Can An Entire Agreements Clause Make A Party To An Agreement Also A Party To Another Agreement?

In construction projects, there will often be several agreements between the various participants. Those agreements may contain “entire agreement” clauses to ensure that the parties are bound only by the terms of the agreement they sign. But could the entire agreement clause have the opposite effect if it refers to one of the other agreements?

In One West Holdings Ltd. v. Greata Ranch Holdings Corp. the British Columbia Court of Appeal recently answered Yes to this question. As a result, the entire agreement clause became an incorporation by reference clause, incorporating an arbitration clause from one agreement into another.

Background

Several parties joined together to buy the Greata Ranch in British Columbia and to subdivide and develop the land for resale. There were three agreements:

the limited partnership agreement between the participants (LPA);

the project management agreement between the limited partnership and the management company One West (PMA); and

the agreement to purchase the ranch (PA).  One West was not a party to the LPA or PA although it was affiliated to a company that was.

The PMA and PA each had an entire agreements clause that said that the PMA, LPA and the PA “and any documents expressly contemplated by this Agreement, constitute the entire agreement between the parties and/or affiliates of the parties and/or affiliates and supersede all previous communications, representations and agreements, whether oral or written, between the parties with respect to the subject matter hereof.…”.

The LPA had an entire agreements clause that said that “This Agreement constitutes the entire agreement between the parties hereto with respect to all of the matters herein and its execution has not been induced by, nor do any of the parties hereto rely upon or regard as material, any representations or writings whatsoever not incorporated herein and made a part hereof.”

The LPA had an arbitration clause requiring the arbitration of “all disputes arising out of or in connection with this Agreement, or in respect of any legal relationship associated therewith or derived therefrom….”  The PMA and PA had no arbitration clauses.

When disputes arose, arbitration proceedings were commenced, and One West was joined as a respondent. One West said that it could not be joined as a party to the arbitration as it was not a party to the LPA and therefore was not a party to the arbitration agreement.

The Decisions

The arbitrator held that, because of the entire agreements clause in the PMA, One West was a party to another agreement, the LPA, and therefore a party to the arbitration agreement in the LPA. On appeal, a judge of the B.C. Supreme Court disagreed, holding that the entire agreements clause in the PMA did not make One West a party to another agreement, the LPA, and to the arbitration agreement in the LPA. The B.C. Court of Appeal disagreed with that decision and agreed with the arbitrator.

The Court of Appeal’s conclusion about the entire agreement clause in the PMA was as follows:

“Article 17.1 does two things: it defines the agreement of the parties and it limits the scope of inquiry. The judge’s approach appears to eliminate the first part of the provision merely because it is called an “entire agreement” clause. It is necessary, as was done by the arbitrator, to look at the opening words of the provision: “This Agreement, the Partnership Agreement and the Purchase Agreement and any documents expressly contemplated by this Agreement, constitute the entire agreement between the parties and/or affiliates of the parties”.
There is nothing ambiguous or unclear about this language. It defines the agreement of the parties. The balance of the provision limits the sources on which the parties can rely and to which the court can look. It reflects the traditional purpose of an “entire agreement” provision, but it does not supplant the agreement of One West that the LPA is part of the agreement between the parties. That agreement contains an arbitration commitment that is binding on One West.”

In effect, the court held that, by reason of the wording of the entire agreements clause in the PMA, One West had agreed that it was a party to the LPA and the arbitration clause in that agreement.

The Court of Appeal gave a second reason for its decision:

“The scope of the arbitration commitment extends to legal relationships associated with or derived from the LPA. The “entire agreement” clause in the PMA extends to the parties and their affiliates.”

In this passage, the Court of Appeal is saying that the arbitration clause itself was sufficient to sweep One West into the arbitration as an affiliate of the party which signed the LPA, quite apart from the argument that the LPA and its arbitration clause were incorporated into the PMA through the entire agreements clause.

Comments

This decision arrives at startling conclusions about both the entire agreement and the arbitration clause. As to the former, entire agreement clauses are not usually thought of as creating new rights but as ensuring that there are no rights other than those contained in the written contract. If this is the purpose of the clause, then when the clause appears in one contract of a number of related contracts to which a number of entities are parties, the clause can be taken to mean that there are no rights in the contract other than those in the respective contract or contracts, not that new rights are created in one contract that are not otherwise there.  But that is the very argument that the court appears to have rejected.

As to the affiliate issue, the PMA and PA said that they constituted the entire agreement between the parties and/or affiliates of the parties.  So far as the reasons of the court disclose, the PMA or PA did not apparently state that they were being executed by one party on behalf of its affiliates who were thereby made a party to and bound by it.  So, again, it seems arguable that the statement about affiliates was that there were no other agreements between all these parties, not that the affiliates were parties to every agreement. But again, that seems to be the argument rejected by the court.

So far as the arbitration clause is concerned, the court’s decision is that an entire agreements clause in one agreement (the PMA in this case) effectively operates as an “incorporation by reference” clause and brings the arbitration agreement from another agreement (the LPA in this case) into the first agreement.  This is a very significant issue for construction law.

There are many cases holding that an arbitration clause is not incorporated from one agreement into another without there being a specific incorporation of that clause. Thus, it has been held in many cases that an arbitration clause in the main contract between an owner and contractor will not be incorporated into the subcontract between the contractor and subcontractor merely because the subcontract states that the terms of the main contract are incorporated into the subcontract: it takes something much more specific to incorporate the arbitration clause from one agreement into the other.

Yet in this case, the court has held that an entire agreements clause –which on its face doesn’t appear to be an incorporation by reference clause at all– is not only an incorporation by reference clause, but it incorporates an arbitration clause from one agreement into another.

With this decision in mind, those involved in preparing building contracts will have to carefully scrutinize their entire agreement and arbitration clauses to ensure that they have the intended ambit and effect.

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

One West Holdings Ltd. v. Greata Ranch Holdings Corp., 2014 Carswell BC 414, 2014 BCCA 67

Building contracts – incorporation by reference – arbitration clauses-third parties –

T.G. Heintzman O.C., Q.C., FCIArb                                           April 6, 2014

www.heintzmanadr.com

www.constructionlawcanada.com

The Traps And Perils Of Limitation Of Liability Clauses

In Swift v. Eleven Eleven Architecture Inc., the Alberta Court of Appeal recently considered the impact and scope of a limitation of liability clause in a consultant’s contract between an owner and the architects on a building project. The court arrived at three important conclusions.

First, the clause did not apply to and did not bar a claim by a co-owner of the property who had not signed the consultant’s contract.

Second, the clause did not apply to a negligent misrepresentation made by the sub-consultant engineers during the project.

Third, the architects could recover the full amount of the settlement payment made by it to the owners from the engineers on restitutionary principles.

This decision has important ramifications for architect and engineers, and indeed for anyone who is a party to a building contract containing a limitation of liability clauses.

Background

The owner Mr. Swift hired the architects to design a home on property owned by Mr. Swift and his wife, Mrs. Swift. The architects hired engineers as sub-consultants to design the structure of the home. The consultant contract dated April 29, 2005 was only between Mr. Swift and the architects, and Mrs. Swift was not a party to it. The consultant contract contained the following limitation of liability clause:

“3.8.1 With respect to the provision of services by the Designer to the Client under this Agreement, the Client agrees that any and all claims which the Client has or hereafter may have against the Designer which arise solely and directly out of the Designer’s duties and responsibilities pursuant to this Agreement (hereinafter referred to in this Article 3 as “claims”), whether such claims sound in contract or in tort, shall be limited to the amount of $500,000.00.”

The engineers designed the home to a Part 9 standard, not the higher Part 4 standard for seismic purposes, under the British Columbia building code. The contractor became concerned about the structural design of the building from a seismic standpoint and retained an engineer to review the matter. Ultimately the municipality stated to the parties that the building had to be designed to a class 4 standard. The engineers then advised that the building’s design met the Part 4 standard, when in fact it did not. The building of the home was delayed and further costs were incurred due to the structural mis-design. As a result, the owner incurred $1.9 million extra expenses and sued the architects and engineers. Before trial, the architects settled the owners’ claim against them for $1 million. Two claims proceeded to trial: the owners’ claim against the engineers; and the architects’ claim against the engineers to recover the $1 million the architects had paid to the owners.

Trial decision

The trial judge held that the limitation clause applied to the claim of both Mr. and Mrs. Swift as Mr. Swift had acted as Mrs. Swift’s agent in signing the consultant’s contract and that the limitation clause applied to all the Swift’s claims including the negligent misrepresentation claim against the engineers. The trial judge also decided that, by reason of the limitation clause the architect was only entitled to indemnity from the engineers for $500,000 of the $1 million they had paid the Swifts in settlement before trial.

Appeal Decision

Was Mrs. Swift bound by the limitation clause?

The Alberta Court of Appeal held that there was no evidence that Mr Swift had acted as agent for Mrs. Swift in signing the consultant’s contract and that she was not bound by the consultant’s contract and by the limitation of liability clause in it. The court noted that “Mr. Swift testified that he was signing the Agreement on his own behalf only. Ms. Swift testified that Mr. Swift did not have authority to sign an agreement or the Agreement on her behalf. The Architects testified that they did not believe that Mr. Swift was executing the Agreement on Ms. Swift’s behalf. This evidence, together with the language of the Agreement defining only Mr. Swift as the “client”, ought to have ended the discussion on actual authority.”

Moreover, no evidence ought to have been admitted to try to prove that Mrs. Swift was an undisclosed principal to the contract through Mr. Swift’s agency, for two reasons:

First, the consultant’s contract unambiguously showed that Mr. Swift was the only client.

Second, in order for an undisclosed principal to be liable on a contract, the surrounding circumstances must permit the possibility of identifying the undisclosed principal, by showing that the agent was not acting as the real and only principal. That was simply not the case here.

Scope of the limitation clause

The Alberta Court of Appeal agreed with the trial judge that the limitation clause applied to and protected the architects and those which it retained, including the engineers. However, it found that there was a good argument that the clause applied to each wrongful act, so that if there were multiple wrongful acts the client was entitled to multiple times the limit of damages. In light of its decision about the negligent misrepresentation, it held that it did not need to decide this issue.

Negligent Misrepresentation

The Alberta Court of Appeal held that the negligent misrepresentations made by the engineers during the project, that the structural design satisfied the Part 4 standard, was not covered by the limitation clause in the consultant’s agreement.  Even if the tort claims contemplated by the original consulting contract were limited by the limitation clause, the negligent misrepresentation claim arising from the conduct of the engineers during the project was not so limited. That conduct occurred in September 2006, long after the consultant contract had been made in April 2005. In response to inquiries from the architects, the municipality and another engineer, the engineers promised to bring the structural engineering of the building up to the Part 4 standard, and then confirmed that they had done so when they had not. That representation caused a delay in starting the remedial work and as construction progressed, it became more expensive to undertake the required work. The court held that “it would be unreasonable to conclude that such negligent misrepresentation was contemplated as being something that “arises solely and directly” out of [the architect’s] duties and responsibilities. This is particularly so given that the structural defects presented a real and substantial danger to its occupants.”

Accordingly, Mr. Swift was entitled to recover the full $1.9 million loss from the engineers. Since he had recovered $1 million from the architects, he was entitled to the further $900,000 from the engineers.

Indemnity

The Alberta Court of Appeal held that the architects were entitled to a full indemnity from the engineers based, not on contract or contributory negligence principles, but upon restitutionary principles. The architects had settled the Swifts’ claim against them for $1 million, and the courts favoured settlements. Since the architects’ liability only arose due to the engineers’ fault, the engineers should indemnify the architects for that full amount.

Comments

There are many issues and questions arising from this decision which could be analyzed. But for the moment, the following advice appears to arise from the decision:

  1. A consultant or contractor which is proposing to enter into an agreement with an owner will want to ensure that it contracts with all the owners and that the owner represents that there are no other owners. In the alternative, the consultant or contractor will want to insert into the agreement a stipulation that the owner is acting as agent on behalf of all the owners which are bound by the contract.  Otherwise, an owner which has not signed the contract is not bound by it and may bring proceedings without regard to the provisions of the contract, including the limitation of liability clause.
  2.  If it is proposed to include a limitation of liability clause in a building or consultant’s contract, then consideration should be given to whether the wording applies to negligent conduct undertaken during the project. According to this decision, unless the clause refers to that sort of conduct the clause will not apply to it. This result may be desirable from the owner’s standpoint and undesirable from the contractor’s or consultant’s standpoint.
  3. Consultants may want to ensure that the contract between them deals with the impact of liability upon one of them caused by the other, or at least devise an insurance regime that provides adequate protection, not just against liability for the wrongful acts of each consultant but for the liability for the wrongful acts of one consultant which are imposed on the others by way of restitutionary principles.

Whether or not one agrees with the conclusions of the Alberta Court of Appeal in this decision, it is certainly a wake-up call about the frailties and hidden traps of limitation clauses in building and consultants’ contracts.

See Heintzman and Goldsmith on Canadian Building Contracts, 4th ed., chapter 6, parts 2(b)(i)(C) and (ii)(C). 
Swift v. Eleven Eleven Architecture Inc. 2014 CarswellAlta 153, 2014 ABCA 49.

Building contracts – limitation clauses – negligent misrepresentation – architects and engineers

Thomas G. Heintzman O.C., Q.C., FCIArb                                                                                   March 30, 2014

www.heintzmanadr.com

www.constructionlawcanada.com

Does Posting A Lien Bond Eliminate A Contractor’s Trust Fund Obligations?

When a contractor posts a bond to secure the construction builder’s lien claim of its subcontractor and the subcontractor discharges its lien, does the contractor continue to have any trust fund responsibilities to the subcontractor? Must the contractor continue to pay to the subcontractor the money it receives from the owner, particularly money received from the owner relating to the work done by the subcontractor?

The Manitoba Court of Appeal recently answered Yes to both these question in Stuart Olson Dominion Construction Ltd. v. Structal Heavy Steel. The court held that the filing of the lien bond does not impair the trust fund rights and obligations under the Manitoba Builders’ Liens Act.

Background

Dominion was the general contractor and Structal was the structural steel subcontractor on a construction project. Structal asserted an $8 million delay claim against Dominion. It filed a builder’s lien in the amount of about $15 million which, beside the delay claim, included about $3.5 million in unpaid invoices and about $3.3 million in statutory holds.

Dominion filed a lien bond for the full $15 million. Structal then discharged its builder’s lien but it continued to assert that it was entitled to be paid for the work it had done.  Sructal’s work was entirely completed and there were no lien claims arising from Structral’s sub-contractors’ work.

Structal had not been paid all the progress payments or the statutory holdback and both amounts were being held by the owner. Structal sought payment of that money. Dominion asserted that it was entitled to that money from the owner and applied to the court for an order declaring that the filing of the lien bond satisfied its trust obligations to Structal and that, upon the receipt from owner of the outstanding progress payments on account of Structal’s work, Dominion could pay those funds to other creditors. Structal opposed Dominion’s application and brought its own motion for an order requiring Dominion to pay Structal all of that money.

The motion judge held that the filing of the lien bond by Dominion satisfied its trust obligations to Structal and that, upon receipt of the progress payments from the owner, Dominion was entitled to pay them to other creditors without being in breach of the trust provisions of the Act.  I dealt with that decision in my article on August 26, 2013.

Manitoba Court of Appeal’s decision

The Court of Appeal reversed the decision of the motion judge. The court held that the lien rights and the trust fund rights of contractors and subcontractor are entirely separate. The mere fact that the contractor had chosen to post a bond for the lien rights did not affect the subcontractor’s trust fund rights.

The court pointed out that it was the contractor, not the unpaid subcontractor, which decided to file a lien bond. The lien bond did not secure the claim any more than did the land. The court noted that the claim must still be proved before steps may be taken by the claimant to realize upon the underlying asset. In these circumstances, the contractor’s decision to file the lien bond could not, in the court’s judgment, affect the subcontractor’s trust fund rights.

In addition, the lien bond was no more than a substitute for the lien on the land, and just as placing a lien on the land does not remove or impair the trust fund rights of the subcontractor, nor does the lien bond. As the court said:

“In my view, it would be unheard of for a contractor to say to a subcontractor that, because he had filed a lien claim, the contractor was no longer obligated to comply with the trust obligations under the Act. Indeed, it is almost inevitably the case that lien claims are advanced because of late payment and a concern as to the possibility of non-payment. It is difficult to understand how, in such a circumstance, a subcontractor, by reason of filing a lien claim, should then be deprived of the benefits of the trust provisions of the Act. And, if that is so with respect to the lien claim filed against the land, it must be so with respect to a lien bond which, as the Act clearly provides, stands in the place of the land.”

Discussion

The Manitoba Court of Appeal’s decision preserves the funnel payment system in the Act. If a contractor could, by filing a lien bond, divert monies from the owner out of that system – and monies payable by the owner for the very work done by the unpaid subcontractor – then a leak in that funnel would arise.  If there are adjustments to be made when the owner pays further trust funds to the contractor, then the adjustment can be made to the amount of the lien bond, if necessary.

As I noted in my article of August 26, 2013, there are two aspects of the lien bond and trust fund sections of the construction/builders’ lien legislation that are noteworthy.

First, the provincial lien statutes are different.

In Manitoba, sub-section 5(3) allows the owner to retain or use trust funds if the contractor has been paid and “provision for the payment of other affected beneficiaries of the trust fund has been made.” The words “provision for payment” also appears in sub-sections 4(3) and 4(4) with respect to the trust fund obligations of contractors and subcontractors.  In each case the contractor’s and subcontractor’s obligation to ensure that provision is made for payment of other affected beneficiaries is in addition to the primary obligation to ensure that the next contractor or subcontractor down the chain is paid.  These words seem to contemplate that, as long as the next contractor is paid and if a lien bond is in place to look after other claimants, then the owner, contractor or subcontractor can make payments from trust funds. However, the obligation to see that the next subcontractor in the chain is paid is paramount and that obligation supports the Court of Appeal’s decision that Dominion (the contractor) was not entitled to the trust funds until Structal (the subcontractor) was paid.

In contrast, sub-sections 7(4), 8(2) and 9(2) of the Ontario Act simply state that the trust is in place until the contractors or subcontractors “are paid.” There is no reference to additional protection for other affected beneficiaries. In the Ontario Act, specific provision is made in section 12 for set-off by a trustee such as an owner, but not in respect of the amount of holdback. The Ontario Act seems to clearly recognize that, until the subcontractor is paid, the subcontractor’s trust fund rights are not impaired by the other provisions of the Act.

The Manitoba Court of Appeal has upheld the primary obligation in the trust fund sections- to use the trust funds to pay the next person in the payment chain. The court has effectively held that the extra protection in the trust fund sections of the Manitoba Act –namely, that the owner (or other person with the trust fund obligation) must also protect other affected beneficiaries – does not allow the lien and lien bond provisions of the Act to diminish the primary trust fund obligation. Accordingly, that decision appears to be applicable to other provincial lien statutes like Ontario’s which contain only the primary obligation and do not contain the extra protection.

Second, none of these statutes makes a direct and explicit connection between lien rights and lien bonds, and trust fund rights.  For example, no specific provision for setoff is made in the trust fund sections of the Manitoba Act. None of the courts in the Stuart Olson v Structal case commented on this disconnect but perhaps the Court of Appeal did so by inference. It held that the lien rights are entirely separate from the trust fund rights. For this reason, no connection is necessary.

See Heintzman and Goldsmith on Canadian Building Contracts, 4th ed. Chapter 11, parts 4(m) and 6.

Stuart Olson Dominion Construction Ltd. v. Structal Heavy Steel 2014 MBCA 8

Construction and builders’ liens – lien bond – security for lien claims – trust funds

Thomas G. Heintzman O.C., Q.C., FCIArb                                                                                                 March 8, 2014

www.heintzmanadr.com

www.constructionlawcanada.com

 

 

Alberta Court Of Appeal Upholds The Dismissal Of A Claim Which Ought To Have Been Arbitrated

One challenge facing a party to an arbitration clause is preserving a claim against the running of the limitation period. Starting the wrong claim may mean that the claim will be dismissed. That is now apparent from the recent decision of the Alberta Court of Appeal in A.G. Clark Holdings Ltd. v. HOOPP Realty Inc..

In an earlier decision, A.G. Clark Holdings Ltd. v. HOOPP Realty Inc., 2013 ABCA 101 (Alta. C.A., the Alberta Court of Appeal had held that the arbitration clause in this A.G. Clarke-HOOPP agreement was a mandatory arbitration clause and had set the matter back to the Queen’s Bench court.  The matter came back to the Court of Appeal after the chambers judge dismissed the action because arbitration of the dispute was mandatory and the limitation period for arbitrating the dispute had expired before any party had taken steps to commence arbitration.

Second Decision of the Alberta Court of Appeal

In this second decision of the Court of Appeal, the court dismissed HOOPP’s appeal for two reasons:

First, it confirmed its decision in Babcock & Wilcox Canada Ltd. v. Agrium Inc. (2005), 42 C.L.R. (3d) 197, 2005 CarswellAlta 208 to the effect that, if the parties have agreed that they must arbitrate a dispute, but instead of issuing a notice of arbitration within the limitation period for arbitration one party issues a statement of claim, then the court must dismiss the action.

Subsection 7(2) of the Alberta Arbitration Act allows the court authority to refuse a stay of an action which is started when the contract contains an arbitration clause. One of the grounds for not staying the action is found in clause (d) which applies if the defendant has unduly delayed in the bringing of the motion to stay the action, as HOOPP accrete had occurred in this case.

Effectively, the Court of Appeal held that, if the action is started in the face of a mandatory arbitration clause and the limitation period for commencing an arbitration has expired, then the discretion to stay the action no longer exists because the alternative of proceeding by way of arbitration no longer exists.  The Court of Appeal said that to allow the court to have a continuing discretion to permit the action to proceed would “render s 51(1) of the Arbitration Act and s 3(1) of the Limitations Act meaningless in the circumstances. It would have the effect of allowing a court to indefinitely extend a limitation period expressly set forth in the Limitations Act. In our view, that was not the intention of the legislature.”

Second, the Court of Appeal held that, in any event, there was no undue delay in the bringing of the motion to stay the action.

Discussion

This decision confirms that, at least in Alberta, the court has no discretion to permit an action to proceed once the limitation period expires and there is an effective and applicable mandatory arbitration clause in the contract. This means that a party must, at the very least, commence an arbitration if the contract contains an arbitration clause.

There are at least two further issues that arise

First, it seems that a party with such a claim may be advised to commence an action as well. The claimant cannot be sure that the respondent will agree that the claim falls within the arbitration clause. If the court or arbitral tribunal later holds that the claim falls outside the arbitration clause, then the claimant may then be out of time to commence an action.   The claimant may be better advised to at least start an action in addition to an arbitration and let the action be stayed pending the arbitration proceeding and the confirmation of the jurisdiction of the arbitral tribunal.

The second issue is whether the decision in this case applies to the other discretionary grounds in section 7(2) of the Alberta Arbitration Act. Those other grounds include: one of the parties to the arbitration agreement was under a legal incapacity when the arbitration agreement was made (clause (a)), the arbitration agreement is invalid (b), the subject matter is incapable of being arbitrated (c), or the matter in dispute is a proper one for default or summary judgment (e).

It is hard to see how the court’s decision in the present case applies to those situations.  So far as clauses (a) to (c), if those facts exist then the arbitration agreement should not or cannot be enforced. Yet, the discretion to stay surely must be operative even if the limitation period has expired if the claim cannot properly be arbitrated, due to the arbitration agreement being invalid or the claim being incapable of being arbitrated or a party being under a disability.

As to (e), the present decision appears to remove the discretionary power to refuse a stay if default or summary judgment could be granted and the arbitral claim is barred by the limitation period. Yet, on its face that clause does not prohibit a plaintiff proceeding with a default of summary judgment even if a limitation period to commence an arbitration has expired.

Perhaps the Court of Appeal is saying that in all these circumstances subsection 7(2) requires that the arbitral tribunal and not the court should decide the issues raised in subsection 7(2) once the limitation period for the claim expires. If so, the question is whether the legislature intended the arbitral tribunal to make those decisions when they were stated in this subsection as being matters to be considered by the court.

Finally, let’s consider subsection 7(5).  That subsection permits the court to allow the action to proceed in part if the arbitration agreement deals with part of the claim and it is reasonable allow another part to proceed in court. If the limitation period for the arbitral claim has expired, does that affect the court’s discretion? Can the court include within the action the arbitral part which can no longer be arbitrated due to the expiry of the limitation period?

Until these questions are resolved, it seems best to commence both an arbitral proceeding and an action, and to do so well within any arguable limitation period.

A.G. Clark Holdings Ltd. v. HOOPP Realty Inc., 2014 CarswellAlta 37, 2014 ABCA 20

Arbitration – Limitation periods – Stay of action or arbitration – Building contracts  – Alternative dispute resolution  –                                                                                                                         

Thomas G. Heintzman O.C., Q.C., FCIArb                                           February 25, 2014

 

What Is The Effect Of Res Judicata On Arbitration?

The recent decision of the British Columbia Supreme Court in Boxer Capital Corp. v. JEL Investments Ltd. raises some fascinating issues with respect to the application of the doctrine of res judicata to the arbitration process.  The court effectively held that res judicata applies with all its force and effect to arbitration.  For this reason, the court set aside an arbitral decision which did not follow or apply a previous arbitration decision and court decision arising in the same dispute.

The proceedings in this case also raise concerns about the ability of arbitration proceedings to deal with disputes on a cost and time effective basis.  This dispute about $750,000 arose in May 2008 and has already been through two arbitral hearings and several trips to the British Columbia courts, and this latest decision was rendered on December 27, 2013 five and a half years after the dispute arose.

The Background

Boxer and JEL were parties to a property development agreement. Boxer had contributed more money to the project than JEL. The agreement contained a shot-gun agreement whereby one party could give notice that it would sell its interest to the other.  Failing the receiving party’s agreement to buy, the receiving party was required to sell at the same price.  JEL gave notice in May 2008 that it was willing to sell its interest in the project for $1.425 million. Boxer declined the offer so it was obliged to sell for that price to JEL. Boxer took the position that it was entitled to receive an amount from JEL which would equalize the difference in their respective capital contributions. Boxer said that JEL would have to pay an extra $765,732.26 to compensate Boxer for the additional capital funds invested by it at the time the property was purchased. JEL said that it was not obliged to pay for that interest or capital contribution and that the monies it would pay as a result of the buy-sell process included whatever obligation it had to pay Boxer for its larger capital contribution.

The Arbitration and Court Proceedings

The parties went to arbitration.  In March 2009, the arbitrator found that JEL was obliged to buy Boxer’s interest for $1.425 million plus a capital adjustment payment of $765,732.26. The arbitrator held that the obligation to pay the capital adjustment payment arose from an implied term in the agreement.

JEL did not comply with the arbitration award. So Boxer commenced an action to specifically enforce that award.  In August 2009, the B.C. Supreme Court issued an order enforcing the arbitration award and incorporated the award into its judgment as a judgment of the court.  The order directed JEL to pay the $1.425 million amount and as well the $765,732.26 capital adjustment amount.  There was no appeal from this order.

In the meantime, JEL sought leave to appeal the 2009 arbitration award to the British Columbia Supreme Court.  Leave to appeal was denied and JEL appealed to the B.C. Court of Appeal and in March 2011 the B.C. Court of Appeal allowed the appeal and granted leave to JEL to appeal from the 2009 arbitration award.

In that appeal, in August 2011 the B.C. Supreme Court held that JEL had validly acquired Boxer’s shares pursuant to the shotgun clause but the court set aside the part of the arbitrator’s award that require JEL to pay the capital adjustment payment. The court agreed with Boxer that it was entitled to be paid the capital adjustment amount but held that Boxer was not entitled to that amount at the time of the buy-out but only when the project became profitable as a first charge on any profits.  The court held that JEL did not purchase or acquire the disproportionate capital contribution made by Boxer, and that that contribution remained “in the project” to be paid out of the project pursuant to the agreement, if and when profits were earned. No appeal was taken from that decision.

The purchase by JEL of Boxer’s interest proceeded and JEL paid the $1.425million to Boxer. JEL took the position that Boxer no longer had any interest in the project.  In December 2011, so Boxer commenced an action to enforce its right to the capital adjustment amount.  JEL brought a motion to stay the action and in May 2012, the action was stayed and Boxer’s claim was directed to proceed by way of arbitration.

The arbitration awards were dated August and December 2012. The arbitrator held that he was not bound by the prior arbitration award or decisions of the B.C. courts.  The arbitrator held that Boxer was not entitled to a capital adjustment amount and that Boxer no longer had any interest in or claim arising from the project.

Boxer sought leave to appeal the 2012 arbitral decisions and in April 2013 leave was granted. JEL appealed to the B.C. Court of Appeal and in June 2013 that appeal was dismissed.

The appeal from the 2012 arbitration decisions was allowed in December 2013. In case you are still following this saga, the proceedings have now been before two arbitrators, before the B.C. Supreme Court five times and before the B.C. Court of Appeal twice. And appeals to the B.C. Court of Appeal and Supreme Court of Canada are still possible.

2013 Decision of the B.C. Supreme Court

The B.C. Supreme Court held that the parties to the 2012 arbitration were bound by the principle of res judicata arising from the 2009 arbitration and the 2011 decision of the B.C. Supreme Court.  Both those decisions had found that Boxer was entitled to the capital adjustment amount. The only difference between those decisions was in relation to the timing of the payment of that amount and whether it was required to be paid at the time of the buy-out (as the 2009 arbitrator found) or at the time the project became profitable (as the 2011 judge found).  Accordingly, the arbitrator had erred in holding that those decisions were not binding upon him.

The B.C. Court essentially found that the 2012 arbitrator was not at liberty to go behind – or “deconstruct” as the 2012 arbitrator said – the 2011 decision of the B.C. Court.  It said:

“Both [the 2009] Arbitrator and [the 2011 judge] interpreted the agreement and found, for different reasons, that the $1.425 million did not include the disproportional capital amount and yet, [in] his first partial award, [the 2012] Arbitrator stated:… ‘I am not bound by [2011 judge’s] reasoning….With great respect to [the 2011 judge], J., I do not agree with his interpretation of the COA on this issue.’

In my view it was an error of law for [the 2012] Arbitrator to “deconstruct” [the 2011 judge’s] reasoning and interpretation of the COA so as to “arrive at an opposite conclusion” regarding the ownership of the disproportionate capital, specifically whether it was included in the undisputed $1.425 million. This was the exact same issue as the one considered by both [the 2009] Arbitrator and the [2011 judge]…”

The 2013 judge also held that the 2012 arbitrator erred in exercising discretion not to enforce the principle of res judicata.  It said:

“Secondly, I disagree that it would be manifestly unfair and would work an injustice to JEL to apply the doctrine of issue estoppel in this case. Discretion must be exercised judicially. In my view, discretion judicially exercised should lead to the opposite conclusion to that reached by [the 2012] Arbitrator. The proper exercise of discretion would work as a grave injustice to Boxer …if the doctrine of issue estoppel were not applied in the circumstances of this case.”

Discussion

The res judicata issue is an extremely important one for the law of arbitration.  That is because arbitration – or at least domestic arbitration – exists within a legal framework that includes two systems, courts and arbitrators. The principle of res judicata is one means by which that relationship is governed as the courts can over-rule an arbitral tribunal if it does not abide by a prior court decision. To maintain the proper balance between the two systems, it could be argued that the court should have due respect for the arbitral system and not impose an unduly strict regime of res judicata on arbitrators, and arbitrators should have due respect for the court’s decisions and make decisions which respect the integrity of those decisions.

What can we learn from the present decision?

First, the decision of an arbitral tribunal about res judicata will be reviewed on a standard of correctness. That is exactly what the 2013 judge has held. No respect for judgment or error will be accorded to the arbitral tribunal on this issue.

Second, it seems clear from this decision that the principle of res judicata does apply to arbitral decisions. Nobody asserted to the contrary in this case and the court clearly applied that principle.

Third, the principle of res judicata applies with the same strictness as it does to a court. Again, no-one apparently argued that there should be some leeway for the arbitral tribunal, on the ground that arbitration is a less formal and legal system than the court system.  Neither side argued that there was a public policy rational for a less lenient approach to res judicata in arbitrations than in court proceedings.  There is no hint of leniency in this decision.

Fourth, the courts will expect arbitral tribunals to give a broad and purposeful interpretation and effect to the court’s prior decisions.  In this case, the court appears to have been impatient with the 2013 arbitrator’s effort to fully understand the 2011 decision of the court.  The court did not accept that the arbitrator had any jurisdiction to disagree with that decision or to be technical with its interpretation.

And Fifth, the courts will expect the parties to exhaust their appeal rights from an arbitral decision before asserting in a subsequent proceeding that the arbitral decision or the court’s review of it was wrong.  In the present case, the failure of JEL to appeal the finding of the 2011 judge that Boxer had a remaining entitlement to the capital adjustment amount was fatal to its efforts to uphold the 2013 arbitral award finding that Boxer had lost its entitlement to that capital adjustment amount.

Proponents of arbitration may wonder if there are better ways to find speedy justice.  The parties selected arbitration presumably to avoid the costs and delays of the court system. That objective was not achieved in the present case.

Boxer Capital Corp. v. JEL Investments Ltd. 2013 CarswellBC 3913, 2013 BCSC 2366

Arbitration – Res Judicata – Standard of Review – Shot-gun agreements

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

www.heintzmanadr.com

www.constructionlawcanada.com

Is Loss Due To An Inevitable Event Covered By Property Damage Insurance?

A continuing issue relating to property damage insurance is whether loss which is bound to occur due to an unknown fault or defect in the structure is covered by the insurance policy. The policy may be a builders’ risk insurance policy maintained during a building project or an all-risk insurance policy maintained by a business. Insurers maintain that this sort of loss is not covered because the insurance covers fortuitous events, not inevitable events. Owners and contractors maintain that this loss is covered because the insured does not know of the circumstances giving rise to the loss and does not intend or expect the loss to occur. So they argue that, from their standpoint, the loss is fortuitous.

In 1422253 Ontario Ltd. v. Coachman Insurance Co., (2014), the Ontario Divisional Court recently adopted the second view and held that the loss fell within an all-risk policy even though the circumstances, which were unknown to the insured, inevitably caused the loss. While the loss did not arise during a construction project, the decision in this case is important for the development of the law relating to risk-based property damage insurance policies, including those used by the construction industry.

The facts

The plaintiff owned and operated a gas bar. The plaintiff had an insurance policy providing coverage for “all risks of direct physical loss or damage from any external cause.” Several automobiles broke down after filling up at the station. These events caused the plaintiff to hire a contractor to examine the underground gasoline storage tank. It was discovered that the fill-in pipe to the tank had developed cracks, allowing water to seep into the tank and contaminate the gasoline.

The plaintiff brought an action in which it asserted that it had coverage under its property damage insurance policy. The insurer defended, saying that the loss was an inevitable result of the circumstances, that the policy only covered fortuitous loss and that the loss was not fortuitous and therefore was not covered by the policy. The plaintiff said that the loss was covered because the plaintiff did not cause or contribute to the fault in the pipe and was not aware of and did not expect the fault or loss. The defendant brought a motion to dismiss the action by way of summary judgment. The motion judge agreed with the defendant that the loss was not fortuitous and not covered by the policy because it was the inevitable result of the circumstances.

The Decision

The Divisional Court reversed the decision of the motion judge. The court held that the proper test for coverage in an all-risk property damage policy is not whether the loss was inevitable due to the physical circumstances, but rather whether the loss was caused by the insurer or was expected to arise in the normal course of business of the insured, such as ordinary wear and tear and depreciation. In this case the pipe had been regularly inspected. The contractor who repaired the pipe said he had never seen such a broken fill-in pipe, and the owner of the gas station had never seen one as well. The court held that “although the cause remains unknown, that the fill-pipe cracked allowing water into the storage tank is exactly the type of fortuitous event that triggers coverage in the all-risk policy.” The court rejected the defendant’s “flood gates” assertion that allowing the claim would extend coverage to the normal risks or day-to-day events in the operation of a gasoline station.

Discussion

The focus of this decision is on the nature of fortuity. The court held that the policy must be interpreted from a common sense business standpoint, and in this context, fortuity means not caused by the insured or not an expected result of the insured’s business activities. Interestingly, the word “fortuity” is not contained in these sorts of property damage insurance policies. Rather, the concept of fortuity is read into the policy as a necessary ingredient of insurance.  The policy could not have been intended to cover loss caused by the insured.  Nor could it have been intended to cover loss arising from the normal business activities of the insured.

The word “fortuity” has been coined to capture the unintended and unexpected nature of the insurance. But the nature and extent of “fortuity” still remains somewhat of a mystery, and a battleground between insureds seeking to recover their unexpected business losses and insurers seeking to minimize claims arising from normal business activities.  This decision tells us that the concept of fortuity will be determined from a business standpoint, not from the standpoint of physics.

See Heintzman and Goldsmith on Canadian Building Contracts (4th ed.), chapter, part   

1422253 Ontario Ltd. v. Coachman Insurance Co., (2014), 117 O.R. (3d) 635 (Div. Ct.)

Insurance –  Builders’ Risk Property Insurance  –  Fortuity  –  Coverage

Thomas G. Heintzman O.C., Q.C., FCIArb                                            February 5, 2014

www.heintzmanadr.com

www.constructionlawcanada.com

What Authority Does The Court Have To Interfere With Decisions Of Arbitrators?

This article will discuss the attitude of Canadian courts toward reviewing arbitral decisions.  The decisions of Canadian judges reflect the legislative regime in the provincial Arbitration Acts which mandates a starkly different approach toward final arbitral awards as opposed to interlocutory decisions (that is, decisions made by the tribunal during the proceeding, and not the final award).  That regime allows Canadian courts to have little hesitation in setting aside final awards if they offend fundamental principles of justice, but directs that interlocutory arbitral decisions are practically inviolate.

The Decisions

In Toyota Canada Inc. v. Ali, the British Columbia Supreme Court  recently set aside an arbitrators decision when the arbitrator allowed evidence in the form of consumer complaints downloaded from the Internet to be adduced without further proof and refused to allow Toyota to obtain the information in the  the “black box” out of Mr. Ali’s car. Mr. Ali alleged that the software in his Toyota automobile was defective and caused the car to accelerate, causing an accident.  Toyota said that the information in the black box might disclose whether or not Mr. Ali had his foot on the accelerator and/or the brakes at the time of the accident. The arbitrator held that that the data from the black box would not be necessary as it would not have any effect on his decision.  The arbitrator proceeded to find that, in the condition described by Mr. Ali, the vehicle was not operating as intended and was therefore malfunctioning. The arbitrator held that this condition must be considered a manufacturing defect.

The B.C. Supreme Court set aside the arbitrators’ decision holding that in admitting hearsay evidence from the Internet without considering the purpose for which it is introduced, whether it is relevant and whether it may be fairly regarded as reliable, and in refusing to admit relevant evidence from the “black box”, the arbitrator had acted in breach of the rules of natural justice.

In Suncor Energy Inc. v. Alberta, Suncor and the province of Alberta were engaged in an arbitration.  Suncor brought an application to the arbitration tribunal for an order that the Province produce certain disputed documents which the Province acknowledged were relevant and material and in its possession and control but which, it asserted, it was legally not obliged to produce. The Province asked the arbitration tribunal to order a question of law to be determined by the court on this issue. The tribunal held that it had the jurisdiction to rule on Suncor’s motion and should do so, and refused to refer the matter to the court as requested by the Province. The Province appealed to the court.  The Province asserted that the documents in issue dealt with or affected the rights of third party producers and their rights to the statutory protections under the Mines and Minerals Act, and that for this reason the tribunal had no jurisdiction to order their production. The Province relied upon several cases in which it had been held that arbitral tribunals did not have the power to make orders against third parties.
The Alberta Court of Queen’s Bench dismissed the appeal. It held that the authorities relied upon by the Province dealt with orders directly affecting third parties, by requiring the third party to attend an examination for discovery or be subject to a Mareva injunction.  The orders sought by Suncor only applied to the Province. While the disputed documents had been provided to the Province by third party producers with the statutory promise of confidentiality under the Mines and Minerals Act, that Act did not create a privilege for the documents and the implied undertaking only to use the documents for the purpose of the arbitration should provide sufficient protection.  The arbitral tribunal had jurisdiction to deal with Suncor’s motion for production. Following decisions of the Ontario Court of Appeal, the Alberta court held that there was no appeal from the interlocutory decision of the arbitral tribunal under section 44 of the Alberta Arbitration Act.

Discussion

The contrast between these two decisions could not be greater. In the Toyota case, the B.C. court was not prepared to countenance any failure by the arbitrator to adhere to procedural fairness. Clearly, the court found it unacceptable that an arbitrator could find an automobile to be defective based upon postings of complaints on the Internet and in the absence of the information from the black box in the automobile which was intended to collect operational information. But the arbitral regime was Canadian Motor Vehicle Arbitration Plan (the “CAMVAP”) set up by Canadian automotive manufacturers, and the arbitrators are presumably selected for their experience, or accumulate experience in the course of the arbitrations they conduct.  Yet, the court was not prepared to accept anything short of the evidentiary rules applied by courts.

In the Suncor case, the Alberta court held that it had no jurisdiction to even touch the issue.  It was for the arbitrator and not the court to decide whether to order the production of documents in the possession of a party, even if that decision involved documents which the party had received from others. The Arbitration Act had made that decision for the court.

Have the provincial Arbitration Acts made the right policy choices?  Should the courts have a more restricted power to review final awards? Should there be a more flexible jurisdiction for the courts to review interlocutory awards?  Should third parties whose rights are potentially affected be given notice of arbitral proceedings?

On its face, the legislature seems to have struck the right balance. For centuries, final awards have been reviewed by courts for their legality.  The Uniform Arbitration Act was promulgated by the Uniform Law Conference of Canada (ULCC) (see https://www.ulcc.ca/en/uniform-acts). The Uniform Act has been adopted in most provinces. A great deal of thought went into that Uniform Arbitration Act before it was published by the ULCC. The Act reflects a conscious decision to limit the review of final arbitral awards to specific grounds and to eliminate in most cases the review of interlocutory arbitral decisions.   We can see the result of that decision in the Toyota and Suncor decisions.  While the contrast between the two review systems is great, there seems to be no good reason to reverse the policy decision.

See Heintzman and Goldsmith on Canadian Building Contracts (4th ed.), chapter 10, parts 3, 5 and 6.

Toyota Canada Inc. v. Ali 2013 Carswell BC 3159; 

Suncor Energy Inc. v. Alberta 2013 CarswellAlta 2530

Arbitration – Final Award and Interlocutory decision of Arbitral Tribunal – Judicial review of arbitration awards – Alternative dispute resolution – Grounds for review  – Public Contracts – Natural Justice – Third Party Rights

 

Thomas G. Heintzman O.C., Q.C., FCIArb       January 19, 2014

www.heintzmanadr.com

www.constructionlawcanada.com

Alberta Court Of Appeal Holds That A Court Action Is Not A Notice Of Arbitration

In previous articles I have warned readers about the dangers of the limitation period in relation to arbitration claims. You can look at my prior articles dated July 17, 2011, February 26, 2012 and August 26, 2012. These dangers are highlighted by the recent decision of the Alberta Court of Appeal in Lafarge Canada Inc. v. Edmonton (City).  The court held that that a Statement of Claim in an action is not a notice of arbitration under an arbitration clause. This may mean that an arbitration claim subsequently commenced is outside the limitation period.

Background

Lafarge entered into a contract with the City to provide cement pipe for a light rail transit project. The City alleged that Lafarge had not delivered the pipe in a timely manner and it set off the delay costs against Lafarge’s invoices. The supply contract contained an arbitration clause which stated that “if any disputes arise under the Contract and the parties are not able to resolve it, the parties shall appoint a single arbitrator to conduct an arbitration in accordance with the Arbitration Act.”

On May 28, 2009, or about 22 months after the dispute arose, Lafarge and the City entered into a standstill agreement.  That agreement provided that the limitation period did not run during the term of that agreement, that the parties could terminate that agreement and that if they did then the parties had 3 months to commence proceedings before the limitation period would apply. Lafarge terminated the standstill agreement on February 2, 2011 and commenced an action on February 11, 2011.  The City served its Statement of Defence on March 14, 2011, the City pleading inter alia that the parties had agreed to submit any disputes arising under the contract to arbitration. In delivering the Statement of Defence, the City’s solicitor said: “I think arbitration may be mandatory but we [sic] happy to discuss future process”. In July 2012 Lafarge delivered its documents and the City said that it would move to stay the action on the basis of the arbitration clause, and also asserted that Lafarge’s claim was now statute barred.  The City’s motion was not brought until June 2012.

Chamber Judge’s Decision

The chambers judge held that the Statement of Claim in the action was a sufficient notice of arbitration under s. 23 of the Alberta Arbitration Act. Section 23 states an arbitration may be commenced in any way recognized by law, including the following:

(a)   a party to an arbitration agreement serves on the other parties notice to appoint or to participate in the appointment of an arbitrator under the agreement; and

(b)   a party serves on the other parties a notice demanding arbitration under the arbitration agreement.

The judge therefore found that there were no limitations defence which applied and that the arbitration process had been sufficiently notified to the City by Lafarge in time under s. 23 of the Arbitration Act. The chambers judge held that in those circumstances it was unnecessary for him to address alternative issues concerning delay and attornment.

Alberta Court of Appeal’s Decision

The Alberta Court of Appeal reversed the chambers judge’s decision, holding that the Statement of Claim was not a notice of arbitration under section 23 of the Alberta Arbitration Act. The court held that to treat the Statement of Claim “as a form of notification of arbitration under s. 23 does not amount to giving a liberal reading to s. 23 of the Act but bursts its conceptual boundaries,” and that “to characterize what amounts to the opposite of notice to commence arbitration as being the same as notice to commence arbitration would take s. 23 outside the scope of predictable meaning.”

The Court declined to decide any issues arising from its decision, and in particular whether the City had attorned to the court’s jurisdiction or whether its delay precluded it from bringing the stay motion. The Alberta Court of Appeal returned the matter to the Court of Queen’s Bench to consider whether there should be a stay of the lawsuit in light of waiver, including attornment and delay in the stay application.

Discussion

As I have said in my prior articles, people tend to forget about limitation periods in respect of arbitration claims because they think they already have a contract so there must be an entitlement to assert an arbitration claim. Since there is no court office in which to start the arbitration claim, people tend to assume that there is no formality to the commencement of the arbitration claim. Not so. The provincial Arbitration Acts have very specific criteria about what amounts to the commencement of an arbitration claim. If those criteria are not met, then no arbitration claim has been commenced and the limitation period continues to run.

So, in the present case, Lafarge commenced an action within the limitation period stated in the standstill agreement but not an arbitration claim as defined in the Alberta Act. The Alberta Court of Appeal has held that the action did not amount to an arbitration claim.  While Lafarge may be held entitled to continue with its action by reasons of the City’s waiver, attornment or delay, the Alberta Court of Appeal’s decision means that it has not commenced an arbitration claim so far as the limitation period is concerned.

The fairness of this decision could be questioned. If the City knew of the claim through the commencement of the action, should it thereafter be able to rely on a limitation period? Should the City be required to renounce a limitation defence in the arbitration when seeking a stay of the action?  There are old cases holding that if a defendant seeks to stay an action on the ground that the courts of another country are the more convenient forum, then the defendant must give an undertaking not to raise a limitation defence in the other forum. Should this rule be adopted on motions to stay actions based upon an arbitration clause?

Some might object to this rule on the ground that it will encourage parties to commence actions in the face of arbitration clauses and then insist on a waiver of the limitation period in the arbitration.  After all, so it goes, arbitration clauses are obvious and can and should be adhered to.

But such a rule does seem sensible. After all, an action is a perfectly proper way to commence a claim. In fact, outlawing a court action is contrary to public policy. It is only if the other party insists on the arbitration clause that arbitration becomes mandatory; if the other party does not, then the court action is perfectly proper. The commencement of the action tells the defendant that there is a claim.  If the defendant invokes the arbitration clause, there is an element of fairness in requiring the defendant not to assert the limitation defence in the arbitration. Maybe the further proceedings in the Lafarge case will explore this issue.

See Heintzman and Goldsmith on Canadian Building Contracts (4th ed.), chapter 10, parts 3, 5,6

Lafarge Canada Inc. v. Edmonton (City), 2013 ABCA

Arbitration –  Limitation periods – Stay of action or arbitration – Building contracts – Public contracts – Alternative dispute resolution  – Relation of arbitration to court proceedings

Thomas G. Heintzman O.C., Q.C., FCIArb                                                                                                                     January 12, 2014

 www.heintzmanadr.com

www.constructionlawcanada.com

 

What are “Making Good”, “Faulty Workmanship” and “Resulting Damage” under a Builders’ Risk Policy?

The decision in Ledcor Construction Ltd. v. Nortbridge Indemnity Insurance Company is another attempt by a Canadian court to deal with the ambiguity in the Builders’ risk insurance policy. The wonder is that insurers and builders do not eliminate the exclusion for faulty workmanship, or clarify what the words “making good”, faulty workmanship” and “resulting damage” mean in this policy.  Instead they leave it up to courts to settle the issue on an ad hoc basis. And it’s no wonder that, in that situation, the courts must find that these ambiguous words provide, and do not exclude, coverage.

Coverage In A Builders’ Risk Policy

There are three elements in the coverage clause of a standard Builders’ Risk policy.

The first element is the “coverage wording”. This element defines, at its broadest, what the policy covers. The policy in the Ledcor case provided very broad coverage for property involved in construction. The policy said that there was coverage for property “undergoing site preparation, demolition, construction, reconstruction, fabrication, insulation, erection, repair or testing…”.  The case law makes it clear that this sort of coverage wording includes coverage for property damage arising from the negligence of the insured unless the policy says otherwise.

The second element of the coverage clause in a Builders’ Risk policy is the “exclusion wording”. In the Ledcor case, the wording took coverage away for “making good faulty workmanship, construction or design.” So the “exclusion wording” is apparently intended to exclude the repair of negligent workmanship. The insurers justify the inclusion of this exclusion on the basis that a property damage policy is not a professional liability policy, and that if coverage for negligence is to be obtained, it should be obtained in a separate policy, or by a further premium and amended wording in the Builders’ Risk policy.

The third element in the coverage clause in a Builders’ Risk policy is the “exemption wording.”  This wording in the policy in the Ledcor case exempted the exclusion if “physical damage not otherwise excluded by this this policy results.”  In this event, the exemption wording said that “this policy shall cover such resulting damage.”

What is one to make of this “wheels within wheels”? It’s like peeling an onion, or taking a Russian doll apart, layer by layer. Except that these layers are words, not physical layers. How does one know where one layer ends and the next begins?  The answer to that question is very important because the insured could make a decision to buy other coverage if it knew where the gap is in the Builders’ Risk policy. Since the insurer doesn’t tell the insured, the insured has to figure it out by reading the cases. And since the insurers don’t tell the insured, the courts inevitably decide the cases in favour of the insureds in case of doubt, of which there is almost always a lot.

Background To The Ledcor Case

Ledcor was the general contractor on a construction project. In the concluding portion of the project, Ledcor retained Bristol to clean the outside of the building. During the cleaning, Bristol scratched and damaged the windows of the building. The windows had to be replaced at considerable cost.  Ledcor and the owner made a claim under the policy.

There did not seem to be any dispute that the damage fell within the coverage element of the policy. There were two issues:

Did the exclusion wording apply? The insurer said Yes, because the scratching of the windows was due to faulty work. The insured said No because the exclusion clause is intended to apply to the costs of having the faulty work re-done, but not to the resultant damage of the faulty workmanship.

Second, did the exemption wording apply? Yes said the insured because the claim was based on resulting physical damage. No said the insurer because the damage in this case was not resulting physical damage, but damage caused directly by the window cleaner.

Decision of the Court

The Alberta Court of Queen’s Bench concluded that the work done by the window cleaning company, Bristol, fell within the words “faulty workmanship” in the exclusion wording. The court compared the present situation to the facts in another case in which the acid cleaning of a boiler was held to fall within the words “faulty workmanship” and the court in the Ledcor case agreed that both cleaning exercises amounted to “faulty workmanship”.

The court held, however, that the words “making good” are ambiguous. They could refer only to re-doing the work that was faulty, which is what the insured asserted. Or they could refer to the damage done by the faulty workmanship, which is what the insurer asserted. In the boiler case, the cleaning was part of the very installation of the boiler, and therefore arguably part of “making good” the work if that meant re-doing the work, including installing a new boiler.  But “re-doing the work” in the present case did not include installing new windows.

The court also considered the words “resultant damage” in the exemption wording and reasoned that these words must have been intended to complement the words “making good” in the exemption wording, so that the exclusion referred to “direct damage of the faulty workmanship as opposed to the indirect consequences.”

The court concluded that both of the interpretations advanced by the parties were reasonable. On balance the one suggested by the insured was somewhat more logical for two reasons.

First, since Builders’ Risk policies are intended “provide coverage for virtually any event which might occur by way of negligence, third party action or act of God, one could conclude that an exclusion as suggested by the [insurers] is inconsistent.

Second, “Bristol, as a sub-contractor, is an additional insured under the policy. Subrogation by the insurers against Bristol can be waived at the option of the [insureds]. Again, all of that suggests broad coverage inconsistent with what the [insurers] say is the effect of the exclusion.”

The Alberta Court of Queen’s Bench held that, at best, the clause was ambiguous and should be interpreted contra proferentem against the insurer.  Therefore, there was coverage under the policy.

Discussion

This decision illustrates the need for insurers and insureds to refine the meaning of the coverage, exclusion and exemption wording of Builders’ Risk policies, or the futility of doing so.  The Ledcor decision means that the policy exclusion does not apply in two situations.

First, if the person who did the faulty work installed something, and whatever was installed caused damage to some other part of the construction, then the damage to that other part is not excluded. That sort of damage is “resultant damage” and not “direct damage” and therefore falls within the exception to the exclusion. One only has to review the decided cases to know how difficult it can be to determine in that sort of situation whether the damage is “direct” or “resultant”.

Second, and this is the nub of the Ledcor decision, if the person who did the faulty work did not construct or install anything, then the claim does not arise from “making good” that work, or is “resultant damage” and not “direct damage.”

However, if the person who did the faulty work also constructed or installed something upon which it did the faulty work (as in the boiler case), then if the “making good” requires the property to be re-installed, then there may be no coverage due to the exclusion.

Two further points can be made about this decision:

First, this decision is a very good example of the rule of interpretation that the words, and all the words, in a contract must be given meaning. Here the key words were “making good”. What do those words mean and why were they used? The insurer really wanted to read the exemption to read as follows: “physical damage arising from faulty workmanship….” instead of “making good faulty workmanship….”  After all, the policy covered “physical damage” and the exemption referred to “physical damage”.   But for some reason, the exemption doesn’t. It refers to “making good”. So the parties must have meant something different by those words than “physical damage.” The court concluded that they can’t and don’t mean “physical damage” because the parties didn’t use those words. Rather, in that context, the words must mean re-doing the work, not repairing the damaged property, at least in the absence of any other or better explanation of what the words mean.  

Second, this decision perhaps demonstrates the futility of the exemption for faulty workmanship. Surely contractors and their advisors do not go through the mental gymnastics to figure out all these permutations and combinations involved in coverage.  And should they have to, especially when all the parties to the construction project are intended to be covered by the policy? Would it not be better simply to eliminate the exemption for faulty workmanship? Since the policy covers all the sub-contractors on the project, would there really be much, if any, additional risk or premium?

Ledcor Construction Ltd. v. Nortbridge Indemnity Insurance Company, 2013 ABQB 585

Builders’Risk Policy – Construction – Sub-Contractors – Contractors – Damages – Insurance – Exclusion Clauses

Thomas G. Heintzman O.C., Q.C., FCIArb                                                        December 27, 2013

www.heintzmanadr.com

www.constructionlawcanada.com

Can An Arbitrator Award Compound Interest?

In the recent decision in British Columbia v. Teal Cedar Products Ltd., the Supreme Court of Canada decided that compound interest could not be awarded in an arbitration arising from a statutory compensation regime. Under that regime, the arbitration was held pursuant to the British Columbia Commercial Arbitration Act (CAA), now the British Columbia Arbitration Act.

While this decision depended upon the specific provisions of the B.C. arbitral legislation, the decision raises the whole issue of whether compound interest can be awarded in arbitrations in Canada. The case raises the real possibility that, despite decisions to the contrary, interest cannot be awarded in arbitrations, at least in British Columbia.

Background

Teal’s annual allowable forestry cut was reduced in 1999, following the creation of a provincial park. In 2001, Teal commenced proceedings against the province claiming compensation for a partial expropriation. In 2002, the province enacted retroactive legislation, the Protected Areas Forests Compensation Act (PAFCA).  That Act stated that the reduction in forestry cut did not amount to expropriation and directed that a claim for such a reduction should be asserted as a claim under the Forest Act, which in turn said that the claim was to be dealt with by arbitration under the CAA.

Teal commenced an arbitration claim. In the arbitration award in 2010, the arbitrator awarded Teal $6.3 million plus legal costs. The arbitrator also awarded compound interest in the amount of $2.2 million from the date of the reduction in Teal’s forestry cut in 1999 to the date of the award.  The award of compound interest was upheld by the B.C. Supreme Court and Court of Appeal.  The Supreme Court of Canada reversed the decision of the B.C. Court of Appeal and held that only simple interest is payable under the relevant B.C. legislation.

The Supreme Court’s decision

The Supreme Court’s decision depended upon the inter-relationship between the forestry legislation, section 28 of CAA and sections 1 and 7 of the B.C. Court Order Interest Act (COIA).

Section 28 of CAA states that:

“For the purposes of the Court Order Interest Act and the Interest Act (Canada), a sum directed to be paid by an award is a pecuniary judgment of the court.”

Sections 1 and 7 of COIA deal with prejudgment (section 1) and post judgment (section 7) interest which may be awarded by a court in British Columbia.   Section 2(c) of that states that “the court must not award interest under section 1…on interest or on costs….”  Section 7(2) says that “A pecuniary judgment bears simple interest…” and section 7(1) defines simple interest to be “an annual simple interest rate that is equal to the prime lending rate of the banker to the government.”  Referring to those subsections, the Supreme Court concluded that “compound interest is prohibited”.

So in British Columbia, the Supreme Court appears to have concluded that only simple interest may be awarded by a court. The Supreme Court effectively held that this court-mandated regime is, by reason of section 28 of CAA, also mandated for arbitrations conducted under the CAA.

A number of submissions why this should not be so were advanced by Teal, all of which were rejected by the Supreme Court. One of Teal’s submissions was that the arbitrator could order compound interest as part of the substantive compensatory award, not as interest on that award. The Supreme Court rejected that submission, holding that it did not conform to the plain meaning and statutory history of the sections.

Teal also argued that section 22 of CAA provided that the rules of the British Columbia International Commercial Arbitration Centre (BCICAC) apply to arbitrations conducted under CAA, and that those rules permit arbitrators to award compound interest.  The Supreme Court pointed out that section 22(3) of CAA states that if the rules of BCICAC are inconsistent with or contrary to the Act, then the Act prevails.  The Supreme Court held that such an inconsistency arose between the provisions of CAA and the rules of BCICAC in relation to interest.

While the Supreme Court held that the statutory regime in British Columbia mandated simple interest for pre and post-award interest in arbitrations under B.C’s domestic arbitration statute, it stated that this regime may not exist in other provinces. The Court also made several comments indicating its view that compound interest awards are truer compensation for a pecuniary loss than simple interest.  The Court said:

“There is no doubt that compound interest is a more accurate way of compensating parties for the time value of money….compound interest is no doubt a better measure of the true cost of the loss suffered by Teal….”

Discussion

This decision is somewhat surprising in light of the previous decisions about the authority of courts and arbitrators to award compound interest.

Many of the provincial statutes dealing with the power of the court to award interest state that interest on interest may not be awarded. Thus section 2(2)(b) of the Alberta Judgment Interest Act says that ”The court shall not award interest….on interest awarded under this Part,” and Section 128(4)(b) of the Ontario Courts of Justice Act states that “Interest shall not be awarded on interest” on judgments.  Those sections seem to mirror sections 2(c) and 7(2) of the B.C. COIA.

Similarly, other provincial arbitration statutes also provide that interest under arbitral awards is to be in accordance with the court-mandated regime. Thus, section 54 (1) of the Alberta Arbitration Act says that an arbitral tribunal has the same power with respect to interest as the court has under the Judgment Interest Act.  Similarly, section 57 of the Ontario Arbitration Act, 1991 says that “Sections 127 to 130 (prejudgment and post-judgment interest) of the Courts of Justice Act apply to an arbitration, with necessary modifications”, thereby adopting the regime in section 128(4)(b) excluding compound interest.

And yet, arbitral tribunals and courts have been held entitled to award compound interest, notwithstanding the apparent statutory prohibition. Thus in Alberta, in Alberta (Minister of Infrastructure) v. Nilsson, 2002 ABCA 283 it was held that an arbitral tribunal could award compound interest as part of the substantive award, that is, as part of the damages and by reason of the exercise of the court’s equitable jurisdiction, notwithstanding the statutory prohibition against compound interest.

Most noticeably, in Bank of America Canada v. Mutual Trust Co, [2002] 2 SCR 601, the Supreme Court of Canada dealt with the interest regime in the Ontario Courts of Justice Act.   The court held that the Ontario court had jurisdiction to award compound interest notwithstanding the apparent prohibition in section 128(4)(b) of the Act against awarding interest upon interest. In arriving at that conclusion, the court relied upon Section 130 of that Act which allows a court, where it considers it just, to vary the interest rate or the time for which interest may be awarded.  The court also relied upon subsections 128(4)(g) and 129(5) of that Act which excludes the court-mandated interest regime – and effectively allows a court to award interest  – where interest is “payable by a right other than under this section”.  The court held that the court’s common law power to award damages flows from the application of contract law and that subsections 128(4)(g) and 129(5) provide statutory authority to award compound pre‑and post‑judgment interest according to this common law power.

In the Teal Cedar decision, the Supreme Court did not refer to its prior decision in Bank of America Canada.

There appear to be two relevant differences between the interest regime in the B.C. COIA and the interest regimes in the Alberta Judgment Interest Act and the Ontario Courts of Justice Act.

First, the latter two statutes give the court the power to award a different rate of interest (Alberta, section 2(3); Ontario section 130(1)(b)).

Second, the latter two statutes give the court the power to award interest “where the payment of pre‑judgment interest is otherwise provided by law” (Alberta, section 2(2)(i); Ontario, section 128(4)(g) and 129(5)). As already noted, it was those subsections that were relied upon by the Supreme Court in the Bank of America Canada decision for the conclusion that the Ontario court did have power to award compound interest notwithstanding the apparent prohibition of compound interest in section 128(4)(b).

Those powers do not appear in the B.C. statute. The only apparent exception to the mandatory simple interest rate in the BC Act is “an agreement about interest between the parties”.

The apparent result is that, for both court and domestic arbitration proceedings in British Columbia, compound interest cannot be awarded, unless there is an agreement between the parties dealing with interest.  There does not appear to be any basis to distinguish between court and arbitral proceedings as the domestic arbitration act adopts the court interest regime.

In other provinces which have interest statutes like those in Alberta and Ontario, compound interest can be awarded both by courts and by domestic arbitral tribunals.

So far as international commercial arbitration is concerned, the B.C. International Commercial Arbitration Act (ICAA) does not contain any provision relating to interest that is similar to that found in the CAA.  Section 31(7) of the B.C. ICAA empowers the arbitral tribunal to award interest, unless the parties have agreed otherwise. But there is no reference to the rates or compounding of interest.  Accordingly, international commercial arbitral tribunals in British Columbia appear to have a wider authority to award interest than domestic arbitral tribunals.

British Columbia v. Teal Cedar Products Ltd., 2013 SCC 51

Arbitration  –  Interest  –  Judgments and Awards

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

www.heintzmanadr.com

www.constructionlawcanada.com