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.
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  A.C. 1 HL.
- 21 Modern Buildings (Waltes) Ltd. v. Limmer & Trinidad Co. Ltd. [ 1975], 1 W.L.R. 1281;  2 All E.R. 549 CA; Owners of the Annefield v. Owners of Cargo Lately Laden on Board the Annefieldl,  P. 168;  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.,  O.J. No. 5389 (Ont. C.A.) at para. 23
- 27 Eli Lilly & Co. v. Novopharm Ltd.,  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