What is the Doctrine of Fundamental Breach?
Let me illustrate by a simple example. Imagine you are purchasing a Ferrari from me. In the contract to purchase the Ferrari, I put in a clause saying you can’t sue me if there is anything wrong with the Ferrari. In other words, you sign a waiver agreeing that if there is something wrong with the Ferrari, you will have no legal recourse against me.
Now assume that I end up delivering a Hyundai instead of the Ferrari. Being outraged, you call me saying “Hey! Where is my Ferrari?”. I simply point to the clause saying that you waived your claim against me by signing the contract. See anything wrong with this picture?
The Doctrine of Fundamental Breach was put in place to combat these issues. The basic idea of the doctrine is that when there is a breach that is so fundamental to the operation of the contract, the waiver contained in the agreement should either be narrowly interpreted or be held entirely unenforceable. In our example, if you sue me for delivering you a Hyundai instead of a Ferrari, I can’t simply point to the waiver and say “tough luck, you should’ve read the contract!”. By delivering you a completely different vehicle, I triggered a fundamental breach of our contract, which bars me from relying on my waiver.
What’s Wrong with this Doctrine and Why we are Trying to Get Rid of it
The basic issue with the Doctrine of Fundamental Breach was that it created interpretive difficulties. Where do we draw the line as to where the breach actually constitutes “fundamental”? Let’s say I delivered you a Ferrari equipped with a Hyundai engine. Would that constitute a fundamental breach? The engine is responsible for driveability, acceleration, and top speed of a vehicle, which to some is the essence of a car. What if I deliver the Ferrari with Hyundai rims and tires? Aesthetically, this is detrimental. But is it “fundamental”? There are host of subjective issues that arise when we try to apply this doctrine in every case.
The Supreme Court of Canada has been trying to get rid of this doctrine for decades. In 2010 in Tercon v. British Columbia (Transportation and Highways) Justice Binnie emphatically laid to rest the Doctrine of Fundamental Breach and devised a three-step test to assess enforceability of waivers in contracts. The test asks the following:
- As a matter of interpretation, did the parties intend that the exclusion clause apply in the circumstances?
- Was the clause unconscionable at the time the contract was made?
- Is there an overriding public policy that would preclude its enforcement?
All three steps of the test need to be true for the waiver to be enforceable. This test puts emphasis on freedom of contract as it underlines the importance of the intention of the parties at the time of contract formation. The first question asks whether the waiver actually applies to the breach in question. In our example, if I include a clause in the contract saying that you can’t sue me if I sell you a Ferrari equipped with a Hyundai engine, then the waiver applies.
The second question relates to the circumstances in which the contract was entered into. Put simply “unconscionability” here relates to fairness. If there is, for example, an unequal bargaining power between the parties and the court finds that one party took advantage of the other in some way during the contract negotiations, then the exclusion clause contained in the contract is deemed unenforceable.
The third question considers public policy, which gives the court residual power to consider whether there are any public policy reasons why the waiver ought not to be enforced. To illustrate the rarity of meeting the requirement under this step, Justice Binnie in Tercon made the example of selling “toxic baby milk” to be consumed by a toddler. Even if the first two steps of the test are made out, it is difficult to make out a case that selling toxic baby milk for consumption would not offend public policy.
The Tercon Aftermath and Canadian Jurisprudence
After the Tercon decision, the jurisprudence on this subject has seen mixed results. Step two – unconscionability – has been the most uncertain aspect of the Tercon test as it pits freedom of contract and fairness against each other. The former has been the quintessential pillar in contract law as it promotes intention of the parties, while the latter is grounded in principles of equity and justice. For the Tercon framework to gain more traction in Canadian jurisprudence, a delicate balance must be struck between these two legal necessities. Perhaps the Supreme Court of Canada will revisit this issue in due time to minimize uncertainty in application of the Tercon test and pave the way for a more uniform application in the future – possibly when one of the Justices of the Supreme Court buys a Ferrari with a Hyundai engine!