Introduction
Since the beginning of the COVID-19 pandemic, a lot of virtual ink has been spilt over the notion of force majeure, whether contractually defined, or as it is defined in the Civil Code of Quebec. Indeed, given the magnitude of the consequences created by the pandemic, many are asking themselves whether the concept of force majeure could be invoked in order to release them from contractual obligations. However, as many analysts have cautioned in the past few days, the answer will not always be yes. Context will often play a crucial role.
Whether force majeure applies or not, the pandemic has brought about an unprecedented upheaval which can directly impact the commercial equilibrium that persons or companies of every sphere meant to create in a now bygone era, when the idea of a pandemic of this scale was the stuff of science fiction.
Many contracts concluded mere weeks ago no longer hold the same value and no longer carry the same consequences today. Even where it is still possible to fulfill contractual obligations and where the criteria for force majeure are not met, contracts may now have become encumbrances which no longer make economic sense for one of the parties.
This situation in which a contract has become detrimental to a party without leading to a situation of force majeure[1] brings us to reflect on another legal theory having made recent headlines in Quebec, that of unforeseeability. This theory, which is codified in several European countries of the civilist legal tradition, provides for the renegotiation of a contract or the modification of contractual obligations where an external event upsets the balance of the contract and where certain other conditions are met.
The Quebec legislator did not adopt the notion of unforeseeability in our Civil Code. However, art. 1375 C.c.Q. states that parties must conduct themselves in good faith at every step of their obligations.
The relationship between the duty of good faith which holds such importance in Quebec law and the theory of unforeseeability was analyzed by the Supreme Court in Churchill Falls (Labrador) Corporation Ltd. v. Hydro-Québec, rendered in 2018.
On the one hand, the highest court confirmed that the theory of unforeseeability does not apply in Quebec civil law and that the obligation of good faith cannot serve as panacea to a party which considers itself disadvantaged by the contract it concluded. On the other hand, the duty of good faith imposes rules of conduct on the contracting parties and the Supreme Court of Canada did not rule out that in a situation of unforeseeability, the conduct of a party could be considered inappropriate and lead to sanctions.
The current crisis has provided an occasion to revisit these concepts, to discuss the judgements rendered in Churchill Falls and to reflect on the consequences of the duty of good faith as we face the pandemic together.
The lessons of Churchill Falls on the Doctrine of Unforeseeability and the Duty of Good Faith
The Facts and the Position of Churchill Falls
The Churchill Falls saga stemmed from a contract concluded in 1969 between Hydro-Québec and Churchill Falls (Labrador) Corporations Limited ("CFLCo") for the construction and operation of a hydroelectric plant on the Churchill River in Labrador.
The contract provided Hydro-Québec with the right to purchase electricity from this plant at fixed prices. Changes in the electricity market made it so that the purchase price for electricity set in the contract was well below market prices. As a result, Hydro-Québec was able to sell electricity to third parties at a high mark-up and reap substantial profits.
CFLCo seized the courts of the matter and argued that the change in the price for electricity was a new and unforeseen reality which granted Hydro-Québec profits that were disproportionate with those of CFLCO. CFLCo submitted that this disproportionate division of profit was incompatible with the interdependent relationship of the parties and was divorced from the original division of risks and benefits.
Among several other arguments, CFLCo pleaded that in the circumstances, Hydro-Québec's obligation to act in good faith, to cooperate and to exercise its contractual rights reasonably required the renegotiation and modification of the contract to provide for payment of a more equitable price.
The Superior Court dismissed CFLCo's action and the Court of Appeal and the Supreme Court dismissed CFLCo's appeals.
CFLCo's request for a renegotiation and modification of the price of electricity echoed the theory of unforeseeability recognized in certain jurisdictions. An event that CFLCo considered unforeseeable, i.e. the drastic change in market prices, led to a contractual imbalance which, according to CFLCo, should have led to a renegotiation or adaptation of the contract. The Court of Appeal and the Supreme Court rejected this argument. Nonetheless, the two courts provided useful comments regarding the role of the duty of good faith where a contractual relationship is affected by an unforeseeable event.
Analysis of the Quebec Court of Appeal
To present the theory of unforeseeability (hardship), the Court of Appeal referred to the Unidroit definitions of hardship and its effects. The Unidroit Principles of International Commercial Contracts are a set of rules published by the International Institute for the Unification of Private which aim to unify or harmonise contract law.[2] The Unidroit definition of "hardship" refers to an occurrence of events that fundamentally alters the equilibrium of a contract:
ARTICLE 6.2.2 (DEFINITION OF HARDSHIP)
There is hardship where the occurrence of events fundamentally alters the equilibrium of the contract either because the cost of a party's performance has increased or because the value of the performance a party receives has diminished, and
- the events occur or become known to the disadvantaged party after the conclusion of the contract;
- the events could not reasonably have been taken into account by the disadvantaged party at the time of the conclusion of the contract;
- the events are beyond the control of the disadvantaged party; and
- the risk of the events was not assumed by the disadvantaged party.[3] (our emphasis)
The effects of hardship include a request for negotiation by the affected party and, eventually, court orders for the termination of the contract or for adapting the contract with a view to restore equilibrium:
ARTICLE 6.2.3 (EFFECTS OF HARDSHIP)
- In case of hardship the disadvantaged party is entitled to request renegotiations. The request shall be made without undue delay and shall indicate the grounds on which it is based.
- The request for renegotiation does not in itself entitle the disadvantaged party to withhold performance.
- Upon failure to reach agreement within a reasonable time either party may resort to the court.
-
If the court finds hardship it may, if reasonable,
- terminate the contract at a date and on terms to be fixed; or
- adapt the contract with a view to restoring its equilibrium.[4] (our emphasis)
The Court of Appeal concluded that the doctrine of unforeseeability applies where, for a party, "the cost of performance rises but the consideration received remains the same or, the cost of performance remains unchanged but the consideration received is of lesser value".[5] In the case of CFLCo's contract, the Court of Appeal held that the conditions of unforeseeability were not met. Indeed, the Court of Appeal noted that though the appellant CFLCo did not share in a more significant gain, it continued to profit from the 1969 power contract. The Court of Appeal also noted that the appellant's solvency was not at risk.
The Court of Appeal declared that in any case, the doctrine of unforeseeability is not recognised in Quebec law and in fact was purposefully left out of the 1991 reform of the Quebec Civil Code.[6] Nonetheless, the Court of Appeal recognized that in true cases of hardship, for example where the financial health and survival of a contracting party are in jeopardy, an opposing party refusing to exhibit some reasonable flexibility regarding the other's obligations could be found to be acting in bad faith:
[155] All of the foregoing presupposes as a common denominator, a serious unforeseen problem in one form or another during the performance of a contract. Probably, amongst those situations are examples of real cases of hardship as articulated in the UNIDROIT Principles where the financial health and survival of a contracting party is in jeopardy. In such circumstances, a party who is refused forbearance, a diminishing of its obligations, a re-ordering of the contract or such other concession objectively reasonable and unharmful to the other party, could plead before a court that its cocontractant is not acting in good faith; it is acting irrationally and inexplicably or in a word, unreasonably. Such a failure to act in good faith and abuse in the exercise of a contractual right are notionally related and perhaps in certain cases, identical. In such vein, the response set forth at the end of paragraph [127] above, remains applicable.[7] (our emphasis)
The Court of Appeal concluded that CFLCo was not in a situation of serious difficulty and that Hydro-Québec did not act in bad faith. In the absence of hardship, the notion of good faith is of no help to the affected party.
Analysis of the Supreme Court of Canada
CFLCo's appeal of the decision of the Quebec Court of Appel to the Supreme Court of Canada was dismissed by the majority of the Supreme Court, with justice Rowe issuing a lone dissent.
The Supreme Court firmly concluded that Quebec civil law does not recognize the general doctrine of unforeseeability.[8] The Court added that any development of concepts analogous to unforeseeability in Quebec civil law must take account of the legislature's choice not to turn this doctrine into a universal rule.[9] In addition, in discussing the theory of unforeseeability, the Supreme Court noted that even in jurisdictions where the theory of unforeseeability is accepted, it applies only where the performance of the contract becomes "excessively onerous", referring to a requirement of "true financial peril".[10]
The Supreme Court recognises that in Quebec civil law, the duty of good faith allows courts to intervene in contractual situations to ensure that parties to a contract execute it in a loyal and equitable manner.
However, the Supreme Court made the following qualifying remarks, which indicate that the duty of good faith does not comprise an overarching duty to introduce major modifications to the contract:
[110] Therefore, if a protection analogous to that of the doctrine of unforeseeability can emerge in this case, it is limited to what is authorized by good faith. On this point, I agree with the Court of Appeal: it cannot be argued that a party to a contract who refuses to make major changes to the contract where there is no "hardship" within the meaning of the Unidroit Principles, or where no objectively reasonable solution is available to that party, is by refusing to do so breaching the general duty to exercise his or her rights in good faith. The unforeseen change in circumstances and the disadvantage suffered by the contracting party who requests that the contract be renegotiated do not in themselves justify a court in requiring the requested renegotiation. The concept of good faith has its own boundaries and its own logic, and its scope cannot be expanded to include the possibility of penalizing a party whose conduct has not been unreasonable, or a duty to renegotiate the principal obligations of a contract in all circumstances.[11] (our emphasis)
Starting at paragraph 113, the Supreme Court nonetheless opens a door. The duty of good faith can indeed play a role where a situation of hardship occurs. That said, "good faith is a standard associated with the parties' conduct"[12] and, more than the presence or absence of hardship, the analysis will center on the conduct of the contracting party who benefits from the change in circumstances:
[113] But because good faith is a standard associated with the parties' conduct, it cannot be used to impose obligations that are completely unrelated to their conduct. What constitutes unreasonable conduct contrary to the duty of good faith must be determined on a case‑by‑case basis. For example, in a situation of "hardship" that corresponds to the description of that concept set out in the Unidroit Principles, the conduct of the contracting party who benefits from the change in circumstances cannot be disregarded and must be assessed.[13] (our emphasis)
As to the conduct of the party who benefits, the Supreme Court mentions the existence of a duty of cooperation and collaboration flowing from the duty of good faith, which imposes on the parties a "positive" obligation to accommodate the interests and legitimate expectations of one another. The Supreme Court notes, nonetheless, that this duty would not, as general rule, require a party to renegotiate the contract or share profits:
[116] That being said, a review of the case law shows that this duty to cooperate has only quite rarely led a court to find that an obligation to amend a contract applied, and that no court has yet found that an obligation to redistribute profits earned under a contract did. Although CFLCo can argue that for a party to consider only the words of the contract without taking the other party's situation into account can become wrongful conduct, it is wrong to rely on this to argue that a refusal to renegotiate a contract or share profits is contrary to the general duty of good faith. One does not necessarily entail the other.[14] (our emphasis)
Thus, the Supreme Court, similarly to the Court of Appeal, does not accept unforeseeability into Quebec law, at least as a basis for requiring the renegotiation of a contact. The Court does not, however, exclude the possibility that in a situation of hardship, a party could breach its duty of good faith by adhering to the express terms of a contract in an unreasonable manner:
[118] Thus, the duty of good faith does not negate a party's right to rely on the words of the contract unless insistence on that right is unreasonable in the circumstances. The examples given by authors involve situations in which, exceptionally, such a stance would threaten the contractual relationship or the harmony of the contract without regard for the contracting partner's legitimate expectations; those in which it would allow one party to derive an unwarranted advantage from his or her situation — [translation] "[b]ut this fault presupposes conduct that truly deviates from that of an honest, prudent contracting party"; and, finally, those in which the party who insists on adhering to the words of the contract is inflexible or is gratuitously impatient or intransigent: […][15]
The Supreme Court, like the Court of Appeal considered that CFLCo's situation could not be likened to a hardship. In its comments, the Supreme Court certainly did not admit the existence of a duty to renegotiate in a case of unforeseeability. The Court did however make it clear that the duty of good faith required a reasonable conduct from the parties.
Unforeseeability, Good Faith and COVID-19
The pandemic will doubtlessly create contractual imbalances that will meet the definition of unforeseeability and create real financial peril. Since the beginning of the crisis, the notion of hardship has already been the object of countless articles and analysis in legal systems where it fully applies.
The reality is different in Québec. In the absence of specific contractual clauses, the Supreme Court judgment in Churchill Falls reminds us that in Quebec law this unfortunate situation will not, on its own, give rise to a systematic duty to renegotiate the contract or to re-allot the financial risks and benefits.
That being said, in a crisis period like the one with which we are faced, the guidance of the Supreme Court regarding the conduct adopted by the parties holds undeniable importance. A party that behaves in an inflexible and unreasonable manner despite the misfortune of its co-contractor could breach its duty of good faith.
The consequences of such a breach remain to be determined and specified according to the facts. It remains to be seen whether the pandemic will lead the courts to take advantage of the (small) opening left open by the Supreme Court of Canada and order accommodations or objectively reasonable concessions in favour of an affected party, or perhaps even, in exceptional cases, order the renegotiation of certain elements of the contract. Current times call for cooperation, not intransigence.
The authors thank Émile Chamberland for his excellent assistance in the drafting of this bulletin.
[1] See art. 1470 CCQ
[2] International Institute for the Unification of Private Law (UNIDROIT), Unidroit Principles of International Commercial Contracts, Rome, 2016 [Unidroit Principles], Online: <https://www.unidroit.org/instruments/commercial-contracts/unidroit-principles-2016>, at pp. xxviii-xxx.
[3] International Institute for the Unification of Private Law (UNIDROIT), Unidroit Principles of International Commercial Contracts, 2016, prec., note 1, art. 6.2.2.
[4] Id., art. 6.2.3.
[5] Churchill Falls (Labrador) Corporation Ltd. v. Hydro-Québec, 2016 QCCA 1229, at para. 152.
[6] 2016 QCCA 1229, at paras. 105 et 107.
[7] Id., at para 155.
[8] Churchill Falls (Labrador) Corp. v. Hydro-Québec, 2018 SCC 46 at para 93.
[9] Id., at para 105.
[10] Id., at para. 91
[11] 2018 SCC 46, at para 110.
[12] Id., at para 113.
[13] Ibid.
[14] 2018 SCC 46, at para 116.
[15] Id., at para 118.
