News

By Julius T. Ko

The Supreme Court of Canada provided more clarity on the principle of the freedom of contract between parties. In particular, limited liability clauses between sophisticated legal parties are not always easily set aside by the doctrine of breach of fundamental obligation, or arguably by the doctrine of fundamental breach under the common law.

The Facts

6362222 Canada Inc (“Createch”), is a software consulting firm specializing in performance improvement and the implementation of integrated management systems. Prelco is a large manufacturing company that makes and transforms flat glass for various uses. In 2008, the parties signed a contract for Createch to implement at Prelco, a Microsoft integrated management system.[1]

During the implementation, numerous problems arose, including inconsistent invoices, errors in orders, shipping delays, and inefficiency in the planning and production system. Prelco terminated the contract with Createch in 2010 and hired another company to complete implementation. Prelco brought an action against Createch for over $6 million in damages.[2] Createch counterclaimed for approximately $300K in unpaid invoices for supplies and services.[3]

The Limitation of Liability Clause:

The contract between the parties contained a limitation of liability clause, which notes in its first paragraph:

Clause 7: “If such damages result from the delivery of unsatisfactory services, Createch’s liability shall be limited to the amount of any fees paid in relation to the said unsatisfactory services.”

The primary issue before the Courts was, can Createch’s failure to perform a fundamental obligation of the contract render clause 7 of the contract inoperative?

Trial Decision

At the level of the Superior Court, in its view, Createch’s conduct “did not show gross recklessness, gross carelessness or gross negligence” and it could not be characterized as an intentional fault.[4] Nevertheless, the trial judge found that the limitation of liability clause in the contract was inoperative, due to a fundamental breach of an obligation by Createch. Specifically, Createch did not understand that the system required indexes, causing the system to freeze for several minutes, amongst other issues. Further, the trial judge found that the contract between Createch and Prelco was one between sophisticated legal parties, and that Prelco was not a consumer.[5]

In summary, the trial judge found clause 7, the limitation of liability clause inoperative and ordered Createch to pay Prelco $2,203,400 minus the counterclaim of Createch of $331,134.42, for a total of $1,872,266.[6]

Court of Appeal Ruling

Createch appealed the Superior Court’s judgement and argued that the trial judge erred in finding that the limitation of liability clause in the contract was inoperative due to a breach of a fundamental obligation. The Justices did not accept Createch’s argument that the rejection of the common law doctrine of “fundamental breach” barred Prelco’s claim. Instead, breach of a fundamental obligation is still applied in Quebec Civil Law, and that the limitation of liability clause can become inoperative in accordance with article 1438.[7]

The Court of Appeal dismissed Createch’s appeal and unanimously found that a breach of a fundamental obligation can render limitation of liability clauses inoperative. The trial judge did not make a palpable and overriding error.[8]

Supreme Court Decision

Public Order

The Supreme Court of Canada noted that in Glengoil Steamship Co., non-liability or limited liability clauses are valid in principle, and that this is based upon the freedom of contract between parties. This is also arguably implicitly recognized in articles 1474 and 1475 of the Quebec Civil Code (the “Code”). The Court then noted that clause 7, or a limitation of liability clause may be rendered inoperative by legislative and judicial public order. For example, article 1437 of the Code expressly recognizes the application of the doctrine of a breach of a fundamental obligation, where there is an abusive contract clause, but it is limited to consumer contracts.[9]

The Court also noted that this premise is also supported in the common law, and in as early as 1989. In the decision of Hunter Engineering Co. the Supreme Court of Canada noted that while analyzing the doctrine of fundamental breach, one must also recognize that exclusionary clauses are not all unreasonable. Then following in Tercon Contractors Ltd., which the Court noted that even if a clause is held to be valid and applicable, it may still be rendered inoperative due to the existence of any overriding public policy.[10]

Reciprocity of Obligations

The Court noted that the Court of Appeal relied on a second basis in its decision, distinct from public order.  The reciprocity of obligations and total absence of cause. Basically, by relying on a non-liability clause, a debtor is allowed to avoid responsibility for their breach of a fundamental obligation, which deprives the contract of its cause. The Court noted that article 1371 of the Code states that the essence of an obligation arising out of a juridical act, there be a cause which justifies its existence.[11]

In applying this framework to the facts of this case, Prelco was correct in noting that it is necessary to take in consideration the Code and public order. However, based on Glengoil and the Code, the Court found that the parties were free to contract between each other. Moreover, the Supreme Court of Canada found that clause 7 did not violate any rule of legislative or judicial public order. Specifically, the Court noted that Prelco was a sophisticated legal person and not a consumer, implying that article 1437 of the Code nor the Consumer Protection Act applied to the contract. [12]

In terms of the reciprocity of obligations, the Court found that clause 7 was not a no obligation clause that would exclude a reciprocity of obligations. They noted that although it is true that the limitation of liability clause significantly limits the sanctions that can be imposed upon Createch, Createch still owed substantial obligations to Prelco. The Court noted that clause 7 did not deprive the contractual obligation of its cause but determines the extent of the debtor’s liability.[13]

The Supreme Court of Canada concluded that both the trial judge and the Court of Appeal erred in law in finding that the limitation of liability clause in the contract was inoperative. The Court did not accept Prelco’s arguments and allowed the appeal in part, that the trial decision regarding the award against Createch on Prelco’s: claims from customers, loss of profits on sales made and loss of profits on sales lost is set aside and that Createch is entitled to its costs throughout.[14]

Implications

The implications of this decision result in some guidance from the Supreme Court of Canada regarding the freedom of contract between sophisticated commercial parties. On a practical level, the Court’s decision implies that the freedom of contract, in particular limited liability causes between sophisticated commercial parties are not always easily set aside by the doctrine of breach of fundamental obligation, or arguably in the common law, the doctrine of fundamental breach.

[1] 6362222 Canada Inc. v Prelco inc, 2021 SCC 39 at paras 6-13. [SCC]

[2] SCC, at paras 14-15.

[3] Prelco inc. v 6362222 Canada Inc., 2016 QCCS 4086 at para 2. [Trial]

[4] Trial, at para 208.

[5] Trial, at paras 210-225.

[6] Trial, at paras 280-292; SCC, at paras 24.

[7] 6362222 Canada Inc. v Prelco inc., 2019 QCCA 1457 at paras 20-41. [Appeal]

[8] Appeal, at paras 48-51; SCC, at paras 25-29.

[9] SCC, at paras 38 – 48.

[10] SCC, at paras 55 – 59.

[11] SCC, at paras 71 – 82.

[12] SCC, at paras 88-91.

[13] SCC, at paras 94-99.

[14] SCC, at paras 103-104.