The appeal by Churchill Falls (Labrador) Corporation Limited ("CFLCo") of the decision rendered by the Court of Appeal of Quebec on August 1, 2016, raised a number of important questions regarding the civil law of contracts.
At trial, the Hon. Justice Joël A. Silcoff of the Superior Court had dismissed the action by CFLCo seeking to compel Hydro-Québec to renegotiate a contract regarding the construction and operation of a hydroelectric plant, to reflect the changes that had occurred in the electricity market since it was signed in 1969.
The issues to be determined by the Supreme Court of Canada ("SCC") in this highly anticipated decision included whether the doctrine of unforeseeability (hardship) was an integral part of Québec law, or the requirements of good faith and equity could provide a legal basis for the claims made by CFLCo.
CFLCo argued, inter alia, that the contract in issue was a "relational" contract and so the parties were bound by the highest duty of good faith. The SCC reiterated that contract characterization had to be considered to be a question of mixed fact and law when, as in this case, the factual circumstances surrounding the formation and performance of the contract had to be taken into consideration in order to determine the true intention of the parties as to its nature. The SCC did not identify any error in the Court of Appeal's analysis that the contract is not, in fact, relational. Having regard to its conclusions as to the nature of the contract, the SCC declined to recognize that there was an implied obligation to renegotiate its terms in certain circumstances.
After establishing the parameters of the doctrine of unforeseeability, the SCC held that the doctrine is not recognized in Québec civil law. The SCC was of the opinion that even if the doctrine were to apply, the circumstances on which CFLCo relied would not have met the criteria for it, considering that the changes in the electricity market did not have the effect of increasing the cost of performing CFLCo's prestations or diminishing the value of the prestations it received from Hydro‑Québec.
While the SCC reiterated the fundamental importance of good faith in Québec civil law, it stressed that the courts must take into account the choice made by the legislature not to incorporate lesion between persons of full age or the doctrine of unforeseeability into the Civil Code of Québec (the "CCQ") when considering arguments based on analogous concepts.
Similarly, the SCC is of the opinion that the principle of equity set out in article 1434 CCQ does not introduce lesion between persons of full age or to introduce unforeseeability into Québec law.
The SCC rejected CFLCo's arguments based on the principles surrounding the requirements of good faith, holding that the purpose of those principles is not to institute a system of distributive justice. One party's insistence on adhering to the words of the contract constitutes a breach of its duty of good faith only where that insistence is unreasonable in the circumstances. In light of its analysis of the entirety of the circumstances, the SCC concluded that Hydro-Québec's conduct could not be characterized as unreasonable. The duty to cooperate that results from the duty of good faith does not extend to compelling a party to sacrifice its interests for the benefit of the other contracting party.
On November 2, 2018, in Churchill Falls (Labrador Corp.) v. Hydro-Québec, the SCC dismissed the appeal by the appellant Churchill Falls (Labrador) Corporation Limited ("CFLCo") from the decision of the Court of Appeal of Quebec dated August 1, 2016.
The dispute between the parties arose out of a contract signed by CFLCo and Hydro-Québec in 1969 for the construction and operation of a hydroelectric plant on the Churchill River in Labrador (the "Contract"). Hydro-Québec's undertakings in the Contract included that it would buy most of the electricity produced by the plant, and this would enable Churchill Falls to use debt financing for the construction of the plant rather than issuing shares. In exchange, CFLCo agreed to give Hydro-Québec the right to purchase electricity at fixed prices for the entire term of the Contract. In the years after the Contract was signed, changes occurred in the electricity market with the result that the prices set by the Contract were much lower than the market price, thus enabling Hydro-Québec to resell the electricity produced by CFLCo's plant to third parties and reap substantial profits. CFLCo asked the Court to compel Hydro-Québec to renegotiate the Contract and rewrite it to include a new price adjustment formula. CFLCo's claims had been dismissed at trial and on appeal.
In the appeal, the SCC had to consider fundamental questions involving the civil law of contracts in Québec, including the issues of contract characterization, good faith and equity, in order to answer the question of whether CFLCo could require Hydro-Québec to renegotiate the Contract because of allegedly unforeseeable changes in the electricity market since it was signed.
To answer that question, the Court had to determine whether the doctrine of unforeseeability could be recognized in Québec law or whether, in the circumstances, the requirements of good faith or equity could allow it to change the content of the contract or require the parties to renegotiate it. Accordingly, the appeal pitted the principles of morality and contractual justice against those of the binding force and stability of contracts.
II. Decision of the Court of Appeal
In a unanimous decision by Justices Thibault, Morissette, St-Pierre, Schrager and Mainville, the Court of Appeal had rejected CFLCo's argument that the equilibrium of the contract had been disrupted by the changes in the electricity market. The Court found that the parties had chosen to have Hydro-Québec bear the risks relating to fluctuations in electricity prices by not including a price adjustment clause. Hydro-Québec had undertaken to buy a fixed volume of electricity at a fixed price, and so it might have had to bear significant losses in the event that the electricity market fell during the term of the Contract. In exchange, Hydro-Québec gained access to a source of electricity production at a stable cost.
CFLCo argued that the Contract was "relational" and so it imposed the highest duty of good faith on the parties. The Court of Appeal did not accept that argument, noting that despite the lengthy term of the Contract, it has no "relational" element, and that, in any event, the fiduciary duties that CFLCo alleged, based on the decision in Bhasin v. Hrynew, derived from equity in common law and were therefore not relevant to the debate.
On the legal principles governing the requirements of good faith and the doctrine of unforeseeability that were raised in the claims made by CFLCo, the Court of Appeal concluded that the doctrine of unforeseeability, under which a party could require that a contract be renegotiated in the event of a sudden change of circumstances, the effect of which was to make the contract too onerous for it, was not recognized by the CCQ.
However, the Court of Appeal had left a glimmer of hope for advocates of the doctrine of unforeseeability by raising the possibility that it might eventually be recognized by the courts in some specific cases where the legislature had left the door open for a court to intervene to deal with abuse of right or unreasonable conduct.
Moreover, the Court of Appeal noted that it was possible, in some cases, that good faith and the doctrine of unforeseeability might overlap to the point of requiring one party to help the other party remedy his or her problems, but did not specify the circumstances in which such a situation might arise. It thus raised the possibility that in a case in which unforeseen events occurred that jeopardized the financial health or survival of a party, refusal by the other party to grant "forbearance, a diminishing of its obligations, a re-ordering of the contract or such other concession objectively reasonable and unharmful to the other party" could enable the party to apply to the courts, citing the principles of good faith and contractual abuse already recognized by the CCQ and the case law.
In light of the facts, the Court of Appeal concluded that Hydro-Québec had not breached its obligations under the Contract, including its duty of good faith, by refusing to renegotiate the prices set by the Contract. While good faith requires that one party look out for the interests of the other in a general way, by doing everything that party is reasonably able to do so that the other party can perform its obligations and receive its due, good faith does not extend to compelling a party to sacrifice its interests for the benefit of the other party.
Purely theoretically, considering its conclusion that the doctrine of unforeseeability is not applicable in Québec law, the Court of Appeal explored the content of that concept, based on the UNIDROIT principles. Those principles state that hardship or unforeseeability exists only in certain very specific circumstances defined in article 6.2.2:
There is hardship where the occurrence of events fundamentally alters the equilibrium of the contract either because the cost of a party's performance has increased or because the value of the performance a party receives has diminished, and
(a) the events occur or become known to the disadvantaged party after the conclusion of the contract;
(b) the events could not reasonably have been taken into account by the disadvantaged party at the time of the conclusion of the contract;
(c) the events are beyond the control of the disadvantaged party; and
(d) the risk of the events was not assumed by the disadvantaged party.
In this case, the contractual disequilibrium alleged by CFLCo could not have amounted to unforeseeability under the above-noted criteria since the effect of the increase in electricity prices was not to make the performance of the prestations owed by CFLCo more onerous or to diminish the value of what it received under the Contract. Here, the issue was, rather, a significant loss of earnings; however, the evidence was that continued performance of the Contract signed by CFLCo and Hydro-Québec in 1969 continued to be profitable for CFLCo. The Court of Appeal also found that CFLCo's solvency was not at risk. In those circumstances, the Court of Appeal held that the concept of equity referred to in article 1434 CCQ was of no assistance to CFLCo.
Lastly, the Court of Appeal found that CFLCo's arguments regarding the disequilibrium between the prestations received by each of the parties to the Contract were more closely related to the concept of lesion. However, the legislature chose not to apply that concept between persons of full age, except in certain specific exceptions expressly defined by law.
III. Decision of the Supreme Court
In a majority decision by Justices Abella, Moldaver, Karakatsanis, Wagner, Gason, Côté and Brown, the SCC dismissed CFLCo's appeal and concluded that Hydro-Québec had no obligation to renegotiate the Contract to redistribute the substantial windfall profits it had generated.
A. Characterization of the Contract
With the aim of persuading the Court that the Contract involved the highest duty of good faith and an implied obligation to share the benefits resulting from the Contract equitably, CFLCo argued that the Contract was a "relational" contract comparable to a joint venture. In CFLCo's submission, the Contract's primary goal was for each of the parties to receive a fair share of the value of the hydroelectric power produced at the Churchill Falls plant.
CFLCo's arguments regarding the "relational" nature of the Contract raised the issue of the characterization of the contract by the trial court and the Court of Appeal. As the SCC recently reiterated in Uniprix inc. v. Gestion Gosselin et Bérubé inc., characterization of a contract is a separate process from the process of interpreting a contract, and consists of classifying the contract "based on the rules that apply to it, the conditions that apply to its formation, its object and how it is performed" in order to define its nature and attach the various effects provided by the law to it, based on the legal category to which the contract belongs (e.g. lease contract, sale contract, service contract, employment contract, etc.). The SCC reiterated, as it had observed in Uniprix, that characterization of a contract is considered to be a question of mixed fact and law when, as in this case, the factual circumstances surrounding the formation and performance of the contract must be taken into account in order to determine the true intention of the parties as to its nature.
Considering the thorough exercise carried out by the trial judge, which was reviewed by the Court of Appeal, the majority of the judges of the SCC were of the opinion that this was a question of mixed fact and law, and so the findings of the trial judge could not be overturned absent a palpable and overriding error. However, the SCC held that CFLCo's arguments did not reveal any error on the part of the trial judge concerning the characterization or interpretation of the Contract.
CFLCo argued that the Contract was akin to a joint venture since the parties intended to combine their resources to carry out a major project and to share the benefits equally. While the SCC did not rule specifically as to the nature of a joint venture contract in Québec law, it was of the opinion that the Contract signed by the parties did not correspond to that type of contract, based both on the criteria specified in article 2186 CCQ regarding contracts of partnership, on which the Québec case law is based, and on the criteria that certain authors have developed in the literature, in particular because of the absence of any intention on the part of the parties to share the financial or logistical responsibility for the project "beyond" the simple cooperation required to perform their respective prestations.
Regarding the "relational" nature of the Contract, the SCC, quoting Professor Jean-Guy Belley, defined that type of contract as "a contract that sets out the rules for a close cooperation that the parties wish to maintain over the long term". Contracts of employment, subcontracts and franchise agreements would be examples of this type of contract. A relational contract emphasizes the parties' relationship and defines the parties' respective prestations in very little detail.
In rejecting CFLCo's argument that a relational contract is, rather, a long-term contract between interdependent parties that requires a high degree of trust and cooperation, the SCC stated that this could not be a relational contract, given that "the various prestations owed for the whole of that term have been defined with precision since day one".The Contract sets out a series of defined and detailed prestations as opposed to providing for flexible economic coordination.
We would note that in his dissent, Justice Rowe was of the opinion that the characterization of the Contract was, rather, a pure question of law, subject to the standard of correctness. Justice Rowe would have found for CFLCo regarding the relational nature of the contract, in light of his interpretation of the facts and his analysis of the Contract.
B. Whether There Was an Implied Duty to Negotiate
Relying on article 1434 CCQ, which provides that a contract "validly formed binds the parties who have entered into it not only as to what they have expressed in it but also as to what is incident to it according to its nature and in conformity with usage, equity or law", CFLCo argued that the Contract contained an implied duty to cooperate and renegotiate or to share the profits in certain circumstances.
Given that it had rejected CFLCo's arguments regarding the nature of the Contract, the SCC declined to recognize the existence of such implied obligations. In any event, the SCC noted that an implied duty must only be recognized when it is necessary for the contract's coherency and if it is consistent with the general scheme of the contract, and not merely to add duties to the contract that might enhance it. Here, the prestations of the parties to the Contract as they were framed were not "incomprehensible and [with] no basis or meaningful effect" in the absence of the implied duties alleged by CFLCo.
C. Interpretation of the Contract Having Regard to the Changes in the Electricity Market
CFLCo argued that the conclusion of the trial judge that the risk associated with fluctuations in electricity prices was borne by Hydro-Québec was wrong in that at the time the Contract was signed, it was impossible for the parties to foresee what would happen in the electricity market. As a result, the parties could not have had a common intention concerning a situation they could not have foreseen. In the opinion of the SCC, that argument, based on article 1431 CCQ, relates to contractual interpretation. However, as the Court had reiterated in Uniprix, a contract may not be interpreted unless the court first finds that there is ambiguity. The SCC held that there was no ambiguity in the Contract as to the prices, which were set for the life of the contract.
In any event, the evidence was that the possibility of changes in the electricity market occurring had been anticipated by the parties, although it was impossible to foresee the nature of such changes.
D. The Doctrine of Unforeseeability
After stating the parameters of the doctrine of unforeseeability, referring, in particular, to the French Civil Code and the UNIDROIT Principles, cited above, the SCC confirmed that this doctrine is not recognized in Québec civil law.
As the Court of Appeal had observed, the SCC considered the fact that the Civil Code Revision Office had initially suggested that the doctrine of unforeseeability be incorporated into the new CCQ. However, that suggestion was not accepted, two reasons being that it would have compromised contractual stability and that the CCQ already assigned an important role to good faith and equity in contractual matters.
The SCC attributed the reluctance of the Québec courts to develop a doctrine of unforeseeability in the case law to the political and social nature of the considerations underlying that choice. In other words, if the doctrine of unforeseeability were to be incorporated into Québec civil law, it would have to be done expressly by the legislature.
In any event, the SCC, following the Court of Appeal's lead, held that the events on which CFLCo relied did not correspond to the criteria of the doctrine of unforeseeability, given that the changes in the market did not have the effect of increasing the cost of performing CFLCo's prestations or diminishing the value of the prestations it received from Hydro‑Québec.
E. Good Faith and Equity
The SCC noted that the binding force of contracts, which is provided for in article 1434 CCQ, is the rule, first and foremost, while the general duty of good faith serves as a basis for the courts "to intervene and to impose on contracting parties obligations based on a notion of contractual fairness".
The SCC pointed out that the courts must take account of the legislature's choice not to incorporate the doctrine of unforeseeability into Québec law when it comes to considering arguments that assert analogous concepts. Given that the position argued by CFLCo amounted to granting it protection that went beyond even the limits of the doctrine of unforeseeability, its arguments based on good faith were rejected by the SCC.
Quoting the arguments made by Hydro-Québec with approval, the SCC stated that "because good faith serves to protect the equilibrium of a contract, it cannot be used to violate that equilibrium and impose a new bargain on the parties". Accordingly, it cautioned the courts against relying on good faith to order the sharing of profits, since good faith "is not synonymous with either charity or distributive justice."
Similarly, the SCC was of the opinion that the principle of equity in article 1434 CCQ, which can occasionally serve as a basis for the courts to intervene in order to remedy unfair situations, also does not operate to introduce lesion between persons of full age or unforeseeability into Québec law. In this case, the Court was of the view that the parties had negotiated on a level playing field and had bound themselves knowing full well what they were doing.
Next, the SCC confirmed that in Québec law, equity does not extend to allowing the will of the parties and their true common intention, as determined from a thorough analysis of the evidence, to be overridden.
While pointing out that the importance and parameters of good faith had already been examined in several of its own decisions—National Bank of Canada (Canadian National Bank) v. Soucisse, Bank of Montreal v. Kuet Leong Ng, Houle v. Canadian National Bank, and Bank of Montreal v. Bail Ltée, the SCC stated that it is, first and foremost, a standard associated with the parties and that adherence to this standard must be assessed on a case by case basis.
It is worth noting that the SCC did not rule out the intransigence of a party that benefited from a change of circumstances corresponding to the criteria of the doctrine of unforeseeability as a possible breach of the requirements of good faith. The Court stated that in those circumstances, the conduct of that party "cannot be disregarded and must be assessed".
However, the SCC observed that a party's insistence on adhering to the words of the contract does not constitute a breach of the party's obligation of good faith unless such insistence is unreasonable in the circumstances. Citing Lluelles and Moore, the SCC gave the example of a situation in which such a stance would threaten the contractual relationship or the harmony of the contract, without regard for the contracting partner's legitimate expectations, one in which it would allow one party to derive an unwarranted benefit, or one in which the party who insists on adhering to the words of the contract is inflexible or is gratuitously impatient or intransigent.
After noting the principle that everyone is presumed to be acting in good faith, as set out in article 6 CCQ, the SCC concluded that Hydro-Québec's refusal to forego the advantages that the Contract secured for it did not constitute unreasonable conduct.
The duty to cooperate, which flows from the requirements of good faith, can require a party to act proactively to accommodate the interests and legitimate expectations of his or her contracting partner. However, the SCC pointed out that the purpose of the duty is primarily to give the contract the broadest scope possible. Conversely, it cannot be argued in order to undermine the paradigm contemplated by the contract, in order to require renegotiation of its essential prestations.
Unlike the actions of the franchisor in Provigo Distribution inc. v. Supermarché A.R.G. inc., Hydro-Québec had done nothing that would have the effect of disrupting the contractual equilibrium between the parties. The circumstances relied on by CFLCo were entirely external to the conduct of the parties.
Moreover, the duty to cooperate does not go so far as to require that a party sacrifice his or her own interests for the benefit of the other party. On the one hand, Hydro-Québec obtained the right to enjoyment of the benefits of the plant over a long period of time in exchange for making substantial investments and assuming significant risks; on the other hand, CFLCo received the ability to use debt financing for the plant and a return on its investment that it considered reasonable at the time of the signing of the Contract.
To summarize: the SCC concluded that good faith and equity did not entitle CFLCo to require that Hydro-Québec renegotiate the Contract.
While the SCC did not question the fundamental role played by good faith, it declined the invitation to extend the scope of that principle to make it into a mechanism of distributive justice which would amount to incorporating the concepts of lesion between persons of full age and unforeseeability when the Québec legislature has chosen to exclude them from the civil law of contracts. Accordingly, the SCC gave precedence to the principles of the binding force of contracts, consensualism, and contractual stability, which ensure a degree of foreseeability in contractual relationships.
Although Churchill draws a line under any debate about the validity of the doctrine of unforeseeability in Québec law, the SCC in no way lessened the importance of good faith in regulating the conduct of the parties to a contract. In fact, the Court left the door open for courts to sanction a party who engages in unreasonable conduct toward the other contracting party when that party is truly faced with unforeseeability, based on the principles that are already recognized in relation to good faith and contractual abuse.
Without a doubt, the impact of the decision in Churchill will be felt over the years to come in the civil law of contracts in Québec. In particular, it will be interesting to keep watch to see whether parties facing a situation that meets the criteria of the doctrine of unforeseeability, as defined by the SCC, try their luck in the courts by arguing that their contracting partners' conduct constitutes a breach of the requirements of good faith.
More generally, we will be keeping an eye on how the Québec courts interpret what the SCC has said. While some observers see it as merely a reaffirmation of the status quo regarding the principles surrounding good faith in Québec, others may see a paradigm shift that give precedence to the stability of contracts versus judicial interventionism based on considerations of equity and contractual fairness.