Ontario Court of Appeal Applies Minimum Performance Principle for Damage Costs in Breach of Contract

The Ontario Court of Appeal has ruled on the relationship between termination for convenience clauses and damages for wrongfully terminating a commercial agreement for cause in its decision in Atos IT Solutions v. Sapient Canada Inc.1 (Atos). It also confirmed the interpretation of "lost profits" in limitation of liability clauses.

What You Need To Know

  • Termination for convenience clauses may serve to define the upper limit of liability for damages for the wrongful termination of services under a contract, even where the terminating party does not rely on the termination for convenience provision.
  • The presence of a termination for convenience fee in respect of one set of services under an agreement will not generally be relevant to assessing damages for the wrongful termination of services for which no termination for convenience rights or fees are set out in the agreement.
  • The Open Window Bakery minimum performance principle can apply to the calculation of damages for breach of contract despite termination in bad faith.
  • Standard limitation of liability clauses excluding "lost profits" are likely to continue being interpreted as referring to indirect lost profits and will not exclude lost profits on the contract that result directly from its breach.

Basis of Decision

In its decision, the Court of Appeal applied the Open Window Bakery principle in quantifying damages for the termination of a subcontract between two technology companies: where there are several ways in which a contract may be performed, breach of contract damages should be calculated based on the mode of performance "least burdensome to the defaulting party and least profitable to the non-breaching party."2

The Court held that where there is a termination for convenience fee set out in the agreement but the terminating party claims it has terminated "for cause," damages should be quantified using the termination fee as an upper limit on liability. The Court also suggested the minimum performance principle operated in conjunction with the organizing principle of good faith contractual performance recognized in Bhasin v. Hrynew3 (Bhasin), and that the principle could act as a limit on damages regardless of whether the terminating party had acted in bad faith.

Atos IT Solutions v. Sapient Canada Inc.

On September 30, 2006, the appellant, Sapient, outsourced work on a legacy software replacement project for Enbridge to the respondent, Atos (formerly Siemens). The subcontract agreement required Atos to provide two services: data conversion (DC services) and application management support (AMS services). The agreement provided Sapient the right to terminate the entire agreement “for cause,” with a more limited right (including a separate damages calculation formula) to terminate the DC services agreement for convenience.

On June 29, 2009, Sapient terminated the entire subcontract for cause and immediately entered into a new agreement with Enbridge to provide the AMS services itself. Atos sued for wrongful termination, and Sapient counterclaimed for damages related to delays.

At trial, the judge found that Sapient had terminated the contract in bad faith, awarding Atos damages of $2.4 million for the balance owing for the DC services and $3.6 million for the estimated gross profits Atos would have earned from the provision of the AMS services.

On appeal, Sapient argued that the Open Window Bakery minimum performance principle entitled it to the benefit of the less burdensome mode of performance in respect of any damages relating to the DC services portion of the subcontract (payment of the termination for convenience fee), even though it had relied on the termination for cause provision when it terminated the entire agreement.

Sapient also appealed the $3.6 million lost profits award related to the termination of the AMS services, arguing the agreement's limitation of liability clause limited Atos's claim to its costs to retain staff to provide the AMS services, in the amount of $550,000. The limitation of liability clause provided:

… [Atos] nor sapient will be liable to the other for indirect, special, consequential or punitive damages or for loss of profits … even if the party has been advised of the possibility of such damages…

Sapient claimed this clause meant Atos could not claim damages for lost profits arising from the breach of the AMS portion of the subcontract.

Atos responded and said the termination for convenience clause was not an alternative mode of performance for the entire subcontract, and therefore it was not entitled to have damages for its termination of the DC services calculated using the termination for convenience clause.

Atos also argued the over-arching duty of good faith and honest performance of contracts recognized in Bhasin precluded the application of the minimum performance principle in cases where the termination was in bad faith. Finally, Atos argued that expectation damages, which are direct damages, include loss of profits and it was therefore entitled to recover the $3.6 million damages figure in respect of the AMS services.

Court Decision

The Court of Appeal held that the correct application of the Open Window Bakery minimum performance principle required that Atos's award for damages pursuant to the termination of the DC services should be recalculated using the formula in the termination for convenience clause. As a result, the award was reduced from $2.4 million to $1 million.

In addressing whether the termination for convenience clause constituted an alternative mode of performance, the Court of Appeal found that the language of the subcontract allowed Sapient to use the termination for convenience clause to terminate the DC services portion only, while relying on the termination for cause provision to terminate the rest of the contract.

The fact Sapient did not actually rely on the termination for convenience provision in its termination letter and could not justify the termination of the subcontract for cause had no bearing on Atos's reasonable expectations of recoverable damages for termination of the DC services. The termination for convenience clause "effectively defined the upper limit of Sapient's liability for damages in respect of DC services."

The Court also rejected Atos's argument that the minimum performance principle should not apply because Sapient had breached its common law duties of good faith. Atos claimed Sapient's bad faith conduct in terminating the subcontract meant Sapient was not entitled to take advantage of the less burdensome damages calculation formula.

The Court found that Bhasin focused on the issue of the performance of contracts and "did not purport to alter the existing principles concerning the proper measure of expectation damages in the event of a breach of contract." The Court suggested that the minimum performance principle could operate in conjunction with the general organizing principle of good faith.

With respect to Sapient's appeal of the damages award in respect of the AMS services, the Court affirmed the trial judge's reasons regarding the interpretation of the limitation of liability clause, holding that the lost profits exclusion applied only to consequential or indirect lost profits. The Court upheld the trial judge's reasonable interpretation that parties who enter into a fixed price commercial contract would rely on the fact that they would receive the loss of profit component of the price in the event of a breach.

Analysis

Atos should lead recipients of services under commercial agreements to consider their strategy in negotiating and relying on termination for convenience clauses. It also confirms that typical excluded damages clauses will continue to be interpreted narrowly.

The ruling suggests a fee for termination for convenience can serve as an upper limit on a customer's liability in the event they choose to terminate services, and will be used by courts as a tool for determining liability for wrongfully terminating services.

Service providers may consider delineating "no fault" circumstances giving rise to termination rights in order to appease customers who rely on broad termination for convenience clauses to manage factors outside of the parties' control (shifts in economic conditions or directions from regulators), or service providers may continue to accept termination for convenience provisions but may take a harder line in negotiating termination fees.

Recipients of services will still likely push for termination of convenience rights and will want to be careful not to "buy" the right to terminate for convenience at too high a cost, at the risk of skewing a court's calculation of damages in the event they wrongfully exercise a "for cause" termination right. Atos does, however, suggest even a high termination may be better than no termination fee at all, as the inclusion of a termination for convenience fee—even one which seems unfavourable—will help remove one of the key impediments to taking decisive action in respect of a contractual relationship: indeterminate liability.

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1 2018 ONCA 374.

2 Hamilton v. Open Window Bakery 2004 SCC 9 (Open Window Bakery).

3 2014 SCC 71.

To discuss these issues, please contact the author(s).

This publication is a general discussion of certain legal and related developments and should not be relied upon as legal advice. If you require legal advice, we would be pleased to discuss the issues in this publication with you, in the context of your particular circumstances.

For permission to republish this or any other publication, contact Janelle Weed.

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