Simon's Megalomaniacal Legal Resources

Contracts - Fundamental Breach

. 1157391 Ontario Inc. v. Ortiz

In 1157391 Ontario Inc. v. Ortiz (Div Ct, 2021) the Divisional Court considers a case of fundamental breach:

[14] The trial judge found that the Defendants were only entitled to terminate the contract if the Plaintiff had fundamentally breached the contract. In doing so, he relied on the Court of Appeal’s decision in Spirent Communications of Ottawa Ltd. v. Quake Technologies, 2008 ONCA 92, 88 O.R. (3d) 721, leave to appeal to S.C.C. refused, 2008 CarswellOnt. 4317. Spirent establishes the following principles:

(a) Only a fundamental breach gives a party the right to terminate a contract: at para. 35.

(b) A “fundamental breach is one which deprives the innocent party of substantially the whole benefit of the contract”: at para. 35.

(c) There are five factors to consider in deciding whether there has been a fundamental breach:

The five factors are: (1) the ratio of the party’s obligations not performed to that party’s obligations as a whole; (2) the seriousness of the breach to the innocent party; (3) the likelihood of repetition of such breach; (4) the seriousness of the consequences of the breach; and (5) the relationship of the part of the obligation performed to the whole obligation: at para. 36.

[15] The trial judge found that the Plaintiff had not breached the contract and that none of the factors for fundamental breach were present.

[16] The Defendants argued on appeal that the trial judge erred in law in relying on Spirent to guide his analysis. According to the Defendants, Spirent is not a construction lien case and the principles that should have been followed are the ones set out in construction lien cases such as Heyday Homes Ltd. v. Gunraj, [2004] O.J. No. 429 (Sup. Ct.) and D. & M. Steel Ltd. v. 51 Construction Ltd., 2018 ONSC 2171, [2018] O.J. No. 1770. This submission has no merit. First, Spirent, while not a construction lien case, is a binding authority on when a party is entitled to terminate a contract. Second, the overarching principles referred to in the construction lien cases cited by the Defendants are consistent with the principles established in Spirent. For example, in Heyday Homes, Master Sandler identified the central issue in the case as being whether either party was in fundamental breach of the contract. He confirmed that a fundamental breach had to be serious and work that is merely “bad or defective” will not entitle an owner to terminate a contract: at para. 343, quoting Goldsmith on Canadian Building Contracts, 4th ed. (Carswell, 1988), at p. 6-4. In D. & M. Steel, Perell J. at para. 51 also accepted that only a fundamental breach will entitle an owner to terminate a contract and that “mere bad or defective work or insignificant non-completion will not, in general, entitle an owner to terminate a contract”. Instead, the owner must first give the contractor an opportunity to remedy the defects or complete the work. Then, the owner may be entitled to sue for damages: at para. 52. An owner may terminate a contract “if a contractor abandons the contract, repudiates the contract, fundamentally breaches the contract, or performs the contract in a way that is so defective as to amount, in substance, to a failure or refusal to carry out the contract work”: at para. 53.

. Tercon Contractors Ltd. v. British Columbia (Transportation and Highways)

In Tercon Contractors Ltd. v. British Columbia (Transportation and Highways) (SCC, 2010) the Supreme Court of Canada 'laid to rest' the doctrine of fundamental breach with respect to exclusion of liability clauses. The following passage from Binnie JA's dissent was approved by Cromwell JA [in para 62]:

[81] Binnie J. (dissenting) — The important legal issue raised by this appeal is whether, and in what circumstances, a court will deny a defendant contract breaker the benefit of an exclusion of liability clause to which the innocent party, not being under any sort of disability, has agreed. Traditionally, this has involved consideration of what is known as the doctrine of fundamental breach, a doctrine which Dickson C.J. in Hunter Engineering Co. v. Syncrude Canada Ltd., 1989 CanLII 129 (SCC), [1989] 1 S.C.R. 426, suggested should be laid to rest 21 years ago (p. 462).

[82] On this occasion we should again attempt to shut the coffin on the jargon associated with “fundamental breach”. Categorizing a contract breach as “fundamental” or “immense” or “colossal” is not particularly helpful. Rather, the principle is that a court has no discretion to refuse to enforce a valid and applicable contractual exclusion clause unless the plaintiff (here the appellant Tercon) can point to some paramount consideration of public policy sufficient to override the public interest in freedom of contact and defeat what would otherwise be the contractual rights of the parties. Tercon points to the public interest in the transparency and integrity of the government tendering process (in this case, for a highway construction contract) but in my view such a concern, while important, did not render unenforceable the terms of the contract Tercon agreed to. There is nothing inherently unreasonable about exclusion clauses. Tercon is a large and sophisticated corporation. Unlike my colleague Justice Cromwell, I would hold that the respondent Ministry’s conduct, while in breach of its contractual obligations, fell within the terms of the exclusion clause. In turn, there is no reason why the clause should not be enforced. I would dismiss the appeal.

. Hunter Engineering Co. v. Syncrude Canada Ltd.

In Hunter Engineering Co. v. Syncrude Canada Ltd. (SCC, 1989) the Supreme Court of Canada [Dickson CJ and LaForest J] question the utility of the doctrine of fundamental breach, here as used in deciding whether to respect an exclusion of liability clause:

I have had the advantage of reading the reasons for judgment prepared by my colleague, Justice Wilson, in this appeal and I agree with her disposition of the liability of Allis-Chalmers. In my view, the warranty clauses in the Allis-Chalmers contract effectively excluded liability for defective gearboxes after the warranty period expired. With respect, I disagree, however, with Wilson J.'s approach to the doctrine of fundamental breach. I am inclined to adopt the course charted by the House of Lords in Photo Production Ltd. v. Securicor Transport Ltd., [1980] A.C. 827, and to treat fundamental breach as a matter of contract construction. I do not favour, as suggested by Wilson J., requiring the court to assess the reasonableness of enforcing the contract terms after the court has already determined the meaning of the contract based on ordinary principles of contract interpretation. In my view, the courts should not disturb the bargain the parties have struck, and I am inclined to replace the doctrine of fundamental breach with a rule that holds the parties to the terms of their agreement, provided the agreement is not unconscionable.

The doctrine of fundamental breach in the context of clauses excluding a party from contractual liability has been confusing at the best of times. Simply put, the doctrine has served to relieve parties from the effects of contractual terms, excluding liability for deficient performance where the effects of these terms have seemed particularly harsh. Lord Wilberforce acknowledged this in Photo Production, supra, at p. 843:

1. The doctrine of "fundamental breach" in spite of its imperfections and doubtful parentage has served a useful purpose. There was a large number of problems, productive of injustice, in which it was worse than unsatisfactory to leave exception clauses to operate.

In cases where extreme unfairness would result from the operation of an exclusion clause, a fundamental breach of contract was said to have occurred. The consequence of fundamental breach was that the party in breach was not entitled to rely on the contractual exclusion of liability but was required to pay damages for contract breach. In the doctrine's most common formulation, by Lord Denning in Karsales (Harrow) Ltd. v. Wallis, [1956] 1 W.L.R. 936 (C.A.), fundamental breach was said to be a rule of law that operated regardless of the intentions of the contracting parties. Thus, even if the parties excluded liability by clear and express language, they could still be liable for fundamental breach of contract. This rule of law was rapidly embraced by both English and Canadian courts.

A decade later in the Suisse Atlantique case, the House of Lords rejected the rule of law concept in favour of an approach based on the true construction of the contract. The Law Lords expressed the view that a court considering the concept of fundamental breach must determine whether the contract, properly interpreted, excluded liability for the fundamental breach. If the parties clearly intended an exclusion clause to apply in the event of fundamental breach, the party in breach would be exempted from liability. In B. G. Linton Construction Ltd. v. Canadian National Railway Co., 1974 CanLII 189 (SCC), [1975] 2 S.C.R. 678, this Court approved of the Suisse Atlantique formulation. The renunciation of the rule of law approach by the House of Lords and by this Court, however, had little effect on the practice of lower courts in England or in Canada. Lord Denning quickly resuscitated the rule of law doctrine in Harbutt's "Plasticine" Ltd. v. Wayne Tank & Pump Co., [1970] 1 Q.B. 447 (C.A.)

Finally, in 1980, the House of Lords definitively rejected the rule of law approach to fundamental breach in Photo Production, supra. In that case, the plaintiff, Photo Production, had contracted with Securicor, a company in the business of supplying security services, to provide four nightly patrols of its factory. At issue was whether Securicor was liable for a fire deliberately set by one of its employees in the course of his duties at the Photo Production factory. The contract between the two parties contained the following limitation clause (at p. 840):

"1. Under no circumstances shall the company (Securicor) be responsible for any injurious act or default by any employee of the company unless such act or default could have been foreseen and avoided by the exercise of due diligence on the part of the company as his employer; nor, in any event, shall the company be held responsible for (a) any loss suffered by the customer through burglary, theft, fire or any other cause, except insofar as such loss is solely attributable to the negligence of the company's employees acting within the course of their employment . . . ."

The limitation clause clearly excluded liability for fire with the exception of fires started by negligent acts. Securicor argued it could not be liable under the contract for the fire that occurred. Photo Production contended that Securicor was liable for the damage done to the factory under the doctrine of fundamental breach.

Lord Wilberforce rejected Photo Production's argument. He began by reviewing the fractured history of the doctrine of fundamental breach and then forcefully repudiated the rule of law concept. Lord Wilberforce reiterated the thoughts articulated in Suisse Atlantique, stating at pp. 842-43, he had no doubt as to,

. . . the main proposition that the question whether, and to what extent, an exclusion clause is to be applied to a fundamental breach, or a breach of a fundamental term, or indeed to any breach of contract, is a matter of construction of the contract.

The policy behind this approach is stated by Lord Wilberforce, at p. 843, as follows:

At the stage of negotiation as to the consequences of a breach, there is everything to be said for allowing the parties to estimate their respective claims according to the contractual provisions they have themselves made, rather than for facing them with a legal complex so uncertain as the doctrine of fundamental breach must be . . . .

At the judicial stage there is still more to be said for leaving cases to be decided straightforwardly on what the parties have bargained for rather than on analysis, which becomes progressively more refined, of decisions in other cases leading to inevitable appeals.

Lord Wilberforce proceeded to examine the contract between Securicor and Photo Production to determine exactly what the parties had provided, at p. 846:

As a preliminary, the nature of the contract has to be understood. Securicor undertook to provide a service of periodical visits for a very modest charge . . . . It would have no knowledge of the value of the plaintiffs' factory: that, and the efficacy of their fire precautions, would be known to the respondents. In these circumstances nobody could consider it unreasonable, that as between these two equal parties the risk assumed by Securicor should be a modest one, and that the respondents should carry the substantial risk of damage or destruction.

The duty of Securicor was, as stated, to provide a service. There must be implied an obligation to use due care in selecting their patrolmen, to take care of the keys and, I would think, to operate the service with due and proper regard to the safety and security of the premises. The breach of duty committed by Securicor lay in a failure to discharge this latter obligation. Alternatively it could be put upon a vicarious responsibility for the wrongful act . . . . This being the breach, does condition 1 apply? It is drafted in strong terms, "Under no circumstances" . . . "any injurious act or default by any employee." These words have to be approached with the aid of the cardinal rules of construction that they must be read contra proferentem and that in order to escape from the consequences of one's own wrongdoing, or that of one's servant, clear words are necessary. I think that these words are clear. The respondents in facts [sic] relied upon them for an argument that since they exempted from negligence they must be taken as not exempting from the consequence of deliberate acts. But this is a perversion of the rule that if a clause can cover something other than negligence, it will not be applied to negligence. Whether, in addition to negligence, it covers other, e.g., deliberate, acts, remains a matter of construction requiring, of course, clear words. I am of the opinion that it does, and being free to construe and apply the clause, I must hold that liability is excluded. [Emphasis added.]

Lord Diplock alluded to the importance of negotiated risk allocation at p. 851:

My Lords, the reports are full of cases in which what would appear to be very strained constructions have been placed on exclusion clauses, mainly in what to-day would be called consumer contracts and contracts of adhesion . . . . In commercial contracts negotiated between business-men capable of looking after their own interests and of deciding how risks inherent in the performance of various kinds of contract can be most economically borne (generally by insurance), it is, in my view, wrong to place a strained construction upon words in an exclusion clause which are clear and fairly susceptible of one meaning only even after due allowance has been made for the presumption in favour of the implied primary and secondary obligations.

In Beaufort Realties, supra, Ritchie J., delivering the judgment of this Court, stated, at p. 723:

Stated bluntly, the difference of opinion as to the true intent and meaning of their Lordships' judgment in the Suisse Atlantique case centered around the question of whether a rule of law exists to the effect that a fundamental breach going to the root of a contract eliminates once and for all the effect of all clauses exempting or excluding the party in breach from rights which it would otherwise have been entitled to exercise, or whether the true construction of the contract is the governing consideration in determining whether or not an exclusionary clause remains unaffected and enforceable notwithstanding the fundamental breach. The former view was espoused by Lord Denning and is illustrated by his judgment which he delivered on behalf of the Court of Appeal in the Photo Production case (supra) . . . .

and at p. 725:

It has been concurrently found by the learned trial judge and the Court of Appeal that article 6 of this contract constituted an exclusionary or exception clause and Madame Justice Wilson adopted the same considerations as those which governed the House of Lords in the Photo case in holding that the question of whether such a clause was applicable where there was a fundamental breach was to be determined according to the true construction of the contract. I concur in this approach to the case.

As Wilson J. notes in her reasons, 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 first step the doctrine of fundamental breach invites the parties to engage in games of characterization, each party emphasizing different aspects of the contract to show either that the breach that 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 views of the trial judge and the Court of Appeal in the present case.

The many shortcomings of the doctrine as a means of circumventing the effects of unfair contracts are succinctly explained by Professor Waddams (The Law of Contracts (2nd ed. 1984), at pp. 352-53):

The doctrine of fundamental breach has, however, many serious deficiencies as a technique of controlling unfair agreements. The doctrine requires the court to identify the offending provision as an "exemption clause", 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". These inquiries are artificial and irrelevant to the real questions at issue. An exemption clause is not always unfair and there are many unfair provisions that are not exemption clauses. It is quite unsatisfactory to look at the agreement apart from the exemption clause, because the exemption clause is itself part of the agreement, and if fair and reasonable a perfectly legitimate part. Nor is there any reason to associate unfairness with breach or with fundamental breach . . . .

....

More serious is the danger that suppression of the true criterion leads, as elsewhere, to the striking down of agreements that are perfectly fair and reasonable.

Professor Waddams makes two crucially important points. One is that not all exclusion clauses are unreasonable. This fact is ignored by the rule of law approach to fundamental breach. In the commercial context, clauses limiting or excluding liability are negotiated as part of the general contract. As they do with all other contractual terms, the parties bargain for the consequences of deficient performance. In the usual situation, exclusion clauses will be reflected in the contract price. Professor Waddams' second point is that exclusion clauses are not the only contractual provisions which may lead to unfairness. There appears to be no sound reason for applying special rules in the case of clauses excluding liability than for other clauses producing harsh results.

In light of the unnecessary complexities the doctrine of fundamental breach has created, the resulting uncertainty in the law, and the unrefined nature of the doctrine as a tool for averting unfairness, I am much inclined to lay the doctrine of fundamental breach to rest, and where necessary and appropriate, to deal explicitly with unconscionability. In my view, there is much to be gained by addressing directly the protection of the weak from over-reaching by the strong, rather than relying on the artificial legal doctrine of "fundamental breach". There is little value in cloaking the inquiry behind a construct that takes on its own idiosyncratic traits, sometimes at odds with concerns of fairness. This is precisely what has happened with the doctrine of fundamental breach. It is preferable to interpret the terms of the contract, in an attempt to determine exactly what the parties agreed. If on its true construction the contract excludes liability for the kind of breach that occurred, the party in breach will generally be saved from liability. Only where the contract is unconscionable, as might arise from situations of unequal bargaining power between the parties, should the courts interfere with agreements the parties have freely concluded. The courts do not blindly enforce harsh or unconscionable bargains and, as Professor Waddams has argued, the doctrine of "fundamental breach" may best be understood as but one manifestation of a general underlying principle which explains judicial intervention in a variety of contractual settings. Explicitly addressing concerns of unconscionability and inequality of bargaining power allows the courts to focus expressly on the real grounds for refusing to give force to a contractual term said to have been agreed to by the parties.

I wish to add that, in my view, directly considering the issues of contract construction and unconscionability will often lead to the same result as would have been reached using the doctrine of fundamental breach, but with the advantage of clearly addressing the real issues at stake.

In rejecting the doctrine of fundamental breach and adopting an approach that binds the parties to the bargains they make, subject to unconscionability, I do not wish to be taken as expressing an opinion on the substantial failure of contract performance, sometimes described as fundamental breach, that will relieve a party from future obligations under the contract. The concept of fundamental breach in the context of refusal to enforce exclusion clauses and of substantial failure of performance have often been confused, even though the two are quite distinct. In Suisse Atlantique, Lord Wilberforce noted the importance of distinguishing the two uses of the term fundamental breach, at p. 431:

Next for consideration is the argument based on "fundamental breach" or, which is presumably the same thing, a breach going "to the root of the contract." These expressions are used in the cases to denote two quite different things, namely, (i) a performance totally different from that which the contract contemplates, (ii) a breach of contract more serious than one which would entitle the other party merely to damages and which (at least) would entitle him to refuse performance or further performance under the contract

Both of these situations have long been familiar in the English law of contract . . . . What is certain is that to use the expression without distinguishing to which of these, or to what other, situations it refers is to invite confusion.

The importance of the difference between these meanings lies in this, that they relate to two separate questions which may arise in relation to any contract.

I wish to be clear that my comments are restricted to the use of fundamental breach in the context of enforcing contractual exclusion clauses.