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Liquidated Damages: Canadian Adoption, Divergence and the Necessity for Restatement

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Liquidated Damages: Canadian Adoption, Divergence and the Necessity for Restatement JOURNAL OF THE CANADIAN COLLEGE OF CONSTRUCTION LAWYERS 2017 Cited as (2017) l J.C.C.C.L. .:.·:~~-.-. ..... ~£()1: THOMSON REUTERS® ........•:::;~· Liquidated Damages: Canadian Adoption, Divergence and the Necessity for Restatement Jeff St. Aubin Rocco Sebastiano Editor's Note Jeff St. Aubin and Rocco Sebastiano have considered a complex set of issues relating to liquidated damages. In light notably of the recent United Kingdom Supreme Court decision in Cavendish Square Holding BV v. Talat El Malcdessi and of the necessity for a restatement of the law of liquidated damages in Canada, which they demonstrate in this learned text, they identify several of the difficulties inherent in such an en­ deavour and then provide some thoughtful suggestions as to how it could be accomplished in a coherent and useful manner. We are reminded of the origin of the penalty rule and of the tension between the penalty rule and the principle of freedom of contract. The authors also consider whether the penalty rule should be abandoned or replaced with the doctrine of unconscionability. Their analysis of Ca­ vendish then sets the stage for an affirmation of the need for Canadian courts to reassess their own approach to liquidated damages given the vast amount of legal discussion raised by that decision. From a Cana­ dian perspective, they identify the following issues for judicial con­ sideration and discuss each one in the fifth section of their text: I. whether the penalty rule should remain operative; 2. the role, if any, that unconscionability should play in the law of stipulated damages; 3. if the penalty rule is to remain operative, then: a. what is the appropriate time of assessment; b. to what extent, if any, should actual damages incurred be relevant; and c. should the Cavendish concept of a legitimate interest be adopted. Given the lack of clarity and the inconsistencies in the Canadian com­ mon law at the present time, this article, written for the Journal of the Canadian College of Construction Lawyers, will provide very useful guidance in the interpretation of construction agreements, which often 140 CCCL JOURNAL 2017 contain liquidated damage provisions, and well beyond to every legal practitioner wrestling with the issues considered here by the authors, to whom we are very grateful. 1. INTRODUCTION Stipulated damages1 are a ubiquitous element of Canadian construction contracts, where such provisions are primarily employed to establish the quantum of damages payable by the contractor in cases of delay, al­ though they are by no means so confined and their application is limited only by the ingenuity of the parties. Construction contracts are well suited to such provisions, as the ventures that they embody are often rife with risks, many of which are unknown at the time the bargain is struck. In addressing these risks, such provisions protect both owner and con­ tractor, by relieving the former from the burden of proof and providing the latter with certainty regarding potential liability. Many Canadian lawyers consider it axiomatic that a stipulated sum is enforceable as liquidated damages if it is a genuine pre-estimate of da­ mages and unenforceable if it is a penalty. The deceptive simplicity of this distinction has been recognized as a potential reason for the dearth of academic commentary on the subject.2 However, the dichotomy be­ tween these two measures has never been entirely clear, as recognized in Astley v. Weldon, 3 where Lord Eldon noted of the jurisprudence that he was "much embarrassed in ascertaining the principles upon which those cases were founded". 4 More than eighty years later Lord Jessel, Master of the Rolls, also recognized such difficulty in Wallis v. Smith,5 where his judgment commenced with the following: This appeal raises a question of very considerable difficulty, and one as to which it is not impossible that learned Judges may in future differ as Judges have differed in past times. 6 The law of stipulated damages has been further complicated as a result of a divergent line of Canadian case law that has incorporated the doctrine of unconscionability as part of the analysis. The resulting state This paper employs the neutral term "stipulated damages" to refer to contractual provisions establishing an amount payable upon breach, whereas the terms "liquidated damages" or "penalty" depend upon or imply a determination regarding enforceability. 2 Paul-Erik Vee!, "Penalty Clauses in Canadian Contract Law" (2008) 66 UTFac L Rev 229 at 231. 3 (1801), 2 Bos. & Pu!. 346. 4 Ibid. at 350. 5 (1882), L.R. 21 Ch. D. 243 (C.A.). 6 Ibid. at 254. Lindley L.J. also noted at 273 that "all the cases on this subject are cases of difficulty". LIQUIDATED DAMAGES 141 of the law has been aptly described "as two distinct yet muddled strands of case law". 7 The focus of this paper is on the necessity for a restatement of the law of stipulated damages in Canada and the recommendations for what such a restatement should include. To establish the foundation for this analysis, the initial sections of this paper address the equitable origin of the penalty rule and its development at common law, including the adoption of the traditional doctrine in Canada. From that point, the focus shifts to the divergence in Canadian law from the traditional doctrine and consideration of whether the current path of Canadian courts should be realigned with the traditional doctrine or developed further in­ dependently, which may include the abandonment of the penalty rule or its replacement with the doctrine of unconscionability. This paper includes a discussion of the United Kingdom Supreme Court decision in Cavendish Square Holding BV v. Talal El Makdessi, 8 where the Court recast the analysis in one of the most important decisions on the law of stipulated damages in the last century. The innovations of Cavendish are analyzed and considered for Canadian adoption in the final portion of this paper, which sets out the questions to be resolved by Canadian courts and a recommended path forward. 2. THE DEVELOPMENT OF THE LAW OF STIPULATED DAMAGES 2.1 Origin of the Penalty Rule The penalty rule is an equitable doctrine derived from the Courts of Chancery, which granted relief in relation to defeasible bonds that were otherwise enforceable at common law. These bonds were designed to require the performance of a particular act and achieved this by re­ quiring the payment of a stipulated sum at a certain time but included a condition that the sum did not need to be paid if the particular act was performed.9 Over ti1ne, the use of defeasible bonds ceased but the principles underlying the penalty rule remained, which prohibited the 7 Vee!, supra note 2 at 231. ' [2015) UKSC 67 [Cavendish]. heard with Parki111;Eye Limited v. Beavis [Parki11gEye]. 9 !hid. at para. 4; S.M. Waddams, Tlze La11· <!f' Danw1;es, loose-leaf (Aurora: Canada Law Book, 1991). Ch. 5 at 8.40-8.50; Harvey McGregor, McGre1;or 011 Danw1;es, 19th ed. (London: Sweet & Maxwell, 2014) at 15-003; Mike Demers, "Liquidated Damages and Penalty Clauses-The Road Ahead Post-Tercon" (2011) I J.C.C.C.L. 45 at 47. In Astley v. Weldon ( 180 I), 2 Bos. & Pu!. 346 at 354 Justice Chambre noted that "[t)hc jurisdiction of Courts of Equity in relieving on penalties is of very high antiquity··. 142 CCCL JOURNAL 2017 stipulation of an amount to be paid for the primary purpose of securing the performance of an obligation. This doctrine evolved to render un­ enforceable contractual provisions that required the payment of a sti­ pulated sum in the event of a breach of contract if such sum was penal. This equitable relief was foisted upon the common law courts by statute at the end of the 17th century, 10 but the common law courts developed the law related to stipulated damages with little reference to this statu­ tory basis. In Betts v. Burch, 11 Lord Bramwell held that the stipulated damages under consideration fell within statute but noted "[a]s to the authorities, it is remarkable that from the first to the last the statute is not mentioned". 12 In Lord Elphinstone v. Monk/and Iron and Coal Co., 13 Lord Halsbury recognized this anomaly, and Lord Bramwell's recogni­ tion of it, when he noted: the learned judges apparently decided that at law as distin­ guished from equity they were entitled to consider penalty as that which was to be enforced in terrorem, without having had called to their attention at all the fact that the Act 8 & 9 William 3, c. 11, existed. It was with reference to that that Lord Bramwell made the not unnatural observation that they had gone right, although they were not aware of the ground upon which at law their judgment could be supported. 14 The modern law of stipulated damages began to take form with the decision of Astley v. Weldon 15 and continued its development through­ out the course of the 19th century. 16 A detailed exposition of this jur­ isprudence is not necessary for our purposes and would arguably only be 10 Administration of Justice Act, 1696, 8 & 9 William 3, Ch. 11, s. 8; Administration of Justice Act, 1705, 4 & 5 Anne c. 16. 11 (1859), 4 H. & N. 506. 12 Ibid. at 510. 13 Supra note 3. 14 Ibid. at 348. The comments of Lord Bramwell referred to by Lord Hals bury were not from Betts v. Burch, supra note 11, but rather from In re Newman. Ex parte Capper (1876), 4 Ch. D. 724 at 734 [Newman], where Lord Bramwell noted that "by some good fortune the Courts have in the majority of cases gone right without knowing why they did so".
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