Upon examining if there were sufficient grounds to terminate the subcontracting agreement between Litostroj Hydro Inc. ("Litostroj") and Ideal Electric Company ("Ideal") for the production of generators in the context of Hydro-Québec's project to build two hydroelectric plants, the Superior Court (the "Court"), presided by Honorable Chantal Tremblay, SCJ, dismissed Ideal's claim in its entirety in the case I.E. Liquidation Inc. v. Litostroj Hydro Inc. In addition, the Court confirmed that the governing principles in the matters of: termination for cause, abuse of right in the execution and termination of contracts, the evaluation of the value of work in such a context, and lawful notification.

The Facts

In February 2005, Hydro-Québec retained the services of Litostroj as a supplier and installer of generating units for its project involving the construction of two hydroelectric plants in Haute-Mauricie. In July 2005, Litostroj executed two identical subcontracting contracts with Ideal for the design, production, installation, and activation of the generators (the "Contract").

The Contract contained a termination for cause clause in the event of insolvency, non‑performance, and work interruption or slowdowns by the subcontractor. Notwithstanding, and except in the event of insolvency, this clause required a written notice be sent to the subcontractor in which, prior to the termination of the Contract, the contractor must identify the alleged shortcomings and grant the subcontractor time to implement appropriate remedies.

From the beginning of the execution of the Contract, Litostroj observed certain problems related to the performance of the work by carried out by Ideal, specifically, as it pertained to the quality of the generators' production design. The financial viability of Ideal, who was unable to provide the performance bond provided for in the Contract, also concerned Litostroj.

As the months passed, Ideal accumulated delays and failed to perform its obligations. In the spring of 2006, Hydro-Québec noticed that the generators being designed and produced by Ideal contained design flaws and requested that Litostroj and Ideal correct the problem before undertaking the production of the components in question.

While offering assurances that the generators met the Hydro-Québec's contractual requirements, Ideal was slow to respond to Hydro-Québecs and Litostroj's concerns and did not implement all the necessary measures to remedy the design problems raised.

At the same time, Ideal, who claimed to be making strides in the production of the generators in question, demanded certain payment installments despite failing to meet all of its expected contractual requirements and obligations. In May and June 2006, to alleviate its subcontractor's financial burden and avoid even longer generator production delays, Litostroj acceded to Ideal's request for payment of agreed-upon amounts (minus deductions provided for in the contract) for the design of the generators. However, Litostroj withheld, during the summer of 2006, certain payments owed for the production of the generators until the design problems related to the coolers and the insulation of the upper levels of the generators were addressed.

In the weeks that followed, Ideal's shortfalls and delays progressively worsened. Ideal's financial difficulties also deepened such that, in August 2006, it requested that Litostroj modify the agreed-upon payment terms so that Ideal might better fund the project. At the time, to escape the impasse in which it found itself, Ideal also enlisted restructuring consultants.

Litostroj refused to modify the agreed-upon payment terms; however, it offered to purchase Ideal's assets, an offer Ideal refused. Several days later, Ideal sent a stop-work notification to Litostroj, citing Litostroj's withholding of payments.

On October 9, 2006, having determined that Ideal was insolvent and unable to meet its contractual obligations, Litostroj sent Ideal a notice of default and termination of the Contract. On October 27, 2006, Ideal accepted the termination of the Contract and, several days later, sought protection under U.S. bankruptcy and insolvency law.

In 2010, Ideal began judicial proceedings against Litostroj, alleging that it had caused Ideal's bankruptcy through its failure to pay during the performance of the Contract and the ostensibly abusive termination of the Contract. Ideal claimed compensation for damages in the amount of $10,660,931.18 (plus interest and additional compensation since the termination of the Contract), citing the alleged progress of Ideal's work at the time the Contract was terminated as well as damages suffered in the context of its bankruptcy.

Litostroj defended its termination of the Contract for cause and maintained that it owed no damages to Ideal. In a counterclaim, Litostroj also demanded reimbursement of the sums paid to Ideal for the design of the generators.

The Ruling

In a detailed judgment, the Court first concluded that, since it had enough information to surmise that its subcontractor was insolvent, Litostroj was within its rights to terminate the Contract for cause and to do so without notification. Furthermore, the Court confirmed that an expert opinion was not necessary to prove the insolvency of a party, when the insolvency was supported by facts, and that such a determination is to be left to the discretion of the court.

The Court then concluded that Ideal was also in breach of its contractual obligations and, despite the absence of the default notice provided for in the Contract, that it was lawfully notified given its repeated failings, the cessation of work in September 2006, and its acceptance of the termination of the Contract.

In short, the court concluded that Litostroj was justified in terminating the Contract and that it had not acted in bad faith or in an abusive way at the time of the termination.

In addition, the court refused to grant Ideal compensation for work performed and materials furnished when the Contract was terminated. Indeed, by applying the principlrs recognized by the Court of Appeal in Corporation Urgences-santé de la région de Montréal métropolitain v. Novacentre Technologie Ltée, Judge Tremblay concluded that in the event of a termination for cause, when work performed or materials furnished are of no value to the co‑contractor, no compensation is owed because one cannot conclude that the services or materials were furnished.

Given Ideal's many shortcomings throughout the performance of its Contract, the court concluded that Litostroj did not behave in an abusive manner by withholding certain payments owed to its subcontractor and that Litostroj was under no obligation to modify the contractual payment terms to help Ideal address its financial difficulties. Thus, the court rejected in its entirety Ideal's claim.

Judge Tremblay also rejected Litostroj's counterclaim arguing that Litostroj had not established that the production designs were of no use to it, to Hydro-Québec, or to new subcontractors involved in the furnishing of generators.

Key Points

It its judgment, the Court confirmed the application of established principles regarding the business contract termination-penalty and defined the damages that can be claimed by a contractor (or a sub-contractor) in this context.

Furthermore, it highlighted the fact that a party's repeated failures to fulfill is obligations can constitute lawful notice and open the way for immediate termination without the necessity of a written notification. In addition, even if clear language exists providing that, in the event of termination, a contractor will be paid for work performed and materials furnished up to the moment the contract is terminated, a court can refuse to grant any damages if, due to a party's failings to perform work, the work and materials furnished cannot be exploited by the party's co-contractor.

Finally, the Court clearly established that, since a contract is essentially a self-serving act, good faith principles in the context of contractual relationships do not require that one party come to the aid of another or that it modify the agreed-upon terms of the contract, more specifically the financial terms of a contract.

A team at Fasken that included, among others, Annie Bernard, Christine Provencher and Jean-François Trudelle represented Litostroj in this case. As of the publication date of this bulletin, the judgment has not been appealed.