Canada: Ontario Court Of Appeal Confirms Parties May Adjudicate Contract Disputes Through Application Despite Factual Questions

In a recent decision, Energy Fundamentals Group Inc. v. Veresen Inc. (Veresen), the Ontario Court of Appeal confirmed that, even where there are factual questions the court must resolve, a contract dispute may be adjudicated by way of an application rather than an action.

The Court of Appeal upheld the Superior Court of Justice's decision that there was an implied term in the agreement between an investment bank and a natural gas terminal operator for the operator to provide the bank sufficient information to determine whether to exercise its option to acquire part of the terminal.

An application can be litigated in months as opposed to years because there is no oral or documentary discovery but rather only limited cross-examination on affidavits and the proceeding concludes by way of an oral hearing before a judge with arguments by legal counsel rather than a full trial with live witness testimony.

The decision also shows the readiness of courts to follow the spirit of recent Supreme Court of Canada (SCC) precedents confirming that contracts between even arm's-length, sophisticated parties are to be interpreted on the principles of business efficacy and good faith.

BACKGROUND

Ontario investment bank Energy Fundamentals Group Inc. (EFG) introduced Veresen Inc. (Veresen), an Alberta energy and infrastructure firm, to a project for the development of a natural gas terminal on the coast of Oregon. The parties signed a non-binding letter agreement in April 2005 through which EFG provided Veresen investment banking services in exchange for a right to invest in the project if it was ultimately commissioned. The parties agreed EFG would have an option to acquire up to a 20-per-cent interest in the project. If EFG exercised the option, it would be required to pay a proportionate share of the equity contributed by Veresen, as well as a proportionate share of future project costs, amounting to several hundred million dollars in total.

As a result of the natural gas boom in the U.S., the project changed from construction of an import to an export terminal. Veresen took the position that this was a change so drastic that the original option no longer applied. Veresen also told EFG that the option was no longer profitable, but refused to provide EFG with documentation to verify the option price or its likely economic value.

EFG brought an application for a declaration that the option was still enforceable, and for a mandatory order requiring Veresen to provide EFG sufficient information to enable it to confirm Veresen's calculation of the option price and to reasonably determine the current value of the 20-per-cent option.

SUPERIOR COURT DECISION

Veresen argued that EFG chose not to bargain for a contractual right to disclosure even though it had done so in another context. Veresen submitted that the context here was not one of a vendor wooing a prospective buyer but of sophisticated parties negotiating compensation for investment services. Veresen argued that to order "reasonable disclosure" in an application would be improper as a trial may be necessary to define what must be disclosed and the scope of any confidentiality undertaking.

Justice M. A. Penny ruled in favour of EFG. Regarding the change in the project from an import to export terminal, Justice Penny found this did not change the "pith and substance" of the project as a natural gas terminal. Further, if the business of the project were restricted to importing based on the terms of the Limited Partnership Agreement (LPA) between Veresen and the developer (as Veresen had argued), then Veresen could not lawfully pursue an export business as it planned to do. Justice Penny also found that EFG was not paid for its work bringing this opportunity to Veresen but instead granted a right to invest in the project. To the extent the nature of the capital investment had grown (from C$1 billion to over C$5 billion), EFG would pay for that in its option contribution requirements — it would not be getting "a free ride".

Regarding implying a right to disclosure, Justice Penny found that the disclosure of information was necessary to enable EFT to make an informed choice whether to exercise the option given the size of the investment entailed by the option.

Regarding the scope of disclosure, Justice Penny held: "The scope of the required financial information should be the scope that would ordinarily apply in transactions of similar scope, size and nature. Similarly, there must be obligations of confidentiality placed upon EFG and any financial backer with which it seeks to share the information."

ONTARIO COURT OF APPEAL DECISION

Whether to imply a contract term is a question of mixed fact and law, to be overturned only for palpable and overriding error. The Ontario Court of Appeal upheld Justice Penny's decision as a "largely factual conclusion" based on his reasonable review of the evidence, which was therefore owed deference. The Court of Appeal pointed to a term in the LPA that contemplated reasonable disclosure of confidential information to prospective investors and explained that requiring EFG to exercise its option blindly would frustrate the business purpose of the letter agreement.

CONCLUSION

The successful litigation of this case as an application rather than an action confirms that contract disputes may still be adjudicated, with some speed, in applications on a limited evidentiary record not requiring a full trial.

Several SCC decisions last year had placed that in some doubt. In Bhasin v. Hrynew, the SCC recognized that a principle of good faith governs contract interpretation and in particular all parties have a (non-waivable) duty of honest performance of contracts. In Sattva Capital Corp. v. Creston Moly Corp., the SCC clarified that contract interpretation raises questions not of pure law but of mixed fact and law or sometimes merely questions of fact, requiring the court to apply the words of the written contract in light of its surrounding circumstances or factual matrix. Combined, the decisions raised the spectre of more contract disputes going to court in protracted litigation. Parties could allege facts based on a breach of good faith duty that could contradict the terms of a written agreement. Applications are not designed to resolve cases that turn on contested questions of material fact, as indicated by the application judge's power under Rule 38.10 to order that all or part of an application proceed to trial. Thus, there was the spectre that even well-written contracts with comprehensive terms defining parties' rights could be subject to protracted litigation due to factual disputes requiring resolution through an action ending in a trial.

While there will undoubtedly be cases in which the factual disputes are so prominent and determinative that a trial would be required, the Veresen case makes it clear that parties and their lawyers should consider carefully whether to litigate a contract dispute by application rather than action. The benefits in time, cost and discovery burden on the client could be significant.

The case also makes it clear that in long-term relationships between even sophisticated parties, the courts will expect them to perform their contracts in good faith. If they do not "fill in the gaps" of a contract themselves when new circumstances arise, the courts will.

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