Construction Summit

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CONSTRUCTION SUMMIT

2005

THE CONTRACTOR ASKS

“SHOULD I WALK OFF THE JOB?”

THE OWNER ASKS

“SHOULD I TERMINATE THE CONTRACT?”

Submitted by Stanley Naftolin, J.D., Q.C., Counsel

Goldman Sloan Nash & Haber LLP

INDEX

1.  The Preamble

2.  The Contract:

a) Interpretation of Contract;

b) Exculpatory Clauses in the Contract

3.  Fundamental Breach:

a) Rescission and Repudiation

b)  Fundamental breach vs. breach of fundamental term

4.  Breach, Termination and Consequences:

a)  Breach By the Owner;

b) Breach By the Contractor;

c) Non-Completion of Contract

d) Damages and Termination

5.  Conclusions:

a)  Effect of Contractor Termination;

b)  Effect of Progress Payments and Failure to Pay

c)  Contracts – Entire or Otherwise

d)  Completion of Contract – Minor Deficiencies

6. Some of the Case Law

7. Historical Analysis of Some of the Cases

8. Conclusion

Preamble

One of the most difficult questions for any construction lawyer or, for that matter, any commercial lawyer, giving advice on contracts, is whether or not a breach of the contract complained of, goes to the root of the contract, thereby allowing the other party to accept the repudiation of the offending party of its obligations to perform under that contract. The undertaking involved with respect to giving such advice requires a painstaking, factual analysis of what has occurred to date, a detailed contract analysis, and in some instances, trying to determine what the intentions of the parties were at the time of execution of the contract. This aspect of the analysis becomes even more important when you come across exclusion clauses which will be discussed later in this paper.

The Contract

It is frequently said, where there is a claim for damages, the best place to start is to look at the contract. Surprisingly enough, it has been my experience that, in many instances, the parties and their counsel frequently overlook many of the salient terms of the contract that set out the protocol that one must follow in terms of dealing with the issue of claims, the damages that subsequently flow and termination.

It is not uncommon to see one of the parties to the contract who seeks to terminate the contract relying on what is called an “alleged repudiation” by the other party of its obligations of performance under the contract. The alleged repudiation being the alleged breach of contract by that party. It is important to determine and properly conclude that the failure to perform, goes to the root of the contract and evidences that party’s intention to be bound no longer.[1]

a) Interpretation of Contract

Contract interpretation also becomes very important. It is said that a fundamental breach is a breach that appears to be so fundamental that it permits the aggrieved party to terminate the performance of the contract, in addition to entitling that party to sue for damages. Some courts have used a strict rule of construction approach when dealing with the terms of the contract and have stated a fundamental breach is found only through examining the reasonable intentions of the parties at the time of the contract.[2] If that is the case, which door do you go through? Pick the wrong door and suffer the consequences.

The question to be asked in all cases of incomplete performance is one of fact: the answer must depend upon the terms of the contract and of course, the circumstances of each case. It is for this reason, that is where the courts deal with the circumstances of each case, that you, as counsel, must understand that the question assumes one of two forms – does the failure of performance amount, in effect, to a renunciation by the party who makes default? Does it go so far to the root of the contract as to entitle the other to say, ‘I have lost all that I cared to obtain under the contract; further performance cannot make good the prior default.’? [3]

Remember that a breach of a contract does not necessarily allow you, in law, to terminate the contract. Depending upon the nature of the breach, one of the following may occur:

a)  the breach gives the other party the right to rescind the contract, that is, to treat it as having come to an end; or

b)  the breach may give rise to an action for damages only but does not terminate the obligations of either party that arise pursuant to the contract.

Goldsmith, in his text Canadian Building Contracts [4] has stated that if the breach is so serious and fundamental as to go to the root of the contract, the other party may elect to treat the contract as at an end. If the breach is not so fundamental, that will only entitle the other party to claim damages that he has suffered as a result of the breach but it will not enable that party to escape from his own obligations under the contract. This is a critical distinction and one which the client and counsel must keep in mind. Some of the obligations are vital to the contract and as Goldsmith has stated, these are generally described as “conditions”. Those that are less important are known as “warranties”. Only breaches of conditions will entitle the other party to treat the contract as at an end; whereas, a breach of warranty gives rise only to a claim for damages. Conditions and warranties are dependant upon the intention of the parties as set out in the contract document and the courts will determine, in each case, which obligations fall into which category. If you are giving the advice, you must make that decision when considering walking off the job or terminating the contract.

b) Exculpatory Clauses in the Contract

Reviewing the contract may disclose numerous exclusion clauses, that is, the contract may stipulate conditions, such as the failure to perform a particular obligation that would entitle the innocent party to terminate the contract. This type of clause is known as a “forfeiture” clause. For those of you who are familiar with the various construction contracts that are being used, they frequently contain forfeiture clauses entitling one party or the other to terminate the contract on the occurrence of certain events. Keep in mind that in order for the forfeiture clauses to be properly enforced and to be relied upon, the protocol set out in the contract must be strictly followed because if it is not and the contract is found to have been improperly terminated, the aggrieved party would be entitled to damages for the improper termination. This is why it is very important to review the contract and in particular, the protocol required for the purpose of allowing one party or the other to terminate the contract.

In most cases, the ordinary rules of construction that apply to contracts are strictly applicable to exclusionary provisions. Chitty on Contracts states that:

“if the clause is expressed clearly and unambiguously, there is no justification for placing upon the language of the clause a strained and artificial meaning so as to avoid the exclusion or restriction of liability contained in it.”[5]

When dealing with exculpatory clauses, they are strictly construed and construed against the interests of the party who drafted the document containing them. This is the rule of “contra proferentem”. Cheshire and Fifoot, in their learned text, Law of Contract [6], have stated:

“If there is any doubt as to the meaning and scope of the excluding or limiting term, the ambiguity will be resolved against the party who has inserted it and who is now relying on it. As he seeks to protect himself against liability to which you would otherwise be subject, it is for him to prove that his words clearly and aptly describe the contingency that has in fact arisen.”

The Courts also consider as previously set out herein, the reasonable expectations of the parties.[7]

You must be very careful when advising about termination of the contract in the event that the parties did not follow the strict protocol as prescribed in the contract. If certain protocol and terms of the contract have not been acted upon, one party may not be able to take advantage of a particular contractual term which would allow them to terminate the contract as a result of default by the other party. The courts have, in cases where the parties, by their course of conduct, been deemed to have amended their written agreement so that it does not represent their original intention, refused to enforce the agreement, even if the existing contract requires changes in the agreement to be in writing. The courts have indicated that, in those circumstances, they have the authority to refuse enforcement. [8]

FUNDAMENTAL BREACH

The Supreme Court of Canada has stated that fundamental breach occurs:

“….. where the event resulting from the failure of one party to perform a primary obligation has the effect of depriving the other party of substantially the whole benefit that the parties intended should obtain from the contract. Fundamental Breach represents an exception to the rule that the contract continues to subsist and that the damages be paid for the unperformed obligations of both parties. This exceptional remedy is available only where the very thing bargained for has not been provided.”[9]

The difficult question to answer when giving advice to clients is, how do you determine whether a particular breach is fundamental? Madam Justice Wilson in the case of Beaufort Realties (1964) Inc. vs. Chomedey Aluminum Co. noted in her reasons for judgment the following:

“…. Canadian Courts have tended to pay lip service to contract construction, but to apply the doctrine of fundamental breach as if it were a rule of law. While the motivation underlying the continuing use of fundamental breach as a rule of law may be laudatory, as a tool for relieving parties from the effects of unfair bargains, the doctrine of fundamental breach has spawned a host of difficulties; the most obvious is how to determine whether a particular breach is fundamental. From this very step, the doctrine of fundamental breach invites parties to engage in games of characterization, each party emphasizing different aspects of the contract to show either that the breach occurred went to the very root of the contract or that it did not. The difficulty of characterizing a breach as fundamental for the purposes of exclusion clauses, is vividly illustrated by the differing view of the trial Judge and the Court of Appeal in the present case.” [10]

Professor S.M. Waddams has written extensively on the issue of fundamental breach and he has stated that the doctrine of fundamental breach has many serious deficiencies as a technique of controlling unfair agreements. His comments were related to the doctrine requiring the Court to identify the offending provisions as “exemption clauses”, then to consider the agreement apart from the exemption clause, to ask itself whether there would have been a breach of that part of the agreement and then to consider whether that breach was “fundamental”.

As can be seen from the references to the Supreme Court of Canada decision in Hunter and the comments of Professor Waddams, counsel may have a difficult time in determining what has been a fundamental breach which would allow the offended party to the contract to terminate the contract.

If a party’s breach is non-material, the non-breaching party’s duty to perform may be suspended until the breach is remedied, or cured. However, a non-material breach will not excuse performance by the non-breaching party. Only a material breach excuses the non-breaching party from its contractual obligations. In order to determine whether a breach goes to the root of an agreement, the Court must examine all of the circumstances surrounding the contract, such as the statements and promises of both parties, which are often different in nature and importance, as well as their uniqueness and meaning.[11]

The New Brunswick Court of Appeal in the case of McDonald vs. Migliore [12] references Cheshire and Fifoot, The Law of Contract, [9th ed. 1976] at pages 571 to 572 which states as follows:

“of what nature then must a breach be before it is said to be called ‘fundamental’?

There are two alternative tests that may provide the answer. The Court may find the decisive element either in the importance that the parties would seem to have attached to the term which has been broken or to the seriousness of the consequences that have in fact resulted from the breach.”

There is an abundance of case law dealing with fundamental breach and whether fundamental breach will allow the party who is affected by the fundamental breach to avoid any exclusion clauses in the contract. We would then need to consider an argument based on “fundamental breach” or, a breach “going to the root of the contract”. These expressions are used in the cases to denote two different things, namely: (i) a performance totally different from that which the contract contemplates (this is the reference to whether or not a fundamental breach entitles a party to relief inspite of the exclusion clause); (ii) a breach of contract more serious than one which would only entitle the other party merely to damages and which would entitle the party to refuse performance or further performance under the contract and to claim for damages. As you can see, there is some confusion, but nevertheless, the concept of fundamental breach still appears to be alive and well, albeit, confusing.

Since there appears to be two types of fundamental breach, it is important to note the distinction between these two. One is a fundamental failure of consideration and the other is a breach that repudiates the contract, thereby entitling the innocent party to accept the repudiation and to refuse further performance of its obligations, [terminate the contract] although it will be entitled to seek damages. There is a repudiation that is said to be a rescission of the contract.