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Fundamental Breach R.I.P. Freedom of Contract Gains Traction in Supreme Court’s Decision in Tercon

Parties to commercial contracts sometimes agree in writing that one or both of them will not sue the other for breach or that there are limits on their ability to sue each other. Such no-claims clauses are as common in complex agreements negotiated between sophisticated business people as they are in consumer contracts where the service provider dictates the terms. If the relationship later breaks down and one of the parties sues the other for breach, the parties typically disagree on the meaning of the no-claims clause. One will rely on the clause as a defence to the claim; the other will look for ways to get around it.

For over 50 years the party seeking to get around the no-claims clause has had the doctrine of fundamental breach in his arsenal of legal arguments. The doctrine, in simplest terms, states that certain breaches of contract are so fundamental as to deprive the innocent party of substantially the whole of what he bargained for. In its original incarnation the doctrine held that a party in fundamental breach could not hide behind a no-claims clause. Plaintiffs would therefore seek to characterize their case as one of fundamental breach while Defendants would do the opposite. Much effort was expended by lawyers and the courts in debating which breaches were fundamental.

In its recent decision in Tercon Contractors Ltd. v. British Columbia the Supreme Court of Canada has “shut the coffin” on the doctrine of fundamental breach and simplified the rules for enforcing no-claims clauses. The Tercon case arose from a construction tendering dispute the details of which are not of general interest. The implications of the decision reach beyond the construction industry and affect the interpretation of no-claims clauses in all commercial contracts.

There has always been a tension in the law on fundamental breach between the freedom of parties to contract as they see fit and the unfairness of depriving the innocent party of a legal remedy for the other’s breach. Fundamental breach clearly favours fairness over freedom. That changed somewhat with the 1989 split decision in Hunter Engineering Co. v. Syncrude Canada Ltd., in which the Supreme Court ruled that the enforceability of no-claims clauses was a matter of contract interpretation instead of a rule of law. Even in cases of fundamental breach, one had to interpret the no-claims clause and determine if the parties intended it to apply. The majority decision in Hunter was a cautious endorsement in favour of greater freedom of contract. Chief Justice Dickson, for the minority, favoured dispensing with fundamental breach altogether.

In Tercon the top court unanimously sided with Chief Justice Dickson. In the words of Mr. Justice Binnie,

On this occasion we should again attempt to shut the coffin on the jargon associated with “fundamental breach”.

The entire court agreed with that sentiment. Mr. Justice Cromwell stated:

On the issue of fundamental breach in relation to exclusion clauses, my view is that the time has come to lay this doctrine to rest, as Dickson C.J. was inclined to do more than 20 years ago.

The Supreme Court in Tercon openly recognizes the tensions hiding within the doctrine of fundamental breach but gives greater credit to freedom of contract, finding that “there is nothing inherently unreasonable about exclusion clauses” and that there is “a public interest in leaving knowledgeable parties free to order their own commercial affairs.” The Court’s three stage test seeks to find a balance of the competing policy interests.

The first stage is to interpret the no-claims clause to decide if it applies to the circumstances of the breach as established by the evidence. If the clause does not apply there is no need to proceed further.

The second stage is to determine if the no-claims clause was unconscionable at the time the contract was made, as might arise from situations of unequal bargaining power between parties to a consumer contract.

The third stage is to determine if there is any overriding public policy reason not to enforce the no-claims clause.

What does Tercon mean for the future of no-claims clauses? For starters:

  • Parties in litigation involving a no-claims clause will no longer have to fight about whether or not a given breach was a fundamental breach, but they will still fight over the correct interpretation and application of the clause in issue. This will provide fertile ground for disagreement as Tercon illustrates so well. Although the Supreme Court agreed on how to analyze the contract, they split on the proper interpretation with 5 Justices concluding that the no-claims clause was not enforceable and 4 Justices concluding that it was. 
  • Contract drafters must continue to draft with precision as to the types of liability they intend to limit by a no-claims clause since the courts will carefully scrutinize the wording used; 
  • No-claims clauses in contracts negotiated between sophisticated parties will ordinarily be enforced according to their terms; 
  • No-claims clauses in “David and Goliath” consumer contracts may be enforced according to their terms but the “Goliath” seeking to rely on the clause should be prepared to show that “David” understood and accepted what he was signing so as to rebut assertions of unconscionability; 
  • Establishing that a no-claims clause should not be enforced for public policy reasons will be difficult because the public policy reason must outweigh “the very strong public interest in the enforcement of contracts.” An example is the recognized policy condemning fraud or criminality in commercial contracts.

In the Tercon decision the Supreme Court has stated unanimously and clearly that the time has come to lay the doctrine to rest. It remains to be seen whether the coffin will stay shut or whether the doctrine will rise up yet again.