Legal: The allocation of supply chain risk under a construction contract in Canada

Submitted by Rob Kennaley
Kennaley Construction Law

Supply chain issues are currently plaguing the construction and services industries on a world-wide and perhaps unprecedented scale, leading to both delays and cost escalations.

In this regard, contractors and trades might wish to argue that the impacts are unanticipated (due to COVID or other factors), such that they are entitled to schedule relief and/or additional compensation.

The starting point for determining who bears the risk of such impacts lies at first instance in the contract between the parties: in virtually every circumstance the expressed or implied terms of the contract will govern. Accordingly, if supply chain risks have been expressly addressed, those terms will prevail. Where the contract is unclear or silent on the issue, however, the “surrounding circumstances”, implied terms, force majeure clauses and the doctrine of “frustration” can play a role in the contract’s interpretation. Each of these might accordingly be used to support a contractor or trade’s claim for relief from supply chain impacts.

We will review the law as it relates to these factors, as doing so may help our readers assess whether or not they might support, or preclude, a claim in any particular circumstance.  In the end, establishing a claim for additional time or money for cost escalations or supply chain problems in the absence of an expressed contractual right can be difficult.  It is possible, however, that the post-COVID nature of many of the problems might be assessed differently than have similar issues in the past. In addition, many owners and contractors are recognizing the unique nature of the current problems and making the business decision to work with their contractors/trades to provide some relief, to ensure that contracts are performed on time and relationships are maintained.

Our leading case on contractual interpretation is the Supreme Court of Canada decision in Sattva Capital Corp. v. Creston Moly Corp.:

1. contractual interpretation requires a practical, common-sense approach to determine the intent of the parties on “a reading of the contract as a whole, giving the words used their ordinary and grammatical meaning, consistent with the surrounding circumstances known to the parties at the time of formation of the contract”;
2. surrounding circumstances are what were, or reasonably ought to have been, within the knowledge of both parties at the time of contracting, including what “would have been understood by a reasonable man”;
3. the role of surrounding circumstances will vary from case to case and cannot be used to change or overrule the plain meaning of the contract; and
4. the subjective intention of the parties does not matter: only objective evidence of what both parties knew or ought to have known at the time of contracting can be admissible.

The Supreme Court also held in M.J.B. Enterprises Ltd. v. Defence Construction (1951) Ltd. that terms will be implied where necessary to give “business efficacy” to a contract, or where the parties would have considered them to be so obvious, that they didn’t need to be written down. An obvious term is established, the Court confirmed, where the parties would have unquestionably said, “of course!”, had a knowledgeable bystander suggested that the term formed part of the deal.

As above, however, surrounding circumstances and implied terms cannot be applied to overrule the written terms of a contract. Accordingly, any “force majeure” clause ought to be considered in assessing whether relief should be granted for cost escalations or supply chain issues.  Such clause commonly provide schedule or other relief if certain listed events occur, often including strikes, lockouts, abnormal weather, fires and (more generally) anything “beyond the control” of the contractor or trade.

It should be noted that “force majeure has no set or specialized meaning”:  it does not exist outside the contract.  Whether or not a force majeure event has occurred, and what relief might flow from the event, will depend in each case on the wording and application of the clause in question. It is also well established that the clauses address “the unexpected, something beyond reasonable human foresight and skill”, are intended to protect parties “from events outside normal business risk”, are “case and industry specific” and should be interpreted “in terms of what, in commercial terms, were the mutual and reasonable expectations of the parties about risks that may arise”.

In the construction context, most force majeure clauses in Canada only provide a schedule extension if a force majeure event occurs: they don’t provide for additional compensation.  Where there is no force majeure clause, of course, one can be implied. (Some minimum form of force majeure relief would, in our view, almost certainly be inferred in most circumstances). In addition, of course, should delays be attributable to someone above the contractor or trade in the construction ladder, the delays would not be attributable to “force majeure” and additional compensation might be payable, depending on what the contract says.

Some have suggested that their contracts are “frustrated” by supply chain and cost escalation problems. “Frustration”, however, involves a high hurdle: the doctrine will only apply when the performance of the contract is virtually impossible. It will not apply where performance is simply more difficult or expensive then originally anticipated. It has been held, for example, that:

“the contract must, as a result, be totally different from what the parties had intended. This difference must take into account the distinction between complete fruitlessness and mere inconvenience. The disruption must be permanent, not temporary or transient. The change must totally affect the nature, meaning, purpose, effect and consequences of the contract so far as concerns either or both parties. Finally, the act or event that brought about such radical change must not have been foreseeable.”

There is little case law on whether or not contractors or trades who did not include for the impacts of the supply chain and cost escalation problems should be entitled to relief under their contracts. Even then, each case would have to be decided on the terms of the specific contract read in the circumstances of the particular case. Still, a review of how our courts have dealt with similar claims in the past can be helpful.

One such case is a BC Supreme Court decision, Domtar Inc. v. Univar Canada Ltd.  Although a lower-level Court decision, it’s helpful because it refers back to prior case law and principles. In this case, a supplier argued:

1. that a force majeure clause which provided relief for “any contingency beyond its reasonable control” applied to “the unprecedented rise in the market price”;
2. that it was “entitled to consider the factual matrix underlying the contract in order to ascertain the surrounding circumstances at the time the contract was made, and to interpret the works of the contract in their proper context”’;
3. that the forced majeure clause was “broad enough to include economic and market conditions ‘”; and
4. that the unprecedented rise in prices was a force majeure event because these conditions made it “commercially impractical” to continue performance for the contract price.

Although the Court agreed that surrounding circumstances had to be considered, it followed a British decision, Tandrin Aviation Holdings Ltd. v. Aero Toy Store LLC (2010), where the force majeure clause (similarly) did not expressly reference economic or market conditions and where the Court had stated:

“It is well established under English law that a change in economic/market circumstances, affecting the profitability of a contract or the ease with which the parties’ obligations can be performed, is not regarded as being a force majeure event”; and followed much earlier English findings that “It does not at all follow that the supplier is entitled to rely upon an increase in the market price in comparison to the contract price as a force majeure circumstance. … the fact that a contract has become expensive to perform, even dramatically more expensive, is not a ground to relieve a party on the grounds of force majeure or frustration” and “the argument that a man can be excused from performance of his contract when it becomes ‘commercially impossible’ seems to me to be a dangerous contention which ought not to be admitted unless the parties plainly contracted to that effect”.

In Tom Jones & Sons Ltd. v. R. (1981), 31 O.R. (2d) 649 (Ont. H.C.) at para 13, (1981), 119 D.L.R. (3d) 684 (Ont. H.C.) a contractor advised the owner that it could not fulfill its obligations under a construction contract because it could not arrange financing due to the volatility of interest rates.

The Court held that the force majeure clause (which contained fairly standard terms) did not apply because, while the rise in rates was beyond the contractor’s control, the failure to obtain financing was not beyond their control.

Tom Jones & Sons Ltd and Tandrin Aviation were each later followed in Roberge v. 1102940 Alberta Ltd., 2012 ABQB 717, where the Alberta Court of Queen’s Bench also refused to apply a force majeure clause to provide relief to a contractor.  In that case, like in many others before it, the Court considered whether the event complained of was related or similar to the events listed in the actual force majeure clause.

Although these cases appear to establish a high hurdle in the absence of a term which provides expressed relief from supply chain and cost escalation impacts, each case must be decided on its own facts, with a view to interpreting the contract in all of the circumstances. As above, interpreting the contract, however, can involve an assessment of surrounding circumstances, commercial realities and the parties’ expectations, including what an “officious bystander” might say should be included.

There is no doubt that, in some cases, the world-wide supply chain problems we currently face are different from the economic and marketplace risks the parties would have contemplated in negotiating contracts. This fact alone might give rise to an implied term in some circumstances. Accordingly, relief might be available on a contract-by-contract basis.

In addition, many owners and contractors have recognized that the unique nature of the current problems and have made the business decision to work with their contractors/trades to provide some relief, towards ensuring that contracts are performed on time and that relationships are maintained.

Kennaley Construction Law is a regional construction law firm with offices in Paris, Toronto, Barrie and Sudbury.