By Michael Colwell, Lawyer

At times, the Civil Code in Quebec departs from upholding freedom of contract in order to neutralize “abusive” clauses that are excessively and unreasonably detrimental to the other party.  At issue in 6362222 Canada Inc. v. Prelco Inc. was whether the breaching party could rely on a clause limiting its liability to the face amount of the contract.  Where the clause is not ambiguous, according the Supreme Court of Canada, the will of the parties should be respected.

A consulting firm, 6362222 Canada Inc. (“Createch”) implemented software systems for its clients. Prelco Inc. was a manufacturing company that makes and transforms flat glass.  In 2008, Prelco asked Createch for advice regarding its computer systems.  A contract was prepared by Createch under which it was to supply software and professional services in order to implement a software system for Prelco.

One of the provisions, clause 7, entitled “Limited Liability”, stipulated that Createch’s liability to Prelco for damages that could be attributed to any cause whatsoever would be limited to amounts paid to Createch under the contract and that if such damages resulted from the delivery of unsatisfactory services, Createch’s liability would be limited to the amount of any fees paid in relation to the unsatisfactory services.  The parties signed the contract in April 2008.  When the system was implemented, numerous problems arose, and Prelco decided to terminate its contractual relationship with Createch in the spring of 2010.  

Prelco brought an action against Createch for $6,246,648.94 in damages for the reimbursement of an overpayment, costs for restoring the system, claims from customers, and loss of profits.  This was the result of the alleged breach of the fundamental obligation, namely, to implement a software system in the context of the Prelco’s business.  

In Quebec’s Civil Code, there is concern regarding specific situations of abuse and contractual imbalance as well as with other cases that are contrary to public order.  Prelco raised both of these principles in hoping to strike down clause 7.

The trial Court concluded that clause 7 of the contract was inoperative on the basis of the Code’s doctrine of breach of a fundamental obligation.  The doctrine disallows certain private law clauses on the basis of upholding public order.  In striking down these clauses, the Code departs from the principle of autonomy in order to neutralize “abusive” clauses that are excessively and unreasonably detrimental to the other party.  

At trial, Prelco successfully argued that the Code prevented the application of the clause on this basis.  The Court found that Createch, having misunderstood the scale and complexity of Prelco’s operations, had committed a fault in its initial choice as to the approach to take in implementing the management system and had as a result breached its fundamental obligation. Because the limitation of liability clause was contrary to public order, it was struck down.  The trial judge granted Prelco’s application and ordered Createch to pay Prelco $2,203,400 in damages.  Createch appealed.

The Quebec Court of Appeal dismissed Createch’s appeal.  The Court of Appeal based its decision on a different principle from the Code, namely, reciprocity of obligations and total absence of cause. According to such “no obligation” principle (clause de non-obligation), a debtor relying on a non liability clause in order to avoid responsibility for his or her breach of a fundamental obligation is in conflict with the scheme of reciprocal benefits which parties normally receive under contract.

The Supreme Court of Canada acknowledged these two principles, which had provided the lower courts with alternate bases for concluding that there had been a breach of a fundamental obligation. But neither of these was sufficiently compelling to interfere with commercial parties who freely consent to contract with each other.  The drafters of Code, the Supreme Court held, intended this result, stating:

Everything suggests that the legislature deliberately chose not to include such a mandatory rule to regulate such clauses in the Civil Code of Québec, preferring to leave it to sophisticated parties to themselves manage the risks of nonperformance, and that it would be inappropriate in the circumstances to do so in their place.

Regarding breach of a fundamental obligation, the Supreme Court noted that the drafters had intended to redress power imbalances in the context of consumer contracts, which are typically long, “take or leave it” contracts.  Cellular phone plan contracts, for example, normally offer the consumer very little contractual freedom.  The parties to the “no liability” clause were sophisticated, however, and capable of exacting concessions from each other during contracting.

As to the no obligation clause principle, the Supreme Court notes that limitation clauses do not “by their nature” have the effect of negating obligations.  Because Prelco was entitled to keep the integrated management system, obtain damages for unsatisfactory service and be compensated for the necessary costs for specific performance by replacement, the clause did not result in depriving Prelco of any benefit (which was a requirement of this principle).  Thus, the limitation of liability clause was not necessarily akin to a “no obligation” clause.  

Where the sources of the law are concerned, the Court noted that the civil law doctrine of breach of a fundamental obligation has a history of its own that is shaped by Quebec’s legislation, jurisprudence and academic commentary and is not dictated by sources from other jurisdictions.  In the common law, as in civil law, there is also concern with specific situations of abuse and contractual imbalance as well as with other cases that are contrary to public order, or are matters of “public policy”.  But at the same time, the Court noted that a non liability clause in a freely negotiated contract can be a fair solution.

Although the Code contains principles which challenge contractual freedom in some cases, they did not apply here.  The Court upheld the “no liability” clause.  The Court noted that neither of the two legal traditions in Canada, the common law and the Quebec Civil Code, has a rule of general application that totally prohibits non liability clauses relating to fundamental obligations in contracts between sophisticated parties.  Prelco thereby aligns the Civil Code of Quebec with the law of the common law provinces.  This enhances consistency for any out-of-province companies who contract there. Companies are advised to carefully consider such clauses during contracting, as they may significantly limit the liability of the breaching party.

Questions?

If you have any questions with respect to this bulletin, please contact Michael Colwell at mcolwell@brownleelaw.com or at 604.754.9446.