What amounts to good faith conduct or repudiation on construction projects?

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1 BuildLaw - Good Faith Conduct or Repudiation on Construction Projects 1 What amounts to good faith conduct or repudiation on construction projects? When is a building contract a joint venture and what amounts to good faith conduct or repudiation on construction projects? A recent decision of the Prince Edward Island Court of Appeal in WCI Waste Conversion Inc. v. ADI International In. involving a joint venture project raised a number of important issues including: a. whether a contractor and subcontractor were actually in a joint venture relationship b. when do parties to a construction project owe duties of good faith or fiduciary duties to each other? c. and what misconduct on a construction project will be considered to be sufficiently serious that it amounts to repudiation entitling the other party to terminate the contract? The Background In June 2000, a PEI Crown Corporation, Island Waste Management Corporation ( IWMC ), issued a Request for Proposals for the design, construction and operation of a central composting facility to serve the province of Prince Edward Island. WCI approached ADI about making a proposal together. The two companies submitted a Pre-Qualification Submission which was expressly made by those companies in association and as a team. The ultimate Proposal was submitted in March 2001 by ADI and it stated that it was prepared by both companies. In July 2001, IWMC awarded the contract to ADI, with WCI which was shown as a subcontractor. In May 2001, ADI and WCI entered into a Memorandum of Understanding ( MOU ). They entered into a further MOU in August 2001 after the contract had been awarded by IWMC to ADI. The key provision of the August MOU stated as follows: It is agreed that ADI will be the prime contracting party, with WCI engaged as a sub-contractor. ADI will provide the bonding and insurances as stipulated by the RFP. However, it is agreed that the actual working THOMAS HEINTZMAN O.C., Q.C. AUTHOR PROFILE Thomas Heintzman specializes in the field of alternative dispute resolution (ADR) and has been senior counsel in actions and arbitrations across Canada, and at all levels of appellate courts including numerous appearances in the Supreme Court of Canada. His practice specializes in litigation, arbitration and mediation relating to corporate disputes, shareholder s rights, securities law, broadcasting/ telecommunications and class actions.

2 BuildLaw - Good Faith Conduct or Repudiation on Construction Projects 2 relationship will be based on the general principles of a joint venture agreement as summarized below. In their correspondence with each other, ACI and WCI frequently referred to the bid as being joint and to the relationship as being a joint venture, but ADI insisted throughout that it was the prime contractor and carried the associated rights and risks. Construction of the project was substantially completed by October During the construction, the relationship between ADI and WCI deteriorated and ADI terminated the contract with WCI. The Sub-Contract or Joint Venture Issue A difficult issue that may arise between contractors and subcontractors is the nature of their contractual relationship. Are they: independent contractors; or partners; or joint venturers; or employees one of the other? The PEI Court of Appeal considered whether a contractor and subcontractor were actually in a joint venture relationship. The decision is an important one as the majority and minority of the court approached the issue in a different way. The trial judge found that the contract between the parties included the two MOUs and the correspondence between the parties, at least so far as determining the relationship between the parties. He held that, for the purposes of the relationship with IWMC, the parties were in a contractor-subcontractor relationship, but between themselves they were parties to a joint venture relationship. A difficult issue that may arise between contractors and subcontractors is the nature of their contractual relationship. A re they: independent contractors; or partners; or joint venturers; or employees one of the other? The majority of the PEI Court of Appeal affirmed this finding. A number of features of its reasoning are important. First, the majority held that ADI could not rely on evidence outside the MOU to contradict the statement in the MOU that the relationship between the parties was a joint venture. Second, the majority held that it was not necessary that WCI have an

3 BuildLaw - Good Faith Conduct or Repudiation on Construction Projects 3 expectation of profit from the prime contract with IWMC for there to be a joint venture between the parties. Even though WCI was only entitled to a fixed payment from ADI, and ADI was entitled to all the upside and subject to the downside of that prime contract, the parties were still entitled to call their agreement a joint venture agreement and thereby impose duties upon themselves consistent with a joint venture. Third, the majority held that contractors and subcontractors are entitled to contract between themselves as joint venturers, and to contract with the owner on the basis that only one of them is the contractor and the other is a subcontractor. The majority distinguished the case of Design Services v. R, [2008] 1SCR 737 in which a subcontractor asserted that it was in a contractual relationship with the owner based upon it really being part of a joint venture with the contractor. The majority of the PEI Court of Appeal said that, in Design Services, the owner had issued no contract at all to the contractor but had issued the contract to another bidder: Canada awarded no construction contract to the contractor, Olympic. Olympic didn t enter into a subcontract with Design Services. In the present case, WCI s claim is between the contracting parties, inter se, where terms have been agreed and expressed by the parties. The minority judge disagreed. As to the clause in the MOU stating the parties relationship, the minority judge held that there was an inconsistency between the first and third sentences and that the court was obligated to find an interpretation which would give meaning to both provisions that create the inconsistency. The majority held that contractors and subcontractors are entitled to contract between themselves as joint venturers, and to contract with the owner on the basis that only one of them is the contractor and the other is a subcontractor. The minority judge then turned to the actual responsibilities and the actual entitlements to payment and profits to determine whether the relationship was really one of joint venture or one of contractor-subcontractor. He found that ADI entered into a fixed price contract with IWMC in which WCI had no entitlement to profit, and that WCI entered into a fixed price contract for WCI to be paid a fixed price. There was no sharing in profits under either arrangement. ADI and WCI had separate activities for which they were responsible. Each party entered into separate sub-contracts. Neither party was vulnerable to the other. In short, all the ingredients of the relationship

4 BuildLaw - Good Faith Conduct or Repudiation on Construction Projects 4 indicated that there was no joint venture and that the parties were independent contractors. According to the minority judge, the statement about a joint venture in the MOU: meant they would work in close cooperation with each other to carry out their specialized duties as contractor and subcontractor. Reliance on joint venture was for purposes of facilitating the proper functioning of their working relationship as contractor and subcontractor there is nothing in their contractual arrangements which would indicate they agreed to enter into a joint venture.the statement standing by itself in the contract did not make their legal relationship that of parties to a joint venture. This disagreement between the majority and minority reveals a fundamentally different approach to determining the legal relationship between the parties. The majority held that, if the parties state in their agreement that they are joint venturers, then the court will hold them to that statement. The minority held that the court may go behind that statement, at least if the parties also state that they have a contractor-subcontractor relationship so far as the owner is concerned; and the court may determine if the relationship between the parties is really one of joint venture and if it is not, then the parties statement about joint venture may be over-ridden. The majority held that, if the parties state in their agreement that they are joint venturers, then the court will hold them to that statement. This difference in opinion raises a number of questions: First, if the parties wish to have a joint venture relationship between themselves, but also wish one of them to be the prime contractor and the other to be the subcontractor, can they legally do so? If they can, how do they do so to ensure that the relationship is not disputed later? The wording used by the parties in the key provision of the MOU seems as clear as possible, namely, that the parties wanted a joint venture arrangement between them, but recognized that one of them would be contractor and the other sub-contractor so far as the owner was concerned. How could they have more clearly stated that intention? Would

5 BuildLaw - Good Faith Conduct or Repudiation on Construction Projects 5 it have been better to leave out reference to the actual working relationship being based on a joint venture agreement, and instead say that the real legal relationship between the parties is that of joint venture? Or with this judicial precedent, can we now proceed on the basis that the words in this contract are sufficient in the future to create a joint venture between a contractor and subcontractor? Second, which approach is better? Should courts accept the parties statement as it is? Or should they inquire into the actual relationship to see if it is one of joint venture? In the employment setting, courts often determine whether the relationship is really one of employment or one of independent contractors, but there are real public policy reasons for doing so. When the parties say that they are partners, should the court go behind that statement to see if they really are? If they say that they have entered into a joint venture agreement, are there good public policy reasons for the court to go behind that statement? What amounts to good faith conduct or repudiation on construction projects? What misconduct on a construction project will be considered to be sufficiently serious that it amounts to repudiation entitling the other party to terminate the contract? What misconduct on a construction project will be considered to be sufficiently serious that it amounts to repudiation entitling the other party to terminate the contract? Under ADI s contract with IWMC, ADI was to enter into a five year operating contract with IWMC, and under the MOU, ADI was to enter into a five year subcontract with WCI under which WCI was to be the operator. In its Substantial Performance letter dated October 7, 2001, IWMC accepted ADI s application for Substantial Performance effective October 1, In accepting Substantial Performance, IWMC stated that its concerns about throughput performance were to be addressed by the date of Total Performance, which was to occur on February 1, As a result, both ADI and WCI had until February 1, 2003 to demonstrate throughput performance. Moreover, the majority of the Court of Appeal concluded that, based upon its conduct leading up to the Substantial Performance letter, ADI effectively viewed WCI s performance with respect to throughput

6 BuildLaw - Good Faith Conduct or Repudiation on Construction Projects 6 performance as being a deficiency, and not conduct which repudiated WCI s obligations under the contract. On November 26, 2002, ADI gave notice to WCI that it was in default of its obligations and gave a five day cure notice to WCI. By letter dated November 29, 2001, WCI denied that it was in default and restated its commitment to improve the throughput performance of the project. By letter dated December 4, 2002, ADI terminated the contractual relationship between the parties. Repudiation and Termination The trial judge held that, as of the date of ADI s termination of the contract, WCI had not repudiated the contract, and therefore ADI s termination was unlawful. This finding was upheld by the majority of the Court of Appeal. There are several aspects of its conclusions that are important. First, the majority of the Court of Appeal held that the cure notice could not be given by ADI if WCI was not then in default. Since WCI had until February 2003 to ensure that throughput performance was met, WCI was not in breach of any obligations as of November 26, 2002 when ADI delivered its cure notice, and December 4, 2002 when it terminated the contract. The Court of Appeal stated its affirmation of the trial judge s conclusion as follows: The trial judge was entitled to find, as he did that WCI did not by its words or conduct repudiate; that, in any event, the time for correction of the deficiencies in question was not exhausted; and, in the circumstances of the status of the deficiencies, ADI did not show that WCI was incapable of performing its part of the contract. This is a very useful check list for a contractor contemplating termination of a subcontractor, particularly when deciding to give or act upon a cure notice. First, by its words or conduct, has the subcontractor really repudiated its obligations? Second, has the time for performance of the obligations in question really been exhausted? And third, is the subcontractor really incapable of performing its contract? And for good measure, can I prove all these elements at a trial? This is a very useful check list for a contractor contemplating termination of a subcontractor... First, by its words or conduct, has the subcontractor really repudiated its obligations? Second, has the time for performance of the obligations in question really been exhausted? An d third, is the subcontractor really incapable of performing its contract? And for good measure, can I prove all these elements at a trial?

7 BuildLaw - Good Faith Conduct or Repudiation on Construction Projects 7 The second important aspect of the Court of Appeal s decision is its affirmation of the principle that when a contract provides a time within which the contract work must be completed, the contractor is entitled to the whole of that time for doing the work relying on Goldsmith and Heintzman on Canadian Building Contracts (4th ed) at chapter 5, part 1(d). Third, the trial judge and majority judgment in the Court of Appeal applied the principle of good faith performance of contractual obligations. The trial judge held that ADI did not act in good faith in seeking approval of Substantial Completion on the basis of throughput performance being achieved by February 2003 and then turning around and terminating the contract with WCI based upon its deficiencies in relation to throughput performance before February The Court of Appeal held that a contract must be performed in good faith, that this obligation involves performance within the reasonable expectations established by the contract, and that the trial judge was entitled to find that ADI s tactics and motivations were inconsistent with a good faith exercise of its obligations and contractual duties to WCI. Fourth, in examining the conduct and rights of ADI and WCI, the trial judge and Court of Appeal looked to the conduct and rights as between the owner, IWMC, and ADI. Thus, IWMC had delivered no cure notice or termination notice to ADI in relation to throughput performance. Why was ADI delivering such a notice to WCI? At ADI s request, IWMC had agreed that throughput performance would be established by the date of Total Performance. Why was ADI not agreeing with WCI to the same date for performance? Clearly, ADI s inconsistent conduct or attitude was of crucial concern to the trial judge, and the Court of Appeal upheld the trial judge s findings based on those concerns. The Court of Appeal held that a contract must be performed in good faith, that this obligation involves performance within the reasonable expectations established by the contract, and that the trial judge was entitled to find that ADI s tactics and motivations were inconsistent with a good faith exercise of its obligations and contractual duties to WCI. The minority judge agreed with this conclusion but would have directed a new trial related to the entitlement of ADI to terminate the operating contract with WCI at its sole discretion and whether it had done so in good faith. All the judges of the Court of Appeal were firmly of the view that the issue of whether or not WCI had repudiated the contract and whether or not ADI had

8 BuildLaw - Good Faith Conduct or Repudiation on Construction Projects 8 the right to terminate the contract based on repudiation, was to be determined on an objective basis. The majority held that repudiating is not lightly to be inferred from a party s conduct, and that, as the terminating party, ADI had the obligation to prove WCI s repudiation and its entitlement to terminate. Accordingly, there was no element of discretion or deference to be accorded to ADI s decision to terminate. In all respects, this decision of the PEI Court of Appeal provides a very useful survey of the issues which must be addressed by contractors and subcontractors when termination for repudiation is contemplated under a construction contract, particularly when a cure notice is involved. Good Faith and Fiduciary Duties The trial judge concluded that, by reason of the joint venture between them, the parties owed fiduciary duties to each other. Both the majority and the minority of the Court of Appeal disagreed. The majority held that a joint venture, unlike a partnership, does not necessarily give rise to fiduciary duties. Without deciding if fiduciary duties did arise in this joint venture, the majority held that the material findings of the trial judge about the conduct of the parties and the legal consequences of that conduct could be supported without reference to fiduciary duties. The minority judge found that it was unlikely that, in the circumstances of this case, fiduciary duties would arise. The minority judge then considered whether the parties had an obligation to exercise their rights under the contract in good faith. He concluded that there was no such obligation in relation to any of the provisions of the contract which did not involve discretion, and that there was in relation to those provisions that did involve discretion. He then concluded that under the cure notice provision of the MOU, if AWI properly followed the notice provisions and WCI did not cure, then the MOU could be terminated without regard to issues of good faith. However, he held that AWI s right to terminate the operating agreement was unilateral and could be exercised in its sole discretion, provided it gave the required notice and paid the required termination fees. In this circumstance, the minority judge concluded that AWI was required to act in good faith in giving a notice to terminate the operating In all respects, this decision of the PEI Court of Appeal provides a very useful survey of the issues which must be addressed by contractors and subcontractors when termination for repudiation is contemplated under a construction contract, particularly when a cure notice is involved.

9 BuildLaw - Good Faith Conduct or Repudiation on Construction Projects 9 agreement. The concepts of a fiduciary duty and a duty of good faith are very different. A fiduciary duty is a duty to act in the utmost good faith and in the other party s best interest. An obligation of good faith is not a fiduciary duty. It is not the obligation to act in the utmost good faith and in other party s best interest. It is the obligation to act in accordance with the purpose of the contract and not to undermine its performance. It is highly doubtful that a true fiduciary duty will arise during a construction project unless the parties call themselves partners. The commercial setting for the project is not consistent with such an obligation. On the other hand, it is hard to see why an obligation to act in good faith should not arise. After all, that obligation simply requires a party not to act in bad faith, not to act for an ulterior motive, that is, a motive which is outside the purpose of the contract. Making an obligation of good faith dependent upon the existence of discretion, as the minority judge did, is highly problematic. The element of discretion is usually relevant to determining whether the duty is a fiduciary duty, not whether a duty of good faith exists. If a cure notice is given properly on its face, but is given for an ulterior motive having nothing to do with the proper completion of the construction project, why should that sort of conduct be valid? Why is the right to terminate the operating contract any more unilateral than the right to give a cure notice? And if a party has a right to terminate in its sole discretion, then surely the real issue is whether that right is exercised for bona fide reasons consistent with the purpose of the contract. In all these circumstances, good faith appears to be applicable to most of the obligations on a construction project. In all these circumstances, good faith appears to be applicable to most of the obligations on a construction project. REFERENCE: WCI v. ADI, 2011 PECA 14 (CanLII) For a copy of the judgment see the International Court Decisions page on the Building Disputes Tribunal website under RESOURCES:

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