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CONSTRUCTION SUMMIT2005

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., CounselGoldman 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

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PreambleOne 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 ContractIt 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

1 Alkok vs. Grymek et al, 67 D.L.R. (2d), 718

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a) Interpretation of ContractContract 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

2 Photo Productions Ltd. vs. Securicor Transport Ltd. [1980] A.C., 827 (Decision of the House of Lords)3 Supra, (1)

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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 ContractReviewing 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

4 Goldsmith, Canadian Building Contracts, [4th ed., Toronto: Thomson Carswell 1988]

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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.”

5 Supra, n. (2) f the Photo Production Case at pages 846 and 8516 9th ed. at pages 152-153

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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

7 Consolidated – Bathurst Export Ltd. vs. Mutual Boiler and Machinery Insurance Company, (1993) 1 S.C.R. 12 (SCC)8 Shelanu Inc. vs. Print Three Franchising Corporation – Decision of the Ontario Court of Appeal, 64 O.R. (3d) 533.9 Hunter Engineering Inc. vs. Syncrude Canada [1989] 1 S.C.R. 426

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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”.

10 Beaufort Realties (1964) Inc. vs. Chomedey Aluminum Co., [1980] 2 S.C.R., 718

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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

11 Supra, n.1, See Mr. Justice Spence’s comments at page 456 where he sets out a passage which is found in Anson’s Law of Contract (21 STEd.)12 64 N.B.R. (2d.) 431

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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.

There are a number of types of breaches that have been found to be fundamental breaches that I am aware of in construction law and they include; abandonment of the work site by the contractor; owner’s eviction of the contractor from the work site; and failure to make payments when payments are due pursuant to the terms of the contract. The latter is probably the clearest fundamental breach of any deemed fundamental breach,13 where the Supreme Court of Canada in the circumstances of this case, felt that the refusal to make progress payments constituted a

13 Supra, n. 10

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fundamental breach of the contract regardless of any exemption or exclusionary clauses in the contract.

Clients and counsel must realize that, if there is a termination or rescission, there is no going back.

a) Rescission and Repudiation

a) The Supreme Court of Canada in Guarantee Company of North America vs. Gordon Capital 14 expressed the distinction with respect to the term “rescission” and “repudiation” and stated the following:

“repudiation, by contrast, occurs by words or conduct invincing an intention not to be bound by the contract. Contrary to rescission, which allows the rescinding party to treat the contract as if it were void ab anitio, the effect of repudiation depends on the election made by the non-repudiating party. If the non-repudiating party accepts the repudiation, the contract is terminated, and the parties are discharged from future obligations, although rights and obligations that have already matured are not extinguished. If the repudiation is not accepted, the contract remains in being for the future and each party has the right to sue for damages for past or future breaches. Courts must be sensitive to the potential for misuse of the term “rescission” and must analyse the entire context of the contract and give effect, where possible, to the parties’ intent.”

Once again, you can see in the Supreme Court of Canada where he indicated that you must analyse the entire context of the contract to give effect to its terms and the parties’ intentions.

14 [1999] 3 S.C.R., 423 (S.C.C.)

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Repudiation will relieve the party from future performance but repudiation preserves certain of the contractual rights acquired before the repudiation. Therefore, a repudiatory breach has important implications that may negate certain contractual obligations while, at the same time, preserving other contractual obligations that are mutually intended to survive repudiation. It all depends upon the analysis of the contract and the terms set out therein coupled with what is deemed to be the intention of the parties.15

b) Fundamental Breach vs. Breach of Fundamental Term

It has been said that there may be a difference between fundamental breach and breach of a fundamental term. Professor G.H.L. Fridman, Q.C., in his book, The Law of Contract in Canada16 stated that “in order to characterize the kind of breach involved in any given instance, regard must be paid to the promised performance in light of the expectations thereby raised in the promisee, and the effects of non-performance upon those expectations. Thus, the law becomes more interested in fundamental breach than in so-called fundamental terms.”

Professor Fridman went on further to state that the concept of fundamental breach has been referred to as a breach in consequence of which the performance of the contract becomes something totally different from that which the contract contemplates. This, of course, is nothing new from what has previously been set out in this paper. It simply emphasizes the nature of the breach that is required.

15 See “The Common Law Enforceability of Exculpatory Provisions in Canadian Construction Contracts: The Divination of Intent – The Primacy of Commercial Reasonability” by R. Bruce Reynolds [2004 The International Construction Law Review, p. 417 - 419] 16 The Law of Contract in Canada by G.H.L. Fridman, Q.C., Carswell, 2nd ed.[1986],

pgs. 531, 534.

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There are a litany of cases that go on to describe what the courts state was fundamental breach. A fundamental breach in a number of cases has been defined as one which: a) destroys the whole contractual substrata; b) is undermining the whole contract; c) is involving a totally different performance of the contract from that intended by the parties; d) is involving an event which deprives the innocent party of substantially the whole benefit which that party was to obtain under the contract; e) entitles the innocent party to treat the contract as repudiated.

Therefore, the notion of repudiation inherently refers to some act which anticipates the due performance of the contract. As a result of this, it is confusing to define a fundamental breach in terms of repudiation of a contract, although to bring the doctrine of repudiation or anticipatory breach into play requires a breach, which undoubtedly qualifies as a breach. To put it in simple terms, the party terminating the contract does so on the basis of the breach committed by the other party, which breach is the repudiation of the contract by the defaulting party which allows the other party to terminate. As I have said, it can be very confusing.

In any event, it is clear that it is a question of fact whether the breach complained of by the innocent party amounts to a fundamental breach or some other kind of breach. And when you look at fundamental breach, and as previously stated in my paper, that depends upon the terms of the contract, the intended benefit to the innocent party, the purpose of the contract and the material consequences of the breach. All of this is clearly set out in Professor Fridman’s text.17

B REACH TERMINATION AND CONSEQUENCES

a) Breach By the Owner17 Supra, n. 16

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We now move on to what are the consequences of termination of the contract. The only way to answer that question is to look at the case law that has developed over the years and to examine the texts of some eminent authorities such as Goldsmith, Waddams and Fridman. In that regard, Goldsmith, on Canadian Building Contracts18 hereinbefore referred to, has stated in Chapter 5 of his book entitled Breach of Contract and under the heading “Breach of Contract: By Owner”, and the sub-heading “Payment of Contract Monies”, the following:

“A contractor is not, in the absence of some express provision in the contract, entitled to payment until substantial completion of the work. On completion ….. the owner must pay the agreed price. In the case of defects in the work, he may have the right to set up a counter-claim for damages to remedy the defective work, but he cannot escape liability for payment of the price agreed upon. Whether the owner is entitled to set off a counter-claim against his obligations to pay the contractor, will depend on whether the two claims are inextricably entwined and it would be unfair to permit the contractor to be paid in the absence of a reduction to allow for the counter-claim. In the case of contracts providing machinery for interim payments, the owner must pay whatever amount has become payable under the terms of the contract within the time specified, or within a reasonable time, and failure to do so will amount to a breach of contract.”

b) Breach By the Contractor

We then go on to look under the heading “Breach of Contract: By the Contractor”, which states the following:

18 Supra, n. 4, Chapter 3, Breach of Contract, pp. 5-1 to 5-5 and pp. 5-10 to 5-15 under the headings, “Breach of Contract: By Owner” and “Breach of Contract: By Contractor”

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“Breaches of contract by the contractor relate almost exclusively to performance of the work, since that is his principle obligation ….. apart from the question of non-completion and defective work, a contractor is under an obligation equivalent to that of the owner not to delay the work beyond any express period for completion and, in absence of such a provision, to carry out the work with reasonable expedition.”

c) Non-Completion of Contract

Goldsmith goes on to say in his text under the heading “Non-Completion”, the following:

“Apart from the fact that a contractor who fails to enter upon or substantially complete his contractual obligations is not entitled to payment of the contract price, failure to complete, either wholly or partially, is a breach of contract.

It is not always easy to determine whether the owner or the contractor is responsible for non-completion. For example, a contractor may be guilty of a minor deviation from the specifications, and the owner may be unreasonable in his demands for a guarantee to compensate for such deviation. If the owner’s demands are disproportionate to the seriousness of the deviation, his refusal to make payments as they become due will amount to a repudiation of the contract which will entitle the contractor to abandon the work.”

d) Damages and TerminationIn Chapter 6, “Remedies for Breach”, under the heading “Damages

and Termination”,19 Goldsmith states:

“As has already been noted, where a breach is of a term of the contract which the parties have stated to be important or the guilty party has evinced an intention no longer to be bound by the terms of the contract, that amounts to a 19 Supra, n. 4

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repudiation of the contract, and the innocent party may accept that repudiation and terminate the contract. A mere, trivial breach will not likely amount to repudiation, and whether in any given circumstances, the breach is sufficiently fundamental so as to amount to repudiation, is in every case, a question to be determined in light of the terms of the particular contract.”

CONCLUSIONS

What does all this mean? As has been stressed during the course of this paper, the terms of the contract and the intention of the parties is obviously very important. When is the owner entitled to terminate the contract? It seems from the relevant authorities and the case law that has developed, that the owner may be entitled to terminate the contract if it is abundantly clear that during the course of the work its contractor is not willing or is able to perform the work. This does not mean that mere bad or defective work will entitle the owner to terminate the contract but in the event that the contractor’s work is so bad or is so defective so as to amount, in substance, to a failure or refusal to carry out the contract work, this may amount to a repudiation. Goldsmith certainly in his text has come to that conclusion.20

Having had a quick look at when an owner may be entitled to terminate, what does the contractor look for with respect to the owner’s conduct which would allow the contractor to terminate? If it appears that an owner has clearly repudiated the contract, meaning that the contractor has come to the conclusion that the breach by the owner is a repudiation of the contractual terms, the contractor then may accept the repudiation and terminate the contract. He may also sue for any damages which he has suffered as a result of the owner’s breach (repudiation). Again, the

20 Supra, n. 4, p. 6-4

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contractor must determine whether the actions taken by the owner clearly amounts to a repudiation of the contract or do the owner’s actions merely point to a breach of the contract which would only allow the contractor to claim for damages. Once again, as the authorities have stated, every case will stand on its own merits and becomes a question that must be determined in the light of the terms of the contract.

a) Effect of Contractor Termination

If in fact the contractor terminates the contract, take note that an owner is excused from any further obligations under that contract but he will be liable to the contractor for work performed to the date of termination and in all likelihood, will be liable on a quantum meruit basis.

Although it is not usual in building contracts for the contractor be paid a lump sum at the completion of the project. In the absence of a partial payment, a contractor is not entitled to any payment until the work has been completed. This is a critical distinction in terms of what a contractor may be entitled to receive by way of compensation in the event that a contract is terminated. Some contracts provide for payments for completion of separate stages of the work to be done which would entitle the contractor to payment when that phase of the work is completed. These payments are not strictly progress payments but, in fact, are probably final payments in the sense that each phase of the work is a separate and complete work in itself and upon completion of that stage of the work, it entitles the contractor to payment. Progress payments, on the other hand, are payments made to the contractor during the progress of the work on an agreed basis before the contractor has actually earned the right to payment as a result of completion of the work. These payments of course are made on account of the contract price but they are not, strictly speaking, instalment payments.

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b) Effect of Progress Payments and Failure to Pay

Where the contract sets up progress payments, a contractor is entitled to be paid those payments properly calculated on the formula and protocol set out in the contract. Failure to pay the contractor constitutes a breach of contract on the part of the owner and if the owner fails to pay the contractor based on the terms of the contract with respect to that particular progress payment that has been certified to be paid, that action by the owner will likely entitle the contractor to regard the contract as having been repudiated by the owner and therefore, the contractor would be entitled to terminate the contract.

c) Contracts – Entire or Otherwise

I once again come back to the distinction in the contracts where, if the contract is an entire contract, meaning all of the work must be completed before there is any entitlement to payment, the contractor is not entitled to payment unless he has performed all of the work. Therefore, when advising a contractor whether or not to terminate the contract, you must give careful consideration to the terms of the contract with respect to the manner in which payments were to be made. The right of payment depends on the terms of the contract and therefore, if it is a lump sum contract, completion will be a condition precedent to the right to payment. Although I am sounding like a broken record, once again, you must look to the terms of the contract when making any decisions with respect to termination. Therefore, if it is a lump sum contract providing for payment upon completion, the contractor must complete before he is paid.

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If he does not complete, he may very well lose his right to payment for work done pursuant to the terms of the contract.

d) Completion of Contract – Minor Deficiencies

When I refer to completion of the contract, this is the term that is usually set out in the contract but in fact, the courts and the authorities on the subject make reference to whether the contract has been substantially performed. Trivial defects in the work for example, and minor deficiencies do not amount to the work not being substantially complete. That said, that would not relieve the contractor from remedying the defects or providing some form of compensation to the owner for the cost of having the defects remedies.

Simply keep in mind that where failure to substantially perform the contract, it will be a question of fact and one that will be required to be determined by the court. Nevertheless, partial performance in these circumstances will not entitle a contractor to any payment unless there is some specific provision found in the contractual terms.

S OME OF THE CASE LAW

A review of the relevant authorities was undertaken by Master David Sandler thus providing me a sound basis for many of the authorities dealing with the principles of repudiation, termination, compensation and consequences. In the case of Heyday Homes Ltd. vs. Gunraj,21 Master Sandler was required to do a complete analysis of contract in that case: what amounted to repudiation; what was the breach and was the breach fundamental in nature? He also canvassed whether or not the action

21 (2004) 31 C.L.R. 3rd., 66

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against the owner was justified and the nature of the damages that flowed as a result of the actions taken by each party.

Master Sandler’s case reviews the case law relating to repudiation, breach, fundamental breach and damages. The decision is under appeal but he goes through a history of the case law. Although under appeal, in the writer’s respectful opinion, the Master’s decision is right on. As a result of the appeal, it now raises the inconclusiveness of the state of the law. It is a very important construction law decision and Master Sandler’s treatment of the facts and his analysis of the applicable law amounted to a Herculean task that he undertook and completed over a very lengthy period of time.

Master Sandler, in his more recent decision of Oleg Kaplun v. Sergei Mihhailenko et al references his previous decision in Heyday and states that all of the cases that are summarized show:

“that where each party to a contract is alleging fundamental breach and repudiation by the other, the Court must determine which party committed a substantial breach which amounts to a repudiation, i.e., evidencing an intention no longer to be bound by the terms of the contract. In making this assessment, the test is an objective one, and even a direct or indirect intention by a party allegedly in breach that it wished to continue the contract is not necessarily conclusive in rebutting a finding of a repudiation of the contract. A party may be bound to have repudiated a contract even when the party honestly believes it wants to continue with the contract to completion.”22

The Master, in the Kaplun case, further goes on to review the manner of termination that was given and looked at whether or not the manner in which the contract was terminated was in accordance with the contract provisions. This again highlights the reason why you must follow the contract protocol in order to properly terminate a contract. A pre-condition

22 Kaplun vs. Mihhailenko, 2005 CanLII 16625 (ON S.C.)

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of the party exercising a right to terminate the contract may be provided for in the contract document and must be strictly adhered to. This statement is not etched in stone and the conduct of the parties throughout the course of the construction phase will come into play if the parties generally did not comply with contract terms.

The Master, in the Kaplun case, goes on further to discuss what he calls “the second central issue”, and asks “can the plaintiff, who has been found to have repudiated, recover anything for the work he did?” If the plaintiff was in fundamental breach, can he recover payment for any work that he has done and has not yet been paid for? If the plaintiff contractor was in fundamental breach, certainly the plaintiff contractor cannot recover damages for any loss of profit. In such a case, it would be the owner who would be entitled to damages for breach of contract from the contractor who was in fundamental breach. The Master goes on to analyse what is required in order for a plaintiff to recover anything if it was found to have improperly repudiated the contract. You must also look at whether or not the contract was “entire” or “divisible”. You must also look to whether or not the contractor abandoned the contract and was there substantial completion in the event that the contract was an entire contract or was there substantial completion of those clearly divisible portions of the contract which specified payments to be made upon the completion of certain phases of the construction. In the Kaplun case, the Master found that the contractor had not achieved substantial completion of those parts of the work that were still in the contract and left to be done. Such being the case, and based on the Master’s findings with respect to the facts of this case, he ruled that the plaintiff contractor could recover nothing on the lien claim for unpaid invoices, nor could the contractor claim for unbilled work actually done.

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I often state that business decisions must be made. The legal world is often murky. Therefore, it is a business decision vs. a legal decision. Sometimes business wins out and you sit back and wait for the possible consequences that may arise as a result of the law.

Historical Analysis of the Cases

The first case that one must look to is the case of H. Dakin vs. d. Lee. 23 In this case, the plaintiff was the builder suing for damages for payment for work done. The plaintiff builder was to make repairs to a house for a lump sum relying on some specifications that were provided. There was a finding that the work was substantially completed but there were some minor defects. The trial Judge in that case held that the plaintiff could recover nothing and that decision was appealed to the Divisional Court which stated that the builder could recover unless, inter alia, the builder had abandoned the work and left it unfinished. The Divisional Court did not find that to be the situation based on the facts of the case. The Court ruled that the cost of correcting the defects would be deducted from any amount owed to the builder. Therefore, the Court came to the conclusion that the contract (the work to be performed pursuant to the contract) was completed except for minor defects and deficiencies and as a result of that finding, the builder was entitled to receive payment less the cost for rectifying the deficiencies. The Court also made it clear that if only part of the work contracted for was done and the rest of the work was abandoned, that the result would have been otherwise. That “otherwise” would mean that the plaintiff builder would have recovered nothing and this is critical. This is one of the consequences that arises in the event that the terms of the contract provide for a lump sum payment upon completion of the work and the builder fails to complete. The builder probably recovers nothing.

23 [1916] 1 KB 566 (CA)

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This principle was clearly stated in the case of Hoenig vs. Isaacs24 where Lord Justice Somerville at page 178 stated:

“In a contract to erect buildings on the defendant’s land for a lump sum, the builder can recover nothing on the contract if he stops before the contract is completed in the ordinary sense – in other words, abandons the contract. He is also usually in difficulty in recovering on a quantum meruit because no new contract can be inferred from the mere fact that the defendant remains in possession of his land.”

The critical issue as you can now see is whether there has been substantial compliance with the contractual terms and again that becomes a question of fact for the court to determine. Once again, that points out the dangers of terminating contracts unless you are more than just reasonably satisfied that one or the other of the parties has committed a material breach, which material breach by the offending party would be deemed to be a repudiation of the contract allowing the innocent party to terminate the contract. Therefore, when examining the situation, you may have to determine whether entire performance of the contract was a condition precedent to payment. The courts have stated that that depends, once again, on the true construction of the contract. Therefore, in examining the terms of the contract, you must come to the conclusion that the contract would not be interpreted as an entire contract thereby preventing a contractor from claiming payment as a result of only part of the work being done which work did not amount to substantial completion of the contract. The term “substantial completion” in this paper does not necessarily mean substantial completion pursuant to the terms of the Construction Lien Act, but that would, in my respectful opinion, be a good start in determining whether or not there has been substantial completion of the contract.

24 [1952] A All ER, (176) C.A.

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I am not suggesting that you throw in the towel if the contract is not substantially complete because there may be a way to convince a court that inspite of the terms of the contract, that quantum meruit may apply. If the contract is, as stated herein, as a lump sum contract and if the work has not been substantially performed and if there has been failure of performance that goes to the root of the contract, e.g., if the work has only been half done or the work is entirely different from that contracted for, then it is clear that no action will lie for a lump sum payment. If the contractor in these circumstances is to be paid, he can only be paid for what he has done if the owner caused the work to be incomplete or there is something to justify the conclusion that the parties have entered into a fresh contract. Once again, this is a question of fact and is often very difficult to determine until you hear both sides of the story. This principle was clearly set out by Lord Justice Denning in the Hoenig case.

In the case of Bradley vs. Horner 25, the contract was an entire one and there were no terms allowing for progress payments. Therefore, the plaintiff could only recover if the work was satisfactorily completed. In this case, the painter left the job when it had only half finished the job and on the facts of that case, the court held that the plaintiff had abandoned the job and therefore, could not recover for the value of the work that he did on a quantum meruit basis.

The courts have, on occasion, found that where a contractor has abandoned the contract, nevertheless, the Contractor was entitled to receive some payment inspite of the fact that it may have been a lump sum contract. If the owner was found to have waived the abandonment by having adopted the fruits of the contract insofar as it had been performed, then the contractor may very well be allowed to recover the amount owing

25 (1957) l0 D.L.R. (2d) 446 (Ont. C.A.)

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to it under the contract less a deduction for the owner’s claim to repair defects or to complete the contract. In that regard, you can refer to the case of Tanenbaum vs. Wright-Winston.26

The Supreme Court of Canada in the case of Alkok vs. Grymek et al,27 in reviewing the contract that provided for payments by installments, dealt with the terms of the contract and in particular, where the contractor failed to provide proof that subtrades had been paid which was a requirement set out in the contract before an instalment was to be paid by the owner to the contractor. In this case, two payments were made without proof of subcontractor payments. The owner took the position that the contractor was in breach and terminated the contract. This was a lien action and the trial Master said the contractor (plaintiff) could recover nothing and that the owner was entitled to terminate because of the refusal of the contractor to provide the evidence of payment set out in the contract. The Master was of the view that this went to the root of the contract.

The Court of Appeal overturned the Master’s decision and stated that the proof of payment of the subtrades was a condition precedent to payment and that there was no doubt the owner was entitled to require such proof before it had to pay but that the contractor was entitled to continue with the work. At this stage, the Court of Appeal said the owner was not in a position to terminate for failing to provide proof. If the owner had made the request in specific terms that the contractor must provide proof of payment, and the contractor refused to proceed, then the Court of Appeal, interestingly enough, came to the conclusion that this would have given the owner grounds for termination and since this did not occur, the owner was found to have improperly terminated the contractor.

26 [1963] 2 O.R. 320 (HCJ)27 Supra, n.1

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The Court of Appeal concluded that the contractor could not recover payment based on the contract because of its provisions and its non-compliance. The Court of Appeal held that the contractor did have a right in law to claim upon a quantum meruit for the value of work done over and above the payments made but unfortunately, there was no evidence given at the trial as to the value of the work done.

The Supreme Court of Canada rejected the contractor’s “cost to complete” approach with respect to damages but did find that there was merit in a quantum meruit award by assuming that the value of the additional work at each completed stage corresponded to the amount agreed to in the contract and that that had to be paid on completion of that stage.

In the Alkok case, there does not appear to be any material reference to the fact that since the owner paid the contractor two payments absent receipt of proof of payment to the subcontractors, that the owner was deemed to have waived that condition and therefore, was obliged to continue to pay absent the provision of the proof of payment to the subcontractors. This is an argument that may have had some merit had it been argued, but it does not appear to have been argued. It is interesting to note that the Court did recognize that the owners paid two installments and part of the third, refusing to pay the balance of the third and any subsequent payments that were due until such time as the contractor satisfied the owner’s architect, that payments to the subcontractors had been made. The Court stated that the owner was entitled to require that the contractor continue its work upon the contract and that the owner was entitled to refuse to pay the contractor until he satisfied the provision. The Court further stated that if the contractor had refused to proceed on that basis, then the contractor would have been in breach of the provision of the contract going to the root thereof, and the owner would have been entitled to terminate the contract.

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I find it interesting that the Court would determine that failure to provide the declaration stating that the subtrades had been paid would be a material breach entitling the owner to terminate. The Court did state that the contractor did not indicated by word or conduct an intention to so act or not to be bound in every way by the contract. As a result, the contractor did not give the owner the opportunity to terminate the contract on the ground that the contactor had been in breach of a term going to the root. The Court stated that it was true that the contractor was in breach of the term requiring it to satisfy the owner’s architect that the subcontracts had been paid but that this term was a mere ancillary term which could be enforced by the owner simply refusing to make payments until they were satisfied. Therefore, as a result of the owner not specifically stating “produce the proof of payment or we are terminating”, that they did not show sufficient grounds to support their termination of the contract. Therefore, what this case does is set out what should have been done by the owner in these circumstances and even if there was a breach, the owner must take steps to crystallize the breach so that he would be legally entitled to terminate as a

result of the proper demands being made on the contractor.28

In another case where the subcontractor withdrew its forces because of non-payment by the contractor, the court found that the subcontractor was the innocent party who had terminated the subcontract because of a fundamental breach by the general contractor in not paying amounts due. The subcontractor in this case was entitled to recovery subject to some deductions for some deficiencies. See the case of Wells Construction Ltd. vs. Thomas Fuller Construction (1987)29

28 Supra,n.1 at page 72129 22 C.L.R. 144 (Nfld. C. S.)

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The problem with giving advice of a general nature becomes evident

when one reviews the case of Coba Industries Ltd. vs. J. Adams Dev. Corp.30 This is a case where the contractor admittedly abandoned the contract midway through and yet the Court of Appeal held that it was entitled to recover damages for work it had invoiced until the date of the repudiation less set off for owner’s damages for breach of contract. The contract did provide for payments to be made as the work progressed and thirty-two (32%) percent of the work had been completed when the contractor stopped work because it had run into financial problems. It repudiated the contract and that repudiation was accepted by the owner. The Court of Appeal stated that there having been an abandonment of the contract part way through, in the circumstances of this case, the contractor was entitled to sue for unpaid instalments that the contract provided for. The owner, of course, would have rights of set-off for damages it sustained for rectifying deficiencies and completing the contract. Once again, and as I have stated throughout, it appears that this decision was based as a result of a detailed analysis of the contract and based on all of the facts as they were put forward. This is the kind of case that highlights the difficulty that you have in determining whether the contractor should walk off or the owner should terminate.

In another case, the contractor contracted to build a house for the owner. There was substantial delay by the contractor in pursuing the work and the owners terminated the contract. The contractor alleged a repudiation by the owner and the contractor sued for work done and not paid for. The owner’s position was that they terminated as a result of the delays caused by the contractor. In this case, the trial judge held that the contract was properly terminated by the owner and held that the contractor could recover nothing and that the owners could recover the cost of completing

30 (1987), 24 C.L.R., 214 (P.C.C.A.)

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and repairing the project over and above the contract price. Once again, this highlights the uncertainty of what might occur if the matter was to proceed to court.31

In a construction lien action where the plaintiff was the subcontractor and the defendant was the general contractor, the general had issued a payment cheque for certified work around the same time that the parties got into a dispute. The general contractor stopped payment and refused to make further payments until the subcontractor posted a bond for the entire balance of the subcontract. This was not a contractual requirement. As a result of this, the subcontractor withdrew its workers and claimed the amount that was certified to be owing but also a further amount for material and services provided since the date of the certified work which work was done prior to the subcontractor leaving the project. The question was, who was in fundamental breach? The trial judge found that the contractor was in fundamental breach and that entitled the subcontractor to treat the contract as terminated and to sue for damages. The Court of Appeal agreed with the trial judge. Therefore, in this case, the subcontractor was entitled to sue for damages and those damages would be the amount owed as a result of the certified work plus the additional work done and the general contractor would not be entitled to claim for completion costs of the subcontract work. It is unclear whether the contractor would have been entitled to set off some of the claim for damages against any deficient work that had to be rectified by the owner.32

Conclusion

31 MacLean vs. Winters (1990), 35 C.L.R. 148, (M.S.Co.C.t.)32Safinco Mechanical Ltd. vs. Toronto District P.S.B. (2002), 14 C.L.R. (3d), 306, aff’d (2003), 24 C.L.R., (3d), 166

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My advice to all counsel advising their clients with respect to what should be done where one party is considering walking off the job or the other party is considering terminating the contract, is to be extremely careful because the advice you give could, and may, come back to haunt you. As you can see, you may find yourself between the devil and the deep blue sea when considering whether or not the offending party, as a result of its alleged breach, repudiated the terms thereby giving the non-offending party comfort in terminating the contract. Based on the case law that I have referred to in this paper, you can see that the terms of the contract, the actual facts and the judge deciding the case all play important roles with respect to the advice that you may be required to give. It is for this reason that I caution you to tread lightly when considering terminating a contract unless you are more than reasonably certain that the termination is proper.

Of course, this requires a risk analysis undertaking and as soon as one mentions the word “risk”, that in itself should raise the red flag to caution you with respect to the proposed steps that you may be contemplating taking. The risk analysis undertaken cannot be casually done when considering advice to be given with respect to the contract, repudiation, what constitutes repudiation, what constitutes fundamental breach and the nature of the damages that may be awarded. The consequences are far too great in the event that the opinion given turns out to be wrong. That said, even if there is a thorough risk analysis undertaken, based on the case law, that does not guarantee that the outcome of the case will be as you would want it, namely, that you have made the right decision and that you will be totally successful in your claim.

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CONCLUDING REMARKS

I would like to thank you for allowing me the opportunity of presenting this rather complicated topic since, regardless of the number of opinions I have given, the review that I have undertaken, certainly amounted to a refresher course for myself. Needless to say, there were some surprises when I reviewed some of the learned authorities’ comments and the present state of the case law. Be careful!

Snaft\PAPERS\Construction Summit 2005

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