7-Jul-2004
This Update addresses two important conditions contained in many construction contracts: force majeure, and liquidated damages. In this and future Updates, we will focus on some of the important commercial terms which serve to allocate risk on construction projects, and which merit close attention at the time contracts are negotiated.
Force Majeure
Ice storms, tornados, hurricanes, earthquakes – these calamities are not at the forefront of the opening contract negotiations for a new project. However, the sudden appearance of Hurricane Juan in all of its destructive glory reminds us that there are events far beyond our control which can have devastating financial consequences. The construction industry is on the front lines when such unforeseen events occur – projects may be irreparably damaged or delayed, causing significant losses. The critical question, of course, becomes “who will bear the loss”. This calls attention to the clause which continues to be known by its ancient label force majeure.
The force majeure clause is common in all types of contracts. It has a long history as is evident by the archaic legal wording often employed. Such risks as “blockade”, “revolution”, “insurrection” and “confiscation” are still found in modern contracts, although no doubt the original draftsmen were not working on a Dell laptop when labouring to protect their clients against the worst. This type of clause is often in the “boilerplate” terms and conditions which will inevitably receive considerably less attention at the time the project is put together than other crucial terms such as price and schedule. Nonetheless, force majeure protection is an important component of the allocation of risk on any significant construction project. Since the Courts will look to the terms of the contract to determine the result in the event of a force majeure event, those terms should be reviewed carefully before the contract is finalized.
Force majeure clauses have not received a great deal of consideration by Courts. The leading Canadian case on force majeure is Atlantic Paper Stock Ltd. v. St. Anne-Nackawic Pulp & Paper Co., decided by the Supreme Court of Canada in 1975. In this case the mill had a force majeure clause in a contract with a waste paper supplier. The force majeure clause excused the mill from purchasing its required amount of waste paper “as a result of an act of God, the Queen’s or public enemies, war, the authority of law, labour unrest or strikes, the destruction of or damage to production facilities, or the nonavailability of markets for pulp or corrugating medium.” The latter condition became important when the markets failed. It was necessary for the court to determine the meaning of this event. Chief Justice Dickson’s comments on interpretation of force majeure clauses have shaped all subsequent cases:
An act of God clause or force majeure clause, and it is within such a clause that the words "non-availability of markets" are found, generally operates to discharge a contracting party when a supervening, sometimes supernatural, event, beyond control of either party, makes performance impossible. The common thread is that of the unexpected, something beyond reasonable human foresight and skill. [emphasis added]
What then should a force majeure clause include? The Alberta Court of Appeal stated in Atcor Ltd. v. Continental Energy Marketing Ltd. that a force majeure clause should address:
- the definition of the triggering events (eg. strikes, lockouts, fire, explosion);
- the impact those events have on the party invoking the clause (eg. extension of time); and
- the effect of invoking the clause on contractual obligation (eg. are all obligations or
just some relieved in the face of a force majeure).
The use of the term “force majeure” itself has little meaning in a contract. If a force majeure clause is to truly allocate the risks among the parties for the occurrence of extraordinary events, it is beneficial for the parties to attempt to list the likely events which could occur in the circumstances of the particular contract. When items are specifically enumerated, it eliminates the need for a Court to ascertain whether an occurrence falls within a more global event, such as the common “events beyond the reasonable control of the parties.” Reliance on global terms can be problematic because parties often have differing views of what is beyond their reasonable control. Courts have stated that the onus is upon the party seeking to rely on force majeure to bring itself squarely within the clause.
In a construction contract, global terminology, such as “events beyond reasonable control”, operates to the benefit of the contractor. It is this party which faces the longest list of supervening events. However, it is still beneficial to enumerate as many events as possible which relate to the circumstances of the particular contract in order to avoid later disputes over whether force majeure has occurred.
Occasionally parties also take the step of enumerating events which will not occasion force majeure, adding even greater clarity. In such cases, from the contractor’s perspective, exclusions need to be carefully scrutinized. An example from one contract we have seen excluded “climatic and weather conditions that are reasonably to be expected for the geographic area”. In an area where very harsh conditions could be reasonably expected, but which would prevent progress of construction, a contractor might not get relief which would otherwise be reasonable.
What will occur in the event of force majeure is equally important. Will the parties be completely excused or will there simply be an extension of time for completion? Some of the items which could be addressed are:
- What obligations there are to mitigate the event;
- What occurs in the event of partial performance;
- The effect on subcontracts;
- Notice requirements on occurrence of the event; or,
- Time after which the contract terminates.
Finally, it should be noted that the interaction of the force majeure clause with other clauses in the contract is important. Force majeure clauses should not be drafted in isolation.
Force majeure clauses need not be a source of angst for parties if they are addressed thoughtfully in the drafting of contracts. Parties should give consideration to what events will forgive or alter performance of the contract and draft accordingly. While some events will always be “beyond reasonable human foresight and skill”, dealing with force majeure in advance will reduce the likelihood of disputes and facilitate resolution of issues.
Liquidated Damages
Liquidated damages (“LD”) clauses set forth a specific sum or formula to calculate a sum payable in the event of the breach of certain contractual obligations. The most familiar form is an LD clause which provides for a per diem amount for each day of delay in the substantial or final completion of the project.
In cases where there is rough equivalency of bargaining power, there is no reason why a properly drafted LD clause should not be enforceable. However, Courts have historically scrutinized liquidated damages clauses, and have exercised an inherent jurisdiction to disallow reliance on LD clauses which are concluded to be a penalty and not a genuine pre-estimate of the damages a party would suffer in the event of a breach. For example, if the LD per diem was $100,000, but actual foreseeable damages for delay to completion were $10,000, the clause may well be struck down. In Elsley v. J.G. Collins Insurance Agencies Limited, the Supreme Court of Canada expressly acknowledged that striking down such a clause is a blatant interference with the freedom to contract, but at the same time, made it clear that the Courts will be concerned with fairness in determining the issue of enforceability. More recently, there is a tendency of Courts to examine whether the clause is oppressive or “unconscionable” before enforcing it.
Liquidated damages can add a great deal of certainty in a contract, at least in respect of non-performance remedies. A well-constructed liquidated damages clause can avoid difficulties and costs of proving actual damages, and accordingly, result in a reduction in the cost of settling disputes. It can also avoid the risk of undercompensation caused by various legal restrictions on damages.
In the case of liquidated damages for delay, it may not be too difficult to determine an estimated daily cost for the overrun. However, it can be more difficult when there are collateral effects on other contracts or sub-contracts. It is also not unusual to fix an amount of damages payable on breach of various covenants such as confidentiality or protection of proprietary information. In these cases it can be more difficult to determine a genuine pre-estimate of damages. This is where Courts examine whether the amount in question is oppressive or unconscionable.
What can be done to craft a clause which will be upheld by the Courts? The following are measures which should be incorporated to increase the chances:
- As noted, the Courts will focus on whether the LD clause is a “genuine pre-estimate of damages”. The best approach therefore is for the party who will benefit from the clause to calculate the amount based on anticipated losses taking into account the circumstances of the particular project. It is not necessary to be exact, simply to demonstrate that the estimate is genuine. Clearly, from an evidentiary perspective it is valuable to have evidence documenting such an effort. Conversely, large lump sums should be avoided unless they can be justified as a loss relating to the contract.
- Avoid tying the clause to events which do not clearly relate to the estimated loss. The usual trigger is a failure to meet the completion date. Other events can trigger the LD clause; however, the estimated loss should be rationally related to the event. For example, if the LD clause were triggered on delay as well as a failure to secure an environmental Certificate of Compliance or a rezoning permit, it would be difficult to reconcile a single LD amount which would cover all events. In such a case thought would have to be given to the estimated loss occasioned by each event and the LD clause structured accordingly.
- Do not require the payment of a larger sum in default of payment of a smaller sum. Courts consider this an obvious penalty.
- The amount of liquidated damages need not be one fixed sum if other approaches are more appropriate. For example, where the losses arising from breach are likely to increase, rather than remain fixed, the clause could include an accelerating amount. This would avoid a situation where a large daily amount is claimed right after breach but it is obvious that the actual loss is small (though likely to increase). The style of clause is limited only by the drafter’s imagination, so long as it is a genuine pre-estimate of losses and the amount determined bears some reasonable relation to the actual loss incurred.
- Avoid using a standard form clause for every contract without tailoring it to individual contracts.
Some contracts may set out an express statement that the parties acknowledge that the Clause is a genuine pre-estimate, using wording such as “Contractor and Owner agree that Owner's actual damages in the event of such delays and failures would be extremely difficult or impracticable to determine and that, after negotiation, Owner and Contractor have agreed that the Liquidated Damages are a reasonable estimate of the damages that Owner would incur as a result of such delays or failures and are not intended in any way to be a penalty.” Such wording would be of some assistance, but would still not obviate the Court’s power to look at the substance of the clause. This wording would not likely carry the day if there was in fact no attempt to pre-estimate loss in determining the LD amount.
A liquidated damages clause can have many forms and is usually tied to a general exclusion of all other liability. This aspect has to be carefully drafted as Courts will also closely scrutinize exclusion clauses. However, in the context of an LD clause negotiated between sophisticated commercial parties, restricting liability to liquidated damages makes inherent good sense. The parties arguably will base their contract price on such negotiated limitations and courts recognize that a failure to enforce the clause can result in an injustice to one or more of the parties.
In New Brunswick, the law has collapsed any distinction between liquidated damages and penalty clauses. Section 5 of the Law Reform Act builds a compromise between their complete unenforceability and their complete enforceability by providing that each will be enforceable to the extent that it is reasonable in all of the circumstances that the clause should be enforced. The use of the term "all of the circumstances" suggests that such circumstances might include those existing at the time the contract is made as well as those existing at the time of enforcement of the clause. This adds flexibility to the enforcement of a liquidated damages clause but the reasonableness requirement does not alter the considerations for drafting such clauses.
The key to an enforceable LD clause is good drafting and forethought in the context of the particular contract. If parties address their mind to what they wish to happen in the event of default or non-performance, the result will generally be acceptable to the courts. Courts are loath to interfere with freedom to contract and where the result is neither oppressive nor unconscionable there will be a preference to enforce a liquidated damages clause. This type of clause can greatly simplify the result of non-performance if properly drafted.
Construction Law Group Members:
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| Mick Ryan, Q.C. | 902.420.3316 | smss.com |
| David Miller, Q.C. | 902.420.3319 | smss.com |
| Jon Stobie, Q.C. | 902.420.3323 | smss.com |
| Will Moreira, Q.C. | 902.420.3329 | smss.com |
| Robert Grant, Q.C. | 902.420.3328 | smss.com |
| Art Barry, Q.C. | 902.420.3364 | smss.com |
| Geoff Machum, Q.C. | 902.420.3338 | smss.com |
| David Farrar | 902.420.3362 | smss.com |
| Rory Rogers | 902.420.3369 | smss.com |
| John MacDonell | 902.420.3393 | smss.com |
| Colin Piercey | 902.420.3345 | smss.com |
| David Henley | 902.420.3381 | smss.com |
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| Eugene Rossiter, Q.C. | 902.629.4502 | smss.com |
| Jim Gormley | 902.629.4513 | smss.com |
| Spencer Campbell | 902.629.4549 | smss.com |
| Geoff Connolly | 902.629.4515 | smss.com |
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| Ken McCullogh, Q.C. | 506.632.2781 | smss.com |
| Peter Klohn | 506.632.2788 | smss.com |
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| Neil McKelvey, O.C., Q.C. | 506.632.2770 | smss.com |
| Wayne Chapman, Q.C. | 506.632.2786 | smss.com |
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| Charles LeBlond, Q.C. | 506.853.1976 | smss.com |
| Robert Dysart | 506.383.2230 | smss.com |
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| Levi Clain, Q.C. | 506.853.1979 | smss.com |
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| Gordon Petrie, Q.C. | 506.443.0150 | smss.com |
| Hugh Cameron | 506.443.0120 | smss.com |
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| Michael Harrington, Q.C. | 709.570.8848 | smss.com |
| Geoff Brown | 709.570.8845 | smss.com |
| Bruce Grant | 709.570.8882 | smss.com |
| Colm Seviour | 709.570.8847 | smss.com |
| Ian Wallace | 709.570.8839 | smss.com |
| Maureen Ryan | 709.570.8880 | smss.com |
| Christine Healy | 709.570.8833 | smss.com |
| Stephen Penney | 709.570.8881 | smss.com |
| Janie Bussey | 709.570.8891 | smss.com |
| Gerry Fleming | 709.570.8836 | smss.com |
