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Tercon and Fundamental Breach – How a Construction Dispute Leads the Way for Licensing Contracts

Published: 05/04/2010

By Bernice Karn

In our last issue we summarized the “Tercon factors” that the Supreme Court of Canada recently approved for assessing whether or not a procurement document should be classified as a true request for proposals (“RFP”) or a call for tenders. We now want to revisit Tercon1 to discuss the critical finding in the case and what it may mean for intellectual property and technology licensing agreements in the future.

Tercon concerned the issuance by the Province of British Columbia of an RFP for a highway construction project. The RFP document called for the submission of proposals from a group of six contractors who had been prequalified through a prior RFEI (Request for Expression of Interest) process. The RFP document also contained an exclusion clause that purported to exclude liability of the Province to the proponents for “any claim for compensation of any kind whatsoever, as a result of participating in this RFP.

To those of us who negotiate licenses, exclusion clauses are old news, particularly in the technology field. Software and hardware vendors know that small “bugs” in products can sometimes have disastrous effects, much more expensive to fix than the value of the fees to be earned under the contract. Accordingly, in the information technology world, vendors regularly seek to allocate risk back to the customer for most of the damages that might be suffered as a result of a failure of the product. The primary device used to allocate risk is the exclusion or limitation of liability clause.

However, in the world of competitive bidding, exclusion clauses in the call for tenders or in the RFP documents is a recent phenomenon. In 1981, the Supreme Court of Canada created a new analytical paradigm for tendering contracts by creating the “Contract A/Contract B” analysis.2 “Contract A” is formed between an owner and a bidder when that bidder submits a compliant bid in response to a call for tenders. The winner of the tender call then is entitled to enter into “Contract B” with the owner for the performance of the actual work. So what is the significance of this framework and why was the issue of an exclusion clause important?

Canadian case law has held that owners issuing calls for tenders have various duties that arise upon the creation of Contract A, which is commonly known as the “bidding contract.” Among other things, these duties include the duty of fairness. In the Tercon case, the use of an exclusion clause was a relatively novel twist on this scenario because, if upheld, the Province of British Columbia could effectively circumvent any liability to proponents for breach of these duties arising under the bidding contract – that is, even if the Province breached Contract A, if the exclusion clause were enforceable, no remedy for damages would be available. Thus, the Supreme Court had a difficult choice to make – uphold the sanctity of the contracting process and hold the parties to the strict terms of Contract A (after all, the proponents read the RFP, presumably saw the exclusion clause and must have agreed to it or why else would they submit a bid?) or find a way to strike down the exclusion clause and hold the Province liable for damages flowing from a breach of Contract A (which occurred in this case because the majority of the Court agreed that the Province had accepted a non-compliant bid because the successful bidder was not one of the six pre-qualified entities).

Although, based on the facts of the case, the Court split on the result, there was unanimous agreement that the notion of “fundamental breach” of contract should not be part of Canadian law and that a new framework should be used when analyzing and enforcing exclusion clauses. Speaking for the Court on this point, Mr. Justice Binnie laid out a three part test that should be adopted, as follows:

  1. Does the exclusion clause even apply to the circumstances established in evidence? This will depend on the Court’s assessment of the intention of the parties as expressed in the contract.
     
  2. If the exclusion clause applies, was the exclusion clause unconscionable at the time the contract was made, “as might arise from situations of unequal bargaining power between the parties.”
     
  3. If the first two parts of the test are answered in the affirmative, should the Court nevertheless refuse to enforce the valid exclusion clause because of the existence of an overriding public policy, proof of which lies on the party seeking to avoid enforcement of the clause, that outweighs the very strong public interest in the enforcement of contracts?

How is this relevant to licensing?

Licensors and licensees can take away a few lessons to be learned from the Tercon case.

  1. Draft and read the limitation of liability language carefully and do not rely on “boilerplate.” If you are a licensor, does the wording really address the events and possible consequences that you want to exclude? If you are a licensee, what is the scope of the limitation and is there any room to manoeuvre within the language to argue that it does not apply to the damages that you are seeking to recover?
     
  2. When seeking to enforce (or avoid) a limitation of liability clause is there any argument that there was inequality of bargaining power so as to render the clause unconscionable? Bear in mind that Courts are loathe to find unconscionability when the negotiation takes place between two sophisticated parties, especially if advised by counsel.
     
  3. If the clause is applicable to the facts and is not unconscionable, could some public policy argument be made that it should not be enforced? Remember that there is a strong public policy bias in favour of upholding the sanctity of contract and it takes an extreme case of conduct to override that bias.

With this new framework now at our disposal, licensors and licensees may have new arguments to use when trying to enforce or avoid the effects of an exclusionary or limitation of liability clause in a contract. No matter which side of the negotiation fence you are on, Tercon should provide a clearer path forward for licensors and licensees alike.

[1] Tercon Contractors Ltd. v. British Columbia (Transportation and Highways), 2010 SCC 4.

[2] The Queen (Ont.) v. Ron Engineering, [1981] 1 S.C.R. 111.