Whether or not a contract is legally enforceable is a question that garners considerable attention within the legal community. When faced with making this determination, courts are required to balance the competing interests of preserving the sanctity of freedom of contract with equitable principles of negotiation. Where a court finds that a party has unduly taken advantage of an inequality of bargaining power between the contracting parties, it is within their discretion to apply an equitable remedy and, in some circumstances, set the contract aside. Unconscionability is one such remedy. Its application by the courts, however, has been largely inconsistent. This inconsistency has created uncertainty and unpredictability around this equitable remedy. That said, developments in the interpretation and application of the principle of unconscionability are relevant to lenders, especially those who, in certain situations, use standard form or non-negotiable agreements with their clients. In a recent appellate decision, the Newfoundland and Labrador Court of Appeal has highlighted some important issues of relevance to all contracting parties (including lenders) when considering how to proactively insulate contracts from being set aside on the equitable grounds of unconscionability, and has provided welcomed clarification and some much-needed guidance in an area of Canadian law that is famously unsettled.

The decision in Downer v Pitcher considered the enforceability of a release agreement between Roger Downer (“Downer”) and Elizabeth Pitcher (“Pitcher”) that was executed after an automobile collision[1]. In response to a subsequent personal injury claim brought by Pitcher, Downer sought to rely on the agreement, which released him of all liability related to the collision. Pitcher claimed that the agreement was unconscionable and should be set aside.

While operating her taxi, Pitcher was rear-ended by Downer while stopped. After the collision, Downer agreed to pay to have Pitcher’s taxi repaired and pay compensation for her loss of income while the taxi was unavailable. Since Pitcher advised that she did not sustain any major injuries, Downer chose not to put the claim through his insurer. Downer’s insurer cautioned him that he could be liable for personal injury claims in the future, unless the parties executed a release form. Downer obtained a standard release agreement from a friend (a lawyer) and asked Pitcher if she would sign it. The document, titled “Full and Final Release”, was very clear – it released Downer from any and all liability arising from the collision, including personal injury loss. Pitcher, having not read the document and without legal advice, signed the document. In an effort to regain her right to sue for personal injury losses, Pitcher urged the Court to set aside the contract on the grounds of unconscionability. The trial court agreed with Pitcher and set the contract aside. The Court of Appeal, however, overturned the trial court’s decision and rejected Pitcher’s arguments, concluding that the release agreement was valid and enforceable.

Although this particular case involved two individuals in a motor vehicle collision and a release form rather than a fulsome contract, the principles highlighted in the judgment apply broadly to contract law as a whole and, in particular, the Court’s approach to setting aside contracts based on equitable remedies. The Court of Appeal recognized that unconscionability is a special defence grounded in equity and, if expanded without restraint, could seriously erode freedom of contract and inhibit regular business activity.[2] In other words, it is not designed to protect foolish parties from entering into a bad deal.[3] The Court of Appeal reviewed the jurisprudence and distilled the defence down to two main principles, or two necessary prerequisites the Court requires before it will consider setting aside a contract on the basis of unconscionability, which are as follows:

  1. there exists inequality of bargaining power between the parties resulting from or created by a special and significant disadvantage by reason of some conditions or circumstance that provides an opportunity for the other party to take advantage of the party suffering from disadvantage;[4] and
  2. the other party unfairly or unconscientiously took advantage of that opportunity.[5]

If a party is successful in proving the elements above, the contract is not necessarily void. The “advantaged” party can defend their actions by proving one of multiple defences.[6]

The lessons to be extracted from this case that could be relevant in the commercial lending industry include: (i) the contract must be clearly drafted; (ii) the behaviour of the parties must not suggest unfairness; and (iii) the accessibility and use of legal advice is important.

With respect to the first item, the Court of Appeal spent a considerable amount of time discussing the clarity of the release agreement. Not only does having a clear agreement avoid uncertainty, it reduces what is admissible as extrinsic evidence to the agreement itself.[7] In other words, Pitcher’s argument failed, in part, because she chose not to read a contract that was clear and unambiguous. This highlights the need for lenders to ensure contracts are clearly drafted.

Secondly, there was no evidence that Pitcher was rushed or pressured into signing the release, nor could it be shown that she signed it out of desperation. The Court’s attention to these details highlights the importance of the behaviour of the parties – unfair behaviour supports the presumption that the party in power is aware (and taking advantage of) the weaker party’s disadvantage. This emphasizes the need for lenders to ensure any delivery deadlines are fair and reasonable and to provide enough time for a full and proper review of the contract(s). Failing to do so (by imposing hasty turnaround requirements, for example) may in some cases open to the door to this type of equitable remedy.

Lastly, the opportunity to obtain and use legal advice is a significant factor.[8] Pitcher, having been notified prior to the parties meeting that Downer wanted her to sign a release, had in the Court’s view ample opportunity to obtain legal advice. Additionally, she had actual experience signing a similar release in concluding a settlement in the past. Given Pitcher’s familiarity with a comparable release, combined with the fact that she had time to retain a lawyer but chose not to do so, the Court of Appeal showed little sympathy for her situation.[9] With respect to lenders who typically conduct business with clients who are represented by legal counsel, this is generally not an issue. If, on the other hand, a lender is contracting with a borrower and/or guarantor that is unrepresented, it would be prudent for the lender to suggest (and in some circumstances insist) that the borrower and guarantor obtain legal advice or independent legal advice prior to signing the documentation. Any waiver of the recommendation to obtain independent legal advice should be fully documented in writing.

This case emphasizes the need for all contracting parties, including lenders, to consider the relationship they have with the other contracting parties and take the appropriate precautions described above to avoid contracts being challenged, and potentially set aside, on the ground of unconscionability. Lenders should consider consulting their in-house counsel or outside counsel if there is any doubt as to whether independent legal advice is recommended or required in any transaction, or if an allegation of unconscionability could potentially be raised in any transaction.