Litigation and Dispute Resolution Bulletin
Exclusion clauses—provisions which generally excuse a party from legal responsibility under a contract—are just like any other contractual term: they must be interpreted according to the ordinary meaning of the words used by the parties read in light of the factual matrix known to each party at the time they entered into a contract. This was one of the main messages from one of the Supreme Court of Canada's more significant private law cases in 2024: Earthco Soil Mixtures Inc. v. Pine Valley Enterprises Inc., 2024 SCC 20.
Background
Earthco is about a compelling subject matter: topsoil. The buyer had a municipal contract to remediate flooding that required it to replace topsoil for drainage purposes. The buyer contacted a seller to obtain topsoil for particular specifications. The seller provided test reports but warned against buying topsoil without contemporaneous laboratory reports. Given time constraints faced by the buyer, it waived its right to test the soil and insisted on immediate delivery. The buyer and seller agreed to add two exclusion clauses to the standard purchase order, which stated that the buyer had the right to test and approve the material before it was shipped, and that if the buyer waived those rights, the seller would not be responsible for the quality of the material once it left its facility (the "Exclusion Clauses").
After delivery of the topsoil, the buyer noted water pooling. Testing confirmed that there was too much clay in the soil. The buyer had to remove and replace the topsoil because it would not drain properly. The buyer sued the seller for damages on the basis that it received topsoil that was not in the range of specifications.
Trial Decision
The trial judge rejected the claim. The judge found that the contract was a sale of goods within the meaning of the Ontario Sale of Goods Act (the "SGA"). Section 14 of that legislation sets out an implied condition that goods must correspond with their description. The judge found that this condition was not satisfied: the topsoil that was delivered did not drain as described. However, the judge also found the Exclusion Clauses constituted an express agreement to contract out of the implied condition under s. 14 of the SGA. This is permitted by s. 53 of the SGA, which states:
Where any right, duty or liability would arise under a contract of sale by implication of law, it may be negatived or varied by express agreement or by the course of dealing between the parties, or by usage, if the usage is such as to bind both parties to the contract.
The Exclusion Clauses in this case did not explicitly mention that they were to oust statutorily implied terms and conditions. Nonetheless, the Judge found they were binding and dismissed the claim. The buyer appealed.
Ontario Court of Appeal Decision
The Ontario Court of Appeal ("ONCA") allowed the appeal and ordered the seller to pay damages. The Court held the judge made three extricable errors of law:
- failing to account for how the implied condition in s. 14 of the SGA relates to the goods' identity (or description) and not their quality;
- failing to properly interpret the requirement for explicit, clear and direct language to exclude a statutory condition in s. 14; and;
- considering the contract's factual matrix beyond its permissible use in interpreting the exclusion clauses.
It was the sellers' turn to appeal, this time to the Supreme Court of Canada (the "SCC").
Supreme Court of Canada Decision
The SCC agreed with the seller and the trial judge and overturned the ONCA's decision. The SCC decision covered two key subjects: the standard of review in contractual interpretation, and the construction of exclusion clauses dealing with statutory provisions.
The SCC took the opportunity in Earthco to chastise provincial appellate courts for too readily interfering with trial judge's interpretations of a contract. Put simply, appellate courts must take the deferential standard of review for contractual interpretation seriously. The SCC stated that the Court's jurisprudence "firmly" established that "questions of contractual interpretation, which involve questions of mixed fact and law, are ordinarily afforded deference on appellate review." The SCC found that the mere fact that the contractual interpretation in this case involved consideration of a statutory provision did not automatically mean that the appellate review must be on a correctness standard.
The bottom line here is that the ability to successfully appeal decisions about what a contract means will remain difficult because appellate courts are instructed to apply a deferential standard. Appellate courts should not look for opportunities to interfere by finding a reason to conduct a correctness standard.
The SCC then provided guidance on contractual interpretation, including how to interpret exclusion clauses. Its key findings included:
- "Technical and legalistic formulations and complex doctrines have been softened in favour of an interpretive approach that focuses on the objective intention of the parties, how the words used were reasonably understood by the parties, and how, subject to limits such as unconscionability, the parties sought to allocate contractual risk" (para. 61);
- The actual words chosen are central to the analysis because it is how the parties chose to capture and convey their contractual objectives. To determine their true intent, decision-makers "must read the contract as a whole, giving the words used their ordinary and grammatical meaning, consistent with the surrounding circumstances known to the parties at the time of formation of the contract" (para. 62);
- While "[t]he facts surrounding the formation of a contract are relevant to its interpretation"... they "must never be allowed to overwhelm the words of that agreement" or cause courts to create brand new agreements (para. 63);
- When seeking the meaning of a document, the focus of the court is properly on what the parties objectively intended and what they reasonably understood their words to mean. This is because the "meaning of words is a matter of dictionaries and grammars; the meaning of the document is what the parties using those words against the relevant background would reasonably have been understood to mean" (para. 64); and
- The meaning of the words used can largely depend on who the contracting parties are, their relationship to each other and their degree of contracting sophistication (para. 96).
The SCC confirmed these principles apply to exclusion clauses, even where the applicability of an exclusion clause is governed by a statute. Accordingly, it held that the ONCA erred in insisting on formulaic and technical language to meet the requirement under s. 53 of the SGA, rather than the intention of the parties as inferred from reading the text in its larger context. The SCC agreed with the trial judge that the general language used in the exclusion clauses exempted the seller from statutory liability under s. 14 of the SGA.
Earthco demonstrates the SCC's continued commitment to the idea that contractual interpretation is a highly factual and circumstantial exercise. Finding meaning in words on a page is thus a very human undertaking. This means the trial phase is the most important opportunity to determine meaning; appeals are generally difficult.
Earthco will be highly influential in the interpretation and drafting of exclusion clauses. Such clauses are essential to the contractual allocation of risks. They are a regular source of litigation for this reason. At a high level, the decision in Earthco will no doubt be relied on parties seeking to avoid other types of statutory rights and conditions that may be waived away by contract. Parties in light of Earthco may argue that general language, viewed in its context, will be good enough to avoid such statutory rights. One can expect even more contentious, fact-driven litigation about the breadth of exclusion clauses going forward.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.