A troubling decision

It is troubling when contract law fails to accord with commercial reality. It is troubling when a commercial case ignores the underlying economic context. In Southcott Estates Inc. v. Toronto Catholic District School Board, the Supreme Court of Canada applied theoretically pure models of contract and corporate law to conclude that the victim of a breach of contract had failed to mitigate its damages. The victim of the breach was therefore denied its damages, which had been assessed at trial at $1.9 million. But in applying pure theory, Southcott ignored commercial reality and the underlying economic context.

Southcott represents a triumph of theory over commercial reality. Southcott is a troubling decision.

The decision

Southcott Estates Inc. (“Southcott Estates”) is part of a group of companies (the Ballantry Group) that is in the land development business in southern Ontario. As is common in the industry, Southcott Estates is a single-purpose company. Its sole purpose was to undertake a single specific transaction, namely the acquisition of a parcel of land that had been put up for sale by a school board and the construction of a residential development on the site. The deal to buy the land fell through as a result of the school board’s breach of contract. Southcott Estates sued for damages (it also sought specific performance, which was denied on the basis that the land was not unique).

After the deal fell through, the Ballantry Group made no effort to have Southcott Estates acquire another piece of land in mitigation of its losses. This was for very sensible commercial reasons. The Ballantry Group was always in the market for new land, and in fact purchased seven parcels of land for development in the period between the date of breach and the date of trial. In accordance with industry practice, it used separate corporate vehicles for those purchases and did not use a corporation that was embroiled in litigation (Southcott Estates). As explained by one of Ballantry’s principals at trial, Ballantry would not have bought in the name of Southcott Estates because “it doesn’t make sense … I can’t imagine my lawyer ever letting me do that… I don’t need the headaches.” He explained that Ballantry would never use a company that was involved in litigation, and in fact “generally we wouldn’t buy anything in another company if it’s still involved in something.”

While the approach is imminently sensible from the commercial perspective of someone running a group of real estate development companies, the Supreme Court of Canada found it to be legally fatal to an effort to collect damages for breach of contract, on the basis that Southcott Estates had failed to mitigate its damages. The decision was six-to-one, with Justice Karakatsanis writing for the majority and with Chief Justice McLachlin penning the lone dissent.

The Court reasoned that “[a]s a separate legal entity, [Southcott Estates] was required to mitigate by making diligent efforts to find a substitute property. Those who choose the benefits of incorporation must bear the corresponding burdens….” Southcott Estates “is entitled to the benefits of limited liability, but it is also saddled with the responsibilities that all legal entities have. The requirement to take steps to mitigate losses is one such responsibility.”

This is excellent legal theory, entirely consistent with the theoretical exposition of the doctrine of mitigation and with corporate law theory, which of course holds as a foundational principle that a corporation is its own legal entity separate from its shareholders. But the approach is entirely divorced from business and economic reality. The real purchaser of the land was not a shell company with no other assets; it was the Ballantry Group. The decision not to use Southcott Estates for another land purchase was not a device to run up the damages on the defendant school board; it was the way the Ballantry Group, and indeed the entire industry, always did business. Since the Ballantry Group was in the market for as much land as it could acquire and actually did acquire other land at the relevant time (transactions which would have been undertaken even if the Southcott Estates transaction had proceeded), the loss of this particular deal was a real loss to the Ballantry Group that could not have been avoided by undertaking a mitigatory transaction.

The result is that a breaching defendant (the school board) that caused $1.9 million in damages gets off scot free. Moreover, a large development group faced with a breaching seller must now either waive its right to sue for damages, or go out into the market and use a shell corporation that is embroiled in a lawsuit to purchase another property – an act which heretofore would have been considered to be something approaching malpractice if recommended by a lawyer, and would likely be difficult to convince a lender to accept given the general reticence to advance funds a company with limited assets that is embroiled in litigation.

Even from the perspective of legal theory, the result is somewhat baffling. In a multitude of different legal scenarios the Supreme Court of Canada has repeatedly emphasized that Canadian law mandates a contextual approach. Indeed, in Southcott itself the Court explained that the doctrine of mitigation requires a contextual analysis: “Mitigation is a doctrine based on fairness and common sense, which seeks to do justice between the parties in the particular circumstances of the case.” Yet in Southcott the Court ignored the most important economic context underlying the case – the nominal plaintiff was in fact just the vehicle by which a large development group was undertaking a particular development project, such that going out into the market and using the same corporation for another purchase would not in fact have avoided a loss for the group as a whole. The Court’s analysis may have been perfectly sensible had the single-purpose company been a company incorporated by an investor to undertake a one-off transaction, but in the context of a large development group undertaking multiple transactions it makes little sense.

This is not to say that the corporate veil should simply be ignored in the mitigation analysis. There is considerable force to the Court’s comment that one who seeks the benefits of incorporation must also bear the corresponding burdens, and no doubt the Ballantry Group would be the first to object if a plaintiff suing one of its companies tried to get access to the assets of the entire Group by pointing to the economic context. But looking to the entire economic context when assessing whether damages have been mitigated is a different analysis than piercing the corporate veil. In mitigation the issue is whether losses could reasonably have been avoided such that it is unfair to make the defendant pay them. Viewed at that level, it is difficult to see why the analysis should end at the corporate veil.

Potential Significance

If nothing else, Southcott at least sets down a clear rule. Every corporation, being a separate legal entity, must seek to mitigate its damages or else be denied recovery for breach of contract – regardless of the commercial reality or the underlying economic context. Legal theory stands pure and unadulterated. But the connection between contract law and commercial reality has, troublingly, been attenuated.

Case information

Southcott Estates Inc. v. Toronto Catholic District School Board, 2012 SCC 51

Court File No.: 33778

Date of Decision: October 17, 2012