(“Earthco”) recently rendered a decision on contracting party’s ability to contract out of a statutorily implied condition under Ontario’s Sale of Goods Act, providing important clarification on the extent to which an exclusion clause must be explicit in order to successfully oust the application a statutorily-implied term. Below, we review the decision and provide key takeaways with respect to the sale of goods and use of exclusion clauses, both of which are highly relevant for the construction industry.

Background

The City of Toronto (the “City”) hired Pine Valley Enterprises Inc. (“Pine Valley”) as the contractor for a flood remediation project, which included the removal and replacement of topsoil for drainage purposes. Pine Valley in turn subcontracted with Earthco Soil Mixtures Inc. (“Earthco”), to supply topsoil with a specified composition (which composition had been specified by the City’s consultant for the project, presumably under the prime contract).

Earthco – whose sales process normally involved a multi-stage testing process prior to contract execution – provided Pine Valley with laboratory reports from different topsoil samples taken roughly six weeks before Pine Valley’s initial solicitation, but specifically warned Pine Valley against purchasing the topsoil without Earthco having the opportunity to conduct its usual testing process. Despite this warning, Pine Valley was seeking delivery of topsoil on an urgent basis, as it had already missed certain project milestones and was looking to avoid the application of liquidated damages by the City under the prime contract. Pine Valley therefore insisted on immediate delivery of the topsoil, rather than waiting for updated test results (in other words, the parties entered into a sale by description).

As a result, the parties agreed to add two clauses to their subcontract, which stated that Pine Valley had the right to test and approve the material before it was shipped, and that if it waived those rights, Earthco would not be responsible for the quality of the material once it left its facility (the “Exclusion Clauses”):

 6) [Pine Valley] has the right to test and approve the material at its own expense at our facility before it is shipped and placed. Please contact [Earthco’s sales manager] to arrange.

7) If [Pine Valley] waives its right to test and approve the material before it is shipped, Earthco Soils Inc. will not be responsible for the quality of the material once it leaves our facility.

After the topsoil was delivered and placed on the project site, water ponding occurred over the topsoil in question. Subsequent testing by Pine Valley revealed that there was substantially more clay in the topsoil than the initial test results had indicated. As a result, Pine Valley had to remove and replace the topsoil supplied by Earthco. The City subsequently levied liquidated damages against Pine Valley; Pine Valley consequently sued Earthco for damages, alleging that it did not receive topsoil consistent with the initial test results.

Decisions of the Courts Below

At trial, the key issue was whether the Exclusion Clauses were sufficiently clear and explicit to oust the implied term established by s. 14 of the Sale of Goods Act, which stipulates that where there is a contract for the sale of goods by description, then there is an implied condition that the goods will correspond with the description.

The trial judge dismissed Pine Valley’s action. He found that although Pine Valley did not get the topsoil for which it had contracted (because of the discrepancy between the topsoil that was promised and the topsoil that was delivered), the Exclusion Clauses met the requirements of an “express agreement” according to section 53 of the Sale of Goods Act, which allows parties to contract out of the implied condition under section 14. Importantly, the trial judge reached this conclusion despite the fact that the Exclusion Clauses did not explicitly mention that they were added to the contract for the purpose of contracting out of section 14 of the Sale of Goods Act; in that regard, the trial judge found that Pine Valley was an experienced purchaser of soils, such that Pine Valley’s waiver of testing meant it deliberately assumed the risk that the soil would not meet the required specifications.

On appeal, the Court of Appeal disagreed with the trial judge, and instead found that the Exclusion Clauses were not sufficiently clear to exempt Earthco from liability under section 14. In particular, the Court of Appeal identified three errors of law:

  • first, in interpreting the exclusion clauses, the trial judge failed to take into account the nature of the implied condition in s. 14, which relates to the identity of the goods rather than their quality;
  • second, the trial judge failed to properly interpret the meaning of the requirement that “explicit, clear and direct language” must be used to exclude a statutory condition; as a result, he did not give proper effect to the Exclusion Clauses’ failure to refer to the identity of the goods or to statutory conditions; and
  • third, the trial judge erred by reading the language of the Exclusion Clauses in broader terms than their actual words and, in doing so, considered the contract’s factual matrix (also known as the surrounding circumstances) beyond its permissible use.

The Court of Appeal therefore allowed the appeal. Earthco then sought and was granted leave to appeal to the Supreme Court of Canada.

The Supreme Court’s Decision

The Supreme Court rendered two judgments, with a 6-judge majority allowing the appeal and finding that the Exclusion Clauses were sufficient to oust the application of s. 14 of the Sale of Goods Act, with Côté J. writing in dissent that the Exclusion Clauses did not oust the implied term of that statutory provision.

Writing for the majority, Martin J first observed with respect to the standard of review. that the Court of Appeal was incorrect in identify the foregoing as either errors, or errors of law in particular. In doing so, the Court of Appeal sought to create general principles of law that would govern the interpretation of all exclusion clauses ousting implied conditions in a contract of sale, while also diminishing the role of the factual matrix in giving meaning to exclusion clauses (contrary to the fundamental principles of contractual interpretation set out in Sattva).

With respect to the Sale of Goods Act, the majority identified three key aspects of that legislation: fitness for purpose, merchantability, and correspondence with description, all of which address the negative effects of caveat emptor. The legislation implies these statutory protections as contractual conditions rather than warranties, which in turn gives an innocent party (in circumstances of a breach of condition) the option to either (1) treat the contract as repudiated, or (2) treat the breach of the condition as a breach of warranty and claim damages.

With respect to the condition at issue in this case – the implied condition that the goods sold by description will correspond with their description – the “description” is tied to identity and only protects those terms which identify the subject matter of the sale. In that regard, Canadian law distinguishes between traits that go to the identity of the goods (which pertains to their description), and those which go to the quality of the goods (which pertains to merchantability and fitness for purpose). The identity of a good should not be conflated with all the words used as descriptors, and instead is limited to “words whose purpose is to state or identify an essential part of the description of the goods”. In other words, quality is a matter of degree, while identity is a matter of kind.

That being said, the majority observed that the Sale of Goods Act is equally clear (at s. 53) that parties are able to contract out of these implied conditions, so long as those parties do so by “express agreement”, conduct, or usage (i.e. commercial custom). Given the nature of the Sale of Goods Act, the majority observed that it was necessary to review s. 53 of the Act alongside the relevant common law on contracts in order to determine whether an “express agreement” was reached in this case.

In that regard, the majority concluded that there were no special interpretive considerations that applied by virtue of the Sale of Goods Act applying, and rejected the proposition that Earthco needed to have explicitly excluded liability for conditions as to the identity of the soil. Furthermore, the term “express” does not refer to what the agreement must say, or to the required level of clarity of specific contractual clauses. Section 53 refers to an “express agreement”, and not the use of “express language ”, as a result of which it does not constitute a qualitative requirement about the specificity of language. Rather, the majority concluded that it will be “express” if it is made in distinct and explicit terms and not left to inference.

Instead, determining what qualifies as an “express agreement” is informed by the basic principles of contractual interpretation, such as those set out in Sattva and the law concerning exclusion clauses, as set out in Tercon, with the paramount consideration being the ascertaining of the parties’ objective intentions. This was particular true in circumstances where s. 57(1) of the Sale of Goods Act explicitly stipulates that common law rules continue to apply to the sale of goods, except in so far as those rules are inconsistent with the express provisions of the Sale of Goods Act.

To that end, the majority observed that although the law recognizes a difference between quality of goods and their identity, courts should not impose an unrealistic burden on contracting parties to be aware of, and fully understand, the legal characterization and consequences of the words they use to express themselves, although in some circumstances, sophisticated parties negotiating through lawyers may know all about the legal difference between conditions and warranties.

Therefore, in the particular context of this case, the majority concluded that although the Exclusion Clauses only explicitly referred to Pine Valley assuming responsibility for the quality of the soil, the surrounding circumstances of the parties’ agreement – including the fact that Pine Valley was an experienced commercial buyer of soil, and that the parties made bespoke edits to the contract without the input of legal professionals. As a result, the Exclusion Clauses applied in this case, and Earthco was not liable to Pine Valley for the incompetent topsoil.

In dissent, Côté J differed from the majority in concluding that the Exclusion Clauses were not sufficiently clear and unambiguous to exclude liability with respect to the identity of the goods. In that regard, the dissent the word “quality” in the Exclusion Clauses could not be taken to include both quality and identity, as this would change the word from its ordinary and grammatical meaning.

In addition, with respect to the meaning of the term “express agreement”, the dissent placed greater emphasis on the statutory interpretation of the term (as opposed to the majority’s focus on contractual interpretation), observing that the dominant approach to  statutory interpretation is to interpret words in their entire context and in their grammatical and ordinary sense harmoniously with the scheme of the applicable Act, the object of the Act, and the intention of the legislature. In circumstances where the words of a provision are “precise and unequivocal”, the ordinary meaning of the words plays a dominant role in the interpretive process. Accordingly, and although not explicitly stated, the dissent appears to have placed greater emphasis on plain and ordinary meaning of the relevant words than the majority. On that basis, the dissent would have dismissed the appeal.

Analysis

Earthco is necessary reading for those practicing in the construction industry, given the extent to which the sale of goods makes up a critical component of all construction projects. Needless to say, it is therefore highly relevant.

On the one hand, the result in Earthco is to some extent unsurprising as an issue of contractual interpretation, in the sense that the majority reaffirmed the primacy of Sattva and its subsequent case law. In that regard, the Court was consistent with other recent cases in which it was asked to consider the applicable rules of interpretation in specific contexts, such as its review of the law on releases in Corner Brook (City) v. Bailey. Accordingly, Earthco simply follows suit in that sense.

On the other hand, however, this conclusion also understates the extent to which the majority and dissenting decisions offer several interesting points to consider.

First, Earthco offers an intriguing example of the difficulties in determining the appropriate balance between contractual interpretation and statutory interpretation, where the contract in question is governed by a specific piece of legislation. This was particular true in the sale of goods context since, as both the majority and dissent observed, the Sale of Goods Act specifically incorporates the common law of contracts by reference. As noted above, the majority and dissent appeared to differ as to which of the two modes of interpretation should take primacy over the other in interpreting s. 14 of the Sale of Goods Act, with the majority prioritizing contractual interpretation and the dissent prioritizing statutory interpretation.

Second, the particulars of Earthco appear to have made it especially challenging to draw a clear distinction between the identity of the goods and their quality, given that the goods (i.e. the topsoil) were required to be composed of a specific collection of soils. In circumstances where goods are a composite of several different components, it is arguably unclear from Earthco whether there is any bright-line rule or guidance as to when a discrepancy between the goods as described versus the goods received will go to the very essence of the goods and rise to the level of incorrect identity. As always, best practice will be to articulate this point clearly in the terms of the relevant contract, but for borderline cases, it appears that it may remain a challenge.

Finally, with respect to the majority’s interpretation of the term “quality” as it appears in s. 14 of the Sale of Goods Act, this may also present a challenge insofar as there may be some circumstances in which it is unclear on the facts of a given case whether the contracting parties are referring to “quality” in the broad and general sense (i.e. potentially inclusive of identity), or whether they are using the term in the technical sense contemplated by the legislation (i.e. distinct from identity). It is plausible that parties without legal counsel might have the technical definition in mind when negotiation a contract for the sale of goods, just as it is plausible that parties with legal counsel advising them on the negotiation of such a contract might not appreciate the technical definition – through inadvertence or otherwise – and have in their contemplation the more expansive, general concept of “quality”. As the majority explained, it will depend upon the surrounding circumstances of each case.

Ultimately, parties in the construction industry will need to be especially mindful of the Sale of Goods Act, and particularly the distinction between quality and identity, when negotiating contracts for the sale of goods (along with any exclusionary clauses contained within such contracts). Because the interpretation of these issues turns so heavily upon the surrounding circumstances at the time of contract formation, parties will be well advised to ensure that the surrounding circumstances weigh in their favour.

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