Insurance & Reinsurance
The Court of Appeal has given its unequivocal support to the theory of essential obligation, which, in certain circumstances, can invalidate a limitation of liability clause.
If there is a point of law that continues to confuse practitioners and academics, it is the scope of limitation of liability clauses in Quebec civil law. In 6362222 Canada inc. c. Prelco inc. (2019 QCCA 1457), the Court of Appeal weighed in and ruled that the civil law must maintain its distinct approach.
The background is as follows: Prelco Inc. (“Prelco”), a company specializing in the transformation of glass, retained the services of 6362222 Canada Inc. (“Createch”). Createch is a company specializing in the implementation of business management systems, among other things, and was retained by Prelco to optimize the coordination of its factories. After assessment, Createch recommended implementing software to optimize coordination. Almost two (2) years after the start of the project, Prelco terminated the contract and asked another company to finish the work. It appears that the implementation of the system was fraught with challenges that led to errors in putting orders into production and delays in shipping products. Prelco ultimately claimed close to six (6) million dollars from Createch, including $4,279,114 in lost profits.
After a lengthy trial, the first instance judge found that both parties were partly responsible for the project’s failure. More specifically, the judge found that Createch incorrectly assessed Prelco’s needs and the appropriate method to integrate its operations. However, Createch invoked a limitation of liability clause that limited the damages to the value of fees paid, or, in the case of damages resulting from lost profits or revenue, completely exonerating it from the damages. The trial judge ordered Createch to pay Prelco $1,872,266, after allowing Createch’s claim for its unpaid fees and effecting compensation. At the same time, he categorically rejected the application of the limitation of liability clause because Createch had breached an essential obligation of its contract, rendering the clause inoperative.
Createch appealed the decision, submitting that the trial judge erred in rejecting the application of the limitation of liability clause for two reasons. First, the Supreme Court in Tercon (Tercon Contractors Ltd. v. British Columbia (Transportation and Highways),  1 SCR 69, 2010 SCC 4) rejected the theory of fundamental breach in common law, on which Createch claimed the theory of breach of an essential obligation is based. Second, even if the theory was applicable, the conditions of application were not met because Prelco had not been denied substantially all the contract’s benefit. The Court of Appeal dismissed both grounds.
First, the Court of Appeal confirmed that the basis of the theory of breach of an essential obligation differs from that of the theory of fundamental breach in common law. According to the judges of the Court of Appeal, the civil law theory is rooted in the case law and commentary rejecting exclusion of liability clauses concerning an essential obligation of the contract.
Second, the Court of Appeal also rejected the argument that the conditions of application were not met. The Court specified that the relevant criteria is not whether a party was denied substantially all the contract’s benefit, but rather whether the clause [translation] “[paralyzes] the essential obligation, the heart of the contract, [concerns] the essence of the contract and the obligations that the debtor agreed to in favour of the creditor, or [nullifies] a fundamental obligation of the contract.” In this case, the Court of Appeal found that the essential obligation of the contract between Createch and Prelco was to correctly identify Prelco’s needs and recommend the appropriate management software for the situation. The trial judge concluded that this obligation had not been fulfilled; the Court of Appeal found that there was no reviewable error and dismissed the appeal.
First, the Court of Appeal confirmed the independent and distinct nature of the theory of the essential obligation of the contract.
Second, the Court of Appeal emphasized the eminently factual and contextual nature of the determination of the essential and fundamental obligation of the contract. It did not, however, set out more detailed criteria to distinguish the essential obligation from accessory obligations. For the time being, the concepts of “essential obligation,” “heart” and “essence” of the contract remain the only guidelines for distinguishing the essential obligation from merely accessory obligations.
The theory of essential obligation is therefore confirmed, but the debate surrounding its application will require continued monitoring.
 [translation] “To set aside an exclusion of liability clause, it must paralyze the essential obligation, the heart of the contract, concern the essence of the contract and the obligations that the debtor agreed to in favour of the creditor, or nullify a fundamental obligation of the contract,” 6362222 Canada inc. c. Prelco inc., 2019 QCCA 1457 at paragraph 44.
 It should also be noted that Prelco brought a cross-application on the issue of the apportionment of liability and the quantum of damages. That cross-application was also dismissed.