When the breach of a fundamental obligation does not invalidate a non-liability clause

A non-liability clause may remain valid even if the contracting party who invokes it breached a fundamental obligation of the contract – that is the key point to retain from the Supreme Court’s most recent judgment on the validity of non-liability clauses in 6362222 Canada inc. v. Prelco inc.

At the outset, we know that non-liability clauses are valid and moreover, they are quite common. It is through these clauses that the parties to a contract agree in advance to limit (limitation clause) or exclude (exoneration clause) the liability of a party, the debtor, when the debtor does not perform its obligation correctly. We also know that the effect of such clauses may be neutralized. In some contexts, the “doctrine of breach of a fundamental obligation” may circumvent the principle of autonomy of the will and render a non-liability clause inoperative.

In its most recent judgment on the issue, the highest court in the land reminds us that a party who wishes to invoke the “doctrine of breach of a fundamental obligation” to neutralize the effect of a non-liability clause must absolutely find support in one of the legal bases underlying that doctrine. Indeed, the general principles of the autonomy of the will and freedom of contract give considerable weight to the validity of non-liability clauses, which, in light of the provisions of the Civil Code of Québec (C.C.Q.), make them much more difficult to invalidate.

In this case, the consulting firm 6362222 Canada inc. (Createch) included a non-liability clause in the contract entered into with the manufacturing company Prelco inc., which makes and transforms flat glass. Under the contract, Createch was to supply software and professional services to Prelco in order to implement an integrated management system. The clause entitled [translation] “Limited Liability” provided that Createch’s liability to Prelco for damages that could be attributed to any cause whatsoever were limited to amounts paid to Createch. The clause also provided that Createch could not be held liable for any damages resulting from the loss of data, profits or revenue or from the use of products or for any other special, consequential or indirect damages.

When the management system was implemented, several problems arose. Prelco terminated its contractual relationship with Createch and then retained another firm to make the integrated management system functional. Prelco then brought an action for damages against Createch, claiming reimbursement of an overpayment, costs for restoring the system, the reimbursement of claims from customers, and loss of profits. Createch in turn filed a cross‑application for the unpaid balance for the project.

From the Superior Court to the Supreme Court, it was found that Createch had committed a fault in its initial choice as to the approach to take in implementing the management system and had as a result breached its fundamental obligation under the contract. The Superior Court and the Court of Appeal found that Createch could not rely on the non-liability clause to limit its liability for the injury it had caused to Prelco, because Createch had breached its fundamental obligation to properly identify and propose a management software and a development approach suited to Prelco’s situation such that the integrated management system would be fully operational.

The Supreme Court, in a judgment written by Chief Justice Wagner and Kasirer J., considered the bases of the doctrine of breach of a fundamental obligation, noting that the doctrine could render a non-liability clause inoperative in two situations: (1) where it violates a rule of public order that limits the contractual freedom of the parties; or (2) where it releases the debtor from all obligations to the creditor, thereby depriving the creditor’s correlative obligation of its objective cause and annulling the reciprocity of the contract.

Indeed, the admissibility of a non-liability clause may, first of all, be limited by public order. In consumer contracts and contracts of adhesion, for example, article 1437 C.C.Q. neutralizes the effect of abusive clauses that depart from the fundamental obligation of the contract to such an extent as to change the nature of the contract. Other provisions, in particular with respect to contracts of lease, sale, and employment, also limit the validity or effectiveness of non-liability clauses. Although contrary to the principle of the autonomy of the will, these limits seek to protect the contracting party who is presumed to be economically weaker or disadvantaged. In more general contracts entered into by mutual agreement, like the contract between Createch and Prelco, the contractual freedom to limit or exclude liability is nevertheless restricted by article 1474 C.C.Q. where there is gross or intentional fault, as well as in cases of bodily or moral injury.

The Supreme Court thus confirmed that, save for these express exceptions, public order does not have the effect of rendering a non-liability clause relating to a fundamental obligation inoperative. In contracts by mutual agreement, the parties are free to allocate the risks associated with contractual nonperformance between them, regardless of whether an obligation is fundamental or accessory. Here, Createch committed a simple fault, Prelco sustained material injury, and the contract was negotiated by mutual agreement between two sophisticated legal persons. Accordingly, for Prelco, public order is of no assistance.

Second, a non-liability clause may be invalidated if it has the effect of depriving the creditor’s obligation of its objective cause. This lies in the fact that, to be valid, the existence of an obligation arising out of a juridical act must necessarily be supported by an objective cause^[1] (article 1371 C.C.Q.). In synallagmatic contracts (where the parties have mutual undertakings), the objective cause of a party’s obligation is logically its co-contracting party’s correlative obligation. Thus, in the event that all of a party’s obligations are negated by the effect of a non-liability clause, for example, the other party’s correlative obligation would be deprived of its objective cause.

As the Court noted, no obligation clauses must however be distinguished from non-liability clauses. The latter do not by their nature have the effect of negating obligations, but rather the liability that flows from the nonperformance of obligations. In Prelco’s case, the non-liability clause limits the sanctions that may be imposed on Createch, but also permits Prelco to keep the integrated management system and to obtain damages for unsatisfactory services, as well as to be compensated for the necessary costs to have the work performed by another firm. Noting the existence of Createch’s remaining obligations, without having to rule on their equivalence, the Court found that Prelco’s obligation did indeed have an objective cause. In the Court’s view, pushing the analysis further would be akin to indirectly applying the concept of lesion, an application that the Code reserves for very specific cases such as minors and protected persons of full age. Once again justified by the principle of freedom of contract, the imbalance between the benefits derived by the contracting parties as a result of the non-liability clause does not amount to a lack of reciprocity in the contract.

Absent the application of one of the bases for the doctrine of breach of a fundamental obligation, Prelco’s argument could not stand, and it remained bound by the non-liability clause granted in favour of Createch.

This judgment highlights the utmost importance of ensuring that the contractual balance intended at the time of consenting to a non-liability clause is maintained. Once such a clause is included in the contract, Quebec civil law precisely defines the circumstances in which its effects may be annulled. In this case, the Supreme Court clearly indicated that the simple breach of a fundamental obligation is not one of those circumstances, so long as the clause is not contrary to public order and does not deprive the creditor’s obligation of its objective cause.

On this last point, however, there is a nuance that the Court did capture, but on which it avoided ruling:  are there circumstances where a non-liability clause relating to a fundamental obligation of the contract could have the effect of depriving the obligation of its objective cause? In other words, how would the Court have treated the non-liability clause if, instead of maintaining some of Createch’s obligations, it had rendered them trivial or insignificant such that they could be considered to be non-existent? As the Court declined to rule in the abstract, this issue remains open and could eventually resurface before the Court.

^[1] In paragraphs 72 and 73 of the judgment, the Supreme Court distinguishes the objective cause from the subjective cause of the obligation; the objective cause is the logical, impersonal and abstract reason that justifies a party’s acceptance of his or her obligations, while the subjective cause concerns a party’s reasons for entering into the contract.