The Supreme Court of Canada released an important decision in Earthco Soil Mixtures Inc. v. Pine Valley Enterprises Inc., 2024 SCC 20 on the construction of exclusion clauses in contracts. Specifically, the appeal concerned a contracting party’s ability to contract out of the statutorily implied condition of sale by description under the Sale of Goods Act, R.S.O. 1990, c. S.1 (“SGA”). The Court re-affirmed that under its leading precedents on the construction of contracts (Sattva) and exclusion clauses (Tercon) the seller had validly excluded the implied condition by an express agreement, even though the wording of the exclusion did not refer to the implied condition or that it was being excluded.
Facts
The buyer, Pine Valley Enterprises Inc., claimed that purchased topsoil involved a sale by description and sought damages because the soil did not correspond to that description. The seller, Earthco Soil Mixtures Inc., said there was no breach of any statutory condition, arguing that the goods not only complied with their description, but also that the parties specifically excluded any such obligation by express written agreement.
The SGA, like other such statutes across the country, provides that parties may contract out of any right, duty or liability that would otherwise arise by implication of law in a contract of sale (s. 53). It may do so, among other ways, by “express agreement”. The parties’ contract contained a clause stipulating that if the buyer chose to waive its right to test the goods, then the seller would “not be responsible for the quality of the material” once it left its facilities. The exclusion wording read as follows:
[Pine Valley] has the right to test and approve the material at its own expense at our facility before it is shipped and placed. Please contact Richard Outred to arrange.If [Pine Valley] waives its right to test and approve the material before it is shipped, Earthco Soils Inc. will not be responsible for the quality of the material once it leaves our facility.
Because the buyer chose to waive its right to test and approve the goods before they were shipped, the seller claimed this clause operated to exclude any statutory condition that the goods must meet certain compositional specifications.
Summary of interpretation principles
The Court agreed with the seller that it had disclaimed the implied condition of sale by description. The Court provided a short summary of its approach to construing exclusion terms saying:
The Court’s main task in this case is to set out the proper way to interpret exclusion clauses in contracts for the sale of goods. This involves determining what qualifies as an express agreement under s. 53 of the SGA, as informed by recent cases on the interpretation of contracts and the legal operation of exclusion clauses. The principles in Sattva Capital Corp. v. Creston Moly Corp., 2014 SCC 53, [2014] 2 S.C.R. 633, and Tercon Contractors Ltd. v. British Columbia (Transportation and Highways), 2010 SCC 4, [2010] 1 S.C.R. 69, apply to the contracts subject to the SGA. These recent restatements of contract law principles give priority to the parties’ intentions in a manner that modifies and relaxes some of the stricter and more technical approaches which found expression in certain prior cases. As this Court stated in Sattva, “the interpretation of contracts has evolved towards a practical, common-sense approach not dominated by technical rules of construction. The overriding concern is to determine ‘the intent of the parties and the scope of their understanding’” (para. 47, citing Jesuit Fathers of Upper Canada v. Guardian Insurance Co. of Canada, 2006 SCC 21, [2006] 1 S.C.R. 744, at para. 27). All contract terms, including exclusion clauses, “should be given their natural and true construction so that the meaning and effect of the exclusion clause the parties agreed to at the time the contract was entered into is fully understood and appreciated” (Hunter Engineering Co. v. Syncrude Canada Ltd., [1989] 1 S.C.R. 426, at p. 510). Ultimately, when courts are faced with applying a combination of s. 53, the principles of contractual interpretation and the law concerning exclusion clauses, it is the objective intention of the parties that must be the paramount consideration.
Meaning of express Agreement
In the course of giving reasons for decision, the Court clarified how the term “express agreement” in the SGA was to be interpreted. The Court stated:
To qualify under the “express agreement” branch of s. 53, there must be both an agreement to vary or negative a right, duty or liability under a contract of sale, and that agreement must be express. These two elements, though referenced together as part of a composite phrase, are conceptually distinct and necessarily involve different considerations.
Some confusion has arisen about what it means for an agreement to be “express” under s. 53. Some think “express” speaks to specific language that must be used to remove the parties from the SGA. I do not think that is the correct approach. The term “express” qualifies the word “agreement” and is directed to how that agreement must be made. Express does not define what the agreement must say or the required level of clarity of specific contractual clauses. Because s. 53 requires an “express agreement”, and not the use of “express language”, it does not constitute, let alone call for, a qualitative requirement about the specificity of language that is needed to vary or negative an otherwise applicable legal liability. While s. 53 insists that the agreement must be express, it imposes no prerequisite about the precision of the words used to manifest such an agreement. The clarity of the language will, however, guide the interpretation of the agreement.
In terms of how the agreement is made, it will be “express” if it is made in distinct and explicit terms and not left to inference. In contrast with the other available avenues to oust the SGA contemplated by s. 53, an express agreement cannot be implied, inferred or imputed from conduct. Neither silence nor omission will suffice. The agreement must be clearly communicated: for the purposes of s. 53 of the SGA, something that is express must be declared in terms and set forth in words (Black’s Law Dictionary (6th ed. 1990), at p. 580; see also Black’s Law Dictionary (11th ed. 2019), at p. 726). The parties must make their mutual intention unmistakably evident. The parties must not be ambiguous or dubious and should be clear, definite, plain and direct. Thus, the “express” component of an express agreement means that the exclusion clause must be plainly laid out and contemplated within the agreement at issue. It must have “been specifically mentioned” (G. H. L. Fridman, The Law of Contract in Canada (6th ed. 2011), at p. 433).
Construction of exclusions clauses
The Court also re-affirmed its approach to the construction of exclusion clauses having regard to its decisions in Sattva and Tercon with this summary of the development and status of the current law on contractual exclusions.
For this reason, the case law on exclusion clauses has undergone various transformations over the years in an attempt to balance freedom of contract, commercial certainty and contractual fairness. The course of this transformation can be traced by reference in part to the doctrine of fundamental breach, which has evolved towards an approach that gives primacy to the objective intention of the contracting parties.
The doctrine of fundamental breach arose in the English courts during the 1950s as a rule of common law that operated where a defendant had so seriously breached the contract that the plaintiff was denied substantially the whole of the contract’s benefit (Hall, at p. 367). While the doctrine was introduced to address certain injustices, there has been a full retreat from it as it had a questionable conceptual basis, “reflected an inherent hostility to [exclusion] clauses that was not justified” and undercut the parties’ intention by rendering exclusion clauses inapplicable even if they were unobjectionable from a policy perspective (Hall, at pp. 367-68).
In Hunter Engineering, this Court was evenly divided on whether the doctrine of fundamental breach should continue in its then current form but concluded that exclusion clauses could only be enforced if they were not unconscionable (at pp. 455-56, per Dickson C.J.) or unfair or unreasonable (p. 517, per Wilson J.; see also Guarantee Co. of North America v. Gordon Capital Corp., [1999] 3 S.C.R. 423). All judges expressly highlighted the centrality of the interpretation of the exclusion clause and the need to preserve the integrity of the parties’ bargain. Dickson C.J. understood that in the commercial context, “clauses limiting or excluding liability are negotiated as part of the general contract” and “[a]s they do with all other contractual terms, the parties bargain for the consequences of deficient performance” such that the exclusion clauses ultimately end up being reflected in the contract price (p. 461). He preferred “to interpret the terms of the contract, in an attempt to determine exactly what the parties agreed” and 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” (p. 462). Wilson J. also warned against giving exclusion clauses a strained or artificial interpretation and stated that the effect of such exclusion clauses is said to depend in each case on the true construction of the contract (p. 509).
The problem-plagued doctrine of fundamental breach was finally “laid to rest” in Tercon, in which this Court favoured a modern and holistic approach that focused on “the real question of what agreement the parties themselves intended” (para. 108, per Binnie J., dissenting, but not on this point). Tercon sets out three steps to help assess the enforceability of an exclusion clause. First, the court must determine whether an exclusion clause even applies in the circumstances, which necessarily depends on an “assessment of the intention of the parties” (para. 122). Post-Tercon, interpretation is thus the initial analytical step when a court is faced with an exclusion clause and this includes “a search for intent using the general rules of contractual interpretation” (A. J. Black, “Exclusion Clauses in Contracts and their Enforceability Following the Decline of Fundamental Breach” (2015), 44 Adv. Q. 139, at p. 163; see also p. 150).
If the exclusion clause is found to be valid at the first step, the second step requires a court to consider “whether the exclusion clause was unconscionable at the time the contract was made” (Tercon, at para. 122). Third, even if not unconscionable, a court may consider if there is some overriding public policy consideration that outweighs the strong public interest in the enforcement of contracts and if there is, the court may refuse to enforce the otherwise valid exclusion clause (para. 123). Thus, concerns of potential unfairness that the doctrine of fundamental breach attempted to remedy are now addressed in the second and third step of the Tercon test (see also C. Pike, “Now We’re Talking: Revisiting the Canadian Approach to No Oral Modification Clauses” (2021), 47:1 Queen’s L.J. 1, at p. 31; J. D. McCamus, “The Supreme Court of Canada and the Development of a Canadian Common Law of Contract” (2022), 45:2 Man. L.J. 7, at pp. 16-17; S. O’Byrne, “Assessing Exclusion Clauses: The Supreme Court of Canada’s Three Issue Framework in Tercon Contractors Ltd v British Columbia (Transportation and Highways)” (2012), 35 Dal. L.J. 215, at pp. 231-32). Establishing unconscionability and the public interest as limits on freedom of contract has returned the focus onto the true contractual intention of the parties.
The modern contractual interpretation principles from Sattva clearly apply to contracts containing exclusion clauses, especially at the first step of the Tercon test. Sattva’s direction to consider the surrounding circumstances when interpreting the terms of a contract means exclusion clauses must also be analyzed “in light of [their] purposes and commercial context” (Tercon, at paras. 64-65; see also Dow Chemical Canada ULC v. NOVA Chemicals Corporation, 2020 ABCA 320, 17 Alta. L.R. (7th) 83, at paras. 47 and 50). Accordingly, “[i]n a commercial contract[,] . . . the court should know the commercial purpose of the contract and this in turn presupposes knowledge of the genesis of the transaction, the background, the context [and] the market in which the parties are operating” (Sattva, at para. 47, citing Reardon Smith Line Ltd. v. Hansen-Tangen, [1976] 3 All E.R. 570, at p. 574; see also Hall, at pp. 34-35 and 89-90).
As a result, when interpreting an exclusion clause, like the express agreements contemplated under s. 53, “bright-line rules of construction are infrequent” and have been replaced by a contextual inquiry into what the parties objectively intended based on the text and surrounding circumstances (Black, at p. 164). Courts can review such clauses for unconscionability and may refuse to enforce the exclusion clause if there is an overriding public policy reason that outweighs the public interest in the enforcement of contracts (Tercon, at para. 123).
Construction of exclusion clauses in Sale of Goods laws
After the somewhat lengthy analysis of the principles to be applied to construing exclusion clauses, the Court summarized the proper approach to interpreting exclusion clauses under Section 53 of the Sale of Goods Act as follows:
In conclusion, because s. 53 requires an express agreement and s. 57(1) confirms the applicability of the common law as it exists from time to time, the principles from Sattva and Tercon extend to contracts for the sale of goods. While recognizing the need to balance protections for parties, freedom of contract and commercial certainty, exclusion clauses in sales contracts are not categorically distinct or subject to different or stricter rules of construction. The SGA must be read as a whole and while the legislature wanted to provide presumptive protections to parties, it also expressly allowed parties to opt out entirely from the implied statutory conditions. The “express agreement” contemplated by s. 53 of the SGA is to be interpreted and applied accordingly.
It is at the first step of the Tercon test where a court should determine whether there is an express agreement between the parties that is sufficient to meet the requirements of s. 53. To do so, a court must apply the principles of modern contractual interpretation, which involves, among other things, a consideration of the words used in the contract, the surrounding circumstances, who the contracting parties are and their level of contracting sophistication. The overall goal is to ascertain whether it was the objective intention of the contracting parties to exempt one party from statutorily imposed liability as permitted by s. 53.
Courts tasked with deciding whether implied statutory conditions have been excluded from a contract will seek to ascertain the objective intention of the parties as manifested by the words chosen and the surrounding circumstances (Sattva, at para. 47). A flexible approach, focused on the objective intention of the parties, will allow courts to give effect to the parties’ bargain while taking into account the nature of the contract and the contracting parties, what the parties would have reasonably understood their words to mean and to ensure the parties’ objective intention is not thwarted by strict rules of interpretation and to control for unfairness by unconscionability and public policy considerations.
As the prevailing goal of contractual interpretation is to ascertain the objective intent of the parties, this necessarily requires a decision-maker to refer to the surrounding circumstances of a contract while at the same time ensuring that the surrounding circumstances do not “overwhelm the words of [the] agreement” (Sattva, at para. 57). This is so because using a “sterile textual analysis of a contract’s language without regard to the surrounding circumstances . . . is apt to lead to indeterminacy and brings a significant risk of inaccurate results” (Hall, at p. 30). A consideration of the surrounding circumstances in this respect necessarily means that the words used by the parties cannot always be interpreted as having a meaning that has been well established in law. The meaning of the words used can largely depend on who the contracting parties are, their relationship to each other and their degree of contracting sophistication. The principles emerging from Sattva require this interpretive flexibility to account for the varying contracting scenarios that can arise between different sets of parties.
If the contract, by express provision, protects a party by ousting implied statutory terms and the court thinks the provision was intended to operate in the circumstances which have occurred, the provision is to be given full effect unless it is found, at steps two and three of the Tercon test, respectively, to have been unconscionable at the time the contract was made or if there are overriding public policy concerns that would compel a court to refuse to enforce it. That is because it was the objective intention of the parties and because commercial certainty is best served by the law giving effect to their actual bargain. Searching for the parties’ objective intention furthers that purpose, whereas an overly technical and legalistic interpretation of exclusion clauses does not. \
An “express agreement” under s. 53 requires that the parties have expressly and unambiguously used language that signals their intention to override the statute. This means that silence or omission does not suffice. Nor can the court imply, impute or infer intention to opt out of the statute based on parties’ presumed intention. Section 53 requires an “express agreement”, not “express language”, and is far removed from setting a legal standard that insists on explicit, clear and direct language which speaks to the legal characterization of the terms at issue. There is no requirement for “magic words”. While the words of the agreement itself are undoubtedly important, Sattva allows a court to read these words with the surrounding circumstances in mind and does not mandate that words be strictly attributed with a singular, prescriptive meaning. It simply requires that any intention of the parties to exclude the SGA be grounded in the text, if the contract is a written one. To have an effective express agreement that satisfies s. 53, the parties’ joint intention must be declared and the exclusion clause must unambiguously vary or negative the statutorily implied obligation, based not only from the words of the contract itself, but also from an analysis of the surrounding circumstances (Sattva, at paras. 58-61).
In sum, any express agreement sufficient for the purposes of s. 53 must be comprised of an agreement to negative or vary a statutorily implied right, duty or liability and such an agreement must be expressly set forth within the parties’ contract. One must be able to point to the contract and say, “that exclusion clause ousts the operation of an implied term of the SGA”.
Reasons why the implied condition was excluded
The Court concluded that the exclusion clauses exempted the seller from any statutorily imposed liability under s. 14 of the SGA. The word “quality” in the exclusion clauses had to be interpreted in a manner consistent with the surrounding circumstances. The buyer was a commercial purchaser with years of experience in buying large quantities of topsoil. Both parties were aware of the changing nature of topsoil and that the existing test results were dated. The parties were free to negotiate and allocate the risk of not testing the topsoil. The buyer was in a rush to receive the topsoil, given the looming threat of liquidated damages. The buyer deliberately assumed the risk through its own conscious strategic decision. The parties came to an express agreement about the allocation of risk, by using direct, clear and express language in their contract, which demonstrated that their objective intention was for the buyer to waive its right to pursue the seller for any liability relating to the topsoil.
Unlike the cases where courts have held that the disclaimer of implied warranties does not oust implied conditions (which the court did not expressly reverse), the Court held that the “cardinal principle requiring courts to interpret a contract in accordance with the parties’ objective intention allows space for what the parties objectively intended those terms to mean.” In the circumstances of the case, the wording was sufficient to oust the implied condition in issue.
Some concluding remarks
The Earthco decision leaves many questions about how courts will apply prior well established principles in construing future exclusion, disclaimer and limitation of liability clauses. For example, the caselaw is replete with interpretive principles about what parties do and not intend with such clauses. Many of the principles are drawn from cases which acknowledge the modern principles of interpretation. For example:
- If there are two possible constructions, the court is entitled to prefer the construction which is consistent with business common sense and to reject the other.
- Where the language used by the parties is unclear the court can properly depart from its natural meaning where the context suggests that an alternative meaning more accurately reflects what a reasonable person with the parties’ actual and presumed knowledge would conclude the parties had meant by the language they used but that does not justify the court searching for drafting infelicities in order to facilitate a departure from the natural meaning of the language used.
- In striking a balance between the indications given by the language and those arising contextually, the court must consider the quality of drafting of the clause and the agreement in which it appears. Sophisticated, complex agreements drafted by skilled professionals are likely to be interpreted principally by textual analysis unless a provision lacks clarity or is apparently illogical or incoherent.
- One starts with the presumption that neither party intends to abandon any remedies for its breach arising by operation of law, and clear express words must be used in order to rebut the presumption.
- The court is unlikely to be satisfied that a party to a contract has abandoned valuable rights arising by operation of law unless the terms of the contract make it sufficiently clear that that was intended. The more valuable the right the clearer the language will need to be.
- The draconian consequences of a clause have led courts to conclude that the clause did not exclude liability for certain types of losses. Had the parties intended an exclusion of all liability for certain types of losses, courts expect them to spell that out clearly.
As a general rule that the more extreme the consequences are, in terms of excluding or modifying the liability that would otherwise arise, then the more stringent the court’s approach should be in requiring that the exclusion or limit should be clearly and unambiguously expressed. - Exclusion clauses are construed contra proferentum.
For cases on point, see UK cases such as Wood v Capita Insurance Services Limited [2017] UKSC 24 and Soteria Insurance Ltd v IBM United Kingdom Ltd. [2022] EWCA Civ 440 (04 April 2022)
