What Does A CGL Policy Cover After Progressive Homes?

A:        OVERVIEW

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

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

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

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

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

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

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

B: ELEMENTS OF THE DECISION IN PROGRESSIVE HOMES

1.      Accident or Occurrence

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

 Justice Rothstein accordingly concluded that:

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

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

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

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

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

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

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

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

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

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

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

3.    The “Work Performed” Exclusions

(a)   Work performed by the Contractor or Subcontractor

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

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

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

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

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

(b)   The Particular Part of the Work exclusion

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

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

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

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

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

C;        APPLICATION OF PROGRESSIVE HOMES IN BULLDOG BAG

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

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

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

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

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

           (b)   Background facts of  Bulldog Bag

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

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

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

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

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

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

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

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

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

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

The Court of Appeal disagreed.  It said:

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

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

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

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

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

D:        CONCLUSION

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

First, at the conceptual level:

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

Second, at the level of the particular coverage:

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

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

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

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

www.heintzmanadr.com

www.constructionlawcanada.com

          

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

Can A Service Contract Create A Duty To Defend?

A clause obliging the insurer to defend an insured, or pay for the insured’s defence, is a well know feature of liability insurance policies. Recently, some Canadian courts have held that the duty of one party to defend or pay for defence of another party to the contract may arise in contracts outside the field of insurance, for instance in building contracts.  This obligation has been found to arise from an indemnity clause or insurance clause in the contract. Such a duty has been held to exist in a service or building contract even though that contract contained no express duty to defend or pay for a defence.

However, a duty to defend or pay for a defence before a finding of liability seems to be an obligation of a different kind than a duty to indemnify or to obtain insurance.  Recently, the Ontario Court of Appeal has clarified this issue in Papapetrou v. 1054422 Ontario Limited. The court held that an insurance clause may create an obligation to pay damages equal to defence costs, but it does not create a duty to defend.

Background

Ms Papapetrou brought a slip and fall claim after she fell on ice on the stairs of The Galleria.  That building was owned by the numbered company and managed by the Cora Group. The Cora Group hired Collingwood to provide winter maintenance and snow removal.

The service contract between Collingwood and the Cora Group contained the following indemnity clause:

The Contractor assumes sole responsibility for all persons engaged or employed in respect of the Work and shall take all reasonable and necessary precautions to protect persons and property from injury or damage. The Owner shall not be responsible in any way … resulting from any act or omission of the Contractor…The Contractor shall indemnify and save harmless the Owner …against all claims, losses, liabilities, demands, suits and expenses from whatever source, nature and kind in any manner based upon, incidental to or arising out of the performance or non-performance of the contract by the Contractor….[Emphasis added.]

The contract also contained an insurance clause. Collingwood agreed to obtain CGL insurance covering the liability of Collingwood and its employees and agents for bodily injury up to a minimum of $2,000,000 and to include the Owners as additional insureds on the policy. Instead, Collingwood obtained an insurance policy covering a maximum of $1,000,000 and the policy did not name The Cora Group as an additional insured.

The Cora Group brought a motion to compel Collingwood to indemnify, and assume the defence of the action on behalf of, The Cora Group. The motion judge granted the motion, finding that “the true nature of [Ms. Papapetrou’s] claim is that [Collingwood and The Cora Group] were negligent in failing to maintain an ice free pedestrian stairway” and that based on the service contract, a duty to defend and indemnify therefore arose. The motion judge stated that Collingwood “should not escape responsibility to defend/indemnify merely because [it] failed to meet [its] contractual responsibility” to name The Cora Group as an additional insured in its CGL policy.  She ordered that Collingwood indemnify The Cora Group and undertake the defence of the action against The Cora Group.

The Court of Appeal’s decision

In the Court of Appeal, The Cora Group acknowledged that an order that Collingwood indemnify it was premature.  No evidence about liability or damages had been led on the motion. The service contract did not require that Collingwood assume sole responsibility for damage to persons and property. Rather, it required Collingwood to assume “sole responsibility for all persons engaged or employed in respect of the Work” and “take all reasonable and necessary precautions to protect persons and property from injury and damage.”  Moreover, Collingwood’s contractual obligation to indemnify The Cora Group was limited to claims “based upon, incidental to or arising out of [Collingwood’s] performance or non-performance of the [service] contract”.

In these circumstances and at this juncture, the Court of Appeal held that there could be no finding that Collingwood’s duty to indemnify had been triggered. Accordingly, the motion judge’s order to indemnify was set aside.

The Court of Appeal also held that the order requiring Collingwood to assume the defence of The Cora Group must be set aside, for two reasons:

First, the service contract contained no duty to defend.

Second, any duty to defend could be no wider than claims arising from Collingwood’s performance or non-performance of its contract.

The Cora Group argued that Collingwood’s obligation to defend arose, not out of the indemnity clause, but rather out of the insurance clause.  It argued that Collingwood’s failure to name The Cora Group as an additional insured in its CGL policy was a breach of contract and that the appropriate remedy was an order requiring Collingwood to defend it. However, the court held that “Collingwood’s breach of this contractual obligation does not create a duty to defend; rather, it gives rise to a remedy in damages.” The court also held that the failure of The Cora Group to object to the form of the insurance was irrelevant.

The court held that the amount of damages suffered by The Cora Group was the amount the CGL insurer would have paid on behalf of The Cora Group.  That amount had to be determined from the service contract, not the CGL insurance policy that Collingwood obtained, since that policy did not contain the additional insured coverage for The Cora Group that it was supposed to contain. The scope of Collingwood’s contractual obligation to indemnify was limited to “claims … based upon, incidental to or arising out of the performance or non-performance of the contract by the Contractor”. Accordingly, the amount of damages was “the amount The Cora Group must pay to defend claims for bodily injury arising out of the manner in which Collingwood performed or failed to perform the service contract.”

The court held that “these costs will include all costs of The Cora Group’s defence of the Papapetrou action, save for any costs incurred exclusively to defend claims that do not arise from Collingwood’s performance or non-performance of the service contract.” The court arrived at this conclusion by analogy to the payment of defence costs under an insurance policy.

First, it applied the principle that an insurer’s obligation to defend is limited to claims that, if proven, would fall within the policy.

Second, it applied the apportionment principle applicable to defence costs under an insurance policy that “where an action includes both covered and uncovered claims, an insurer may nonetheless be obliged by the terms of the policy to pay all costs of defending the action save for those costs incurred exclusively to defend uncovered claims.”

In view of the allegations of Ms. Papapetrou, there was a conflict of interest between Collingwood and The Cora Group, and The Cora Group was entitled to retain separate counsel.

The Court of Appeal set aside the motion judge’s order and substituted an order requiring that Collingwood pay for The Cora Group’s defence of the action, save for any costs incurred exclusively to defend claims that did not arise from Collingwood’s performance or non-performance of the service contract.

Discussion

There are a number of interesting aspects of this decision from the aspect of construction law and insurance law.

First, this decision has to some extent clarified the law with respect to whether a duty to defend can arise from an indemnity or insurance clause in a non-insurance contract, such as a building contract.  The Court of Appeal has certainly held that such a duty does not arise from the breach of an insurance clause, and that the proper remedy is damages. If this is so, it seems hard to imagine that another court could conclude that an indemnity clause gives rise to a duty to defend and not damages. As well, it appears that a number of recent lower court decisions, holding that a duty to defend may arise from an indemnity clause in a non-insurance contract, are no longer good law.

Second, if a future action arises from the breach of an indemnity clause, we cannot be certain what principles the court will apply to the calculation of damages.  In the present case, since the breach was of the insurance clause, the court had a convenient proxy or reference point in the cases dealing with the determination and apportionment of defence costs under a liability insurance policy.  No policy reasons come to mind for applying different principles to breach of an indemnity clause, but we will have to await such a case for a clear answer.

Third, it may be a little surprising that, on an interlocutory motion, the court made what appears to be a final order determining the principles upon which damages were to be paid. There may be an argument on a duty to defend motion under an insurance policy as to whether, and to what degree, the court should finally determine the principles upon which the defence costs are to be paid, and the degree to which the trial judge should be left with some discretion on that matter.  In the present case, the Court of Appeal appears to have finally decided the matter.

Fourth, the court appears to have finessed the issue of whether the claim by Ms. Papapetrou was entirely covered under Collingwood’s CGL policy.  There is no mention in the decision of any coverage dispute under that policy, so perhaps coverage was not an issue. In addition, the Court of Appeal may be saying that, because Collingwood did not obtain the coverage for The Cora Group, it could not argue anything about the scope of coverage under the policy. But in another case, if coverage is an issue under the “policy that wasn’t obtained” then this may be raised as an issue by the defaulting party.  That party may argue that there should be an additional exception to its liability, namely, “to the extent that coverage was not available under the policy not obtained.”

Fifth, this decision shows how a breach of an insurance clause can be expensive. By failing to obtain the right insurance, Collingwood turned what would have been a claim for payment of costs against the insurer under the CGL policy into a claim for costs against it personally.

Finally, the insurance law junkies will take note that the Court of Appeal has once again applied the apportionment principle that requires the insurer (and by analogy in this case, the party in breach of contract) to pay defence costs except to the extent that those costs are due exclusively to uncovered claims.  This rule is favourable to the insured and is generally applied by Anglo-Canadian courts to apportionment disputes, but other rules less favourable to the insured may be applied in other jurisdictions and are advocated for by many insurers.

See Heintzman and Goldsmith on Canadian Building Contracts, 4th ed. Chapter 5, part 3

Papapetrou v. 1054422 Ontario Limited, 2012 ONCA 506

Building Contracts –  Insurance –  Indemnity and Insurance Clauses  –  Duty to Defend    –   Damages

 Thomas G. Heintzman O.C., Q.C., FCIArb                                                                                  September 23, 2012

www.heintzmanadr.com
www.constructionlawcanada.com

 

Is Certainty An Essential Element Of A Building Contract?

Overview

Courts are often unwilling to hold that an agreement is unenforceable for uncertainty when, by all appearances, the parties intended to make a contract.  But in a very spirited and colourful judgment, the Court of Appeal for Alberta has recently weighed in very heavily on the need for certainty in any contract, and particularly a building contract. In Seong Yun Ko v. Hillview Homes Ltd., that court provided a virtual law library on the Anglo-Canadian law, plus a dictionary of aphorisms and Latin phrases, on the subject of certainty in contracts.  Put this case in your hip pocket for the next time you need to address the issue because it will take you to all the important principles and cases.

The Alberta Court of Appeal also pointed out that the principles of contract law are a seamless web in which each principle is connected to another, while each principle remains an essential thread in a valid contract.  Thus, the intention to make a contract is one thread, but does not replace the need for certainty, and the mere existence of an intention to make a contract does not create certainty. And certainty of contract is connected not just to the initial validity of the contract, but to the objective terms of the contract and to a mistake about the terms of the contract, all of which may render the contract non-existent from the beginning, influence the contents of the contract or render it terminable by rescission.

Background

The plaintiff was a licensed realtor and the defendant was a home builder.  The defendant sold the plaintiff a lot and agreed to build a home on the lot for the total price of about $1.2 million.  The contract contained an Entire Agreements clause precluding any reference to representations, warranties and previous statements. The contract stated that a particular model of the house was to be built on the lot.  It also contained short form language that the parties agreed meant that the house was to contain 1,666 more square feet, costed at $80 per square feet.  Those 1,666 square feet were not a minor part of the proposed building, and amounted to about 60 per cent of the size of the building if the size of the model house referred to in the agreement was used as a reference. However, the parties did not agree on what those 1666 square feet were to be added on to (and thus, what the total square feet were to be), or where the 1666 square feet were to be located in the house, or what they would contain, or anything else about those square feet.

The Decisions

The trial judge held that there was a valid contract.  The trial judgment granted specific performance for the lot itself, but not as to the house.  The trial judge held that the plaintiff was entitled to damages for the increased cost of construction of the house.

The Court of Appeal for Alberta held that there was no contract because of the uncertainty as to what the defendant was to build.  The fact that the parties may have thought that they made a contract, and had the requisite contractual intent, did not overcome the necessity that the terms of the contract be reasonably certain.  And here, because the parties had not agreed upon what the 1,666 square feet were to contain or where they were to be located, the terms of the contract were uncertain and there was no contract.

The Reasons of the Alberta Court of Appeal

The reasons of the Court of Appeal canvas virtually the entire scope of the Anglo-Canadian law on the subject of certainty as an essential element of an enforceable contract. Since the issues that the court addressed are so numerous, it might be helpful to list them one after another.

Here are the Top 10 David Lederman-style lessons from Ko :

  1. A contract for the sale of land with a finished building for a specific price as adjusted by a square feet formula is not a design-build contract.  So the uncertainty of the agreement could not be repaired or justified on the basis that it was a contract to provide professional or trade services at a reasonable rate. Moreover, even for a design-build contract to contain terms which meet the test of reasonable certainty, there must be a “warranty of suitability by the designer, restrictions on any variation by the owner and permission for variations by the builder” with the result that there is “control of the design by the designer, and a limitation on interference in it by the owner.”  None of that was present in this case
  2. While “house-building companies commonly agree with a customer to modify one of their standing plans when building his or her specific house”, there must be “more care… and a moderate degree of detail” for the contract to be enforceable.
  3.   The Entire Agreement clause precluded the parties from relying upon the negotiations and discussions to create certainty of terms. In any event, the plaintiff acknowledged that there was no agreement on where the 1,666 square feet would go, nor did the evidence disclose what the 1,666 square feet represented. Moreover, the parties’ subsequent conduct could not, and did not, clarify their prior agreement.
  4.  Certainty is an essential element of the validity of a contract, and that element is tied into all the other elements of contractual validity. The court said that “certainty of terms is not a separate self-contained defence….Quite to the contrary, certainty is an integral part of the very heart of the contract… The rule is far from a technicality.”  Thus, it is part of the law of offer and acceptance.  It is part of the reasonable bystander test as to whether there is an enforceable contract: “if the bystander could not make any sense of it, or finds it contradictory, there is no contract. It is void ab initio for mistake.” It is part of the law of contractual mistake.  It is part of the law of contractual remedies: the court will not grant a remedy for an uncertain agreement because in awarding damages or granting specific performance, the court “compares what the vendor contracted to provide with what it did provide. So one must know what it contracted to give.”
  5.  Whether an alleged agreement is sufficiently certain to be a contract cannot be determined in the abstract.  It depends on the subject matter of the contract.  Thus, “what is enough specificity to make a valid contract to buy an existing power mower may not be enough for a contract to build a new house.”
  6.  Uncertainty as to any essential term of the alleged contract renders that contract void from the beginning.  Uncertainty is not just limited to parties, price and terms: “any term which the parties thought they needed and included in the agreement, but which is too vague, renders the contract void.”  The court said that: “Disagreement on even a small term bars a contract”, usually on the basis that the offer and acceptance did not match to create a contract.
  7.  Complete silence on price may enable the court to set a reasonable price.  But the court cannot do that for the subject matter and the parties: the court cannot “set the parties or the property”.  And so far as the price, if the parties specify a price formula which is uncertain, the court cannot supply the price for them.
  8.  There is a substantive difference between an agreement in which the parties agreed that the terms were to be “fixed by their later agreement” and an agreement in which “the parties called for a future formal contract, but all its terms were fixed at once.” The former is not a contract but the latter is.
  9.  There are solutions available to parties who wish uncertainty in their agreement but want to have an enforceable contract.  The court listed four solutions:

 (a)  A  specific means to decide the matter, such as a published standard, price list or other reference;

(b)   An arbitrator, valuator or referee to fix the matter;

(c)  A custom of the trade;

(d)  An implied term if the term or matter is obvious.

None of those solutions applied in the present case.

10.  The alleged duty to negotiate could not overcome the absence of certainty, for two reasons.

First, “designing and negotiating are not the same thing” and the court could not impose a duty to design the house which was enforceable on the parties.

Second, “a mass of binding and persuasive authority” made it impossible to overcome the absence of certainty with an obligation to negotiate.

The Aphorisms and Latin phrases of the Court of Appeal

The Court of Appeal was obviously steamed up about the state of contract law in Canada if the trial judgment was correct.  In addressing this state of affairs, the court employed colourful language, aphorisms and Latin phrases which certainly keep the reader interested.

Here are just a few which you can put in your kit bag for further use:

“Commerce needs predictability. So do ordinary Canadians about to commit their future earnings and life savings, especially to acquire a house.”

“If that truly is Canadian contracts law, it needs fixing.  It is another reason why litigation today is often priced out of reach. If it is not correct law, the present judgment should be changed and the correct law affirmed and clarified.”

 “’De gustibus non est disputandum’, says a Latin proverb millennia old. One cannot debate tastes.”

“Ex nihilo nihil fit is a maxim meaning ‘From nothing, comes nothing.’

Conclusions

In its reasons, the Court of Appeal cites over 45 Canadian cases, and also several of the leading English cases, tracing the law relating to contractual certainty back to the 1800s. So it is a virtual treasure trove of case law on the subject.

Some might argue with the strictness of the court’s approach to the subject matter.  Case law could be cited that is more generous to the use of conduct after the alleged contract to shed light on its meaning and certainty. The suggestion that lack of agreement on non-essential terms dooms the alleged contract also seems harsh.  But the facts of the case did not render those points essential: here, the conduct of the parties after the contract did not clarify the terms of the alleged contract, and the 1,666 square feet of undefined and undefinable square footage was an important part of the building.  So the comments of the Court of Appeal on these points may not be binding in future cases.

What is important about the decision is the re-affirmation of the need for contracts, and particularly building contracts, to be reasonably certain.  And helpfully, the court stated many reasons that support that principle and identified several techniques to deal with uncertainty if the parties cannot agree on the specifics.  The bottom line message is: when negotiating a contract, don’t throw the ball up in the air and expect the courts to catch it.

See Heintzman & Goldsmith on Canadian Building Contracts, 4th Edition Chapter 1, Part 1C

Seong Yun Ko v. Hillview Homes Ltd. 2012 ABCA 245

Building Contracts  –  Enforceability  –  Certainty of Terms

Thomas G. Heintzman O.C., Q.C., FCIArb                                                             September 15, 2012

www.heintzmanadr.com

www.constructionlawcanada.com

Can Someone Be Compelled To Arbitrate By Estoppel?

Can the conduct of the parties after they have signed a commercial contract influence the interpretation of the arbitration agreement contained in that contract? If they take one position during the performance of the contract with respect to whether a dispute is arbitrable, can they be estopped from asserting to the contrary when a dispute actually arises?  The Albert Court of Queen’s Bench has recently answered Yes to both questions in Alberta Oil Sands Pipeline Ltd v. Canadian Oil Sands Limited.  This decision raises important issues relating to the conduct of parties leading up to arbitration, particularly under long term commercial agreements.

Background

Alberta Oil Sands Pipeline Ltd. (AOSPL) owned and operated a pipeline between Fort McMurray and Edmonton in Alberta. AOSPL entered into an agreement with Canadian Oil Sands and other companies (the Participants) which had refineries in Fort McMurray.  Under that agreement, AOSPL agreed to build a new portion of the pipeline.  However, AOSPL did not complete 4.1 kilometres of the new pipeline. The Participants said that this failure amounted to a breach of the agreement. AOSPL said that it did not, and that the existing pipeline, together with the new portion it had constructed, satisfied all of the obligations it had undertaken in the agreement. In April 2009, the parties entered into a tolling agreement preserving their right to raise claims and defences with respect to the 4.1 kilometre pipeline dispute.

Then, other disputes also arose. One related to an increased pipeline tariff imposed by AOSPL and another relating to the details of invoices submitted by AOSPL. The Participants asserted their right under the agreements to audit the books and accounts of AOSPL. As a result of the 2009 audit, the Participants submitted a claim against AOSPL. Article 18.3 of the agreement provided for arbitration of audit claims.  The Participants submitted their claim under that article. In June 2010, AOSPL submitted its response and the Participants replied to AOSPL’s response, both within the time period called for in that article. After the 180 day period for resolving disputes referred to in Article 18.3, in November 2010 the Participants delivered a notice of arbitration of their claims.

In December 2010, AOSPL commenced an action for a declaration that the audit claims were not subject to arbitration.  The Participants filed a Statement of Defence asserting that they were subject to arbitration and brought an application to stay the action.  In that motion, AOSPL asserted that the right of audit was only a right to verify its books and records from an accounting or mathematical standpoint, and not from a contractual correctness standpoint and that therefore the arbitration agreement did not apply to the Participants’ claims.  The Participants asserted that the audit and arbitration processes applied to any errors in the books and records of AOSPL.

In March 2011, AOSPL gave the Participants 60 days’ notice of the termination of the tolling agreement.  The Participants then immediately commenced an action for damages for breach of contract by reason of AOSPL’s failure to complete the 4.1 kilometres of pipeline. Both parties agreed that this claim was not an audit claim and was not arbitrable.  AOSPL brought a motion to consolidate this action with its action relating to the audit claims.

The Decision

The Court found that the arbitration clause applied to the audit claims. It held that “it is unreasonable commercially to accept that the intention of the parties was to resort to two different forums for the resolution of disputes about a single aspect of the pipeline tariff,” one relating to accounting correctness and the other relating to contractual correctness.  The court noted that the Alberta Arbitration Act specifically gave the arbitrator the authority to determine questions of law, and there was nothing in the arbitration agreement that removed that authority.

The judge also held that, if she was incorrect in that interpretation, she would arrive at the same conclusion by reference to the conduct of the parties subsequent to the making of the contract, and this is the interesting point which is addressed in this article.  The judge held that the conduct of the parties was relevant for two reasons:

First, as an aid to interpret the contract, and

Second on the ground of estoppel

The conduct of AOSPL that the judge found relevant was of two kinds.

First, during the claims process arising from the present dispute, AOSPL had followed the claims and arbitration process and only asserted that the claims were not arbitrable after they had been submitted to arbitration by the Participants.  In that process, personnel of AOSPL made statements, both within AOSPL and in meetings with the Participants, that the claims were arbitrable.

Second, AOSPL had participated in arbitration proceedings relating to audit claims in 2001, 2002 and 2005.  In 2001, when the Participants had issued a Statement of Clam with respect to audit claims, AOSPL had referred the issue to arbitration, the action was stayed and the dispute was arbitrated.

AOSPL submitted that none of this conduct was relevant due to the clause in the contract stating that there was to be no waiver of a party’s rights by virtue of its conduct. To this the judge replied that the relevance of AOSPL’s conduct was not whether it had waived any rights but the proper interpretation of the contract in light of the parties’ conduct.

As to estoppel, the judge found that AOSPL’s conduct amounted to a representation by conduct. AOSPL had participated in the claims process leading to arbitration and that amounted to a representation to the Participants that the “audit procedure …was not disputed.” If it was an essential ingredient in an estoppel that the Participants had altered their position, that alteration was present. If AOSPL had notified the Participants of its position at the outset, then the Participants would have issued a Statement of Claim immediately, and not be faced with the limitations defence that AOSPL now raised.

While silence is not always a representation, the judge concluded that silence is a representation when the parties are in a contractual relationship with each other and engaged in a dispute resolution process. In those circumstances, AOSPL had a duty to respond and to not remain silent about its position that the audit claims were not arbitrable.

The judge then considered whether the audit claims should proceed to arbitration or be tried with the 4.1 kilometre claim. The judge refused to exercise her discretion to order that the audit claims proceed in court, for two reasons.

First, the audit and 4.1 kilometre claims were different.

Second, AOSPL had asserted a limitation defence to the audit claims if they proceeded in court. In the result, there was good reason to apply the mandatory language in section 7 of the Alberta Arbitration Act and stay AOSPL’s action brought in the face of the arbitration agreement.

Discussion

The judge’s decision to apply the principles of estoppel to an arbitration agreement is novel, but one could argue that it is heartening.   It is novel because estoppel is usually thought of as either a principle of evidence or a principle of substantive law.  In this case, estoppel was applied in a procedural setting, in the lead-up to the commencement of an arbitration.

But some will see this decision as welcome on the ground that estoppel is an ideal response when contradictory positions are taken in pre-arbitral proceedings, especially when the result is the loss of time and expense and, possibly, a limitation period.  Indeed, in the face of an assertion that a limitation period has been lost, it is hard to imagine that a court could take any other position than sustain the earlier proceeding.

Estoppel has a particular application to the commencement of arbitration proceedings. As I have commented in a recent article, it is sometimes difficult to know whether an arbitration proceeding has been commenced, or properly commenced.  There is no court office in which the arbitration claim may be issued. When the agreement requires that certain steps be taken before the arbitration is started, there is no court to rule on whether those steps have been properly taken. Even after notice of arbitration is given and before the arbitral tribunal is appointed, there is no body to rule on whether the arbitration has been properly started.  Yet time is passing and a limitation period may go by. The whole process seems dependent on each party stating a timely objection to any steps leading to the appointment of the arbitral tribunal.

Estoppel also seems appropriate when the parties have an ongoing contractual relationship.  Thus, under a labour, franchise or construction agreement, when the parties deal with each other over a period of time and are not just engaged in a one-off transaction, they make daily decisions which are instantly understood to be acceptable to the other party if there is no objection, and without turning to each other each time and saying “Right?”  True, each party is not expected to be the other party’s lawyer.  But making timely procedural objections does not seem to be too much to ask, or if not made, that the silent party live with the procedural result.

Alberta Oil Sands Pipeline Ltd v. Canadian Oil Sands Limited, 2012 ABQB 524

Arbitration – Stay of arbitration – Limitation Period – Estoppel  –  Refusal to arbitrate

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

www.heintzmanadr.com

www.constructionlawcanada.com

When Does An Arbitral Limitation Period Commence?

An arbitration is usually considered to be a less formal type of dispute resolution than court litigation.  For this reason it may be thought that less formal rules about limitation periods apply to arbitrations.

If you had this impression, then the recent decision of the Ontario Court of Appeal in Penn-Co Construction Canada (2003) Ltd. v. Constance Lake First Nation will quickly disabuse you of that view.  Just like a court action, unless an arbitration is started within the appropriate limitation period, the right to commence the arbitration claim will be lost. The issue may be trickier in an arbitration than in a court action since, unlike in a court action, there is no court office in which to issue the arbitration claim.  But it is still the same question: was the proceeding commenced within the limitation period?

The appeal to the Court of Appeal in the Penn-Co case was from a 2011 decision of the Ontario Superior Court.  I commented on that decision in my article of November 6, 2011.

The Legal Background

In Ontario, there are two enactments that are relevant to the limitation period for an arbitration claim.

First, the Limitations Act, 2002 says that the general limitation period in Ontario is two years from the discovery of the facts giving rise to the claim. Section 52(1) of the Ontario Arbitrations Act, 1991 (the Act) says that “the law with respect to limitation periods applies to an arbitration as if the arbitration were an action and a claim made in the arbitration were a cause of action.” So, an arbitration must be commenced within two years of the date that the would-be applicant first had knowledge of the facts giving rise to its claim.

Second, section 23 of the Act says that an arbitration may be commenced “in any way” including three particular ways:

A party to the arbitration agreement serving on the other parties to that agreement a notice to appoint or to participate in the appointment of an arbitrator under the agreement;

If a third party has the power to appoint an arbitrator, serving a notice on that third party to exercise that power, and serving the other parties with that notice;

A party serving on the other parties a notice demanding arbitration under the agreement.  (emphasis added by the Court of Appeal)

As a result, the limitation issue in the Penn-Co case was whether Constance Lake took one of these three steps before the limitation period expired.

The Background Facts

In 2003, the parties signed a standard form building contract for the construction by Penn-Co of a school for Constance Lake.  The contract contained a three-step process for resolving disputes: negotiations involving the consultant, mediation and arbitration.  By the summer of 2005, there were several alleged deficiencies in Penn-Co’s work that were the subject matter of dispute.  In December 2005, Constance Lake served a cure notice on Penn-Co. Penn-Co’s counsel responded by asking for mediation.  Then, on January 20, 2006, counsel for Constance Lake suggested that the parties dispense with the provisions under their contract and proceed directly with arbitration under an amended form of the CCDC 40 Rules for Arbitration of Construction Disputes. In response, Penn-Co’s counsel suggested that the parties proceed with a neutral third party “peer review”. However, the parties could not agree upon the terms of the peer review and by mid-2006 that process was abandoned.

In June 2007, Penn-Co commenced an action against Constance Lake.  In response, in May 2009 Constance Lake instituted a counterclaim in that action.  That counterclaim was instituted more than two years after December 2005 when, as acknowledged in its own cure notice, Constance Lake had knowledge of its claim against Penn-Co.  Penn-Co brought a motion to dismiss the counterclaim on the ground that the counterclaim was barred by the limitation period.

The Superior Court judge had held that the counterclaim was barred, and the Court of Appeal agreed.  It held that the letter of January 16, 2006 did not commence an arbitration.  It said that that this letter, and the other correspondence between the parties, amounted to “mere proposals for an arbitration agreement” and not a notice under the existing arbitration agreement which satisfied section 23 of the Act. The Court of Appeal held that the “parties failed to commence an arbitration under the building contract or any other agreement.”  Accordingly, the limitation period to do so had expired.

In these circumstances, the Court of Appeal also held that section 52(2) of the Act had no application. That sub-section gives powers to the court when it sets aside an arbitration award or terminates an arbitration or declares an arbitration to be invalid. In those circumstances, the court may order that the “period from the commencement of the arbitration to the date of the order” is to be excluded from the computation of time for limitation purposes. The Court of Appeal held that, if no arbitration was commenced, then this sub-section had no application.

Finally, the Court of Appeal held that Penn-Co was not estopped by its conduct from relying on the limitation period. None of the elements of estoppel were present.  There was no evidence that Penn-Co gave any assurance or representation that it would not rely on the limitation period, or that Constance Lake relied upon any such assurance.

Discussion

This decision is a good reminder that an arbitration is a formal proceeding and must be formally commenced. But this decision does not answer the question of what exactly such a formal commencement might encompass.

Section 23 of the Act says that an arbitration may be commenced “in any way recognized by law”.  That is just about as broad a definition as could be drafted.  One wonders what the limit of that definition might be, apart from the examples given in the section.  The legislature has said that a notice demanding arbitration is sufficient.  If that is so, and if that is included within but is not exhaustive of the definition, then something less than such a notice may amount to a commencement. The Court of Appeal has said that proposing arbitration under some other procedure or regime is not sufficient, at least until that regime is agreed to. But exactly what can amount to a “commencement” of an arbitration less than a notice of arbitration is left uncertain.

Several lessons can be learned from this decision.

One is that, before a party suggests alternatives to the arbitration agreement that is already in place, that party should first give notice of arbitration under that agreement.  Then, other dispute resolution solutions can be proposed.

The second lesson is that the institution by one party of mediation or arbitration does not protect the other party.  In the present case, Penn-Co instituted the mediation provisions of the building contract.  Whether the commencement of mediation proceedings stops the limitation period from running is open to question.  As I have commented upon in previous articles, the Ontario Court of Appeal has issued two decisions on this issue which arrived at contradictory results.  But the commencement of mediation proceedings by one party will not likely stop the running of the limitation period against the other party.

Finally, the limitation issue may not entirely deprive Constance Lake of its cause of action.  It may still be able to rely upon that cause of action by way of defence and setoff against the claim by Penn-Co.  The limitation statutes bar the commencement of a claim but not the reliance on the cause of action in any other way.

See Heintzman & Goldsmith on Canadian Building Contracts (4th ed.) at Chapter 10, part 6

Penn-Co Construction Canada (2003) Ltd. v. Constance Lake First Nation, 2012 ONCA 430

Building Contract  –  Arbitration  –  Limitation Periods  –  Commencement of Arbitration

Thomas G. Heintzman O.C., Q.C., FCIArb                                                            August 27, 2012

www.constructionlawcanada.com

www.heintzmanadr.com

Does An Insurer’s Duty To Defend Apply If The Insured Complies With An Environmental Investigation?

The scope of an insurer’s duty to defend is a crucial issue in relating to any liability insurance policy, particularly those applying to building projects.   One of the questions which may arise is:  what is the nature of a “claim” for the purpose of the duty to defend?  That question will almost always be determined by the particular wording in the policy.  In General Electric Canada Company v. Aviva Canada, Inc., the Ontario Court of Appeal has just held that the wording of the policy did not apply when the insured complied with a request by the Ontario Ministry of Environment for an environmental investigation.

The Background

GE owned the subject property from 1903 to 1980, during which time it manufactured a variety of products on the site. During some period of that time, it used trichloroethylene (“TCE”) as a degreasing agent. In February 2004, the Ontario Ministry of the Environment (MOE) wrote to GE and other former owners of the property advising that it was reviewing potential TCE contamination and requested the assistance and co-operation of GE and the other recipients of the letter, asking them to provide any environmental assessments that they had in their possession.

In April, 2004, the MOE sent a second letter to GE, requesting further information concerning about potential TCE contamination.  The letter said that:

 “the data appears to support a TCE plume migrating from/ through the former GE property…As discussed you will be required to take action in delineating the source area on your former property. The delineation investigations are to determine the current levels and the full vertical and horizontal extent of all contamination within the soil and groundwater which are on site location. The delineation report shall include at minimum the following….At this time the ministry is willing to enter into an agreement with GE to pursue the required action items voluntarily. If at any time the ministry determines there is unsatisfactory progress a Director’s Order will be issued to resolve the matter.”

GE agreed to cooperate with the MOE request. It asserted that, in responding to that MOE request, it had incurred out-of-pocket expenses of $2.1 million for investigation costs, $1.86 million for remedial costs and $750,000 for legal costs. GE made a clam against its CGL insurers for payment of those costs.

The Policies

The two CGL policies contained language which required the insurer:

“to pay on behalf of the Insured all sums which the Insured shall become obligated to pay [by] reason of the liability imposed upon the Insured by law… for damages because of damage to or destruction of property caused by an occurrence within the Policy Period…

To serve the Insured by the investigation of claims on account of such damage to or destruction of property and occurrence alleged as the cause thereof,

To defend in the name and on behalf of the Insured any suit against the Insured alleging such damage to or destruction of property and seeking damages on account thereof, even if such suit is groundless, false or fraudulent.”

The Decision

The trial judge held that GE’s claim did not fall within the policy because GE had complied with the MOE’s request, and had not defended against it.  He said:

“What GE calls “defence costs” were not costs of defending against the MOE’s claim but, in fact, the costs of complying with the MOE’s claim. GE complied with the MOE’s request and performed the work on the basis that it was thought to be in GE’s best interests to do so.

In coming to this conclusion, I make no finding on whether the matters alleged and requested in the MOE’s letter fall within the coverage language of the Aviva and Dominion policies from an indemnity perspective. I base my conclusion rejecting GE’s request for a declaration that Aviva and Dominion have a duty to investigate and to defend the MOE’s request solely on the fact that there was no investigation or defence of the MOE’s claim at all. What GE is seeking, in my view, is indemnification for its costs of complying with the MOE’s claim. This is not the time to make findings on the merits of GE’s indemnity claim in this regard. As the Ontario Court of Appeal said in Halifax Insurance, supra, the time to determine the insurer’s duty to indemnify is at the conclusion of the underlying litigation, not during the abbreviated application for defence costs. My conclusion, therefore, is without prejudice to the parties’ positions on whether the MOE letter is a “claim” or to GE’s right to seek these costs by way of an indemnity claim against Aviva, Dominion, or both, as well as the right of those insurers to argue against the existence of that obligation.” (emphasis added)

The Court of Appeal agreed with this conclusion.  It said:

[T]the only evidence of a “claim” by the MOE in the April letter is the request, or requirement if you will, that GE take action in delineating the source of the TCE contamination. GE did not oppose, defend or investigate that request. GE, as it was invited to do in the letter, voluntarily complied with the request of the MOE. It cannot be said that it has suffered any defence or investigation costs recoverable under its insurance policies. As the application judge concluded, the costs incurred were compliance costs – not defence costs. The fact that GE provided a list of costs, which it has characterized as potential defence costs does not, in my view, change the analysis of whether the April letter triggers a duty to defend.

In the result, these decisions undertook no analysis of the indemnity coverage under the policy.  The courts did not consider whether there was indemnity coverage for the damage to the land, or whether there was an environmental exclusion.  Nor did they consider whether the MOE’s request was a “suit” against GE.  All that the courts decided was that GE’s cost of cooperation did not amount to defence costs.  The Court of Appeal declined to consider American case law on the issue.

This is an interesting decision from a number of aspects:

First, while the court’s reading of the word “defend” as excluding cooperation may be based on sound grammar and literal meaning, there could be a debate about whether it is based upon sound policy. If cooperation is the best defence, should the costs of that cooperation be excluded from coverage for defence costs?  Is fighting better or different than cooperating so far as a defence is concerned?

Second, if the cost of “cooperating” doesn’t amount to defence, does the cost of settling an action or regulatory proceeding amount to defence? Normally, the costs of settling an action, and obtaining the best evidence and expert reports to do so advantageously, would be included within defence costs under a liability policy.

Third, if the cost of cooperating is not defence costs, then that cost may fall within the indemnity coverage arising from damage to the property.  The trial judge’s decision appears to allow GE to argue that it does.  If so, then this proceeding was much to do about nothing.  Except that, by cooperating, GE may have materially reduced the insurer’s potential exposure.

See Heintzman and Goldsmith on Canadian Building Contracts, 4th ed. Chapter 5, Part 3

General Electric Canada Company v. Aviva Canada, Inc., 2012 ONCA 525

Building Contracts   –   Insurance   –   Duty to Defend

Thomas G. Heintzman O.C., Q.C., FCIArb                                         August 14, 2012

www.heintzmanadr.com

www.constructionlawcanada.com

What Is The Effect of Piercing The Corporate Veil?

When the court pierces the corporate veil of a corporation, can another party be found to be the real party to the contract? Or is that other party only subject to consequential relief and not contractual relief? That is the issue which the English Court of Appeal recently faced in VTB Capital Plc v. Nutritek International Corp. That Court recently held that even in the face of fraud and other serious wrongdoing, the other party cannot be held to be a party to the contract unless the corporation which was shown as a party to the contract was a façade or sham.

The identity of the parties to a contract is fundamental to the contract’s legal existence and its commercial viability. In the context of building contracts, that identity is even more important since the parties undertake inter-related performance obligations and are relying upon the creditworthiness of the other parties to make sure that the project is completed. So the decision in VTB Capital should be carefully analyzed by those concerned with building contracts.

The Factual Background

 

The claim arose from a loan by VTB Capital, a company incorporated in England which carried on business as a bank in London. VTB Capital was controlled by a Russian state bank. The loan was to a company (RAP) incorporated in Russia, and was for the purpose of RAP buying six dairy companies in Russia. Other related agreements were also made, including a share warrant deed and participation agreement. The loan was not repaid and VTB Capital commenced an action in the English courts and sought to serve the claim on the defendants outside England. VTB Capital originally alleged that it was induced to enter into the loan by two other Russian companies and a Russian individual (the “Russian third parties”). It then sought to amend its claim to “pierce the corporate veil” of RAP, and assert that RAP was really only a puppet of the Russian third parties and that they were the real parties to the contract. VTB then asked permission to serve its claim outside England, with that contractual allegation included in the claim.

The English Court of Appeal held that when a corporation is a party to a contract and the corporate veil of the corporation is sought to be pierced so as to make others liable, then apart from the case where the corporation is a façade or sham, those others are not liable as parties to the contract. The other parties are only liable for consequential relief or based upon separate tortious or other wrongdoing. Accordingly, the Court of Appeal held that the new contract claim against the three Russian companies was not a valid legal claim and refused to permit the claim with this contractual allegation to be served outside England.

Piercing The Corporate Veil

The Court of Appeal undertook a lengthy review of English case law concerning “piercing the corporate veil.” It agreed that the corporate veil of a corporation can be pierced if there are “special circumstances….indicating that [the corporation] is a mere façade concealing the true facts.” Yet, it held that a proper reading of English cases disclosed that the “fraudulent or dishonest use of a company by its corporators or controllers so as to conceal the latters’ true identities” cannot in law possibly make those third party corporators or controllers the real and original parties to the contract. Rather, the corporation remained the party to the contract. If the corporators and controllers were to be held liable, that could occur through consequential remedies which would hold them accountable for monies or benefits received or for other equitable remedies, or they might be liable based upon separate tortious claims.

The Court of Appeal refused to apply the agency doctrine of undisclosed principals to this situation. The court said that the law on that subject was “anomalous”. On the facts of the case, the court said that the doctrine could not apply because “the puppeteers [had not] authorized the puppets to enter into the contracts on their behalf”, and because “VTB [did not intend] to contract with anyone other than the counterparties” named in the contracts.

The Court of Appeal accordingly found that the judicial authorities

“do not, however, go to the length of treating the puppet company as other than a legal person that is formally distinct and separate from the puppeteer; and were they to do otherwise, they would be ignoring the principles of Salomon. Consistently with that, they do not provide any basis for the proposition that the puppeteer should be regarded as having always been a party to a contract to which it or he plainly was not a party.”

This decision will have to be read very carefully. A bald conclusion – that the fraudulent or dishonest use of a company whereby the real actors’ identity is not disclosed cannot give rise to contractual liability for those actors -appears to raise serious legal questions, at least in Canada.

Moreover, this decision was given in the context of an application to serve the claim outside the jurisdiction and not upon the ultimate merits of the case. So the ambit or application of the decision may be somewhat in doubt. The following are some of the apparent limitations of the decision.

First, the Court of Appeal did not doubt that, if the corporation was a “façade or sham”, then the corporate veil could be pierced. So, the VTB Capital decision involves a party to a contract which was a real party with a real corporate existence. What amounts to a “façade” or “sham” in any particular case may be a factual issue, but the present decision does not exclude the contractual liability of a third party if the corporate party fits within those words. However, if the “puppet” is a real and existing entity, then the puppet and not the puppeteer is liable.

Second, the Court of Appeal did not hold that, if the facts of a case fit the doctrine of undisclosed liability, then that doctrine cannot and should not be applied. All it held was that the present facts could not be “shoe-horned” (as it said) into that doctrine.

In essence, the Court of Appeal accepted the “façade or sham” basis for piercing the corporate veil but rejected the two other submissions for doing so.

First, it rejected the proposition that the court has a general power to pierce the corporate veil and that the court could hold the third party contractually liable “in the interests of justice.”

Second, it rejected the proposition that the corporate veil could be pierced if “the company was involved in some impropriety”. If the latter conduct existed, then the “relevant wrongdoing must be in the nature of an independent wrong that involves the fraudulent or dishonest misuse of the corporate personality of the company for the purpose of concealing the true facts”, and not the contractual liability of the wrongdoer.

There is little doubt that, the next time a plaintiff in the Anglo-Canadian context attempts to pierce the corporate veil, the decision in VTB Capital will be pulled off the shelf, or downloaded from bailii. It is a densely written decision which cited many English decisions. But it cited no cases from Canada where the “corporate veil” issue has been frequently addressed.

On policy grounds, the decision adheres strictly to traditional contract law limiting the effect and enforcement of a contract to the parties named in it. The English Court of Appeal made a policy decision not to allow fraudulent corporate activity to give rise to a contract remedy against third parties. It did so at a time when courts, at least in Canada, are giving broader effect to contracts and allowing them to be enforced by third parties, and when Canadian courts seem inclined to provide wide remedies against corporate fraud. The future impact of the VTB Capital will depend, at least in Canada, on whether the same policy choice is made in Canada as was made in England.

Building Contracts – Parties – Corporations – Piercing the Corporate Veil

See Heintzman and Goldsmith on Canadian Building Contracts (4th ed.) at Chapter 1, Part 1(a)(i)(E)

VTB Capital Plc v. Nutritek International Corp., [2012] EWCA 808

Thomas G. Heintzman O.C., Q.C., FCIArb                                                                                          August 7, 2012

www.heintzmanadr.com

www.constructionlawcanada.com

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

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

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

The Background

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

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

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

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

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

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

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

Contractor’s Tender Methodology Became A Contract Specification

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

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

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

Owner’s Contractual Obligation To Commence The Project With Dispatch

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

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

The Building Contract Arises From The Tender Process Itself

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

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

Damages awarded to Bre-Ex

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

Important Conclusions

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

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

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

Construction Law   –   Tenders   –   Implied Duties   –   Performance

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

www.heintzmanadr.com

www.constructionlawcanada.com

 

Incorporation By Reference In Building Contracts

Incorporation by reference in building contracts

By Thomas G. Heintzman and Julie Parla1

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

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

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

Uses of Incorporation by Reference Clauses

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Application of Contract Interpretation Principles

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

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

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

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

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

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

An Attempt to Draw General Principles

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

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

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

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

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

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

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

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

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

Conclusion

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

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

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

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

www.constructionlawcanada.com                                                                                                                               July 25, 2012

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Can An Arbitration Survive Fraud?

When material evidence tendered to an arbitral tribunal is fraudulent, we expect the court having jurisdiction to be very inclined to set the award aside.  But as the recent decision of the English High Court in Chantiers de l’Atlantique S.A. v. Gaztransport & Technigaz S.A.S. demonstrates, “it ain’t necessarily so.”  In that case the award was upheld despite the findings by the court that the arbitral tribunal heard material evidence which it held to be fraudulent.  How did the court arrive at that conclusion?

The arbitration was an ICC arbitration held in Paris between French companies. The arbitration clause stated that the seat of the arbitration was in London, so the English Courts exercised supervisory jurisdiction over the arbitration and the application to set aside the award was made to the English courts.

The applicant to the arbitration, Chantiers de l’Atlantique (CAT), built LNG carriers.  It licensed a technology from the respondent to the arbitration, Gaztransport & Technizaz (GTT) for the construction of the containment system in the tankers.  During the sea trials of the tankers, it was discovered that nitrogen was passing through the barriers in the containment system, suggesting faults in that system.  The faults could be due to GTT’s design or poor construction by CAT.  Eventually, the ships were constructed with a barrier system that worked.  However, CAT commenced an arbitration against GTT alleging that the initial failures in the barrier system were due to mis-design by GTT.

The arbitral tribunal dismissed the arbitral proceeding.  It did so as it found that CAT could not establish “gross fault” on the part of GTT and thus could not meet the test imposed by French law for liability by a licensor to a licensee for a design fault or economic fault.

After the arbitral decision, CAT received a tip-off from a whistleblower raising questions about tests of the barrier system conducted by GTT and the alleged non-disclosure of those tests in the evidence that GTT had presented to the arbitral tribunal.  CAT accordingly brought an application before the English courts for an order setting aside the arbitral award under section 68(2)(g) of the English Arbitration Act, 1996.  That clause, like Section 46(1).9 of the Ontario Arbitration Act, 1991, authorizes the court to set aside the award if it is “obtained by fraud”.

After a very long review of the evidence led before the arbitral tribunal, the English Court concluded that fraud had been established for the purpose of section 68(2)(g) of the English Act.   The misconduct arose from the non-disclosure of tests conducted by GTT.  Yet the court declined to set aside the award.  The reasoning of the judge is an important explanation and exploration of the factors which should guide a court in its consideration of the power to set aside an arbitral award for fraud.

First, the court set out the four principles:

(a)   An arbitral award will only be set aside for fraud in extreme cases;

(b)   Fraud is dishonest, reprehensible or unconscionable conduct.  Fraud must be distinctly pleaded and proven to a heightened burden of proof.

(c)    The Award must have been caused by the fraud.  There must have been fraud “in the arbitration itself” and there must be “a causative link between the deliberate concealment of the document and the decision in the award”.

(d)   The evidence of fraud must not be “of such as could have been obtained or produced at the arbitration hearing with reasonable diligence” and must be “so material’ it “would probably have affected the result of the arbitration.”  The test does not require that the applicant show that the evidence would have affected the result, as such a test would usurp the function of the arbitral tribunal in the event that the matter is remitted to the tribunal, but the applicant must show that the evidence “would have had an important influence on the result.”

Except for the second test, these tests appear to be relevant for use by Canadian courts. But Canadian courts generally hold that there are only two standards of proof:  balance of probabilities in civil cases, and beyond a reasonable doubt in criminal cases.  So a Canadian Court would more likely apply a balance of probabilities to the second element of these principles.

Second, the judge went out of his way to point out that the arbitration had been conducted under the IBA rules.  Under those rules, he said that “there was no duty to disclose relevant documents, akin to CPR Part 31, such as would be the case with London arbitration conducted in accordance with English procedure. In these circumstances, the court must be careful not to import into its assessment of GTT’s conduct….English concepts of the duty of disclosure.”

In the result, the judge found that, while some of GTT’s answers were misleading and inaccurate, there had been no fraud arising from the Requests that had been made during the arbitration.  One is left to wonder whether the result would have been the same under common law duties of disclosure.

Third, the judge found that, while there had been fraud in the arbitration arising from the non-disclosure of testing results, the disclosure of the true position would not have affected the result of the arbitration.  He gave seven reasons for arriving at that result.  The most material and interesting are as follows:

  1. The other tests and evidence submitted by GTT to the arbitral tribunal demonstrated that the design of the barrier system was satisfactory.  In light of all the evidence, the judge concluded that the impugned tests would not have affected the arbitral decision.
  2. Ultimately, the barrier system did work.  In this context, a defect in design was not a likely explanation.
  3. If the impugned tests had been revealed, they would not have had a devastating impact on the conduct of the arbitration.
  4. The non-concealment of some tests was not the “tip of the iceberg.”  It did not demonstrate that non-concealment was a wider issue.
  5. The arbitral tribunal had held that, even if design fault was proven, the standard of misconduct required by French law had not been established.  The tribunal decided that, under French law, the design had to be “technically unusable or extremely difficult to use” to give rise to liability.  Since the barrier technology had ultimately been implemented, that test could not be met.

These conclusions are noteworthy on a number of accounts:

First, the judge went into the technical evidence, and the evidence before the arbitral tribunal, to an extraordinary extent.  His conclusions, and particularly as to whether the impugned evidence would probably have impacted the arbitral tribunal, came very close to a re-trial of the merits of the substantive issue between the parties, something which the judge warned himself that he should not undertake.

Second, the judge was largely unmoved by the impact on credibility that the disclosure of the impugned tests would have had on the arbitration process and tribunal.  This reaction of the judge is somewhat surprising, having regard to the unpredictable impact which non-disclosure can have upon the credibility of parties and witnesses during any contested proceeding.  Here, the issue might be what exactly is the question:

Is it:  Would the disclosure of the true position probably have affected the result of the arbitration? (as stated by the judge).  Or is it, or does it include:  Did the non-disclosure of the true position probably affect the result of the arbitration?  Those two questions do not necessarily lead to the same answer.

Third, the principles applied by English courts are based upon a strong disinclination to interfere with arbitration proceedings, even in the presence of fraud.  Is this the right judicial attitude?  Is the test used by the court too high a test?  Is using this test the best way to ensure that both the stature and credibility, and the independence, of arbitral proceedings are protected?  These questions will be further debated in the courts as arbitration proceedings, and in particular international commercial arbitrations, become even more common.

Fourth, the court’s decision seems to have been overwhelmingly driven by the very high test for liability under French law which the arbitrators applied, and the fact that the barrier system ultimately did work.  The judge seems to have felt that, since the system did work, the applicant’s complaint was something of a tempest in a teapot, no matter how serious were his findings of misconduct.

These latter two factors may well not be present in another case. In North America, the test for negligence does not appear to be nearly as high as the test under French law used by the arbitrators.  And if, in another case, the design or manufacture of the article is ultimately shown to be faulty, then the second factor will not exist.

In any event, this decision will be a useful precedent for future considerations of arbitral awards attacked on the ground of fraud.

See Heintzman and Goldsmith, Canadian Building Contracts (4th ed.), Chapter 10, Part 3

International Arbitration  –  Setting Aside Arbitration Award  –  Fraud or Misconduct

Chantiers de l’Atlantique S.A. v. Gaztransport & Technigaz S.A.S., 2011 EWHC 3383 (Comm)

Thomas G. Heintzman O.C., Q.C., FCIArb                                                                          July 15, 2012

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