Tuesday, November 08, 2016

Supreme Court of Canada Contract Interpretation Update

The Supreme Court of Canada continues to provide guidance on the interpretation of contracts. In the recent decision of Ledcor Construction Ltd. v. Northbridge Indemnity Insurance Co. 2016 SCC 37 (“Ledcor”), it held that the interpretation of a standard form contract should be recognized as an exception to the Court’s holding in Sattva Capital Corp. v. Creston Moly Corp. 2014 SCC 53 (“Sattva”)(*1) and that in the contractual interpretation of standard form contracts the “factual matrix” carries less weight in interpretation.

In Sattva the Supreme Court of Canada affirmed the contextual approach to contractual interpretation and explained the role of surrounding circumstances in contractual interpretation. The contract must be read as a whole and the words in the contract must be given their plain and ordinary meaning, consistent with the surrounding circumstances at the time of contracting, i.e. the “factual matrix.” The Supreme Court of Canada has in Ledcor indicated this “factual matrix” will be given less weight in contractual interpretation.

The Ledcor decision involved a claim that occurred during construction: a building’s windows were scratched by the cleaners hired to clean them. The cleaners used improper tools and methods in carrying out their work, and as a result, the windows had to be replaced. The building’s owner and the general contractor in charge of the construction project claimed the cost of replacing the windows against a builders’ risk insurance policy issued in their favour and covering all contractors involved in the construction. The insurers denied coverage on the basis of an exclusion contained in the policy for the “cost of making good faulty workmanship”.

The trial judge held the insurers liable, finding that the exclusion clause was ambiguous and that the rule of contra proferentem applied against the insurers. The Court of Appeal reversed that decision. Applying the correctness standard of review to the interpretation of the policy, the court held that the trial judge had improperly applied the rule of contra proferentem because the exclusion clause was not ambiguous. The court devised a new test of physical or systemic connectedness to determine whether physical damage was excluded as the “cost of making good faulty workmanship” or covered as “resulting damage”. Based on this test, the court concluded that the damage to the windows was physical loss excluded from coverage, because it was not accidental or fortuitous, but was directly caused by the intentional scraping and wiping motions involved in the cleaners’ work. 

The Supreme Court of Canada allowed the appeal by the insured. It did apply the standard of review as correctness (which was an exception to the standard of review of reasonableness as set out in Sattva) as this was a standard form contract.

The Supreme Court of Canada held that, at para. 28:

While a proper understanding of the factual matrix is crucial to the interpretation of many contracts, it is often less relevant for standard form contracts, because “the parties do not negotiate terms and the contract is put to the receiving party as a take-it-or-leave-it proposition”: MacDonald, at para. 33. Standard form contracts are particularly common in the insurance industry

The Court, in this paragraph, was referring to MacDonald v. Chicago Title Insurance Company of Canada, 2015 ONCA 842 where the Ontario Court of Appeal dealt with standard form contracts  (*2). The Court of Appeal in the same year also opined on standard form contracts in in Daverne v. John Switzer Fuels Ltd. 2015 ONCA 919(*3).  The Ontario Court of Appeal considered whether a one year limitation period in an insurance policy was a “business agreement” and would be enforced. A fuel oil tank leak caused damages to property owned by Gerald Daverne and Jutta Daverne. McKeown & Wood Limited (“MW”) had sold the tank to the Davernes. MW was insured by Federated Insurance Company of Canada (“Federated”). At issue in the litigation considered by the Court of Appeal was whether the one year limitation period set out in Federated’s insurance policy was enforceable against MW. The judge hearing the original application had found that the clause was not enforceable. The Court of Appeal disagreed. Firstly, the Court of Appeal found that the standard of review (of the judge’s decision) was correctness. The Court of Appeal reiterated that the correctness standard of review applies on standard form insurance contracts. The Court of Appeal held that, in the case of insurance policies, which involve the interpretation of similar if not common language and the application of general principles of insurance law, the high degree of generality and precedential value justifies a departure from the reasonableness standard of appellate review set out by the Supreme Court of Canada in Sattva.

This body of law from 2015 from the Ontario Court of Appeal was followed in Ledcor by the Supreme Court of Canada. The Court noted at paragraphs 37 to 39 of the Ledcor decision:

In many cases, appellate courts need not review for correctness the contractual interpretation itself in order to perform their functions — namely, ensuring the consistent application of the law and reforming the law. That is because, in general, the interpretation of a contract has no impact beyond the parties to a dispute …

For the interpretation of many contracts, precedents interpreting similar contractual language may be of some persuasive value. However, it is the intentions of the particular parties, as reflected in the particular contractual wording at issue and informed by the surrounding circumstances of the contract, that predominate…

These teachings, however, do not necessarily apply in cases involving standard form contracts, where a review on the standard of correctness may be necessary for appellate courts to fulfill their functions. Standard form contracts are “highly specialized contracts that are sold widely to customers without negotiation of terms”: MacDonald, at para. 37. In some cases, a single company, such as a bank or a telephone service provider, may use its own standard form contract with all of its customers: Monk, at para. 23. In others, a standard form agreement may be common throughout an entire industry: Precision Plating, at para. 28. Either way, the interpretation of the standard form contract could affect many people, because “precedent is more likely to be controlling” in the interpretation of such contracts: Hall, at p. 131. It would be undesirable for courts to interpret identical or very similar standard form provisions inconsistently, without good reason. The mandate of appellate courts — “ensuring the consistency of the law” (Sattva, at para. 51) — is advanced by permitting appellate courts to review the interpretation of standard form contracts for correctness.

In dealing with the Ledcor facts the Court held that while the base coverage under the relevant clause of the policy was for physical loss or damages, the exclusion clause need not necessarily encompass physical damage because perfect mutual exclusivity between exclusions and the initial grant of coverage is neither provided for under the policy nor required when interpreting the exclusion clause. Accordingly, the physical or systemic connectedness test established by the Court of Appeal was unnecessary.

The Court went on to note that while the language of the exclusion clause was ambiguous, the general principles of contractual interpretation led to the conclusion that the exclusion clause serves to exclude from coverage only the cost of redoing the faulty work, that is, the cost of recleaning the windows. The damage to the windows and therefore the cost of their replacement was covered. Given that the general rules of contract construction resolve the ambiguity, it was not necessary to turn to the contra proferentem rule.

The Court added, at para. 66:

Therefore, in my view, the purpose behind builders’ risk policies is crucial in determining the parties’ reasonable expectations as to the meaning of the Exclusion Clause. In a nutshell, the purpose of these polices is to provide broad coverage for construction projects, which are singularly susceptible to accidents and errors. This broad coverage — in exchange for relatively high premiums — provides certainty, stability, and peace of mind. It ensures construction projects do not grind to a halt because of disputes and potential litigation about liability for replacement or repair amongst the various contractors involved. In my view, the purpose of broad coverage in the construction context is furthered by an interpretation of the Exclusion Clause that excludes from coverage only the cost of redoing the faulty work itself — in this case, the cost of recleaning the windows.

It is now clear that for standard form contracts, the “factual matrix” in the formation of the contract will carry less weight with interpretation. For standard form contracts, appeal judges will review the case based on correctness as opposed to reasonableness of the decision.

(*1) See the Fernandes Hearn LLP newsletter article on Sattva in August 2014.
(*2) See the Fernandes Hearn LLP newsletter article in January 2016.

(*3) See the Fernandes Hearn LLP newsletter article in March 2016.


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