NBD Bank v. Dofasco Inc. (1999), 46 O.R. (3d) 514, 181 D.L.R. (4th) 37 (Ontario C.A.), leave to appeal denied
[2000] S.C.C.A. No. 96.
46 Hadley v. Baxendale (1854), 9 Exch. 341, 156 E.R. 145.
45
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party who breaches a contract and profits from the breach is obliged to make
restitution of the profits where the innocent party has not suffered any damages.
Generally speaking, the principle for the measure of damages for breach of contract
is that the innocent party is to be compensated by being put into the position that it
would have been in had the contract been properly performed. There are often
situations where the contract breaker profits from breaching the contract and the
innocent party does not suffer any damages in the traditional sense. The idea that a
contract breaker should be made to disgorge the profits or benefits he may have
obtained by his breach is related to the notion of an “efficient breach.”48 This notion
asserts that there may be an economic advantage in allowing parties to break their
contracts, deliberately, if to do so would be to promote “wealth maximization.” The
introduction of such a principle would lead to the recognition of a distinction
between deliberate breaches of contract on the one hand, and negligent or
completely innocent breaches on the other. Under the current state of the law, there
is no right of recovery to the victim of a breach where the victim does not suffer any
damages in the traditional sense.49 Although courts often, in areas outside of
contract law, grant orders that a party breaching an obligation disgorge its profits
(breach of copyright, breach of trust or fiduciary duty, waiver of tort), there has not
been any unqualified acceptance that the court can order profits to be disgorged for
a breach of contract.
5.1.2
Facts
The defendant in Blake was the infamous British traitor, George Blake. He was a
member of the British intelligence forces during and after the war. He was also a
Russian spy and in 1961 he was imprisoned for breach of the Official Secrets Act,
Attorney-General v. Blake and Jonathan Cape Ltd., [2000] 3 W.L.R. 635 (H.L.)
For a review of this principle, see Sharpe, Injunctions and Specific Performance, 2nd ed. (1992), ¶¶7.120-7.170.
49 See Asamera Oil Corp. v. Sea Oil & General Corp.; Baud Corp., N.V. v. Brook (1979), 89 D.L.R. (3d) 1 at 30 (S.C.C.)
per Estey J.: “…the motives or unjust enrichment of the defendant on breach are generally of no concern in the
assessment of contractual damages.” See also judgement of English Court of Appeal in Surrey C.C. v. Bredero
Homes Ltd. [1993] 3 All E.R. 705 (C.A), indicating that damages compensate the plaintiff, and are not intended to
transfer the defendant’s gains to the plaintiff.
47
48
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having disclosed sensitive information to the Soviet Union. He escaped from prison
and fled to Moscow. In 1990 he published a book about his life. By that time the
information he had disclosed was no longer secret. He had, however, signed an
undertaking when he was a British officer not to divulge any official information
gained by him as a result of his employment in the press or in a book and this
undertaking expressly applied after the end of his employment. The British
Government did not suffer any loss from the publication of the book, but was
seeking in this action the payment that was to be made by the publisher to Blake
(£60,000).
5.1.3
Holding
After reviewing the case law in various areas, Lord Nicholls of Birkenhead
concluded that there was no reason in principle why the court must rule out an
account of profits as a remedy for breach of contract and, in fact, the law supported
such a remedy. (He preferred the phrase “account of profits” over “restitutionary
damages”.) Remedies are the law’s response to a wrong. When “exceptionally” a
just response so requires, the court should be able to grant the discretionary remedy
of requiring a defendant to account to the plaintiff for the benefits he has received
from his breach of contract. In the same way as a plaintiff’s interest in performance
of a contract may render it just and equitable for the court to order specific
performance or injunction, so the plaintiff’s interest in performance may make it just
and equitable that the defendant retain no benefit from the breach. With respect to
confidentiality agreements he said that if confidential information is wrongfully
divulged in breach of a non-disclosure agreement it would be nothing short of
sophistry to say that an account of profits may be ordered in respect of the equitable
wrong but not in respect of the breach of contract.
5.1.4
Comment
However, it should be noted that the court made it clear that this will be an
appropriate remedy only in “exceptional” cases. Only where compensatory
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damages, specific performance or an injunction are not an adequate response can an
accounting be ordered. Beyond that the court would not set any fixed rules. The
court will have regard to all the circumstances, including the subject matter of the
contract, the purpose of the breached term, the circumstances of the breach, the
consequences of the breach and the circumstances in which relief is being sought. A
useful general guide, although not exhaustive, is whether the plaintiff had a
legitimate interest in preventing the defendant’s profit-making activity and hence, in
depriving him of his profit. Something more than the breach of a negative obligation
is also required. Also, the fact that the breach was cynical and deliberate, that the
breach enabled the defendant to enter into a more profitable arrangement, or that
the defendant put it out of his power to perform by entering into a more profitable
contract were not sufficient factors in and of themselves.
In this case the court was concerned that neither Blake nor any other member of the
secret service should have a financial incentive to breach his undertaking. To allow
Blake to profit from such behaviour would be an affront to justice. Lord Steyn, for
example, stated that “practical justice strongly militates in favour of granting an
order for disgorgement” and frankly admitted that he was willing to “subordinate
conceptual difficulties” to achieve that end.50
5.2
Other possible implications of Blake
Although the principle of gain-based relief has received relatively little attention in
Canada, the House of Lords decision in Blake may encourage claimants to seek a
disgorgement of profits. Confidentiality contracts are obviously entered into with
great frequency in the context of major transactions, particularly in a pre-acquisition
period. We might see attempts to apply Blake in the context of confidentiality or
other agreements perhaps where the party is unable to get specific performance or
an injunction not because damages are adequate, but for other reasons such as not
bringing the motion on quickly enough. In such a case an accounting of profits
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might be a useful remedy. While the House of Lords found that its application
should be quite limited, the fact that the remedy is a possibility could have a
significant impact on settlement negotiations.
6
NON-COMPETITION AGREEMENTS
6.1
Lyons v. Multari
6.1.1
Facts
The Ontario Court of Appeal recently issued an important decision on noncompetition and non-solicitation agreements. Lyons v. Multari51 was concerned with
non-competition clauses in the context of employment agreements. The plaintiff and
the defendant were both oral surgeons. The defendant, a recent graduate, was hired
as an associate by the plaintiff, a senior Windsor practitioner. They signed a short,
hand-written contract that contained the following non-competition clause:
“Protective covenant. 3 yrs—5 mi.” The defendant worked with the plaintiff for
about 17 months. As he was required to do under the employment agreement, he
gave six months’ notice that he was leaving. Six months after his departure, he and
another dentist opened an oral surgery practice that contravened the three year/five
mile restriction in the non-competition clause. The plaintiff brought an action
against the defendant for damages for breach of contract. The action was allowed.
The trial judge upheld the restrictive covenant, holding that the three year/five mile
ambit was not overly broad and did not restrict competition generally. The
defendant appealed.
6.1.2
Ruling
The Ontario Court of Appeal held that, generally speaking, non-competition clauses
will not be enforced where a non-solicitation clause would adequately protect an
employer’s interest. A non-solicitation clause prohibits a departing employee from
50
51
Note 47, above at 646.
Lyons v. Multari (2000), 50 O.R. (3d) 526 (Ontario C.A.), leave to appeal denied, [2000] S.C.C.A. no. 567.
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soliciting the customers of his or her previous employer. A non-competition clause
does more than merely attempt to protect the employer’s client or customer base, it
attempts to keep the former employee out of the business of the employer. In the
court’s view, in some exceptional cases, the nature of the employment may justify a
covenant prohibiting an employee not only from soliciting customers, but also from
establishing his own business. In determining whether a non-solicitation agreement
was sufficient under the circumstances, the court in Lyons considered the Supreme
Court of Canada’s decision in Elsley v. J.G. Collins Insurance Agencies Ltd.,52 where
Supreme Court defined the “exceptional” circumstances in which a non-competition
agreement is enforceable. The kind of case the Supreme Court had in mind is that in
which the employee is so closely associated with the business by the employer's
customers that he or she would be able, simply by opening a competing business
and without any solicitation, to attract a significant share of the employer's client base.
The court concluded that this case did not fall within the Elsley exception. Hence the
non-competition agreement was unenforceable. The court noted that a nonsolicitation agreement would have been enforceable. In arriving at this conclusion,
the court considered the following factors relevant:
52
53
The bargaining power of the parties;
The treatment of the employee by the employer;
The employer’s proprietary interest;
The business relationship between the employer and the employee;
The role of the employee within the organization;
Whether the protection is required for trade secrets, confidential information and
trade connections of the employer;
Whether the restrictive covenants are a normal practice within the relevant
profession or industry.53
Elsley v. J.G. Collins Insurance Agencies Ltd., [1978] 2 S.C.R. 916.
Elsley, n. 52 above, ¶¶39-48.
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The court held that while the relationship between the plaintiff and the defendant
had been one of equals, and while the plaintiff had treated the defendant well
during their association, the case did not fall within the Elsley exception. First,
although the plaintiff had had some proprietary interest in referrals from certain
dentists who regularly referred patients to him, he had no proprietary interest in
referrals from any other local dentists. Second, although the plaintiff had treated the
defendant well during their association, this worked as much to his benefit as to the
defendant’s since the plaintiff retained a percentage of the defendant’s earnings.
Third, the role of the defendant in the plaintiff’s oral surgery practice was that of a
normal associate who did not participate in the management of the practice. Finally,
when he departed, the defendant did not take any trade secrets or confidential
information with him because he never saw a list of patients or referring dentists.
On this basis, the court concluded that the plaintiff’s legitimate interest in protecting
his own referring dentists and patients could have been protected by a nonsolicitation clause. In the recent case of Orlan Karigan & Associates v. Hoffman54 the
court followed Lyons v. Multari and refused to sever an invalid non-compete from a
non-solicitation clause.
6.2
Drafting employment contracts in light of Lyons
Lyons v. Multari and Orlan Karigan serve to remind us that the exception set out in
Elsley to the general rule against non-competes is sufficiently narrow that we should
never assure a client that a non-competition agreement will be enforceable. An
employer must exercise caution and restraint in drafting non-competition
agreements since courts will generally not “read down” or rewrite an invalid noncompetition agreement. As the court did in Elsley, where it is determined that a
covenant is unreasonable, courts will tend to declare the covenant void so that no
restriction will apply. Also, because non-competition agreements are difficult to
enforce, an employer should always be advised to have an employee sign a non-
54
Orlan Karigan & Associates Ltd. v. Hoffman (2001), 5 C.C.E.L. (3rd) 311 (Ont. S.C.J.).
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solicitation agreement in addition to any non-competition agreement that may be
signed. A non-solicitation covenant, especially one connected to customers of whom
the employee had knowledge or with whom he had personal contact, is generally
viewed as more reasonable than a general non-competition covenant. It is
recommended that an employer consider a non-solicitation covenant as an
alternative to, or in addition to, a non-competition covenant. The non-solicitation
agreement should be a stand-alone agreement.
7
RECTIFICATION
7.1
Introductory comments
Perhaps the most bizarre contract decision of the past few years is one that has
significantly expanded the doctrine of rectification. Rectification is a doctrine that
permits the court to redraft a contract where the parties have made a mistake in
reducing their agreement to writing.55 Rectification is concerned with contracts and
documents, not intentions. The principle is designed to bring the actual document
which was expressed or intended to be in pursuance of a prior agreement into
harmony with that agreement. Until recently it was employed by courts where
contracting parties having reduced into writing the agreement reached by their
negotiations, have made some mistake in the wording of the written contract, thus
changing the effect, in whole or in part, of the contract.
7.2
Applying the rectification remedy in tax cases
7.2.1
Re Juliar
INTRODUCTORY COMMENTS
Beginning with the 1997 decision of the Federal Court of Appeal in Dale et al. v. The
Queen56, the courts have been asked to apply the rectification remedy in novel ways
55 See the discussion on the rectification remedy in G.H.L. Fridman, The Law of Contract in Canada, 4th ed.
(Toronto: Carswell, 1999), 820-32.
56 Dale et al. v. The Queen (1997), 97 D.T.C. 5743 (Ont. S.C.J.).
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in tax related situations. The recent decision by the Ontario Court of Appeal in Re
Juliar and Attorney General of Canada57 appears to have greatly broadened the
equitable remedy of rectification, at least in this context. A lower court allowed the
rectification of an agreement where the parties had structured it in such a way that
they did not get the tax treatment they had expected. The Attorney-General of
Canada was made a respondent on the application presumably in order that
Revenue Canada would be bound by the decision.
FACTS
The Juliars had a 50% interest in a corporation and the other 50% was owned by
another family group. It was decided to spin off those interests into holding
companies for each of the two families and tax advice was sought. The transaction
decided upon was a transfer of the shares in the corporation to the holding
companies in exchange for promissory notes of the holding companies. It turned out
that this structure gave rise to a deemed dividend. The accountant had suggested
this form because he and the Juliars mistakenly believed that the cost base of the
shares was higher than it was. There was no question that the parties intended the
consideration to be promissory notes issued by the holding company.
HOLDING
The trial judge described the four requirements that must be found to exist in order
to give a court the basis to order the relief of rectification. The four necessary criteria
are:
A prior agreement.
A common intention.
A final document that does not properly record the parties’ intention.
A common or mutual mistake.58
Re Juliar and Attorney General of Canada (1999), 46 O.R. (3d) 104 (Ont. S.C.J.); (2000), 50 O.R. (3d) 728 (Ont. C.A.);
Leave to appeal denied, S.C.C., May 24, 2001.
58 Re Juliar, n. 57 above, ¶32 (Ontario S.C.J.).
57
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The judge noted that rectification of a mistake is a discretionary remedy that must be
cautiously watched and jealously guarded. He also quoted with approval an earlier
summary of the law:
It is not a question of the Court being asked to speculate about the parties’
intention, but rather to make an inquiry to determine whether the written
agreement properly records the intention of the parties as clearly revealed in
their agreement. The Court will not write a contract for businessmen or
others but rather through the exercise of its jurisdiction to grant rectification
in appropriate circumstances, it will reproduce their contract in harmony
with the intention clearly manifested by them, and so defeat claims or
defences which would otherwise unfairly succeed to the end that business
may be fairly and ethically done.59
The trial judge closely considered the 1994 Ontario decision in 771225 Ontario Inc. v.
Bramco Holdings Co.60 In that case the court refused rectification of a contract for the
sale of land where the purchaser was liable to pay 20 percent non-resident land
transfer tax. The purchaser had been assigned the right to buy the land by an
affiliated corporation. The assignment was made so as to save income tax in the
future. The immediate large land transfer tax liability was not contemplated at the
time of the assignment. Rectification to revert the sale to the affiliate that had
originally signed the purchase agreement was denied. The court could find no
evidence that the shareholder had formed a specific intention to minimize land
transfer tax before closing the transaction. The court held that in this case the land
transfer tax was a consequence of the transaction, rather than its purpose, and
therefore did not fall within the strict confines for granting such relief. The Ontario
Court of Appeal in Bramco subsequently refused to apply the rectification remedy on
the basis that “to do so would run contrary to a well-established rule in tax cases
that the courts do not look with favour upon attempts to rewrite history in order to
obtain more favourable tax treatment.”61
59 Re Juliar, n. 57 above, ¶31, quoting from H.F. Clarke Ltd. v. Thermidaire Corp. Ltd. (1973), 33 D.L.R. (3d) 13
(Ontario C.A.), at 20-21.
60771225 Ontario Inc. v. Bramco Holdings Co. (1994), 17 O.R. (3d) 571 (Ontario Gen. Div.)
61 Re Juliar, n. 57 above, ¶33, quoting Re Slocock’s Will Trust, [1979] 1 All E.R. 358 (Ch.D.).
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Although the Attorney General argued hard that the Bramco precedent should
apply, the trial judge found grounds on which to distinguish Bramco. The court held
that the Juliars, had established that their intention was for the transaction to be
done on a no-tax basis and that this was a fundamental aspect of the transaction. The
lower court rectified the agreement to allow the consideration to be shares in the
holding company, a structure which would not give rise to a deemed dividend. In
fact the court rectified not only the agreement between the holding company and the
Juliars but also the corporate resolutions of the holding company and the
corporation, including new resolutions to allot and issue shares that would qualify
for rollover treatment and an agreement to cancel and declare void the promissory
notes, all backdated to the date of the original transaction.
It is particularly notable that in Bramco Feldman J. held that rectification is to be
accorded with caution in tax cases, for fear of producing a flood of litigants hoping
to cut down their tax bills by claiming to have mistakenly chosen the wrong
structures for their transactions. The trial judge and the Court of Appeal in Juliar
tried to address this by holding that what was important in this case was that tax
avoidance was “a primary and continuing objective” of the transaction.62 By
contrast, in Bramco avoidance of the high-rate land transfer tax did not surface until
after the tax was assessed.
The Court of Appeal cited Re Slocock’s Will Trust, a 1979 English decision that had
allowed rectification for tax purposes where this would “enable the parties to obtain
a legitimate fiscal advantage which it was their common intention to obtain at the
time of the execution of the document.”63
COMMENT
It is quite doubtful that this was an appropriate case for rectification. There was no
mistake in documenting the parties’ agreement to issue a promissory note for the
62
63
Re Juliar, n. 57 above, ¶43.
Note 61 above, at 363, per Graham J.
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shares. This is clearly what had been agreed to. It could very well be that rescission
would have been an appropriate remedy in this case given that there was an
operative mistake of fact. The parties could then have entered into new transactions
on a rollover basis. However, this would not have the effect of backdating the
transactions and this must have been important to the parties in this case. In any
event, it is a decision of the Ontario Court of Appeal, with leave to appeal denied by
the Supreme Court of Canada in May 2001, giving the decision significant weight. It
remains to be seen how far it could be taken. It would be relatively easy to ignore it
because it does state the law correctly.
It's how the law was applied that is
unprecedented.
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