August 2, 2022
Supply chain risks: Construction/Services contracts
BY ROB KENNALEY
Supply chain issues are currently plaguing the construction and services industries on a worldwide basis. The starting point for how the parties allocated the risk of this problem is the contract between the parties: in virtually every circumstance the written or implied terms of the contract will govern. As regards supply chain issues, it is particularly important that “surrounding circumstances” can be taken into consideration.The leading Canadian case on contract interpretation is the Supreme Court of Canada decision in Sattva Capital Corp. v. Creston Moly Corp., 2014 SCC 53, where the court held that a practical, common-sense approach is to be taken, with a view to determining the intent of the parties on “a reading of 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” (emphasis added). The court held that surrounding circumstances are what was, or reasonably ought to have been, within the knowledge of both parties at the time of contracting. They can include “anything which would have affected the way in which the language of the document would have been understood by a reasonable man.”
The court went on to confirm that the role of surrounding circumstances will vary from case to case and cannot be used to change or overrule the plain meaning of the contract. Also, the subjective intention of the parties does not matter: only objective evidence of what both parties knew or ought to have known at the time of contracting can be admissible.
Where the contract is silent on an issue, the Supreme Court of Canada established in M.J.B. Enterprises Ltd. v. Defence Construction (1951) Ltd., [1999] 1 SCR 619 that terms will be implied where they are necessary to give “business efficacy” to a contract, or where the parties would have considered them to be so obvious that they didn’t need to be stated. The latter can be established, the court held, where the term meets the “officious bystander test”: Where the parties would have unquestionably said, “of course!” had a helpful bystander suggest that they formed part of the deal.
The circumstances surrounding worldwide supply chain problems might then be used to assist the parties to interpret a contract or to imply a term into the contract. Whether or not this can occur in any particular case depends on the words of the existing contract and the circumstances of each particular case. If the current (and perhaps heretofore unanticipated) supply chain risks have been expressly allocated (one way or another), those terms will almost certainly be enforced. However, if the contract is silent or in any way unclear on the issue, surrounding circumstances and implied terms might play a role.
There are two other legal concepts to be considered: force majeure and frustration. A force majeure clause is the ‘circumstances beyond the parties’ control’ clause. It is a creature of contract, in that force majeure relief is not available on its own unless the contract provides for it. (This is not to say that force majeure terms cannot be read into the contract by surrounding circumstances or implied terms). Important considerations include:
a) What the contract has defined as a force majeure event. Commonly specified events include strikes, lockouts, “acts of god,” war, insurrections and circumstances beyond a parties’ control. If an event (such as the pandemic) is not listed, it might be read in, as above. However, if it is dealt with expressly, the express terms will govern;
b) Whether or not a force majeure event has actually occurred. Our courts have historically not allowed contractors or suppliers to rely on economic or marketplace changes to claim for force majeure relief. However, it might be argued (in certain circumstances and depending on what the contract says) that COVID-19 related worldwide and systemic transportation and logistics problems differ from the economic and marketplace risks which contractor/supplier agreed to assume; and
c) What relief the contract provides for upon a force majeure event. Each contract has to be interpreted on its own to determine if the contractor/supplier gets a schedule extension, additional compensation, or both, or neither. We note, however, that most force majeure clauses, on their face, only provide schedule relief. They do not expressly provide for additional compensation.
Frustration is a common law concept which applies when it is virtually impossible for a party to perform its obligations under a contract. It occurs, for example, where a contractor has been retained to build a cottage on the edge of a cliff that has slid into an ocean. It is well settled that frustration does not apply where performance is simply more difficult, or more expensive, then the contractor/supplier anticipated. As regards supply chain issues, if it is impossible to get the supply any quicker (from the same or a different source), frustration might apply to provide relief.
In the end, as above, whether or not a contractor or supplier might be entitled to relief from supply chain impacts (and what that relief might be) will be a function of how the contract is interpreted. The exception is where performance is impossible, in which case “frustration” might apply. When read in its entirety, if the contract has unequivocally allocated the risk of the current (and perhaps unique) supply chain issues, it will generally be enforced on its terms. Interpreting the contract, however, can involve an assessment of surrounding circumstances, commercial realities and the parties’ expectations, including what an “officious bystander” might say should be included
There is no doubt that, in some cases, the worldwide supply chain problems we currently face are different from the economic and marketplace risks the parties would have contemplated in negotiating contracts. Accordingly, depending on what the contract is interpreted to say, relief might be available on a contract-by-contract basis.
Rob Kennaley is with Kennaley Construction Law, a construction law firm with offices in Simcoe, Toronto and Barrie.