An insurer’s right of subrogation is one of the cornerstones of a contract of insurance. Once the insurer has indemnified the insured, the right of subrogation allows the insurer to “step into the shoes of the insured” and claim against the relevant third party in order to recoup some or all of the indemnity payments made.
However, before proceeding with litigation that can be expensive, an important consideration is to determine the potential for recovery from the defendant. While the most obvious challenge could be an impecunious defendant, an often over-looked issue would be where an insured has negotiated a reduction in its rights.
Where an insured has contractually agreed to restrict or limit the extent to which a third party is liable to the insured, then the subrogating insurer is similarly bound by that limitation. Such clauses, known as “limitation of liability clauses” have become increasingly common in recent years and can be an unwelcome surprise to the subrogating party.
Limitation of Liability Clauses
Canadian courts have allowed parties to negotiate to limit liability for claims arising in either contract or tort through appropriately drafted exclusion or limitation of liability clauses.[i] A limitation of liability clause serves to limit the amount and types of compensation one party can recover from the other party. It caps or narrows the losses to be pursued by one party, and correspondingly reduces the risk to the other party.
These type of clauses are seen in professional service agreements to limit the exposure of, for example, home inspectors, engineers, accountants, etc. to the value of the fees paid for services rendered or to the value of set amounts of professional liability insurance. These types of clauses are also seen in supplier contracts for products to cover any latent defects. A limitation of liability clause may also restrict a party’s exposure to damages caused by negligent acts, or work to exclude liability for certain types of damages, such as consequential damages or business interruption losses.
For subrogating insurers, while investigating a file for its potential for recovery, it is essential to recognize such a contractual provision between the insured and any third party at the investigative stage. The first stage of inquiry would be to determine if the limitation of liability clause is drafted such that it will be enforced. If so, then it may be efficient to either forgo subrogation or focus efforts of recovery towards third parties that are not bound by such clauses.
However, in certain cases, as described in further detail below, courts may refuse to apply the limitation of liability clause. In many instances, it may be valuable to seek a legal opinion on the validity of such clauses. Where the facts are favourable, judicial intervention might also be sought to render such clauses unenforceable.
Enforceability of Limitation of Liability Clauses
Limitation of liability clauses have gained prominence since the 2010 decision of the Supreme Court of Canada in Tercon Contractors Ltd. v. British Columbia (Transportation and Highways) (“Tercon”)[ii], which established that limitation of liability or exclusion of liability clauses would be presumptively enforceable.
For a proper analysis to determine whether a limitation of liability clause would be enforceable, Justice Binne set out a three part test:
- As a matter of ordinary contractual interpretation, does the exclusion clause apply to the circumstances established in the evidence?
- If so, was the exclusion clause unconscionable at the time the contract was made?
The Supreme Court of Canada stated that unconscionability involves two elements: inequality in bargaining power and a resulting improvident bargain that unduly advantages the stronger party or unduly disadvantages the weaker party.[iii]
- If not, should the Court decline to enforce the clause because of an overriding policy concern?
Generally, where a party seeking to rely on an exclusion clause either knew it was putting the public in danger by providing a substandard product or service, or was reckless as to whether it was doing so, a limitation of liability clause is not enforced on grounds of public policy.
Enforcement of a Limitation of Liability Clause
As explored below, limitation of liability clauses have generally been enforced.
For example, where a security company is guilty of negligence in failing to report an alarm[iv] or is in breach of its contract in negligently failing to properly protect the plaintiff against burglary during a temporary installation[v], or a monitoring service neglected to report a burglary to the police[vi], courts have held a limitation of liability clause to be not unconscionable, and denied or reduced damages accordingly.
In the pre-Tercon case of Fraser Jewellers (1982) Ltd. v. Dominion Electric Protection Co. (Fraser),[vii] the security company failed to respond when it received a signal of ongoing burglary at the plaintiff’s jewellery store. The contract contained a clause limiting the defendant’s liability for any loss, damage or injury due to a failure of service or equipment. The trial judge refused to give effect to the exclusion clause in the contract, holding that the failure to respond promptly to the holdup alarm signal constituted a fundamental breach of the agreement and that the clause, in any event, was unconscionable. However, on appeal, this decision was overturned.
The Ontario Court of Appeal found that there was no fundamental breach of the contract. While the appeal judge agreed that there may have been unequal bargaining power, there was no abuse of bargaining power. It was held that in the absence of fraud or misrepresentation, a person is bound by an agreement to which he has put his signature whether he has read its contents or not. Further, the court stated that whether the breach was fundamental or not, an exclusionary clause of the kind should be enforced according to its true meaning. Relief should be granted only if the clause, seen in the light of the entire agreement, could be said to be unconscionable, or unfair or unreasonable.
Post-Tercon, fundamental breach is no longer a tool to avoid exclusion and limitation clauses. The court is instead required to use its discretion to interpret clauses in a manner that leads to a fair result. Courts can always decide to decline to enforce a limitation of liability clause if there is a compelling public policy rationale to do so.
In a commercial setting it is expected that a party who executes a document will exercise reasonable care before doing so, and parties who are careless enough to execute a document without reviewing it may do so at their peril. In Suhaag Jewellers Ltd. v The Alarm Factory Inc.,[viii] the facts were similar to those in Fraser. After a burglary took place at its jewellery store, the plaintiff sought damages from the alarm company. The contract between the parties included an exclusion clause that precluded the plaintiff from bringing the proceeding. The plaintiff claimed that he had not read or understood the terms of the contract. The court noted that the plaintiff had occasion to read the terms, and gave effect to the exclusion clause and concluded that it was not unconscionable.
A well drafted, unambiguous clause will generally be enforced. In Biancaniello v. DMCT LLP[ix], the Court of Appeal considered a broadly worded exclusion clause included in a release signed to settle litigation between the parties. The litigation arose due to unpaid fees by a client to the accounting firm. Some years after the release was signed, a claim unanticipated at the time the settlement agreement was signed came to light. The issue was whether the release applied to the new claim. The Court of Appeal noted that the language used was unambiguous and encompassed all claims, and gave effect to the limitation of liability clause.
Similarly, in Lippa v. Colletta[x], a court rejected a plaintiff’s attempts to avoid application of the limitation of liability set out in a home inspection agreement (which intended to limit the inspector’s liability for unreported defects). While the court was sympathetic to the plaintiff’s position, the court noted that it was impossible to ignore the clear wording of the exclusion clause included in the agreement.
Further, a failure to bring an exclusionary clause to the attention of the plaintiff will not necessarily render such a clause invalid or unenforceable. In the Alberta case of Bragg Creek Community Association v. Tyco Integrated Fire & Security Canada, Inc.[xi], the plaintiff claimed against the defendant in relation to a water loss after one of the fire suppression pipes in the ceiling burst, causing loss and damage to the auditorium and meeting rooms at a community centre. The contract contained a limitation of liability clause that would limit the amount of the damages to the amount paid for the inspection of the fire suppression system.
The signatory to the contract was an experienced facility director with the plaintiff. While the evidence suggested it was unlikely that the limitation of liability was brought to the plaintiff representative’s attention, the court also noted that a notification of those clauses within the Terms and Conditions was provided in bold, capital letters just above the signature block of the agreement. The Court held that the agreement was between sophisticated commercial parties and was signed by a suitably trained employee who could have sought further clarification, but chose not to do so. Accordingly, the plaintiff was bound by the exclusion clause and its claim against the defendant was limited to the amount paid to defendant for the inspection services provided.
Recently, in the Saskatchewan case of Smith v. Hawryliw[xii],a home inspector sought to limit its liability to the amount of fee charged for the inspection in accordance with his agreement with the plaintiff. The reading of the provision was unambiguous and the Court found that the exclusion clause did apply based on the principles in Tercon. The Court also found that the clause was not unconscionable due to the defendant’s failure to bring the exclusion clause to the plaintiff’s attention or to canvas her knowledge of the terms of the agreement. Finally, relying on Tercon, the court concluded that there was no public policy rationale that negated the public interest of supporting freedom of contract.
While the status quo might suggest that limitation of liability clauses are enforced, there has nevertheless been development in the case law. Exceptions are being created. For example, in certain situations, courts have been reducing the contractual protections available to professionals under the limitation of liability clauses. These inquiries are based on the test set out in Tercon.
In the 2014 decision of Creston Moly Corp v. Sattva Capital Corp.[xiii], the Supreme Court of Canada affirmed that the goal of contractual interpretation is to ascertain the intention of the parties at the time when the contract was executed. The Supreme Court also, however, added a new element to this exercise, requiring the trial judge to consider the “factual matrix” surrounding the formation of the contract.
The factual matrix is comprised of “objective evidence of the background facts at the time of the execution of the contract, that is, knowledge that was or reasonably ought to have been within the knowledge of both parties…”[xiv] A trial judge should consider the factual matrix when interpreting a contract to ensure consistency between the written words of the contract and the intentions of the parties, even when there is no apparent ambiguity in the written contract.
The intention of the parties is to be determined on an objective basis of what a contract would mean to a reasonable person. Accordingly, trial judges moving forward will have a greater discretion to determine the true meaning of the contracts before them in the context of the relationship between the parties and the facts that existed at the time the parties signed the agreement.
Where a court is not satisfied that the exclusion clause applied to the circumstances established in the evidence, such a clause is not held to be valid. In the British Columbia decision of Peter v. Soares[xv], the plaintiff, Mr. Peters, filled out and signed a membership agreement to a Brazilian Martial Arts Club. The provisions of the membership agreement referred to waiver of claims against the club relating to all claims, liability, injury and damages. On a later date, Mr. Peters got injured in a competition and sued the defendant club. The defendant sought to rely on the exclusion clause. The Court found that there was no evidence that the competition was in Mr. Peters’ contemplation at the time he signed the membership agreement, and so there was no factual basis on which Mr. Peters could have contemplated that the waiver provisions of the membership agreement would apply to the competition. The vourt also engaged in the Tercon test and stated that the first Tercon inquiry [i.e. whether the clause applied to the circumstances] is answered in the negative. The membership agreement waiver did not relate to Mr. Peters’ claim regarding the injuries he allegedly sustained in the competition and so could not exclude Mr. Peters’ claim.
A party to a contract will not be permitted to engage in unconscionable conduct secure in the knowledge that no liability can be imposed upon it because of an exclusionary clause. In Plas-Tex Canada Ltd. v Dow Chemical of Canada Ltd.,[xvi] Dow knowingly supplied defective plastic resin to pipeline fabricator, choosing to rely on a contractual limitation clause rather than disclosing the defect. This, it was held, created significant risk to public health and property. Accordingly, the court held that the exclusion clause not enforceable.
In another 2014 decision of Bhasin v. Hrynew, the Supreme Court created a general duty of honest contractual performance, which requires the parties to be honest with each other in relation to the performance of their contractual obligations.[xvii] According to Bhasin, parties must not lie or otherwise knowingly mislead each other about matters directly linked to the performance of the contract. The Court ruled that the duty of honest performance “operates irrespective of the intentions of the parties, and is to this extent analogous to equitable doctrines which impose limits on the freedom of contract, such as the doctrine of unconscionability”.
Where a contractor or a service professional makes a misrepresentation about the work carried out, the application of a limitation clause is not allowed. In Swift v. Tomecek Roney Little & Associates Ltd.[xviii], the plaintiffs jointly purchased land on Vancouver Island, on which to build a large custom home. Mr. Swift signed the architect’s agreement containing a limitation of liability clause which also extended to the architect’s sub-consultants. The engineer, a sub-consultant of the architect made a mistake that resulted in damages. The engineer represented that the mistake had been corrected, when it had not been. The trial judge held that the limitation clause applied to the plaintiff’s claims, including the negligent misrepresentation claim against the engineer.
The Alberta Court of Appeal, however, reversed the decision of the trial judge. While the court agreed that the limitation clause protected the architect and its sub-consultant, it held that the negligent misrepresentations made by the engineer during the project were not subject to the limitation clause. Consequently, the engineer’s liability was not limited. This case arguably carves out an exception in the contractual protection available to design consultants by way of a limitation of liability clause.
In short, the Supreme Court of Canada seems to have given more tools to judges in the analysis of limitation of liability clauses. The factual matrix approach may assist parties in obtaining relief from overly harsh contract provisions in certain agreements. An inquiry into the behaviours and conduct of the parties may further curb the so-called freedom of contract between parties. While this may also make trial decisions less predictable in cases involving contract interpretation in the future, it will open up opportunities for subrogating insurers to bring claims that they may have previously thought barred. When faced with a limitation of liability clause, a legal opinion on the enforceability of such a provision may open doors for a subrogated claim that may previously have seemed questionable.
Limitation of liability clauses have generally been enforced, especially when a clearly worded exclusion has been drafted into the agreement, and entered into by parties with equal bargaining power. However, where there is an imbalance in bargaining power (unsophisticated parties or contracts of adhesion), or a scenario where a sophisticated party may be abusing their power, some courts have refused to give effect to the limitation clauses.
For subrogating insurers, the devil is in the details. It is essential to conduct thorough investigation early on, review any contracts to identify limitation of liability provisions, and to determine, by way of direct evidence from the insured, if there are any factors present that may aid in vitiating such a clause. Unwelcome surprises can be avoided.
[i] Edgeworth Construction Ltd. v. N.D. Lea & Associates Ltd., 1993 CanLII 67 (SCC)
[ii] Tercon Contractors Ltd. v. British Columbia (Transportation and Highways), 2010 SCC 4
[iii] Uber Technologies Inc. v. Heller, 2020 SCC 16 at para 65
[iv] D. Thomas Furs Ltd. v. Wackenhut of Canada Ltd.,  O.J. No. 1758 (Dist. Ct.)
[v] Marmac Credit Jewellers Ltd. v. Dominion Electric Protection Co. , 3 B.L.R. 144 (Ont. H.C.J.)
[vi] Loeb Inc. v. Bomar Security & Investigations Ltd.,  O.J. No. 109 (Gen. Div.)
[vii] Fraser Jewellers (1982) Ltd. v. Dominion Electric Protection Co. 1997 CarswellOnt 1894,  O.J. No. 2359, (ON CA)
[viii] Suhaag Jewellers Ltd. v. Alarm Factory Inc., 2015 ONSC 3542, 2015 CarswellOnt 8530 (Ont. S.C.J.)
[ix] Biancaniello v. DMCT LLP, 2017 ONCA 386, 2017 CarswellOnt 6974, (Ont. C.A)
[x] Lippa v. Colletta, 2017 ONSC 1122, 2017 CarswellOnt 2382 (Ont. S.C.J.)
[xi] Bragg Creek Community Association v. Tyco Integrated Fire & Security Canada, Inc., 2019 ABQB 226, 2019 CarswellAlta 628 (Atla QB)
[xii] Smith v. Hawryliw, 2020 SKQB 169, 2020 CarswellSask 320 (Sask QB)
[xiii] Creston Moly Corp v. Sattva Capital Corp., 2014 SCC 53, 2014 CarswellBC 2267
[xiv] Ibid. at para. 58
[xv] Peters v. Soares, 2019 CarswellBC 319, 2019 BCSC 189 (BC SC)
[xvi] Plas-Tex Canada Ltd. v. Dow Chemical of Canada Ltd.,2004 ABCA 309, 2004 CarswellAlta 1290 (Atla CA)
[xvii] Bhasin v. Hrynew, 2014 SCC 71 (CanLII) at para. 93.
[xviii] Swift v. Eleven Eleven Architecture Inc., 2014 ABCA 49, 2014 CarswellAlta 153 (Atla CA)