Default, liability and remedies in shipbuilding in Canada

Default, liability and remedies

Do courts consider defective design to fall within the scope of poor workmanship for which the shipbuilder is liable under the warranty clause of the contract?

This will, in most cases, depend on the wording of the contract. Where the buyer provides the design, the builder will usually exclude liability for design. Where the builder is also the designer, the contract will typically specify the design warranty and any limitations. Absent an express warranty or exclusion, where the builder was the designer of the vessel, it will be liable to the buyer for defective design.

Are there any remedies available to third parties against the shipbuilder for defectiveness?

Claims for economic loss by third parties present a particular challenge. In order to meet the requirements of general negligence law, a claimant will need to demonstrate that the builder owed it a duty of care, breached the standard of care and that the injury was foreseeable as a result of the builder’s actions. While Canadian courts have in some cases found a prima facie duty of care owed to certain third parties (for example, a rig owner in Bow Valley Husky (Bermuda) Ltd v Saint John Shipbuilding Ltd, [1997] 3 SCR 1210), the policy concerns with respect to indeterminate liability usually bar recovery by third parties against the shipbuilder.

If the contract contains a liquidated damages clause or a penalty provision for late delivery or not meeting guaranteed performance criteria, must the agreed level of compensation represent a genuine link with the damage suffered? Can courts mitigate liquidated damages or penalties agreed in the contract, and for what reasons?

Canadian courts will not enforce a liquidated damages clause that is found to be a penalty clause. In this respect, to be enforceable, a liquidated damages clause should reflect a genuine pre-estimate of damages that would be occasioned by the particular breach. The use of the term ‘liquidated damages’ or a statement that it is a ‘genuine pre-estimate’ will not avoid a determination that the clause is a penalty.

Canadian courts generally follow the House of Lords approach articulated in Dunlop Pneumatic Tyre Co v New Garage & Motor Co (1914), [1915] AC 79 (UK HL) (see, for example, HF Clarke Ltd v Thermidaire Corp, [1976] 1 SCR 319 (SCC)). In this respect, whether an amount specified as liquidated damages is a penalty is a question of construction. The cases cite a number of considerations in this respect:

• if the amount is extravagant and unconscionable in comparison with the loss that could be proved, it will likely be a penalty;
• it will be held to be a penalty if the breach consists only of not paying an amount of money, and the amount specified as liquidated damages is greater than the amount that ought to have been paid; and
• where a single lump sum amount is payable as liquidated damages, on the occurrence of one or more of several events, and these events are of varying levels of seriousness, there is a presumption that the amount is a penalty.

As a general rule, a liquidated damages clause that meets the above requirements will operate as a ceiling on the amount of damages recoverable for the applicable breach.

If the building contract contains a liquidated damages provision, for example, for late delivery, is the buyer then precluded from claiming proven higher damages?

As a general rule, a liquidated damages clause in a ship construction contract will operate as a ceiling on the amount of damages recoverable for the applicable breach absent express provision to the contrary. The courts will look to the construction of the contract for intention, but liquidated damages clauses in Canadian shipbuilding contracts are typically drafted so that they are the buyer’s exclusive remedy for delay.

Are the parties free to design the force majeure clause of the contract?

The parties may specify force majeure provisions in the contract. It would be unusual for a Canadian shipbuilding contract not to provide detailed force majeure events.

Is certain ‘umbrella’ insurance available in the market covering the builder and all subcontractors of a particular project for the builder’s risks?

Shipbuilders and buyers have access to umbrella or project-based insurance.

Will courts or arbitration tribunals in your jurisdiction be prepared to set terms if the parties are unable to reach agreement on alteration to key terms of the contract or a modification to the specification?

Where the contract provides for resolution of such a dispute by arbitration, arbitration can be used to resolve such a matter. However, where parties cannot agree on a change to a contract or modification to the specification, it is doubtful that a court would impose a change upon the parties. If the dispute is with respect to the meaning of a key term of the contract or specification, courts or arbitral tribunals will resolve the meaning. Courts will also imply terms into a contract where it is necessary to the contract’s commercial efficacy.

Does the buyer’s signature of a protocol of delivery and acceptance, stating that the buyer’s acceptance of the vessel shall be final and binding so far as conformity of the vessel to the contract and specifications is concerned, preclude a subsequent claim for breach of performance warranties or for defects latent at the time of delivery?

The role of the protocol of delivery and acceptance is governed by the terms of the contract. In this respect, the usual purpose of such a protocol is to record agreement by the parties as to the time and date that risk passes for the purpose of insurance and title, if the contract provides that title passes on delivery. Canadian shipbuilding contracts will typically include detailed provisions for delivery and acceptance of the vessel, as well as transition to the builder’s warranty obligations.

Can suppliers or subcontractors of the shipbuilder exercise a lien over the vessel or work or equipment ready to be incorporated in the vessel for any unpaid invoices? Is there an implied term or statutory provision that at the time of delivery the vessel shall be free from all liens, charges and encumbrances?

A supplier or subcontractor to the shipbuilder does not have a lien over the vessel. Provided that the builder is still the owner of the vessel, the supplier or subcontractor would have the ability to arrest the vessel in the Federal Court as security for its claims against the builder, referred to as a statutory right in rem. This is particularly important because the claims of the supplier or subcontractor against the vessel will not survive change of title of the vessel to the buyer.

Suppliers or subcontractors to the builder have in common law a possessory lien enabling them to retain possession of work or equipment ready to be incorporated in the vessel for any unpaid invoices. Once this work or equipment is delivered to the builder, the possessory lien is lost.

There is no implied term or statutory provision that at the time of delivery the vessel shall be free from all liens, charges and encumbrances. However, the statutory form of bill of sale used by the Canadian Register of Vessels includes the statement that the ship is ‘free of encumbrances except as appears on the register of the vessel’. A similar warranty is commonly given by the builder in a shipbuilding contract.

Does a reservation of title by a subcontractor or supplier of materials and equipment survive affixing to or incorporation in the vessel under construction?

Suppliers will often reserve title under their contracts until payment is made. Affixation to or incorporation in the vessel will not necessarily defeat a claim by the supplier. This may be determined largely by the extent to which the materials or equipment are removable or no longer retain their independent character.

Provincial sale of goods legislation typically has a provision that a shipbuilder, as a buyer in possession of the goods, may sell the goods and pass title to the ultimate vessel owner. This would leave the supplier with a claim for damages against the builder, but not against the ultimate buyer of the vessel.

Assuming title to the vessel under construction vests with the builder, can third-party creditors of the builder obtain a security attachment or enforcement lien over the vessel or equipment to be incorporated in the vessel to secure their claim against the builder?

Where the third party is a creditor of the builder and the builder has title to the incomplete vessel, then the creditor generally is entitled to enforce its contractual security interests in the property of the builder including the vessel under construction. For this reason it is prudent for the buyer that has not yet taken title to hold security, such as a third-party refund guarantee, for repayment of advances on account of construction. The Canadian Admiralty Court has recently upheld the validity and enforceability of a builder’s mortgage made in favour of the buyer to secure repayment of advances: Offshore Interiors Inc v Sargeant, 2015 FCA 46. A third-party creditor of the builder may take a security interest in the vessel by way of a builder’s mortgage (see question 23).

Concerning equipment or materials not yet incorporated into the vessel, any enforcement of the creditor’s security rights would require demonstration that its debtor continues to be owner of that property, which in addition to issues of possession as discussed in question 33 would engage consideration of the contractual terms between that debtor and the builder.

Can a subcontractor’s or manufacturer’s warranty be assigned to the buyer? Does legislation entitle the buyer to make a direct claim under the subcontractor’s or manufacturer’s warranty?

The ability to assign such warranties depends on the terms of the underlying subcontract, though contracts often require certain warranties to be assignable to the buyer or owner. There is no legislation that entitles a buyer to make a direct claim under the subcontractor’s or manufacturer’s warranty.

Where a builder defaults in the performance of the contract, is there a legal requirement to put the builder in default by sending an official notice before the buyer’s remedies begin to accrue? What remedies will be open to the buyer?

Requirements to give notice of default and to provide opportunity to cure default exist only if the contract so stipulates.

The contract should specify default remedies. The typical remedies provided in a Canadian shipbuilding contract are:

• the right to terminate, in some cases after a reasonable cure period;
• the right to take possession of the vessel and complete the work, either at another location or at the builder’s yard. This right is more common in the construction of vessels for the government and uncommon in non-governmental construction;
• the right to claim for damages arising from the breach; and
• the right to call upon any guarantees or performance security provided by the builder to the extent of the costs to complete the vessel or in respect of damages claimed.

In theory, specific performance is available as a remedy but it would be unusual for a court to compel a builder to complete a vessel. The owner’s primary remedy is to terminate and claim damages. Only the rarest of situations would justify an order of specific performance, likely only where the vessel was so unique that it could not be completed or acquired elsewhere.

Are there any remedies available to the shipowner in the event of protracted failure to construct or continue construction by the shipbuilder apart from the contractual provisions?

Non-performance remedies are found within the contract and are usually provided in detail. Other than the usual common law contractual remedies, there would be no other remedies available to the buyer for protracted failure to construct or continue construction.

Would a buyer’s contractual right to terminate for the builder’s insolvency be enforceable in your jurisdiction?

Yes. Contractual rights of termination on builder’s default, which typically would be defined to include builder’s insolvency, are enforceable in Canada. Certain Canadian insolvency statutes provide for suspension of creditors’ rights to enforce security and to proceed with litigation of claims while judicial proceedings before the insolvency court are pending. These statutes may impede the buyer’s contractual rights of termination, or may introduce practical complexities making it unattractive to the buyer to exercise such rights. Concerning forms of security available to buyers against risk of builder insolvency, see question 34.

What institution will most commonly be agreed on by the parties to decide disputes?

Arbitration clauses are often provided in Canadian shipbuilding contracts. Such clauses sometimes refer to the Association of Maritime Arbitrators of Canada, but more often to the commercial arbitration legislation of the province in which the shipyard is situated. Some provinces also have an International Commercial Arbitration Act modelled on the Model Law on International Commercial Arbitration, though it is unusual for a Canadian shipbuilding contract to utilise this for arbitration. Alternatively, the parties are free to agree to foreign (a non-Canadian seat of) arbitration if they see fit.

There are no specialised admiralty courts in Canada. However, many judges of the Federal Court of Canada have some level of expertise in maritime law. By virtue of section 22(1) of the Federal Courts Act, the Federal Court has concurrent original jurisdiction with the provincial courts in all cases where a claim for relief is made or a remedy sought with respect to Canadian maritime law or any other law of Canada coming within navigation and shipping. The scope of Canadian maritime law has generally been accepted to include contracts for the sale of ships and claims between shipowners and shipyards. However, because of the concurrent jurisdiction with provincial courts, claims involving shipbuilding contracts are often litigated in provincial courts.

Would a buyer’s contractual right to take possession of the vessel under construction and continue construction survive the bankruptcy or moratorium of creditors of the builder?

If title to the vessel under construction remains in the builder then in the event of bankruptcy of the builder that vessel, like all the builder’s property, is subject to liquidation for the benefit of creditors subject to the rights (if any) in that vessel of the builder’s secured creditors. The contractual rights of the buyer, with regard to the builder, would normally be subordinate to the security rights of secured creditors and the statutory rights of unsecured creditors.

On a somewhat related topic, it is possible in theory in Canadian law for the buyer, prior to taking title, to hold a statutory builder’s mortgage on the vessel under construction (assuming agreement between the builder, the buyer and as a practical matter the builder’s other secured creditors); such an arrangement was held permissible in principle by Canada’s Federal Court of Appeal in Offshore Interiors Inc v Sargeant et al, 2015 FCA 46. Under such a scheme, and subject to the specific rights of the buyer secured by the mortgage (in this decision the court declined to decide whether non-financial obligations may be secured by a builder’s mortgage) and also to the rights of competing other secured creditors (if any), the buyer would be entitled to enforce its mortgage without regard for bankruptcy proceedings. For clarity however, buyer’s rights in that scenario derive from its status as a secured creditor and are only as extensive as the mortgage instrument may provide, and do not derive per se from buyer’s entitlements under the shipbuilding contract.

In your jurisdiction, do parties tend to incorporate an ADR clause in shipbuilding contracts?

Arbitration clauses are often provided in Canadian shipbuilding contracts. The parties are at liberty, but are not required, to stipulate antecedent ADR procedures such as mediation prior to initiation of arbitration.

Where the buyer defaults in the performance of the contract, what remedies will be available to the builder? What are the consequences of the builder’s cancellation of the contract?

In cases of buyer default, the builder’s termination or other remedial rights, including consequences of builder’s termination of the contract where that right matures, would normally be stipulated in detail in the contract, and such contractual provisions will be enforced provided that they are clearly expressed. Subject to contractual stipulations, which if made will govern, the builder’s remedies would normally be damages for breach of contract, including the value of work performed but not yet paid, unrecoverable cost of materials or equipment reasonably pre-ordered but not yet incorporated into the vessel, and damages for lost profit. Although some portion of the amounts so recoverable could be secured by the builder’s possessory lien, Canadian law tends to restrict the amount so secured to the value of work actually performed. If the buyer is, at time of default, owner of the vessel under construction then the builder has under Canadian law a right to proceed in rem against and to arrest the vessel in respect of its claim.