Capital Steel Inc v Chandos Construction Ltd

In the Court of Appeal of Alberta

Citation: Capital Steel Inc v Chandos Construction Ltd, 2019 ABCA 32

Date: 20190129

Docket: 1703-0085-AC

Registry: Edmonton

Between:

Deloitte Restructuring Inc. in its Capacity

as Trustee in Bankruptcy of Capital Steel Inc., a Bankrupt

Appellant

(Plaintiff/Applicant)

- and -

Chandos Construction Ltd.

Respondent

(Defendant/Respondent)

_______________________________________________________

The Court:

The Honourable Madam Justice Patricia Rowbotham

The Honourable Madam Justice Barbara Lea Veldhuis

The Honourable Mr. Justice Thomas W. Wakeling

_______________________________________________________

Reasons for Judgment Reserved of The Honourable Madam Justice Rowbotham

Concurred in by The Honourable Madam Justice Veldhuis

Dissenting Reasons for Judgment Reserved of The Honourable Mr. Justice Wakeling

Appeal from the Order by

The Honourable Mr. Justice K.G. Nielsen

Dated the 17th day of March, 2017

Filed on the 27th day of March, 2017

(Docket: BK03 2169632)

_______________________________________________________

Reasons for Judgment Reserved of

The Honourable Madam Justice Rowbotham

_______________________________________________________

I.

Introduction

A construction contract between Capital Steel Inc. (Capital Steel) and Chandos

[1]

Construction Ltd. (Chandos) contained a provision that imposed a monetary consequence on

Capital Steel’s insolvency. When Capital Steel filed an assignment in bankruptcy, Deloitte

Restructuring Inc. (Deloitte) was appointed as the trustee in bankruptcy for Capital Steel’s estate.

A chambers judge allowed Chandos to rely on the provision with the result that there were less

assets in Capital Steel’s estate for distribution to creditors. At issue on appeal is whether the

provision conflicts with the common law anti-deprivation rule, which prevents parties from

contracting out of bankruptcy laws.

[2]

This case is not fundamentally one of contract law but of bankruptcy law. It is insolvency

law that determines the outcome. The Bankruptcy and Insolvency Act, RSC 1985, c B-3 (BIA)

provides the mechanism for the orderly liquidation of a bankrupt’s estate and the distribution of the

value of the estate in accordance with the statutory provisions, including the priorities established

therein. Its purpose is to codify, for all debtors and creditors, what will transpire in the event of a

bankruptcy. This certainty is critical to the operation of commercial entities throughout Canada.

[3]

One of the purposes of the BIA is to prevent a premature race to the debtor’s assets. The Act

is premised on collective action intended to maximize the return to all creditors pari passu. The

Act specifically gives trustees the power to set aside preferences and other fraudulent transactions

whose underlying objective is to circumvent the Act.

[4]

A trustee in bankruptcy has an obligation to take possession of all property of the bankrupt.

Section 67(1) of the BIA defines property of the bankrupt that is divisible among the creditors.

Accounts receivable clearly fall within that definition. In addition, a right of set off that existed at

the date of bankruptcy (not as a result of the bankruptcy) is not affected.

[5]

A contractual provision triggered only in the event of insolvency or bankruptcy which

would deprive creditors of value otherwise available to them and effectively directs the value to an

unsecured creditor is void: Aircell Communications Inc v Bell Mobility Cellular Inc, 2013 ONCA

95 at paras 10-12, 14 CBR (6th) 276.

[6]

The contractual provision at issue in this appeal is such a provision and offends the

common law anti-deprivation rule. The rule forms part of the common law of Canada and has not

been ousted by amendments to the BIA. The chambers judge acknowledged the rule but, in my

view, applied the wrong test for determining whether the provision offended the anti-deprivation

rule. I allow the appeal.

Page: 2

II.

Facts

Chandos was hired as the general contractor for a condominium project in St. Albert,

[7]

Alberta. It subcontracted steel-related work on the project to Capital Steel for a price of

$1,373,300.47. Capital Steel completed the majority of the work required under the subcontract,

and Chandos made payments to Capital Steel totalling $1,223,682.08. This left an outstanding

balance of $149,618.39.

[8]

On September 26, 2016, Capital Steel filed an assignment in bankruptcy. Deloitte was

appointed as the trustee. Capital Steel had not completed everything required under the

subcontract prior to filing the assignment, causing Chandos to incur costs estimated at $22,800.00

to complete Capital Steel’s work on the project.

[9]

Offsetting the $22,800.00 in completion costs against the outstanding balance of

$149,618.39, Chandos owed a total of $126,818.39 to Capital Steel. Chandos took the position that

it was entitled to further offset this amount against 10 percent of the total contract price, or

$137,330.05, which it alleged Capital Steel had agreed to forfeit in the event of insolvency. This

would effectively eliminate the debt owing from Chandos to Capital Steel and give Chandos a

$10,511.66 claim provable in the bankruptcy proceedings. Clause VII Q of the subcontract reads,

in part:

In the event the Subcontractor commits any act of insolvency, bankruptcy, winding

up or other distribution of assets, or permits a receiver of the Subcontractor's

business to be appointed, or ceases to carry on business or closes down its

operations, then in any such events:

…

(d) the Subcontractor shall forfeit 10 [percent] of the within Subcontract

Agreement price to the Contractor as a fee for the inconvenience of

completing the work using alternate means and/or for monitoring the work

during the warranty period.

[10] On March 6, 2017, Deloitte applied to the Court of Queen’s Bench seeking advice and

directions on whether Chandos was entitled to rely on clause VII Q(d).

III.

Decision Below

[11] Before the chambers judge, Deloitte argued that clause VII Q(d) had the effect of

withdrawing value from Capital Steel’s estate that would otherwise flow to creditors. As the clause

was triggered by Capital Steel’s insolvency, Deloitte argued that it violated the common law

anti-deprivation rule. It also argued that clause VII Q(d) was an unenforceable penalty, rather than

a liquidated damages provision.

Page: 3

[12] The chambers judge recognized that the common law anti-deprivation rule prevents parties

from contracting out of bankruptcy laws. He stated that if clause VII Q(d) were a liquidated

damages provision rather than a penalty, it would not violate the rule.

[13] The chambers judge ultimately found that the clause was a genuine pre-estimate of

damages, which imposed liquidated damages and not a penalty. He also held that clause VII Q(d)

represented a bona fide commercial transaction that did not have as its predominant purpose the

deprivation of Capital Steel’s property. Consequently, the chambers judge concluded that Chandos

could enforce clause VII Q(d) against Deloitte.

IV.

Grounds of Appeal and Standard of Review

[14] Deloitte’s appeal raises two issues:

1. Does clause VII Q(d) violate the common law anti-deprivation rule?

2. Does clause VII Q(d) impose liquidated damages or a penalty?

[15] The content of the common law anti-deprivation rule and the proper test for invalidating

penalty provisions are pure questions of law reviewable for correctness: Housen v Nikolaisen,

2002 SCC 33 at para 8, [2002] 2 SCR 235. Absent an extricable legal error, the chambers judge’s

application of the proper tests is reviewable on a standard of palpable and overriding error: Housen

at para 36.

V.

Analysis

[16] The common law anti-deprivation rule and the rule against penalties are two distinct

concepts that must be assessed separately. Clause VII Q(d) may be found unenforceable under

either of the two rules. I conclude that clause VII Q(d) conflicts with the anti-deprivation rule, and

it is therefore unnecessary for me to consider whether clause VII Q(d) imposes liquidated damages

or a penalty.

A. The Common Law Anti-Deprivation Rule

[17] The anti-deprivation rule forms a part of what is referred to as the “fraud on the bankruptcy

law” principle. The essence of the fraud on the bankruptcy principle is that parties cannot arrange

their affairs through contract in a way that conflicts with the operation of bankruptcy laws:

Roderick J Wood, “Direct Payment Clauses and the Fraud Upon the Bankruptcy Law Principle: Re

Horizon Earthworks Ltd. (Bankrupt)” (2014) 52:1 Alta LR 171 [Wood, “Fraud Upon the

Bankruptcy”]; Anthony Duggan et al, Canadian Bankruptcy and Insolvency Law, 3rd ed (Toronto:

Emond, 2015) at 297.

[18] The chambers judge commented that there was some debate about whether the

anti-deprivation rule applied in Canada and the extent of its application. He ultimately concluded

Page: 4

that it was clear that there was a common law rule, based on public policy, that prevented parties

from contracting out of bankruptcy law and that given the rule, he would determine whether clause

VII (Q)(d) was an attempt to contract out of bankruptcy law. Deloitte submits that Canadian

jurisprudence recognizes the common law anti-deprivation rule. Chandos does not deny the

existence of the rule, but contends it has not enjoyed significant application in Canada. My

colleague, Wakeling JA, goes further and concludes that the common law anti-deprivation rule is

not part of Canadian law. I disagree with his conclusion.

[19] The fraud on the bankruptcy law principle traces its origins from England; by the 19th

century, the principle’s adoption was certain enough to warrant commentary that “the law is too

clearly settled to admit of a shadow of doubt” about its application: Whitmore v Mason (1861), 70

ER 1031 at 1034, 2 J & H 204.

[20] The fraud on the bankruptcy law principle can be divided into two distinct sub-rules:

Roderick J Wood, Bankruptcy and Insolvency Law, 2nd ed (Toronto: Irwin, 2015) at 88 [Wood,

“Bankruptcy and Insolvency”]. The first is the pari passu rule. This rule invalidates contractual

provisions that, if enforced during bankruptcy proceedings, would alter the bankruptcy scheme of

distribution. Provisions that offend the pari passu rule do not affect the size of the total pot of

assets available to creditors but allow certain creditors to receive more than their fair share:

Duggan et al at 444; Wood, “Fraud Upon the Bankruptcy” at 177. Under the pari passu rule, it is

irrelevant whether the contractual provision is triggered by insolvency; arrangements that would

have been enforceable against the debtor outside of bankruptcy proceedings, but would alter the

scheme of distribution after proceedings begin, are unenforceable against the trustee: Wood,

“Fraud Upon the Bankruptcy” at 177.

[21] The second rule of the fraud on the bankruptcy law principle is the anti-deprivation rule.

The anti-deprivation rule prevents parties from agreeing to remove property from a bankrupt’s

estate in the event of insolvency that would have otherwise vested in the trustee: Duggan et al at

297; Wood, “Fraud Upon the Bankruptcy” at 176. Provisions that offend the anti-deprivation rule

reduce the total pot of assets available to the bankrupt’s creditors. As stated in Whitmore at 1034:

[N]o person possessed of property can reserve that property to himself until he shall

become bankrupt, and then provide that, in the event of his becoming bankrupt, it

shall pass to another and not to his creditors.

[22] In my view, the fraud on the bankruptcy law principle, including the anti-deprivation rule,

has a clear jurisprudential and policy basis that supports its application. The anti-deprivation rule

was adopted from England and continues to apply in Canada.

[23]

There is no doubt that the pari passu rule applies in Canada. In AN Bail Co v Gingras et al,

[1982] 2 SCR 475, 54 NR 280, the Supreme Court dealt with a direct payment clause in a

construction contract. The clause allowed the property owner to pay any amounts owing to the

general contractor directly to subcontractors to satisfy the general contractor’s obligations. When

Page: 5

the general contractor entered bankruptcy, the trustee argued that this provision was no longer

effective. While the provision would not reduce the total amount available to creditors, the

subcontractors receiving a direct payment would have received more than what they would have

under the applicable legislative scheme. The Supreme Court stated at 487 that:

It would be to disregard the Bankruptcy Act and deprive it of all meaning if the

debtor of a bankrupt, instead of paying the trustee, were authorized, by contract or

some other means, to pay one or other of the creditors of the bankrupt as he saw fit.

[24] Notably, the contractual arrangement in Bail would have been enforceable against the

debtor outside of bankruptcy proceedings. And even though, as a general rule, the trustee in

bankruptcy enjoys no greater rights than the debtor, it would have been inequitable to enforce the

provision against the trustee to alter the legislated scheme of distribution.

[25] This Court applied Bail to invalidate a similar provision in Greenview (Municipal District

No 16) v Bank of Nova Scotia, 2013 ABCA 302, 556 AR 34, as offending the pari passu rule.

[26] Canadian courts have also adopted the anti-deprivation rule: In re Hoskins and Hawkey,

[1877] OJ No 16, 1 OAR 379 (CA); Re Wetmore, [1924] NBJ No 6, [1924] 4 DLR 66 (SC (AD));

Westerman (Re) (Trustee of), 1998 ABQB 946, 234 AR 371, rev’d on other grounds 1999 ABQB

708, 275 AR 114; Knechtel Furniture Ltd (Re), [1985] OJ No 1265, 56 CBR (NS) 258 (SC);

Frechette (Re) (1982), 138 DLR (3d) 61, 42 CBR (NS) 50 (Que SC). Canadian Imperial Bank of

Commerce v Bramalea Inc (1995), 33 OR (3d) 692, [1995] OJ No 4884 (Ct J (Gen Div)), is often

cited as the leading authority. The provision at issue in Bramalea would have allowed one party to

purchase their insolvent partner’s partnership interest at the lesser of book value or fair market

value. Blair J accepted the respondent’s argument, at 694, that:

A provision in an agreement which provides that upon an insolvency, value is

removed from the reach of the insolvent person's creditors to which would

otherwise have been available to them, and places that value in the hands of others

... is void on the basis that it violates the public policy of equitable and fair

distribution amongst unsecured creditors in insolvency situations.

[27] The Ontario Court of Appeal recently adopted Blair J’s formulation of the rule: Aircell at

paras 10-12. The rule was again recently recognized by the Ontario Superior Court: HGC v IESO,

2019 ONSC 259 at para 100.

[28] A judge of this Court has also recognized the anti-deprivation rule. At issue in 1183882

Alberta Ltd (Sok’s Contracting) v Valin Industrial Mill Installations Ltd, 2012 ABCA 62, 522 AR

285, leave to appeal to SCC refused, [2012] SCCA No 180, was a contractual provision that

conveyed an option that had the effect of depriving creditors of one of the debtor’s assets.

McDonald JA concluded that the provision offended the common law anti-deprivation rule and

Page: 6

was therefore invalid. While McDonald JA was in dissent, the majority did not comment on the

provision or the anti-deprivation rule.

[29] There does not appear to be any decision that expressly rejects the anti-deprivation rule’s

application in Canada. Chandos argues, however, that the Supreme Court of Canada’s decision in

Coopérants, Mutual Life Insurance Society (Liquidator of) v Dubois, [1996] 1 SCR 900, 133 DLR

(4th) 643 implicitly abandons the rule. This argument is premised on the basis that the reasoning in

Bramalea relied, in part, on the Quebec Court of Appeal decision that was overturned by the

Supreme Court of Canada in Coopérants. In my view, Coopérants does not reject the

anti-deprivation rule’s application in Canada. The outcome in Coopérants turned on the fact that

there was no evidence the contractual provision at issue prejudiced creditors: Adrienne Ho, “The

Treatment of Ipso Facto Clauses in Canada” (2015) 61:1 McGill LJ 139 at 169.

[30] The provision at issue in Coopérants allowed the debtor’s co-owners, in the event of the

debtor’s insolvency, to purchase the debtor’s interest in certain immovable property at 75 percent

of the property’s fair market value. Though this type of provision could potentially prejudice

creditors, the Supreme Court determined that no prejudicial effect was apparent in the

circumstances. The property’s fair market value was calculated without considering ownership

restrictions that would affect the price obtained through liquidation: Coopérants at para 42. The

evidentiary record also lacked information about the property’s appraisal value, which prevented

the Court from identifying any prejudice: Coopérants at para 44. The Supreme Court stated at para

40 that:

The assets available for distribution to the other creditors are not diminished. Even

if this may mean that the appellant's claim is satisfied while unsecured monetary

claims are not, the other unsecured creditors cannot complain because they will not

be suffering any harm.

[31] The Supreme Court’s reasoning in Coopérants is consistent with the anti-deprivation rule

described in Bramalea. The anti-deprivation rule is concerned with provisions that have a

prejudicial impact on creditors. The rule has no application where the prejudicial effect is not

immediately apparent and the party seeking to have the contractual arrangement deemed

unenforceable has not established any prejudice.

[32] In summary, the principle that parties cannot contract out of bankruptcy laws has a lengthy

common law history, dating back at least to the 18th century in England: Wood, “Fraud Upon the

Bankruptcy” at 171. The anti-deprivation rule in particular has received positive treatment from

Canadian courts. Contracting parties cannot rely on provisions that are engaged by a debtor’s

insolvency and remove value from the debtor’s estate to the prejudice of creditors. Much like the

pari passu rule, I accept that it would disregard the BIA and deprive it of all meaning if a bankrupt

could agree that assets would be diverted out of its estate in the event of insolvency: Bail at 487.

Page: 7

B. Effect of the Statutory Ipso Facto Provisions

[33] The BIA includes provisions invalidating certain types of contract clauses that take effect

upon the occurrence of a debtor’s insolvency. However, the statutory provisions apply only to

corporate restructuring, consumer proposals, and consumer bankruptcies. None of the BIA

provisions applies to corporate bankruptcies, meaning that they do not apply in this case. Chandos

contends and my colleague concludes that the BIA provisions codify and, in the present context,

supplant the common law anti-deprivation rule. In my view, a more appropriate conclusion is that

the statutory provisions were intended to expand the common law to provide protection to debtors

in situations where the anti-deprivation rule would not have protected them.

[34] Provisions that offend the anti-deprivation rule are also referred to as ipso facto clauses, a

term which encompasses any provision that sets out the consequences of a debtor’s insolvency:

Black’s Law Dictionary, 10th ed, sub verbo “ipso facto clause”; Duggan et al at 296. However, not

all ipso facto clauses offend the anti-deprivation rule. For example, some ipso facto clauses

operate to terminate executory agreements between an insolvent debtor and another contracting

party: Duggan et al at 296; Wood, “Bankruptcy and Insolvency” at 178. Eliminating a debtor’s

opportunity to perform a contract does not necessarily result in a deprivation of value that would

prejudice creditors.

[35] The United States Code expressly prohibits ipso facto provisions regardless of whether

they offend the anti-deprivation rule: 11 USC § 365(e); 11 USC § 541(c). The provisions read, in

part:

365(e)(1) Notwithstanding a provision in an executory contract or unexpired lease,

or in applicable law, an executory contract or unexpired lease of the debtor may not

be terminated or modified, and any right or obligation under such contract or lease

may not be terminated or modified, at any time after the commencement of the case

solely because of a provision in such contract or lease that is conditioned on—

(A) the insolvency or financial condition of the debtor at any time before the

closing of the case;

(B) the commencement of a case under this title; or

(C) the appointment of or taking possession by a trustee in a case under this

title or a custodian before such commencement.

…

541(c)(1) … an interest of the debtor in property becomes property of the estate …

notwithstanding any provision in an agreement, transfer instrument, or applicable

nonbankruptcy law—

Page: 8

…

(B) that is conditioned on the insolvency or financial condition of the

debtor, on the commencement of a case under this title, or on the

appointment of or taking possession by a trustee in a case under this title or

a custodian before such commencement, and that effects or gives an option

to effect a forfeiture, modification, or termination of the debtor’s interest in

property.

[36] In contrast, section 65.1 of the BIA, which applies when a commercial debtor has filed a

notice of intention or proposal, is representative of the BIA’s ipso facto provisions. The provision

reads, in part:

65.1 (1) If a notice of intention or a proposal has been filed in respect of an

insolvent person, no person may terminate or amend any agreement, including a

security agreement, with the insolvent person, or claim an accelerated payment, or

a forfeiture of the term, under any agreement, including a security agreement, with

the insolvent person, by reason only that

(a) the insolvent person is insolvent; or

(b) a notice of intention or a proposal has been filed in respect of the

insolvent person.

[37] Sections 66.34 and 84.2 of the BIA are similarly worded and invalidate ipso facto clauses in

the context of consumer proposals and consumer bankruptcies, respectively. Notably, all of these

sections mirror 11 USC § 365(e) but make no mention of the property deprivation targeted by 11

USC § 541(c). In my view, this is because the BIA provisions were primarily intended to prohibit

ipso facto clauses that terminate or modify executory agreements.

[38] The prohibition on ipso facto clauses initially applied only to commercial restructuring and

consumer proposals, as sections 65.1 and 66.34 of the BIA were enacted prior to section 84.2. In

other words, Parliament first saw fit to prohibit the use of certain ipso facto provisions in contexts

where debtors are attempting to reach a compromise with their creditors. In those contexts, it is

important to maintain the status quo by allowing debtors to continue to rely on existing contractual

relationships: Ho at 146. Preserving such relationships helps provide debtors with the opportunity

to successfully restructure their liabilities: Crystalline Investments Ltd v Domgroup Ltd (2002), 58

OR (3d) 549 at paras 6-8, 210 DLR (4th) 659 (CA), aff’d 2004 SCC 3, [2004] 1 SCR 60. The same

concern is not as pressing with respect to a corporate bankruptcy, as the corporate entity is destined

for liquidation: Ho at 182.

Page: 9

[39] For consumers, the ipso facto provisions provide further protection, preventing creditors

from terminating basic services even where the debtor has failed to make required payments: BIA,

ss 66.34(3), 84.2(3).

[40] For example, section 66.34(3) provides:

66.34 (3) Where a consumer proposal has been filed in respect of a consumer

debtor, no public utility may discontinue service to that consumer debtor by reason

only that

(a) the consumer debtor is insolvent,

(b) a consumer proposal has been filed in respect of the consumer

debtor, or

(c) the consumer debtor has not paid for services rendered, or

material provided, before the filing of the consumer proposal

until the consumer proposal has been withdrawn, refused by the creditors or the

court, annulled or deemed annulled.

[41] In the 2009 amendments to the BIA, the ipso facto prohibitions were extended to consumer

bankruptcies. This was motivated by the “fresh start” principle that stems from the discharge

available to consumer bankrupts. Prohibiting ipso facto termination clauses ensures that a debtor

seeking a fresh start cannot be “unreasonably evicted from their home, denied basic and essential

services or denied other benefits to which they would otherwise be entitled”: Duggan et al at 296,

citing Industry Canada, Bill C-55 Clause-by-Clause Analysis (6 September 2011). The Senate

Standing Committee on Banking, Trade and Commerce, which recommended the reform,

similarly stated that ipso facto clauses “should be unenforceable in order to ensure that debtors

continue to have access to the basic services that they and their families need”: Senate, Standing

Committee on Banking, Trade and Commerce, Debtors and Creditors Sharing the Burden: A

Review of the Bankruptcy and Insolvency Act and the Companies’ Creditors Arrangement Act

(November 2003) at 75 (Chair: Hon Richard H. Kroft). This concern has no bearing on corporate

bankruptcies.

[42] The statutory provisions exhibit a debtor-protection purpose with two facets. First, they

ensure that consumer and corporate debtors seeking to restructure their affairs have the time and

resources to do so by maintaining the status quo. Second, the provisions extend protection to all

consumer debtors to prevent the termination of basic services and executory agreements. This

protection recognizes the impact such terminations would have on individuals and their families.

These purposes are either less pressing or completely inapplicable to corporate bankruptcies,

which may explain why the statutory provisions were not extended to those situations. Moreover,

the debtor-protection purpose of the statutory provisions stands in contrast to the anti-deprivation

rule, which protects creditors by ensuring a fair and equitable distribution of the debtor’s estate:

Page: 10

Bramalea at 694. In my view, this difference in purpose suggests that the statutory provisions

expanded the common law. It does not lead to the inference that the common law rule was

replaced.

[43] Furthermore, the BIA provisions represent only a partial codification of the

anti-deprivation rule: Wood, “Bankruptcy and Insolvency” at 90. None of the statutory provisions

mentions a deprivation of assets from the debtor’s estate – the sole concern of the anti-deprivation

rule. In my view, there are at least some deprivations of property that would not be considered a

termination, amendment, acceleration, or forfeiture of a term caught by the language of the

statutory provisions. Professor Wood also notes that “there may be instances where the transaction

arises out of a grant rather than an agreement or involves a transfer of an asset to a third party so as

to take it outside the ambit of the statutory provision[s]”: Wood, “Bankruptcy and Insolvency” at

90.

[44] Even if the BIA provisions do fully capture the common law rule, their scope is certainly

much broader. The anti-deprivation rule is not generally concerned with the termination of

agreements unless value is removed from the debtor’s estate. The anti-deprivation rule also

differentiates between the defeasance of an absolute interest and grants that create limited interests

from the outset, holding that the latter are enforceable: Belmont Park Investments Pty Ltd v BNY

Corporate Trustee Services Ltd, [2011] UKSC 38 at paras 84-87, [2012] 1 All ER 505; Knechtel.

The BIA provisions do not have the same limitation, extending their application to interests such as

leases and licenses: Wood, “Bankruptcy and Insolvency” at 90. I conclude that expansion of the

common law in the restructuring and consumer bankruptcy contexts does not mean that the

anti-deprivation rule was eliminated for corporate bankruptcies.

[45] In my view, the distinctions between the statutory provisions and the common law

anti-deprivation rule prohibit the inference that the statutory provisions have occupied the field

with respect to ipso facto clauses. As the BIA provisions and the anti-deprivation rule serve

different purposes, and the overlap between them is not extensive, Parliament’s legislative

prohibition of one type of clause does not invite the inference that it condones the other. The

statutory provisions expand the common law, protecting debtors by prohibiting ipso facto clauses

that would not have been caught by the anti-deprivation rule. The anti-deprivation rule continues

to apply, protecting creditors by ensuring that a bankrupt’s property is distributed in accordance

with the BIA’s scheme of distribution.

C. The Test for Applying the Anti-Deprivation Rule

[46] Even if the anti-deprivation rule applies in Canada, Chandos contends that it does not

invalidate good faith commercial transactions and urges this Court to adopt the test enunciated by

the United Kingdom Supreme Court in Belmont. The court concluded that the anti-deprivation rule

does not apply to “bona fide commercial transactions which do not have as their predominant

purpose, or one of their main purposes, the deprivation of the property of one of the parties on

bankruptcy”: Belmont at para 104. This test looks at the purpose of the provision rather than its

Page: 11

effect. I decline to adopt Belmont. The purpose-based test articulated in Belmont is inconsistent

with Canadian cases applying the anti-deprivation rule and would eliminate virtually all of the

rule’s utility.

[47] Canadian cases applying the anti-deprivation rule adopt an effects-based approach to

determining the validity of a contractual provision: Wood, “Bankruptcy and Insolvency” at 89-90.

Blair J in Bramalea, stated that the fraud on the bankruptcy law principle targets “not necessarily

‘fraud’ in the sense of dishonesty or impropriety, but fraud in the effect”: Bramalea at 694. And

while the Supreme Court of Canada did not address the issue directly in Coopérants, an

effects-based approach is implicit in the court’s determination that no prejudicial effect was

evident in the circumstances: Coopérants at para 44.

[48] Cases dealing with the pari passu rule similarly apply an effects-based approach. Bail and

Greenview both dealt with contractual provisions allowing payments to be made directly to

subcontractors to satisfy the obligations of a general contractor. Such provisions are generally

motivated by the inability of subcontractors to acquire liens over public lands: Greenview at para

31; Bail at 483-484. The provisions clearly served a legitimate commercial purpose. Nevertheless,

applying them after the general contractor had entered bankruptcy proceedings would have

operated to disrupt the bankruptcy scheme of distribution. Both this Court and the Supreme Court

of Canada refused to allow such a result.

[49] In Belmont at paras 78-79, the court distinguished between the anti-deprivation rule and the

pari passu rule, holding that a purpose-based approach applies only to the former. However, both

rules stem from the basis that it would be inequitable to creditors if parties could contract out of the

bankruptcy scheme. I see no principled basis to adopt differing standards for the two rules.

[50] Furthermore, adoption of a purpose-based approach in the United Kingdom has received

criticism for defeating the purpose of the anti-deprivation rule. Professor Worthington notes that

“insisting that breach of the [anti-deprivation] rule depends on a deliberate intention to evade the

insolvency law effectively emasculates this limb of the [fraud on the bankruptcy principle]”: Sarah

Worthington, “Good Faith, Flawed Assets and the Emasculation of the UK Anti-Deprivation

Rule” (2012) 75:1 Mod L Rev 112 at 117. Professor Wood similarly concludes that Canadian

courts should not adopt a purpose-based test: Wood, “Fraud Upon the Bankruptcy” at 184. The

purpose of the anti-deprivation rule is to ensure that contracting parties cannot opt out of the

distribution of assets mandated by the BIA. This purpose is best served by invalidating provisions

that operate in the event of insolvency and have the effect of prejudicing creditors.

[51] Finally, I do not accept that an effects-based approach would inappropriately undermine

the values of freedom of contract and party autonomy, given the creditor-protection purpose of the

fraud on the bankruptcy principle. The Supreme Court recognized this in Coopérants at para 41,

stating that contracts signed in good faith should be respected, “unless the obligations contained

therein are prejudicial to the other creditors and give rise to an unjust preference in light of all the

circumstances” [emphasis added]. Freedom of contract is a much more central consideration when

Page: 12

enforcing provisions that have been negotiated by the parties they affect. A party who might

become insolvent has no motivation to negotiate a clause that directs property out of its estate upon

insolvency. At the moment the clause becomes operative, the insolvent party is set to lose the

property regardless of the contractual provision. The creditors who are impacted by the clause do

not have a seat at the negotiating table.

[52] For all of these reasons, I decline to adopt the purpose-based approach espoused in

Belmont. Canadian authorities on the anti-deprivation rule support an effects-based approach to

determining whether a provision is enforceable against the trustee in bankruptcy. Moreover, I

agree with the conclusion that considering the purpose of a contractual provision would all but

sterilize the anti-deprivation rule. The anti-deprivation rule applies to provisions that operate in the

event of insolvency and, in effect, remove value from a bankrupt’s estate to the prejudice of the

bankrupt’s creditors. It follows that I do not endorse the new test proposed by my colleague.

VI.

Application

[53] The chambers judge correctly identified the existence and application of the fraud on the

bankruptcy principle in Canada. In outlining the scope of the anti-deprivation rule, however, the

chambers judge erred. The chambers judge adopted the purpose-based approach set out by the

Supreme Court of the United Kingdom in Belmont. He stated that if the clause were a genuine

pre-estimate of damages, or a bona fide commercial transaction not premised on the avoidance of

bankruptcy laws, it would have to be upheld.

[54] As I have indicated, the proper approach is to look at the effect of clause VII Q(d), rather

than its purpose. Whether the provision is a liquidated damages or penalty clause is a separate

analysis.

[55] Looking at the effect of clause VII Q(d), this case is not comparable to Coopérants, where

there was no established prejudice to creditors. Clause VII Q(d) effectively redirects $126,818.39

to Chandos that would have otherwise formed part of Capital Steel’s estate and gives Chandos a

further claim for $10,511.66. Other provisions of Clause Q address the ability of Chandos to

complete the work, to recover the cost to complete the work, and to withhold a percentage of the

contract price until all warranties have expired. It is only Clause VII Q(d) which is at issue. While

Chandos undoubtedly has legitimate commercial interests it was seeking to protect, it would

conflict with the BIA’s scheme of distribution if Chandos could elevate itself to a preferred status

through such a contractual arrangement. The common law anti-deprivation rule invalidates clause

VII Q(d) and Chandos cannot rely on the provision in defence of a claim for payment by the

trustee.

[56] Given that clause VII Q(d) contravenes the common law anti-deprivation rule, it is

unnecessary to address whether it also would constitute an unenforceable penalty.

Page: 13

VII. Conclusion

[57] The appeal is allowed. Chandos is not entitled to rely on clause VII Q(d) of the subcontract

against Deloitte, the trustee in bankruptcy.

Appeal heard on November 28, 2017

Reasons filed at Edmonton, Alberta

this 29th day of January, 2019

Rowbotham J.A.

I concur:

Veldhuis J.A.

Page: 14

_______________________________________________________

Dissenting Reasons for Judgment Reserved of

The Honourable Mr. Justice Wakeling

_______________________________________________________

I.

Introduction

[58] This case presents challenging contract and bankruptcy law issues of national importance.

[59] At issue is the enforceability of a construction-contract term providing that the

subcontractor forfeits ten percent of its total fee if the subcontractor commits an act of bankruptcy.

[60] I agree with the chambers judge that it is enforceable and dismiss the trustee in

bankruptcy’s appeal.

A.

The Penalty Rule Issue

[61] For over 200 years courts in England¹and the United States²and, for shorter periods of

time in Canada,³Australia,⁴New Zealand⁵and Hong Kong,⁶have declined to enforce contractual

¹Holles v. Wyse, 23 Eng. Rep. 787 (Ch. 1693)(the Court refused to enforce a default-interest-uplift term because it

was a penalty); Sloman v. Walter, 28 Eng. Rep. 1213 (Ch. 1783)(the Court refused to enforce a promise a coffee-house

partner made to pay £500 to another partner if the promisor refused to make available a particular room in the

coffee-house whenever the promisee demanded it: “where a penalty is inserted merely to secure the enjoyment of a

collateral object [access to the coffee-house room], the enjoyment of the object is considered as the principal intent of

the deed, and the penalty only as accessional, and therefore, only to secure the damage really incurred”); Hardy v.

Martin, 29 Eng. Rep. 1046 (Ch. 1783)(the Court enjoined by injunction a promissee who secured a common law

judgment on a bond from enforcing it because the promisor breached his obligation not to operate a competitive

brandy-merchant business within a defined area and time); Astley v. Weldon, 126 Eng. Rep. 1318 (Common Pleas

1801)(the Court characterized an actress’ promise to pay 200£ if she failed to discharge her obligations to the theatre

owner as a penalty and unenforceable because the parties did not intend her to pay £200 for any breach regardless of its

nature); Kemble v. Farren, 130 Eng. Rep. 1234 (Common Pleas 1829)( the Court characterized a comedian’s promise

to pay £1000 if he failed to discharge his obligations to the theatre owner as an unenforceable penalty because the

parties could not have intended this to be the consequence of minor and major breaches alike); Betts v. Burch, 157

Eng. Rep. 938 (Ex. 1859) (the Court upheld a jury verdict that the purchaser of stock-in-trade was not obliged to pay

the vendor £50 for breach of the purchase-and-sale agreement as it was an unenforceable penalty); Commissioner of

Public Works v. Hills, [1906] A.C. 368 (P.C.) (Cape of Good Hope) (the Court held that a ten per cent forfeit of

retained moneys was unenforceable because it did not reflect the promisee’s actual loss); Pearl Assurance Co. v. South

Africa, [1934] A.C. 570 (P.C.) (S. Africa); (the Privy Council declared that a term in a commercial agreement

acknowledging that a £10,000 deposit be forfeited on the occurrence of certain conditions and described as liquidated

damages was an unenforceable penalty); United Dominions Trust (Commercial) v. Ennis, [1967] 2 All E.R. 345 (C.A.)

(the Court refused to enforce a term in a consumer hire-purchase contract that obliged the hirer to pay a minimum of

two-thirds of the hire-purchase price on early termination of the hire-purchase agreement); Gilbert Ash (Northern) Ltd.

v. Modern Engineering (Bristol) Ltd., [1974] A.C. 689, 703 (H.L. 1973) per Lord Morris of Borth-y-Gest (“Such a

heavily penalising provision ought not to be accorded any validity”); Jobson v. Johnson, [1989] 1 All E.R. 621 (C.A.

Page: 15

1988) (the Court characterized a term in a share-purchase agreement that required the purchaser of shares in a football

club to deliver the shares to the vendor upon default for one-quarter of the instalment amounts paid before default as an

unenforceable penalty); Workers Trust Bank Ltd. v. Dojap Ltd., [1993] A.C. 573 (P.C.)(Jamaica)(the Privy Council

allowed a land purchaser’s appeal and held that the forfeiture of a twenty-five percent deposit was an unenforceable

penalty); Jeancharm Ltd. v. Barnet Football Club Ltd., [2003] EWCA Civ 58 (the Court allowed an appeal on the

ground that a 260 percent annual interest on late payments was an unenforceable penalty) & CMC Group Plc & Ors v.

Zhang [2006] EWCA Civ 408 (the Court allowed the appeal on the ground that the key term in the settlement

agreement was primarily a deterrent and not a genuine preestimate of damages).

²Perkins v. Lyman, 11 Mass. 76 (Sup. Ct. 1814)(the Court held that a ship vendor’s promise not to do business in the

northwest coast of America and pay $8000 if he did to be an unenforceable penalty); Robeson v. Whitesides, 16 Serge

& Rawle 320; 1827 Pa. Lexis 88 (Sup. Ct.) (the Court held that a $1000 defeasible bond made void upon the obligor’s

extinguishment of encumbrances on sold property within a nine month period was an unenforceable penalty); Van

Buren v. Digges, 52 U.S. 461, 477 (1851)(“The clause of the contract providing for the forfeiture of ten per centum on

the amount of the[building] contract price, upon a failure to complete the work by a given day, cannot properly be

regarded as an agreement or settlement of liquidated damages. … [I]t has no necessary or natural connection with the

measure or degree of injury which may result from a breach of contract, or from an imperfect performance. It implies

an absolute infliction, regardless of the nature and extent of the causes by which it is superinduced”); Greenblatt v.

McCall, 67 Fla. 165, 169 (Sup. Ct. 1914)(the Court concluded that a retailer’s promise to pay a sum equal to two-thirds

of the charges for the duration of the supply contract following breach was an unenforceable penalty); Advance

Amusement Corp. v. Franke, 109 N.E. 471 (Ill. Sup. Ct. 1915) (the Court upheld lower court determinations that a

theatre-rental deposit of $2500 was not liquidated damages and on breach of the rental agreement the theatre owner

was not entitled to keep it); Priebe & Sons, Inc. v. United States, 332 U.S. 407, 418 (1947) per Frankfurter, J.

(“exactions for a breach of contract not giving rise to damages and merely serving as added pressure to carry out

punctiliously the terms of a contract, are not enforced by courts. In familiar language, penal provisions in a contract ...

are not enforceable”); Wilmington Housing Authority v. Pan Builders, Inc., 665 F. Supp. 351, 354 (D. Del. 1987)(“If

the provision fails to meet one of these criteria, the damages stemming from a breach being easily ascertainable or the

amount fixed excessive, the provision is void as a penalty”); City of Rye v. Public Service Mutual Insurance Co., 315

N.E. 2d 458 (N.Y. Ct. App. 1974) (the Court refused to enforce against a surety a construction bond for late

completion of a large residential complex on the ground that it provided for a penalty) & American Law Institute, The

Restatement (Second) of Contracts (1981) §356(1) (“Damages for breach by either party may be liquidated in the

agreement but only at an amount that is reasonable in light of the anticipated or actual loss caused by the breach and

the difficulties of proof of loss. A term fixing unreasonably large liquidated damages is unenforceable on grounds of

public policy as a penalty”).

³Empire Loan and Savings Co. v. McRae, 5 O.L.R. 710 (H. Ct. 1903) (the Court upheld a Master’s decision refusing

to give force to a term it characterized as a penalty); Townsend v. Rumball, 19 O.L.R. 433 (Div. Ct. 1909)(the Court set

aside a County Court judgment on the ground that a noncompetition term in a business-sale contract was a penalty and

not liquidated damages); St. Catherines Improvement Co. v. Rutherford, 26 O.W.R. 76 (K.B. 1914)(the Court refused

to enforce a stipulated-payment-on-breach term characterizing it as a penalty); Shatilla v. Feinstein, [1923] 3 D.L.R.

1035 (Sask. C.A.) (the Court characterized a promise by a wholesale dry-goods merchant to pay the purchaser of the

business $10,000 if the vendor engaged in a competitive business as an unenforceable penalty); MacDonald v. N.W.

Biscuit Co., [1924] 1 D.L.R. 987, 998-99 (Alta. Sup. Ct. App. Div.)(the Court declared a provision in a construction

contract that deprived the contractor of an amount over and above the cost of repairing deficient work to be an

unenforceable penalty); Waugh v. Pioneer Logging Co., [1949] S.C.R. 299 (the Court characterized a provision in a

commercial logging contract that entitled the vendor of the timber rights to claim a portion of the proceeds of the sale

of timber held in trust as an unenforceable penalty); Charterhouse Leasing Corp. v. Sanmac Holdings Ltd., 57 W.W.R.

615 (Alta. Sup. Ct. 1966) (the Court held that a term obliging the lessee of equipment on default to pay immediately

the whole balance due under the lease was an unenforceable penalty); Canadian Acceptance Corp. v. Regent Park

Butcher Shop Ltd., 3 D.L.R. 3d 304 (Man. C.A. 1969)(the Court held that an acceleration-payment term in an

Page: 16

equipment-lease agreement was an unenforceable penalty); H.F. Clarke Ltd. v. Thermidaire Corp, [1976] 1 S.C.R.

319, 339 (1974)(“I would characterize the exaction of gross trading profits for a three-year period as a penalty [and

unenforceable] ... The respondent is, however, entitled to recover its provable damages for the breach of covenant”);

Unilease Inc. v. York Steel Construction Ltd., 83 D.L.R. 3d 275 (Ont. C.A. 1978) (the Court allowed the appeal on the

ground that the accelerated-lease-payment-on-default term was an unenforceable penalty); Dial Mortgage Corp. v.

Baines, 15 Alta. L.R. 2d 211 (Q.B. 1980)(the Court declined to enforce a stipulated-payment-on-breach term in a

mortgage application because it was a penalty); Prince Albert Credit Union v. Johnson, 131 D.L.R. 3d 710 (Sask. Q.B.

1982)(the Court held that a term requiring the defaulting borrower to pay a designated sum to cover the lender’s

resulting expenses on default was an unenforceable penalty); Dezcam Industries Ltd. v. Kwak, [1983] 5 W.W.R. 32

(B.C.C.A.)(the Court reversed the original court and held that the licencee’s obligation to pay $85,000 was an

unenforceable penalty); B.L.T. Holdings Ltd. v. Excelsior Life Insurance Co., 52 A.R. 1 (Q.B. 1984)(the Court

characterized a mortgage standby fee of $61,500 as an unenforceable penalty), rev’d, [1986] 6 W.W.R. 534 (C.A.);

Federal Business Development Bank v. Eldridge, 76 N.B.R. (2d) 399 (C.A. 1986) (the Court upheld the trial judgment

declaring a commitment fee of three percent an unenforceable penalty); Newman, Hill, Duncan & Lacoursiere v.

Murray, [1987] B.C.J. No. 2326 (C.A.)(the Court held that a provision in an employment agreement obliging the

employee who breached a noncompetition term to pay 150 % of the fees the plaintiff charged the client that the

defendant serviced contrary to the employment agreement as an unenforceable penalty); Deer Valley Shopping Centre

Ltd. v. Sniderman Radio Sales and Services Ltd., 67 Alta. L.R. 2d 203 (Q.B. 1989)(the Court declined to enforce an

interest-escalation-on-overdue rent term because it was an unenforceable penalty); Ashland Scurlock Permian Canada

Ltd. v. NESI Energy Marketing Canada Ltd. (Bankrupt), [1999] 1 W.W.R. 364, 371 (Alta. Q.B. 1998) (the Court

declared a provision in a natural gas sales contract as an unenforceable penalty because “the amount of the multiple

used in the formula creates an extravagant amount which cannot be regarded as having any real relation to any loss

which Ashland could possibly sustain”); Cracknell v. Jeffrey, 284 A.R. 372, (Prov. Ct. 2001) (the Court refused to

enforce a property-lease term that obliged the tenant to pay a $5 assessment for every day rent is outstanding); Place

Concorde East Limited Partnership v. Shelter Corp. of Canada, [2003] O.J. No. 5437; 43 B.L.R. 3d 54 (Super.

Ct.)(the Court declined to enforce an interest-escalation term on a promissory note default); MTK Auto West Ltd. v.

Allen, 2003 BCSC 1613 (the Court declared a provision in a vehicle-purchase agreement that obliged the purchaser to

pay the car dealer $5000 if the purchaser sold the vehicle in the United States contrary to the terms of the

vehicle-purchase agreement to be an unenforceable penalty) & Dundas v. Schafer, 2014 MBCA 92; 377 D.L.R. 4^th

485 (the Court refused to enforce a term in a prenuptial agreement that obliged the wife to pay the husband $20,000 if

she challenged the prenuptial agreement on the ground that it was a penalty).

⁴O’Dea v. Allstates Leasing System (W.A.) Pty. Ltd., [1983] HCA 3, ¶15; 152 C.L.R. 359, 374 (the High Court held

that a stipulated-payment-on-breach term in a truck-lease contract was an unenforceable penalty); Paciocco v.

Australia and New Zealand Banking Group, [2016] HCA 28,¶74; 258 C.L.R. 525, 558 per Gageler, J. (“The ultimate

question ... is whether the contractual stipulation for the late payment fee was unenforceable as a penalty at common

law”).

⁵T.K. (Hong Kong) Ltd. v. Diamond Milk Formulas Ltd., [2016] NZHC 2642, ¶39 (“before there can be any question

of disallowance of penalties, it must involve the contract imposing a penalty in circumstances where it provides for a

sanction to be paid by a party breaking the contract which exceeds the likely loss that will flow from the breach”).

⁶Leatra Co. v. Wing, [1978] HKDC 32 (the Court refused to enforce a termination term in an employment contract

because it was not a pre-estimate of damages; it was a penalty); Arnold & Co. v. Attorney General, [1989] HKCFI 275

(the Court declared a fee-reduction-for-delay term in a construction contract as an unenforceable penalty); Polyset Ltd.

v. Panhandat Ltd., [2002] HKCFA 15 (the Court held that a term in a commercial land agreement allowing the vendor

to keep $40.25 million in deposits in a $115 million transaction on the failure of the purchaser to close was an

unenforceable penalty); Savino Del Bene China Ltd. v. Convac Technologies Ltd., [2002] HKDC 106 (the Court

refused to enforce a term in a freight contract relieving the shipper of the obligation to pay the freight forwarder

because part of the shipment was not delivered on time); Ricoh Hong Kong Ltd. v. Maxwin Digital Printing Ltd., 2008

Page: 17

stipulated-consequence-on-breach terms⁷that they characterized as penalties and contrary to

public policy. As a consequence, in spite of the promisor’s express agreement to the contrary, the

disappointed promisee has had to prove the damages caused by the promisor’s contract breach, just

as the promisee would have had to do if there had been no stipulated-consequence-on-breach

term.⁸These and related propositions are known as the common law penalty rule. ⁹

HKDC 146 (the Court characterized an acceleration-payment in an equipment hire-purchase agreement as an

unenforceable penalty); Canning International Ltd. v. Freenet Asia Ltd., [2011] HKDC 1595 (the Court characterized

a delay-charge-reduction term in a clothing manufacture contract as an unenforceable penalty) & Sun Champ

Investment Ltd. v. Green Leaves Trade Investment Ltd., [2013] HKDC 1461 (the Court refused to enforce a term in a

property sale agreement obliging the vendor to pay a stipulated sum on its failure to convey good title, characterizing

the term as an unenforceable penalty).

⁷This is a contractual term that imposes an obligation on a promisor to pay a sum of money to the promisee or do some

other thing for the promisee’s benefit, or accept some other detriment for the promisee’s benefit if the promisor fails to

discharge a specified obligation in the agreement. Scottish Law Commission, Discussion Paper on Penalty Clauses

(No. 162) 11 (November 2016) (“[The Scottish Law Commission] recommended that judicial control over contractual

penalties should apply whether the penalty was expressed in monetary terms or in some other way. The basis of our

recommendation was that there was no apparent reason why a provision should escape control simply because it is in

the form of a penalty other than the payment of money”). E.g., Jobson v. Johnson, [1989] 1 All E.R. 621, 628 (C.A.

1988) (the Court characterized a term in a football-club share-sale contract that obliged the purchaser to transfer

ownership of the shares back to the vendor for a fraction of the price the purchaser had paid before the purchaser

defaulted on an instalment payment as a penalty) & Cavendish Square Holding BV v. El Makdessi, [2015] UKSC 67,

¶16; [2016] A.C. 1172, 1197 (S.C.) per Lord Neuberger & Lord Sumption (“there is no reason why an obligation to

transfer assets (either for nothing or at an undervalue) should not be capable of constituting a penalty”), ¶170 & [2016]

A.C. at 1253-54 per Lord Mance (“the doctrine should [not] be confined to cases of payment of money. It would be

absurd to draw a rigid distinction between a requirement to transfer money and property. It would also be absurd to

draw such a distinction between them and the withholding of moneys due. Such uncertainties as may exist regarding

the doctrine’s applicability to deposits or to clauses forfeiting pre-payments must await decision in due course”) &

¶226 & [2016] A.C. at 1270 per Lord Hodge (“I see no principled reason why the law on penalties should be confined

to clauses that require the contract-breaker to pay money in the event of breach and not extend to clauses that in the

same circumstances allow the innocent party to withhold moneys which are otherwise due”).

⁸Cavendish Square Holding BV v. El Makdessi, [2015] UKSC 67, ¶9; [2016] A.C. 1172, 1195 per Lord Neuberger &

Lord Sumption (“Deprived of the benefit of the provision, the innocent party is left to his remedy in damages under the

general law”); Scandinavian Trading Tanker Co. v. Flota Petrolera Ecuatoriana (Scaptrade), [1983] 2 A.C. 694, 702

per Lord Diplock (“The classic form of relief against ... a penalty clause has been to refuse to give effect to it, but to

award the common law measure of damages for the breach of the primary obligation instead”); Dunlop Pneumatic

Tyre Co. v. New Garage and Motor Co., [1915] A.C. 79, 100 (H.L. 1914) per Lord Parmoor (“If the Court ... comes to

the conclusion that the parties have made a mistake in calling the agreed sum liquidated damages, and that such sum is

not really a pactional pre-estimate of loss within the contemplation of the parties at the time when the arrangement was

made, but a penal sum inserted as punishment on the defaulter irrespective of the amount of any loss which could at the

time have been in contemplation of the parties, then such sum is a penalty, and the defaulter is only liable in respect of

damages which can be proved against him”) & United States v. Bethlehem Steel Co., 205 U.S. 105, 119 (1907) (“[the

courts] tendency was to construe language as a penalty, so that nothing but the actual damages sustained by the party

aggrieved could be received”).

Page: 18

[62] The classic penalty rule – a stipulated-consequence-on-breach term that is a penalty and

not a genuine pre-estimate of damage is unenforceable – is confusing and complex¹⁰and produces

inconsistent results. Its value has been questioned for almost as long as it has existed.

[63] In 2015 Lord Neuberger and Lord Sumption, of the United Kingdom Supreme Court,

described the penalty rule in unflattering language:¹¹“The penalty rule in England is an ancient,

haphazardly constructed edifice, which has not weathered well, and which in the opinion of some

should simply be demolished ...”.

[64] These judges were not the penalty rule’s first detractors.

[65] There were a number of high profile nineteenth century critics. Lord Eldon railed against

the penalty rule in 1811, ¹²observing that the rule was “utterly without foundation”. Justice

Ruggles of New York’s highest court acknowledged in an 1854 opinion that “[t]he ablest of judges

have declared that they felt themselves embarrassed in ascertaining the principle on which the

decisions [refusing to enforce stipulated-consequence-on-breach terms] were founded”.¹³In 1859,

⁹The penalty rule is not an alien concept in the civil law. See generally Scottish Law Commission, Review of Contract

Law: Discussion Paper on Penalty Clauses 15-18 (Discussion paper No. 162 November 2016) for a discussion of the

law of France, Germany and the Netherlands.

¹⁰Mortgage Makers Inc. v. McKeen, 2009 NBCA 61, ¶39; 312 D.L.R. 4^th82, 100 (“The above summary attests to the

complexity of the common law surrounding the enforcement of clauses that pre-determine damages for breach of

contract”).

¹¹Cavendish Square Holding BV v. El Makdessi, [2015] UKSC 67, ¶3; [2016] A.C. 1172, 1192. Lord Carnwath

agreed with his colleagues.

¹²Hill v. Barclay, 34 Eng. Rep. 238, 239 (Ch. 1811). See also Astley v. Weldon, 126 Eng. Rep. 1318, 1321 (Common

Pleas 1801) per Lord Eldon (“when their case came before me ..., I felt as I have often done before in considering the

various cases on this head, much embarrassed in ascertaining the principle upon which those cases were founded”) &

Robophone Facilities Ltd. v. Blank, [1966] 3 All E.R. 128, 142 (C.A.) per Diplock, C.J. (“I make no attempt, where so

many others have failed, to rationalize this common law rule”).

¹³Cotheal v. Talmadge, 9 N.Y. 551, 553 (Ct. App. 1854). Other American judges have subsequently expressed similar

sentiments. E.g., Brecher v. Laikin, 430 F. Supp. 103, 106 (S.D.NY. 1977) (“Liquidated damages provisions have a

checkered history”); Callanan Road Improvement Co. v. Colonial Sand & Stone Co., 72 N.Y.S. 2d 194, 196 (Sup. Ct.

App. Div. 1947) (“Many more complex and intrinsically less tractable subjects have been reduced to order; this one,

from the struggles of the English judges with it before the Revolution to the present time, remains oddly elusive”);

Evans v. Moseley, 114 P. 374, 377 (Kan. Sup. Ct. 1911) (“There is no branch of law on which unanimity of decision is

more difficult to find or on which more illogical and inconsistent holdings may be found”); Wilson v. Mayor of

Baltimore, 34 A. 774, 775 (Md. Ct. App. 1896) (“Whether a sum named in a contract to be paid by a party in default on

its breach is to be considered liquidated damages or merely a penalty, is one of the most difficult and perplexing

inquiries encountered in the construction of written agreements. The solution of that question ... [is] to some extent

controlled by artificial general rules which are not wholly in harmony with the ordinary canons of construction);

Gobble v. Linder, 76 Ill. 157, 158 (Sup. Ct. 1875) (“ No branch of the law is involved in more obscurity, by

contradictory decisions, than whether the sum named in an agreement to secure performance will be treated as

liquidated damages or as penalty”) & Jaquith v. Hudson, 5 Mich. 123, 133 (Sup. Ct. 1858)(“It is not to be denied that

Page: 19

Baron Martin¹⁴of the English Court of Exchequer expressed his frustration with the penalty rule.

He complained that binding precedent precluded him from declaring that “parties are at liberty to

enter into any bargain they please” and must live with “improvident” bargains. In 1882 Sir George

Jessel decried it as an “absurdity”¹⁵and lamented that he did not know “[t]he ground of that

doctrine”.¹⁶

[66] Opposition to the penalty rule in India was so profound in the nineteenth century that it was

statutorily revoked by s. 74 of the Indian Contract Act, 1872. ¹⁷Speaking almost 100 years after

this legislative intervention, the Indian Supreme Court observed that “[s.74] is clearly an attempt

to eliminate the somewhat elaborate refinements made under the English common law in

distinguishing between stipulations providing for payment of liquidated damages and stipulations

in the nature of penalty”.¹⁸

[67] Complaints about the theoretical underpinnings of the penalty rule continued in the

twentieth century. For example, Lord Parmoor, in 1914, used more restrained language to flag the

rule’s shortcomings:¹⁹“It is too late to question whether such interferences with the language of a

contract can be justified on any rational principle.”

[68] The Supreme Court of the United Kingdom, in Cavendish Square Holding BV v. El

Makdessi,²⁰the High Court of Australia in Paciocco v. Australia and New Zealand Banking Group

Ltd.²¹and the Scottish Law Commission²²have all recently extensively reviewed the merits of the

penalty rule and provided valuable fresh insights on its utility. This is a task that the Supreme

there is some conflict, and more confusion, in the cases; judges have been long and constantly complaining of the

confusion and want of harmony in the decisions upon this subject”) (emphasis in the original).

¹⁴Betts v. Burch, 157 Eng. Rep. 938, 940 (Ex. 1859).

¹⁵Wallis v. Smith, 21 Ch. D. 243, 257 (1882). See also 21 Ch. D. 243, 277 per Lord Justice Lindley (“The decisions on

penalty and liquidated damages ... are perplexing”).

¹⁶Id. 256.

¹⁷C. 6, as amended (“When a contract has been broken, if a sum is named in the contract as the amount to be paid in

case of such breach, or if the contract contains any other stipulation by way of penalty, the party complaining of the

breach is entitled, whether or not actual damage or loss is proved to have been caused thereby, to receive from the

party who has broken the contract reasonable compensation not exceeding the amount so named or, as the case may

be, the penalty stipulated for”).

¹⁸Fateh Chand v. Balkishan Das, [1964] 1 S.C.R. 515, 526 (1963).

¹⁹Dunlop Pneumatic Tyre Co. v. New Garage and Motor Co., [1915] A.C. 79, 101 (H.L. 1914).

²⁰[2015] UKSC 67; [2016] A.C. 1172.

²¹[2016] HCA 28; 258 C.L.R.525.

²²Review of Contract Law: Discussion Paper on Penalty Clauses (No. 162) (November 2016).

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Court of Canada has not yet undertaken. Indeed, it has not had an opportunity to do so since its

1978 judgment in Elsley v. J.G. Collins Insurance Agencies Ltd.²³

B.

The Fraud-on-the-Bankruptcy-Law Issue

[69] England enacted its first bankruptcy statute in 1542.²⁴It²⁵

displayed two central features of bankruptcy law that have persisted to the present

day. First, it created a summary and collective procedure that operated for the

benefit of all the creditors, and not simply for the creditor who initiated the process.

Second, it adopted a pro rata sharing principle in respect of the distribution of the

debtor’s assets among the creditors.

[70] It is not clear when English judges first thought it prudent to construct a rule that parties

could not order their affairs so as to minimize the adverse effect the fundamental tenets of the

bankruptcy laws would have on their legitimate interests. But it is obvious that by 1812 such a

principle had been in place for a considerable period of time.²⁶Lord Eldon, in Higinbotham v.

Holme,²⁷described a trust term the validity of which had been challenged as a “direct fraud upon

the Bankrupt Laws” and refused to enforce it against the interests of a bankrupt’s creditors. No

doubt, the strategies that ingenious English solicitors had adopted to diminish the harm the

application of the bankruptcy laws had on their clients’ interests prompted this judicial response.

[71] Bankruptcy practitioners usually refer to contract terms that impose adverse consequences

on the insolvent party and the insolvent party’s creditors on the occurrence of an act of insolvency

as ipso facto clauses.²⁸

²³[1978] 2 S.C.R. 916.

²⁴An Acte against such persons as doo make Bankrupte, 34 & 35 Hen. 8, c. 4. In 1571 Parliament passed a second

bankruptcy act, An Acte touching Orders for Bankruptes, 13 Eliz. 1, c. 7. It introduced more acts of bankruptcy and

only applied to merchant or trader debtors. R. Wood, Bankruptcy and Insolvency Law 30 (2d ed. 2015) & C. Tabb,

The Law of Bankruptcy 40 (2d ed. 2009). A third amendment in 1705, An Act to prevent Frauds frequently committed

by Bankrupts, 4 & 5 Anne, c. 4 introduced “the concept of the discharge of a bankrupt. Prior to this, a bankrupt

remained liable for all amounts remaining unpaid to the creditors following the bankruptcy”. R. Wood, Bankruptcy

and Insolvency Law 31 (2d ed. 2015). See also C. Tabb, The Law of Bankruptcy 40 (2d ed. 2009).

²⁵R. Wood, Bankruptcy and Insolvency Law 30 (2d ed. 2015).

²⁶E.g., Re Murphy, 1 Sch. & Lef. 44, 49 (Ch. 1803) (Ire.) (“All the cases in England have held this to be a fraud upon

the bankrupt laws which cannot be supported”).

27

34 Eng. Rep. 451, 453 (Ch. 1812). Writing in 2012, Lord Collins observed that “[t]he

[fraud-on-the-bankruptcy-law] rule has existed for nearly 200 years”. Belmont Park Investments Pty Ltd. v. BNY

Corporate Trustee Services Ltd., [2011] UKSC 38, ¶59; [2012] 1 A.C. 383, 409.

²⁸R. Wood, Bankruptcy and Insolvency Law 178 (2d ed. 2015)(“these [contractual] provisions – often referred to as

ipso facto clauses – stipulate that the commencement of bankruptcy or other insolvency proceedings is of itself an

event of default that permits the party to terminate the contract”); Ho, “The Treatment of Ipso Facto Clauses in

Page: 21

[72] One wonders why, if the harm ipso facto clauses caused was so pressing, Parliament did

not declare them unenforceable.²⁹This, after all, was an era when “English Law had a distinctly

pro-creditor orientation … Imprisonment for debt was the order of the day, from the time of the

Statute of Merchant in 1285, until Dicken’s time in the mid-nineteenth century”.³⁰

[73] I suspect that at least 150 years following 1542 passed before a judge introduced the

fraud-on-the-bankruptcy-law principle. In this gap period courts gave ipso facto terms in contracts,

wills and trusts their plain and ordinary meaning.

[74] By 1861 the existence of this rule was not in doubt. Sir W. Page Wood, V.C., in Whitmore

v. Mason,³¹proclaimed that “the law is too clearly settled to admit of a shadow of a doubt that no

person possessed of property can reserve that property to himself until he shall become bankrupt,

and then provide that … it shall pass to another and not to his creditors”.

[75] The same observation cannot be made about the Canadian law. The Supreme Court of

Canada has never acknowledged that a fraud-on-the-bankruptcy law principle is a component of

the Canadian common law. Only a few Canadian courts have ever considered it.³²If there is such a

principle in Canada, its content is certainly debatable.

[76] In 2009 important changes were made to the Bankruptcy and Insolvency Act³³and the

Companies’ Creditors Arrangement Act.³⁴These amendments declared unenforceable ipso facto

Canada”, 61 McGill L.J. 139, 141 (2015) (“Many parties preserve contractual rights, through what are commonly

known as ipso facto clauses, to terminate and amend contracts or to demand an accelerated payment in the event that a

counterparty to the contract becomes insolvent”) & Black’s Law Dictionary 905 (10^thed. B. Garner ed. in chief

2014)(“A contract clause that specifies the consequences of a party’s bankruptcy”).

²⁹Professor Atiyah notes that at the dawn of the nineteenth century Parliament and the executive were not assisted by

a large complement of skilled civil servants and that “there was good reason to assume that in general the Courts

would make a better job of law-making than Parliament’. P. Atiyah, The Rise and Fall of Freedom of Contract 96

(1979). While this may be true, Parliament had amended the bankruptcy statute on several occasions before this

judicial foray into law making. C. Tabb, The Law of Bankruptcy 40 (2d ed. 2009)(“The first comprehensive

bankruptcy law was passed in 1570 during the reign of Queen Elizabeth I. Over the next two centuries, Parliament

periodically amended the bankruptcy laws, in each instance enhancing the power of the bankruptcy commissioner to

reach more of the debtor’s assets and increasing the penalties against debtors”).

³⁰C. Tabb, The Law of Bankruptcy 39 (2d ed. 2009).

³¹70 Eng. Rep. 1031, 1034 (Ch. 1861).

³²Ho, “The Treatment of Ipso Facto Clauses in Canada”, 61 McGill L.J. 139, 170 (2015) (“the anti-deprivation rule

… has not been widely used in Canadian jurisprudence”).

³³The Economic Recovery Act (stimulus), S.C. 2009, c. 31, s. 64 introduced s. 84.2 of the Bankruptcy and Insolvency

Act. It came into force December 15, 2009. Section 65.1 of the Bankruptcy and Insolvency Act came into force on

August 1, 1992. An Act to amend the Bankruptcy Act and to amend the Income Tax Act in consequence thereof, S.C.

1992, c. 27, s. 30 & S.I./92-135. This section declared unenforceable an ipso facto term affecting an insolvent debtor –

a natural person or a corporation – upon the debtor filing a notice of intention or proposal.

Page: 22

terms that imposed adverse consequences on natural person bankrupts and corporations pursuing

restructuring and their creditors.

[77] The 2009 amendments said nothing about corporate bankruptcy ipso facto terms. Section

VII Q(d), the term under review in this appeal, is a corporate bankruptcy ipso facto term.

II.

Questions Presented

A. Contract Law

[78] On what principled basis may a court decline to enforce a stipulated-consequence-

on-breach term in a commercial contract between two or more parties that have the resources

necessary to obtain legal advice and that are perfectly capable of protecting their own interests?

[79] What is the common law in Canada on the enforceability of

stipulated-consequence-on-breach provisions in commercial contracts?

[80] Does the classic penalty rule apply?

[81] Or is a stipulated-consequence-on-breach term only unenforceable if it is oppressive?

[82] If so, what are the features of an oppressive term?

[83] How does the law apply to the term in dispute in this appeal?

[84] Is s. VII Q(d), the provision in the agreement between Chandos Construction Ltd. and

Capital Steel Inc. in which Capital Steel agreed that “[i]n the event [it] ... commits any act of ...

bankruptcy [it would] forfeit ten percent of the [$1,373,000] ... subcontract agreement price to ...

[Chandos Construction] as a fee for the inconvenience of completing the work using alternate

means ... [or] for monitoring the work during the warranty period [or both]”, a stipulated-

consequence-on-breach term?

[85] If so, is it enforceable?

³⁴R.S.C. 1985, c. C-36. An Act to establish the Wage Earner Protection Program Act, to amend the Bankruptcy and

Insolvency Act and the Companies’ Creditors Arrangement Act and to make consequential amendments to other Acts,

S.C. 2005, c. 47, s. 131 introduced s. 34 of the Companies’ Creditors Arrangement Act. This provision came into force

on September 18, 2009. S.I./2009-68.

Page: 23

[86] Justice Nielsen concluded that s.VII Q(d) was an enforceable liquidated-damages term, in

part, because the sum – $137,300 – was not “extravagant and unconscionable” and that it would be

“impossible to calculate the cost of [Capital Steel’s] ongoing obligations with any precision”.³⁵

B.

Bankruptcy Law

1. Introduction

[87] There are two sets of questions here. The first set focuses on the common law. The second

set puts the Bankruptcy and Insolvency Act³⁶under the microscope.

2.

Common Law

[88] In 2011 the United Kingdom Supreme Court substantially rewrote the English common

law on ipso facto terms.³⁷It directed courts to enforce an ipso facto clause unless it has as its

“predominant purpose, or one of ... [its] main purposes, the deprivation of the property of one of

the parties on bankruptcy”.³⁸Ipso facto terms that constitute “a blatant attempt to deprive a party of

property in the event of liquidation”³⁹contravene public policy and are of no force.

[89] Is a similar principle part of the common law of Canada?

[90] If so, what are its distinguishing features?

3.

Bankruptcy and Insolvency Act

[91] The Bankruptcy and Insolvency Act⁴⁰is a sophisticated and comprehensive statute. It has

close to 300 sections. It applies to both natural persons and corporations, and, as its title reveals, to

both bankruptcies and insolvencies.⁴¹

³⁵Appeal Record F11.

³⁶R.S.C. 1985, c. B-3.

³⁷Belmont Park Investments Pty Ltd. v. BNY Corporate Trustee Services Ltd., [2011] UKSC 38; [2012] 1 A.C. 383.

³⁸Id. at ¶104; [2012] 1 A.C. at 421.

³⁹Id.

⁴⁰R.S.C. 1985, c. B-3.

⁴¹The American Bankruptcy Code, 11 U.S.C. also applies to both natural persons and corporations. “In England,

Australia, and New Zealand, there is a basic division between insolvency of individuals and insolvency of

corporations. Bankruptcy law governs the former, while corporate insolvency legislation governs the latter”. R. Wood,

Bankruptcy and Insolvency Law 35 (2d ed. 2015).

Page: 24

[92] Section 84.2 of the Bankruptcy and Insolvency Act, introduced by the 2009 amendments,⁴²

and in force as of December 15, 2009, declares a category of ipso facto terms unenforceable if the

bankrupt is a natural person.⁴³

[93] But no provision in the Bankruptcy and Insolvency Act declares corporate ispo facto terms

of any type of no force or effect.

[94] Also noteworthy is the fact that on September 18, 2009 s. 34 of the Companies’ Creditors

Arrangement Act came into force.⁴⁴This provision expressly deprived a corporate restructuring

ipso facto term of any force.

[95] Is it reasonable to assume that if Parliament had intended to accord the same treatment to

corporate bankruptcy ipso facto terms as it attached to natural bankruptcy person ipso facto terms

and corporate restructuring ipso facto terms that it would have incorporated unambiguous

statutory text to that effect?

[96] Has Parliament, with the passage of s. 84.2 of the Bankruptcy and Insolvency Act, occupied

the field relating to the regulation of ipso facto clauses tied to an act of bankruptcy?

[97] If so, does that mean that s. VII Q(d), a corporate bankruptcy ipso facto term, must be

enforceable?

[98] If Parliament has not occupied the field and the common law on ipso facto terms applies, is

s. VII Q(d) enforceable?

[99] Does the bankrupt’s property include the accounts receivable for work performed for

Chandos Construction but unpaid or does it exclude the ten percent forfeiture fee triggered when

Capital Steel became bankrupt?

III.

Brief Answers

A. Contract Law

[100] The classic penalty rule provides no principled basis for assessing the enforceability of

stipulated-consequence-on-breach provisions in commercial contracts between parties with

sufficient resources to protect their own interests. It should not be used anymore.

[101] The Supreme Court said so in Elsley v. J.G. Collins Insurance Agencies Ltd.⁴⁵It stated that

only oppressive stipulated-consequence-on-breach terms were unenforceable.

⁴²Economic Recovery Act (stimulus), S.C. 2009, c. 31, s. 64.

⁴³Bankruptcy and Insolvency Act, R.S.C. 1985, c. B-3.

⁴⁴S.I. /2009-68.

Page: 25

[102] The Supreme Court of Canada has not recorded the benchmarks of an oppressive

stipulated-consequence-on-breach term in the context of ascertaining the enforceability of such a

term.

[103] Because freedom of contract is of paramount importance in Canada, oppression should be

given a limited meaning.⁴⁶

[104] It should only apply in extraordinary circumstances to a commercial contract between

parties that have the resources necessary to retain legal counsel to advise them on the nature of

their responsibilities and benefits under a proposed contract. It makes no sense whatsoever to ask a

court to assess the enforceability of a term that commercial entities with the resources required to

secure legal advice have agreed upon. It is presumptuous in the extreme to believe that judges have

a better grasp of what obligations and benefits should be in a commercial contract than those who

negotiated it and are expected to understand the implications of their bargain.

[105] The United Kingdom Supreme Court case – Cavendish Square Holdings BV v. El

Makdessi⁴⁷– illustrates this point. One contracting party was part of the world’s leading marketing

communications group.⁴⁸The other contracting parties, Messrs. Makdessi and Ghossoub, were the

co-founders and co-owners of the Middle East’s largest advertising and marketing

communications group.⁴⁹Messrs. Makdessi and Ghossoub had agreed to sell sufficient shares in

⁴⁵[1978] 2 S.C.R. 916, 937.

⁴⁶See Philips Hong Kong Ltd. v. Hong Kong, [1993] UKPC 3a, ¶22; [1993] 1 H.K.L.R. 269, 280 (“the court has to be

careful not to set too stringent a standard and bear in mind that what the parties have agreed should normally be

upheld. Any other approach will lead to undesirable uncertainty especially in commercial contracts”).

⁴⁷[2015] UKSC 67; [2016] A.C. 1172. See also Clydebank Engineering and Shipbuilding Co. v. Castaneda, [1905]

A.C. 6 (H.L. 1904) (why should judges be asked to review a contract between the Spanish government and a

shipbuilder in order to determine whether an important term should be enforced?) & Polyset Ltd. v. Panhandat Ltd.,

[2002] HKCFA 15, ¶158 (why should judges be asked to review a $115 million land sale contract to determine

whether the purchaser’s agreement to forego a $40.25 million deposit in the volatile Hong Kong real estate market if it

failed to close? per Litton, N.P.J.: “Over the past half-century there have been many cycles of dramatic rise and fall.

Upon entering into the contract, in May 1997, the purchaser had the possibility of almost immediate profit upon

sub-division and re-sale. With the contract in hand, in an inflationary environment, the purchaser would have had little

difficulty in raising money from the market. The vendor was, of course, locked into the contract for over 9 months, and

exposed to uncertainties over a long period. It was therefore entirely reasonable for the vendor to seek reassurance that

if the market should fall and the purchaser should default, it would be compensated: And that the compensation should

be certain : that is to say, not dependent upon a court assessing the amount of compensation years after the event : Few

vendors would welcome the prospect of expensive litigation to claim compensation, when the outcome would depend

upon the resolution of conflicting evidence based upon valuation exercises by opposing experts, whose opinions could

vary widely (as occurred in this case). The size of the deposit was a matter of bargain for the parties, as was every other

term. They were contracting at arm’s length, each independently advised, with each looking to its own advantage”).

⁴⁸[2015] UKSC 67, ¶116; [2016] A.C. 1172, 1232.

⁴⁹Id.

Page: 26

their advertising and marketing business to give Cavendish Square Holdings majority control of it.

The purchase price was over US $100 million. Mr. Makdessi had violated a term in the share-sale

agreement and the purchaser sought a declaration that the agreed-upon consequences for that

breach were now in force and that the amount the purchaser had to pay Mr. Makdessi for this

shares had drastically declined. No court should have to spend much time assessing the

enforceability of a term in this contract.

[106] An extraordinary circumstance exists if the stipulated-consequence-on-breach term is

oppressive. A term in a commercial contract is oppressive if it is so manifestly grossly one-sided

that its enforcement would bring the administration of justice into disrepute. The focus is on the

contested term and not the relative bargaining strengths of the contracting parties.⁵⁰

[107] This is a bright-line test.

[108] Stipulated-consequence-on-breach terms in commercial contracts will seldom breach this

marker.

[109] The oppression concept may be engaged more frequently in consumer contracts. A less

demanding standard for oppression in consumer contracts – rental-car, parking, credit-card and

utility adhesion contracts and perhaps also increasingly online contracts of adhesion, such as

Facebook’s “terms of use” – may be appropriate. In these situations a dominant party provides a

service or a product to a large number of consumers who are not in a position to extract any

concessions from the service or product provider. If the consumer wishes to acquire the services or

the product provided by the dominant party, it will be only on the terms stipulated by the dominant

party.

[110] A promisor that asks to be relieved of a burden that it promised to discharge bears the legal

burden of establishing the facts it relies on to support its oppression claim.⁵¹

[111] In this appeal, there can be no reason to doubt that both Chandos Construction and Capital

Steel had the resources necessary to retain legal counsel and secure competent advice as to the

burdens and benefits that each party would have under their steel-construction contract. They were

able to protect their own interests.

⁵⁰Imperial Tobacco Co. v. Parsley, [1936] 2 All E.R. 515, 522 (C.A.) (the Court thought it important that the

tobacconist who entered into a price-maintenance agreement was “of full age and understanding” and that it was

irrelevant that the tobacco supplier was a large commercial enterprise). Some courts have held that inequality of

bargaining power is a relevant consideration. E.g., Birch v. Union of Taxation Employees Local 70030, 2008 ONCA

809, ¶45; 305 D.L.R. 4^th64, 78 & Bankers Mortgage Corp v. Plaza 500 Hotels Ltd., 2016 BCSC 722, ¶71; 35 C.B.R.

6^th263, 278.

⁵¹Mortgage Makers Inc. v. McKeen, 2009 NBCA 61, ¶47; 312 D.L.R. 4^th82, 104 & Robophone Facilities Ltd. v.

Blank, [1966] 3 All E.R. 128, 142 (C.A.). Contra, Law Reform Act, S.N.B. 1993, c. L-1.2, s. 5(1).

Page: 27

[112] The term in this commercial contract is a stipulated-consequence-on-breach term and is

undoubtedly enforceable. The breach is the subcontractor’s failure to carry on business and

discharge the promise that it made and its acquisition of the status of a bankrupt.

[113] Section VII Q(d) is part of a binding contract between commercial actors. It clearly is not

so manifestly grossly one-sided that its enforcement would bring the administration of justice into

disrepute. This term is not one-sided in any way at all. A judgment giving effect to s. VII Q(d) will

not diminish the reputation of the judicial branch of government.

[114] The result would be the same if the standard applied was that fashioned by the House of

Lords and the Privy Council at the start of the twentieth century in Clydebank Engineering and

Shipbuilding Co. v. Castaneda,⁵²Dunlop Pneumatic Tyre Co. v. New Garage and Motor Co.⁵³and

Webster v. Bosanquet⁵⁴and adopted by many Canadian courts.

[115] Section VII Q(d) is not a penalty provision. It is fair and balanced. It serves a justifiable

business purpose. It is not unreasonable, extravagant, or unconscionable. It may fairly be

characterized as a liquidated damages term.

B.

Bankruptcy Law

1. Common Law

[116] The fraud-on-the-bankruptcy-law principle is not now and likely never has been part of the

common law of Canada.

[117] The Supreme Court of Canada has never expressly acknowledged the existence of this

principle and has implicitly denied its status as part of Canadian law.⁵⁵

[118] Only one provincial appellate court has applied the concept.⁵⁶It did so in a 2013 appeal in a

very brief judgment that assumed the fraud-on-the-bankruptcy-law was an element of Canadian

common law. No consideration was given to the effect that the 2009 amendments to the

Bankruptcy and Insolvency Act and the Companies’ Creditors Arrangement Act had on the

common law.

[119] If the fraud-on-the-bankruptcy-law principle was ever a feature of the Canadian common

law, the aspect that dealt with ipso facto clauses ceased to exist no later than 2009.

⁵²[1905] A.C. 6.

⁵³[1915] A.C. 79 (H.L. 1914).

⁵⁴[1912] A.C. 394 (P.C.) (Ceylon).

⁵⁵Les Coopérants Société mutuelle d'assurance-vie (Liquidateur) v. Dubois, [1996] 1 S.C.R. 900.

⁵⁶Trustee of Aircell Communications Inc. v. Bell Mobility Cellular Inc., 2013 ONCA 95; 14 C.B.R. 6^th276.

Page: 28

[120] The amendments to the Bankruptcy and Insolvency Act and the Companies’ Creditors

Arrangement Act that came into force in 2009 relating to ipso facto terms now constitute the code

governing the enforceability of ipso facto clauses. There was no room for any common law norms

after 2009.

[121] If, contrary to my conclusion, the 2009 amendments do not occupy the field and there is

still some room for the common law, does it have the bite that the Ontario Court of Appeal

attributed to it – an ipso facto term is unenforceable if its effect is the diminution of the bankrupt’s

estate?⁵⁷Or should the benchmark of an enforceable corporate ipso facto term be less demanding

and easier to meet? Should the common law test not accord more weight to the values of party

autonomy and freedom of contract?

[122] I agree with the approach that the United Kingdom Supreme Court set out in Belmont Park

Investments Pty Ltd. v. BNY Corporate Trustee Services Ltd..⁵⁸The common law should attach

more weight to the value of party autonomy and freedom of contract than the collective interests of

creditors favoured by the effects-based test given that bankruptcy is a statutory construct and

judicial intervention is only interstitial in nature. Parliament has already identified the

circumstances when collective interests trump party autonomy and freedom of contract.⁵⁹

[123] This rebalance leads to a new Canadian common law test.

[124] A corporate bankruptcy ipso facto term is enforceable if its most important feature is the

advancement of a reasonable and defensible commercial purpose and its enforcement provides a

benefit for the nonbankrupt party that is not significantly greater than is necessary to promote the

nonbankrupt party’s legitimate commercial interests.

[125] Section VII Q(d) meets this new common law standard.

[126] Its only purpose is to declare the amount to which Chandos Construction is entitled if

Capital Steel goes out of business and Chandos Construction must find other suppliers to provide

the material and services that Capital Steel had promised to provide. Objectively assessed, this is a

reasonable and defensible commercial purpose.

[127] The benefit Chandos Construction derives from the enforcement of the ipso facto clause is

not greater, let alone significantly greater, than is necessary to promote Chandos Construction’s

legitimate commercial interests.

[128] Section VII Q(d) is not a blatant and egregious attempt to hijack Capital Steel’s property

and attack the interests of its creditors.

⁵⁷Id.

⁵⁸[2011] UKSC 38; [2012] 1 A.C. 383.

⁵⁹Bankruptcy and Insolvency Act, R.S.C. 1985, c. B-3, ss. 65.1, 66.34 & 84.2.

Page: 29

2.

Bankruptcy and Insolvency Act

[129] Parliament’s decision in 2009⁶⁰not to follow the American⁶¹and Australian⁶²legislative

models and accord the same treatment to natural person bankruptcy and corporate bankruptcy ipso

facto terms is strong evidence that Canada’s legislators were not convinced that corporate

bankruptcy ipso facto clauses are inimical to the welfare of the Canadian bankruptcy regime.

[130] I am satisfied that Parliament has occupied the field and that corporate bankruptcy ipso

facto terms are enforceable.

[131] If Parliament had intended to deny enforceability to corporate ipso facto clauses it would

have said so in unambiguous language.

[132] There is no compelling reason that would justify the contrary conclusion. Parliament

cannot have left this subject matter unregulated satisfied that the common law had introduced

norms that are generally recognized and applied across the country. There is little judge-made law

on this topic.

[133] Because the Bankruptcy and Insolvency Act does not deprive a corporate bankruptcy term

of its force and s. VII Q(d) is a corporate bankruptcy term, s. VII Q(d) is enforceable.

3.

Conclusion

[134] To summarize, s. VII Q(d) is enforceable for two independent reasons. First, the

Bankruptcy and Insolvency Act does not proscribe corporate bankruptcy ipso facto terms. Section

VII Q(d) is a corporate bankruptcy ipso facto term. Second, if the Bankruptcy and Insolvency Act

does not extinguish the common law on corporate bankruptcy ipso facto clauses, s. VII Q(d) meets

the new party-autonomy-inspired common law test and is valid.

IV.

Statement of Facts

A. The Construction Contracts

[135] On March 2, 2015 Boudreau Developments Ltd., the developer, and Chandos

Construction, the general contractor, entered into a stipulated-price contract for the construction of

⁶⁰Economic Recovery Act (stimulus), S.C. 2009, c. 31, s. 64.

⁶¹Bankruptcy Code, 11 U.S.C. §365(e).

⁶²Bankruptcy Act 1966, No. 33 s. 301 (Cth) & Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Act

2017, No. 112, s. 7 (introduced s. 415 D of the Corporations Act 2001, No. 50). See Australia House of

Representatives, Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Bill 2017 Explanatory

Memorandum.

Page: 30

phase one of “The Botanica” condominium project in St. Albert.⁶³The developer agreed to pay the

general contractor $55 million to construct phase one.

[136] In order to discharge its obligation to the developer, Chandos Construction entered into a

number of agreements with other construction businesses to perform and provide some of the

necessary tasks and materials.

[137] Capital Steel was one of these construction enterprises. It agreed to supply and install the

64

structural and miscellaneous steel components of the project. The agreed price was

$1,373,300.47.

[138] Capital Steel did not do what it promised. It did not complete its work.

[139] Chandos Construction paid Capital Steel $1,223,682.08 for the work performed and

material supplied. The outstanding balance is $149,618.39.

[140] The completion costs are estimated to be $22,800.

[141] Capital Steel is responsible for warranty work that arises in a twelve-month period

following substantial completion of the project. The start date has tolled. The extent of this

obligation cannot be catalogued until the warranty period has expired.

B.

Capital Steel Is a Bankrupt

[142] On September 26, 2016 Capital Steel filed an assignment in bankruptcy.

[143] The court subsequently appointed Deloitte Restructuring Inc. as the trustee of the estate of

the bankrupt Capital Steel.

C.

Deloitte Restructuring Seeks Advice and Directions

[144] On March 6, 2017 Deloitte Restructuring filed an application in the Court of Queen’s

Bench asking the court to determine “whether Chandos [Construction] is entitled to rely on s. VII

Q(d) of the Subcontract between it and Capital Steel and, if not, for a direction that the balance of

$126,818.39 is payable to ... [Deloitte Restructuring”].⁶⁵

⁶³This is a standard form contract prepared by the Canadian Construction Documents Committee. This committee is a

national joint committee made up of representatives of public and private sector owners, The Association of

Consulting Engineering Companies, The Canadian Construction Association, Construction Specifications Canada and

The Royal Architecture Institute of Canada.

⁶⁴Counsel informed us during oral argument that this is a contract Chandos Construction uses. It is not prepared by the

Canadian Construction Documents Committee.

⁶⁵This is the difference between the outstanding balance of $149,618.39 and estimated completion costs of 22,800.

Page: 31

D.

Justice Nielsen’s Decision

[145] Justice Nielsen concluded that s. VII Q(d) is valid and that the $126,818.39 is Chandos

Construction’s property.

[146] The key parts of Justice Nielsen’s March 17, 2017 decision are as follows:

Section 97 of the Bankruptcy and Insolvency Act ... provides that the law of set off

... applies to all claims made against the estate of the bankrupt, except in cases

involving frauds or fraudulent preferences. …

In this case, there is no suggestion by … [the bankruptcy trustee] of fraud or a

fraudulent preference in relation to … [s. VII Q(d)].

The issue … is whether … [s. VII Q(d)] was such as to provide that all funds due

from Chandos to Capital Steel would be the property of Capital Steel unless it

became insolvent, in which case the property would pass to Chandos, as opposed to

… [s. VII Q(d)] being a genuine covenanted pre-estimate of damages.

To answer this question, it is necessary to have regard to the whole … [of the two

contracts between Chandos Construction and Capital Steel, and Boudreau

Developments and Chandos]. Chandos … is fully responsible for the acts and work

of its subcontractors. Further, it has undertaken to indemnify… [Boudreau

Developments] in respect of the involvement of Chandos … . Chandos has

undertaken to warrant the work under the [contract with Boudreau Developments],

which includes the work of Capital Steel, for a period of one year from the date of

substantial performances of the work, which has not yet occurred.

…

… [Section VII Q(d)] provides for the payment of a fee to Chandos of 10 percent of

the subcontract price. … [T]he total amount of the subcontract was $1,373,300. A

10 percent fee is … $137,330.

I do not find that such a sum is “extravagant and unconscionable in amount in

comparison with the greatest loss that could conceivably be proved to have flowed

from the breach”, nor is it “a grossly and punitive response to the problem to which

it was addressed”, all as referred to by the Supreme Court of Canada in the H.F.

Clarke Ltd. case.

Clearly, Chandos has ongoing obligations which flow from the work of Capital

Steel … . It would be impossible to calculate the cost of such ongoing obligations

with any precision. It is, therefore, fair and reasonable for such risk to be calculated

on the basis of a percentage of the value of … [the contract between Chandos

Page: 32

Construction and Capital Steel]. … [T]he value of the … [contract between

Chandos Construction and Capital Steel] is $1,373,300. The value of the [contract

between Boudreau Developments and Chandos Construction] was $56,852,453. In

my view, a payment of 10 percent of … [$1,373,300] or 0.24 percent of the value of

the [contract between Boudreau Developments and Chandos Construction], could

not be considered to be gross and punitive given the ongoing obligations of

Chandos and its potential risk with respect to the work of Capital Steel.

I acknowledge that ... [s. VII Q(d)] uses the term “forfeit”. This is an unfortunate

choice of words as it could connote that the 10 percent amount is being lost or

surrendered as a penalty. In my view, this single word cannot be determinative of

the issue. ... [Section VII Q(d)] must be considered in the context of the [two

contracts] and the position that Chandos is in as a result of the insolvency of Capital

Steel. Clearly, it would incur administration and management costs as a result of

the insolvency of Capital Steel, and is at risk for future liabilities of Capital Steel.

[Chandos Construction and Capital Steel] must be taken to have had these

considerations in mind at the time of execution of ... [their contract].

E.

Deloitte Restructuring Appeals

[147] Deloitte Restructuring appeals. It argues that Justice Nielson committed several reversible

errors.

V.

Relevant Contract and Statutory Provisions

[148] The relevant provisions of the contract between Chandos Construction and Capital Steel

are set out below:

III. Guarantee

[Capital Steel] agrees to immediately, or in accordance with a schedule acceptable

to … [Chandos Construction], repair and make good any defect in its work and all

resulting damages that may appear as the result of any improper work or defective

materials furnished by … [Capital Steel]. This provision shall apply for the entire

guarantee period specified in the prime contract, but shall not be less than one year

from completion of the project.

VII. Conditions

…

Q. Subcontractor Ceases Operations

Page: 33

In the event …[Capital Steel] commits any act of insolvency, bankruptcy, winding

up or other distribution of assets, or permits a receiver of the Subcontractor’s

business to be appointed, or ceases to carry on business or closes down its

operations, then in any of such events:

(a) this Subcontract Agreement shall be suspended but may be reinstated and

continued if … [Chandos Construction], the Liquidator, or Trustee of …

[Capital Steel] and the surety, if any, so agree. If no agreement is reached, …

[Capital Steel] shall be considered to be in default and … [Chandos

Construction] may give written notice of default to … [Capital Steel] and

immediately proceed to complete the work by other means as deemed

appropriate by … [Chandos Construction], and

(b) any cost to … [Chandos Construction] arising from the suspension of this

Subcontract Agreement or the competition of the work by … [Chandos

Construction] plus a reasonable allowance for overhead and profit, will be

payable by … [Capital Steel] and or his sureties, and

(c) [Chandos Construction] … is entitled to withhold up to 20% of the within

Subcontract Agreement price until such time as all warranty and or guarantee

periods which are the responsibility of … [Capital Steel] have expired, and

(d) [Capital Steel] shall forfeit 10 percent of the … Subcontract Agreement price

to [Chandos Construction] as a fee for the inconvenience of completing the work

using alternate means [or] monitoring the work during the warranty period [or

both].

[149] The important parts of the “General Conditions” of the stipulated price contract between

Boudreau Developments Ltd., the owner of the condominium project, and Chandos Construction,

follow:⁶⁶

GC 3.7 Subcontractors and Suppliers

3.7.1 The Contractor shall preserve and protect the rights of the parties under

the Contract with respect to work to be performed under subcontract,

and shall:

…

.3 be as fully responsible to the Owner for acts and omissions of Subcontractors

… as for acts or omissions of persons directly employed by the Contractor.

⁶⁶Emphasis in original.

Page: 34

Part 12 Indemnification, Waiver of Claims and Warranty

GC 12.3 Warranty

12.3.1 Except for extended warranties, as described in paragraph 12.3.6, the

warranty period under the Contract is one year from the date of Substantial

Performance of the Work.

12.3.4 Subject to paragraph 12.3.2, the Contractor shall correct promptly, at the

Contractor’s expense, defect or deficiencies in the Work which appear prior to

and during the one year warranty period.

[150] Sections 2, 65.1,⁶⁷66.34,⁶⁸71, 84.2,⁶⁹95(1) and (2), and 97(3) of the Bankruptcy and

Insolvency Act⁷⁰are as follows:

2 In this Act,

…

property means any type of property, whether situated in Canada or elsewhere, and

includes money, goods, things in action, land and every description of property,

whether real or personal, legal or equitable, as well as obligations, easements and

every description of estate, interest and profit, present or future, vested or

contingent, in, arising out of or incident to property ... .

65.1(1) If a notice of intention or a proposal has been filed in respect of an insolvent

person, no person may terminate or amend any agreement, including a security

agreement, with the insolvent person, or claim an accelerated payment, or a

forfeiture of the term, under any agreement, including a security agreement, with

the insolvent person, by reason only that

(a) the insolvent person is insolvent; or

(b) a notice of intention or a proposal has been filed in respect of the insolvent

person.

⁶⁷An Act to amend the Bankruptcy Act and to amend the Income Tax Act in consequence thereof, S.C. 1992, c. 27, s.

30 (in force November 30, 1992 S.I./92-194).

⁶⁸An Act to amend the Bankruptcy Act and to amend the Income Tax Act in consequence thereof, S.C. 1992, c. 27, s.

32 (in force November 30, 1992 S.I./92-194).

⁶⁹Economic Recovery Act (stimulus), S.C. 2009, c. 31, s. 64 (in force December 15, 2009 S.I./2009-68).

⁷⁰R.S.C. 1985, c. B-3.

Page: 35

…

66.34(1) If a consumer proposal has been filed in respect of a consumer debtor, no

person may terminate or amend any agreement, including a security agreement,

with the consumer debtor, or claim an accelerated payment, or the forfeiture of the

term, under any agreement, including a security agreement, with the consumer

debtor, by reason only that

(a) the consumer debtor is insolvent, or

(b) a consumer proposal has been filed in respect of the consumer debtor

until the consumer proposal has been withdrawn, refused by the creditors or the

court, annulled or deemed annulled.

…

(5) Any provision in an agreement that has the effect of providing for, or

permitting, anything that, in substance, is contrary to subsections (1) to (3) is of no

force or effect.

...

71 On a bankruptcy order being made ... , a bankrupt ceases to have any capacity to

dispose of or otherwise deal with their property, which shall, subject to this Act and

to the rights of secured creditors, immediately pass to and vest in the trustee named

in the bankruptcy order ... .

…

84.2(1) No person may terminate or amend – or claim an accelerated payment or

forfeiture of the term under – any agreement, including a security agreement, with a

bankrupt individual by reason only of the individual’s bankruptcy or insolvency.

(2) If the agreement referred to in subsection (1) is a lease, the lessor may not

terminate or amend, or claim an accelerated payment or forfeiture of the term

under, the lease by reason only of the bankruptcy or insolvency or of the fact that

the bankrupt has not paid rent in respect of any period before the time of the

bankruptcy.

(3) No public utility may discontinue service to a bankrupt individual by reason

only of the individual’s bankruptcy or insolvency or of the fact that the bankrupt

individual has not paid for services rendered or material provided before the time of

the bankruptcy.

Page: 36

(4) Nothing in this section is to be construed as

(a) prohibiting a person from requiring payments to be made in cash for goods,

services, use of leased property or other valuable consideration provided after

the time of the bankruptcy; or

(b) requiring the further advance of money or credit.

(5) Any provision in an agreement that has the effect of providing for, or

permitting, anything that, in substance, is contrary to this section is of no force or

effect.

…

95(1) A transfer of property made, a provision of services made, a charge on

property made, a payment made, an obligation incurred or a judicial proceeding

taken or suffered by an insolvent person

(a) in favour of a creditor who is dealing at arm’s length with the insolvent

person, or a person in trust for that creditor, with a view to giving that creditor a

preference over another creditor is void as against — or, in Quebec, may not be

set up against — the trustee if it is made, incurred, taken or suffered, as the case

may be, during the period beginning on the day that is three months before the

date of the initial bankruptcy event and ending on the date of the bankruptcy; and

(b) in favour of a creditor who is not dealing at arm’s length with the insolvent

person, or a person in trust for that creditor, that has the effect of giving that

creditor a preference over another creditor is void as against — or, in Quebec,

may not be set up against — the trustee if it is made, incurred, taken or suffered,

as the case may be, during the period beginning on the day that is 12 months

before the date of the initial bankruptcy event and ending on the date of the

bankruptcy.

(2) If the transfer, charge, payment, obligation or judicial proceeding referred to in

paragraph (1)(a) has the effect of giving the creditor a preference, it is, in the

absence of evidence to the contrary, presumed to have been made, incurred, taken

or suffered with a view to giving the creditor the preference — even if it was made,

incurred, taken or suffered, as the case may be, under pressure — and evidence of

pressure is not admissible to support the transaction.

…

97(3) The law of set-off or compensation applies to all claims made against the

estate of the bankrupt and also to all actions instituted by the trustee for the

Page: 37

recovery of debts due to the bankrupt in the same manner and to the same extent as

if the bankrupt were plaintiff or defendant, as the case may be, except in so far as

any claim for set-off or compensation is affected by the provisions of this Act

respecting frauds or fraudulent preferences.

[151] Section 3(1) and part of s. 34⁷¹of the Companies’ Creditors Arrangement Act⁷²read as

follows:

3(1) This Act applies in respect of a debtor company or affiliated debtor companies

if the total of claims against the debtor company or affiliated debtor companies ... is

more than $5,000,000 or any other amount that is prescribed.

…

34(1) No person may terminate or amend, or claim an accelerated payment or

forfeiture of the term under, any agreement, including a security agreement, with a

debtor company by reason only that proceedings commenced under this Act or that

the company is insolvent.

(2) If the agreement referred to in subsection (1) is a lease, the lessor may not

terminate or amend the lease by reason only that proceedings commenced under

this Act, that the company is insolvent or that the company has not paid rent in

respect of any period before the commencement of those proceedings.

…

(5) Any provision in an agreement that has the effect of providing for, or

permitting, anything that, in substance, is contrary to this section is of no force or

effect.

VI.

Analysis

A. Introduction

[152] The first part of this segment of the judgment records the deficiencies that strip the classic

penalty rule of any utility and explains why a stipulated-consequence-on-breach term in a

⁷¹An Act to establish the Wage Earner Protection Program Act, to amend the Bankruptcy and Insolvency Act and the

Companies’ Creditors Arrangement Act and to make consequential amendments to other Acts, S.C. 2005, c. 47, s. 131

(in force September 18, 2009 S.I./2009-68).

⁷²R.S.C. 1985, c. C-36.

Page: 38

commercial contract should be enforced unless it is oppressive, a position staked out by the

Supreme Court of Canada in 1978. ⁷³The next part applies the oppressive test to s. VII Q(d).

[153] The second part explains why corporate bankruptcy ipso facto terms are lawful in Canada.

It also constructs a new common law test for the identification of unenforceable corporate

bankruptcy ipso facto terms, in the event the Bankruptcy and Insolvency Act⁷⁴does not preclude

common law intervention. The final segment applies the new common law test to s. VII Q(d) and

concludes that it is enforceable against the bankruptcy trustee.

B.

Section VII Q(d) Is Neither Oppressive Nor a Penalty and Is Enforceable

1. The Classic Penalty Rule Is Without Merit and Should Be Abandoned

[154] The penalty rule was suspect when common law courts first applied it and it has not shed

this limiting characteristic in the intervening centuries.⁷⁵It is unsound and should not be used any

more. Justice Dickson, as he then was, speaking for the Supreme Court in Elsley v. J.G. Collins

Insurance Agencies Ltd.,⁷⁶said so roughly forty years ago. But many Canadian courts have not

paid heed to his unequivocal message.⁷⁷

[155] A stipulated-consequence-on-breach term should be enforced unless doing so would bring

the administration of justice into disrepute.⁷⁸With regard to a commercial contract, this would

happen only if a stipulated-consequence-on-breach term is manifestly grossly one-sided. A less

onerous standard may be suitable for consumer contracts.

⁷³Elsley v. J.G. Collins Insurance Agencies Ltd., [1978] 2 S.C.R. 916, 937.

⁷⁴R.S.C 1985, c. B-3.

⁷⁵Cavendish Square Holdings BV v. El Makdessi, [2015] UKSC 67,¶36; [2016] A.C. 1172, 1206 (“[The penalty rule]

is the creation of the judges, and, she argued, the judges should now take the opportunity to abolish it. There is a case

to be made for taking this course. ...We rather doubt that the courts would have invented the rule today if their

predecessors had not done so three centuries ago”).

⁷⁶[1978] 2 S.C.R. 916, 937.

⁷⁷E.g., B.L.T. Holdings Ltd. v. Excelsior Life Insurance Co., [1986] 6 W.W.R. 534 (Alta. C.A. 1986); Dial Mortgage

Corp. v. Baines, 15 Alta. L.R. 2d 211 (Q.B. 1980); Dezcam Industries Ltd. v. Kwak, [1983] 5 W.W.R. 32 (B.C.C.A.);

Colliers Macaulay Nicolls Inc. v. Park Georgia Properties Ltd., 2003 BCSC 1785; 15 R.P.R. 4^th132; Schindler

Elevator Corp. of Canada v. New Vista Society, [1998] B.C.J. No. 2327 (Sup. Ct.); Place Concorde East Ltd.

Partnership v. Shelter Corp. of Canada, [2003] O.J. No. 5437; 43 B.L.R. 3d 54 (Sup. Ct.).

⁷⁸See Principles, Definitions and Model Rules of European Private Law, Draft Common Frame of Reference (C. von

Bar & E. Clive eds. 2009)(a penalty clause may be modified and a different obligation imposed only if it is “grossly

excessive”); Scottish Law Commission, Report on Penalty Clauses (No. 171) ¶3.10 (May 1999) (the Commission

recommended that a penalty term be unenforceable only if it is “manifestly excessive”) & Davis, Penalty Clauses

Through the Lens of Unconscionability Doctrine: Birch v. Union of Taxation Employees, 55 McGill L.J. 151, 164

(2010) (“Employing the unconscionability doctrine instead of the traditional penalty doctrine was a bold and valuable

step. But the potential benefits of that innovation will not be realized so long as courts’ vision continues to be occluded

by the remnants of the penalty doctrine”).

Page: 39

a.

The Purpose of the Penalty Rule Is Unclear

[156] The purpose of the penalty rule is unclear.⁷⁹The few courts that have addressed this issue

have presented a variety of opinions. This is troublesome.⁸⁰If there is no consensus as to the

purpose a concept serves, how can it be implemented in a consistent and rational manner?

[157] Chief Justice Laskin, in H.F. Clarke Ltd. v. Thermidaire Corp.,⁸¹asserted that the rule “is

simply a manifestation of a concern for fairness and reasonableness ... whenever the parties seek to

remove from the courts their ordinary authority to determine ... what damages may be recovered as

a result [of contractual breach]”. Is this focus on the fairness and reasonableness of a contractual

term misplaced? Courts have historically disavowed any jurisdiction to review bargains for their

fairness or reasonableness.⁸²Why should a stipulated-consequence-on-breach term be singled out

for special treatment?

[158] Lord Roskill, in Export Credits Guarantee Department v. Universal Oil Products Co.,⁸³a

1983 case, suggested that the “main purpose [of the penalty rule] ... is to prevent a plaintiff

⁷⁹Robophone Facilities Ltd. v. Blank, [1966] 3 All E.R. 128, 142 (C.A.) per Lord Diplock (“I make no attempt ... to

rationalize this common law rule”); Hill v. Barclay, 34 Eng. Rep. 238, 239 (Ch. 1811) per Lord Eldon (“[the penalty

rule was ] utterly without foundation”) & Astley v. Weldon, 126 Eng. Rep. 1318, 1321 (Common Pleas 1801) per Lord

Eldon (“I felt ... much embarrassed in ascertaining the principle upon which [the penalty rule cases were founded”).

⁸⁰Holmes, “The Path of the Law”, 10 Harv. L. Rev. 457, 469 (1897)(“a body of law is more rational ... when every

rule it contains is referred articulately and definitely to an end which it subserves, and when the grounds for desiring

that end are stated ... in words”) & Coke, The First Part of the Institutes of the Lawes of England or a Commentarie

upon Littleton 395 (1628) (“knowing for certaine that the Lawe is unknowne to him that knoweth not the reason

thereof”). See The Queen v. Big M Drug Mart Ltd., [1985] 1 S.C.R. 295, 331 (“All legislation is animated by an object

the legislation intends to achieve”); City of Montreal v. 2952-1366 Quebec Inc., 2005 SCC 62, ¶23; [2005] 3 S.C.R.

141, 156 (“Identifying the purpose of a regulation can be helpful in determining the meaning of a given word or

expression”); Hirsch v. Protestant Board of School Commissioners, [1926] S.C.R. 246, 267 (a court must always

consider the object of the statute) & Alberta v. Cardinal, 2013 ABQB 407, ¶51; 565 A.R. 271, 286 (“a court forced to

interpret legislation and apply it to a fact pattern without an understanding of the underlying purpose of the enactment

functions with a severe handicap”).

⁸¹[1976] 1 S.C.R. 319, 331 (1974).

⁸²Cavendish Square Holding BV v. El Makdessi, [2015] UKSC 67, ¶13; [2016] A.C. 1172, 1196 (H.L) per Lord

Neuberger & Lord Sumption (“Leaving aside challenges going to the reality of consent, such as those based on fraud,

duress or undue influence, the courts do not review the fairness of men’s bargains either at law or in equity”) & ¶73,

[2016] A.C. at 1216 per Lord Neuberger & Lord Sumption (“It is not a proper function of the penalty rule to empower

the courts to review the fairness of the parties’ primary obligations, such as the consideration promised for a given

standard of performance”); Export Credits Guarantee Department v. Universal Oil Products Co. [1983] 1 W.L.R.

399, 403 (H.L.) per Lord Roskill (“it is not and never has been for the courts to relieve a party from the consequences

of what may ... prove to be an onerous or possibly even a commercially imprudent bargain”); Bridge v. Campbell

Discount Co., [1962] A.C. 600, 626 (H.L.) per Lord Radcliffe (“the courts of equity never undertook to serve as a

general adjuster of men’s bargains”) & Jobson v. Johnson, [1989], 1 All E.R. 621, 626 (C.A. 1988) (“This is of course

not saying that the courts claim a general power not to enforce any agreement which the courts regard as

unconscionable and extravagant”.)

⁸³[1983] 1 W.L.R. 399, 403 (H.L.). The other judges agreed with Lord Roskill.

Page: 40

recovering a sum of money ... which bears little or no relationship to the loss actually suffered by

the plaintiff as a result of the breach by the defendant”. The unstated assumption is that an innocent

promisee deprived of a bargained benefit is only entitled to an award in accordance with governing

common law damage principles and that this principle is more important than the benefits society

derives from the enforcement of bargained contracts. It is not obvious to me that this is a defensible

proposition.

[159] Justice Frankfurter, dissenting in Priebe & Sons, Inc. v. United States,⁸⁴had a different

understanding: “I assume that the basic reason for this doctrine is that the infliction of punishment

through courts is a function of society and should not inure to the benefit of individuals”. He cites

no authority for this opinion. ⁸⁵The underpinning for this norm is the assumption that a promisor

has agreed to suffer punishment if the promisor fails to discharge a contractual promise. This

strikes me as an unsupportable assumption. The promisor makes a commitment necessary to

secure the agreement of the other side. From my perspective, the punishment concept has nothing

to do with whether a stipulated-consequence-on-breach-term is enforceable.

b.

There Are Fundamental Problems with the Classic Penalty

Rule

[160] There are six fundamental problems with the classic penalty rule – and one unrelated and

unwelcome consequence.

[161] First, it is not clear what constitutes a penalty. “The test for distinguishing penal from other

principles is unclear”.⁸⁶This is a significant drawback.⁸⁷If an adjudicator does not know what the

core element of a principle is, it is impossible to apply it rationally and consistently.⁸⁸

⁸⁴332 U.S. 407, 418 (1947).

⁸⁵Justice Frankfurter was not the first to present this idea. See Craig and Son v. M’Beath, 1 M. 1016, 1018 (Scot. Ct.

Sess. 1863) per Inglis, L.J.-Clerk (“Parties cannot lawfully enter into an agreement that the one party shall be punished

at the suit of the other”). Other jurists have subsequently agreed with Justice Frankfurter. See Paciocco v. Australia

and New Zealand Banking Group Ltd., [2016] HCA 28, ¶253; 258 C.L.R. 525, 605-06 per Keane, J. (“the real

objection, as a matter of public policy, to a penalty clause which operates upon breach of contract is that it is no part of

the law of contract to allow one party to punish the other for non-performance”) & Legione v. Hateley, [1983] HCA

11, ¶32; 152 C.L.R. 406, 445 per Mason & Deane JJ. (“A penalty ... is the nature of a punishment for non-observance

of a contractual stipulation; it consists of the imposition of an additional or different liability upon breach of the

contractual stipulation”).

⁸⁶Cavendish Square Holding BV v. El Makdessi, [2015] UKSC 67, ¶3; [2016] A.C. 1172, 1192 per Lord Neuberger &

Lord Sumption.

⁸⁷See Clarkson, Miller & Muris, “Liquidated Damages v. Penalties: Sense or Nonsense?” 1978 Wis. L. Rev. 351 &

Hunter Engineering Co. v. Syncrude Canada Ltd., [1989] 1 S.C.R. 426, 460 (the Court favoured abandoning the

fundamental breach doctrine because the proper characterization of a breach is fraught with difficulties and tended to

camouflage the important issue – did the parties intend the limitation-of-liability term to capture this breach?).

Page: 41

[162] Some courts adopt an objective test and employ a variety of inconsistent criteria.⁸⁹

[163] Some courts scrutinize the contract text⁹⁰to determine if the parties agreed that the

stipulated-consequence-on-breach term is liquidated damages⁹¹or a penalty.⁹²Does the text mean

⁸⁸International Association of Firefighters, Local 2461 v. County of Strathcona 22 (Wakeling 1982)(“Neither the

shooters nor the officials know what the target is when the match begins”) & Woodlands Enterprises Ltd. v.

International Woodworkers of America Local 1-184, at 4 (Wakeling 1978) (“Should both sides discharge their

howitzers against different targets, an observer will never know which one is the better shot”).

⁸⁹Canada: Chief Justice Fitzpatrick, in Canadian General Electric Co. v. Canadian Rubber Co., 52 S.C.R. 349, 351

(1915), stated that “[a] penalty is the payment of a stipulated sum on breach of the contract, irrespective of the damage

sustained”. This is not helpful. Under this test, all stipulated-payment-on-breach terms are penalties. United Kingdom:

Lord Neuberger and Lord Sumption, with Lord Carnwath’s concurrence, in Cavendish Square Holding BV v. EI

Makdessi, [2015] UKSC 67, ¶32; [2016] A.C. 1172, 1204, concluded that “[t]he true test is whether the impugned

provision is a secondary obligation which imposes a detriment on the contract-breaker out of all proportion to any

legitimate interest of the innocent party in the enforcement of the primary obligation”. This obviously introduces an

objective yardstick – what is “out of all proportion”? Lord Diplock presented a definition in Scandinavian Trading

Tanker Co. v. Flota Petrolera Ecuatoriana (“The Scaptrade”), [1983] 2 A.C. 694, 702 (H.L.) that adopted an element

with historical precedents: “The classic form of penalty clause is one which provides that upon breach of a primary

obligation under the contract a secondary obligation shall arise on the part of the party in breach to pay to the other

party a sum of money, which does not represent a genuine pre-estimate of any loss likely to be sustained by him as a

result of the breach of primary obligation but is substantially in excess of that sum”. Lord Dunedin, in Dunlop

Pneumatic Tyre Co. v. New Garage & Motor Co., [1915] A.C. 79, 86 (H.L. 1914) opined that “[t]he essence of a

penalty is a payment of money stipulated as in terrorem of the offending party”. This is an objective feature, but is it

helpful? Could a term not be a penalty even if it does not terrorize the promisor? This distinction strikes me as highly

artificial. See also Lordsvale Finance PLC v. Bank of Zambia, [1996] Q.B. 752, 762 (“whether a provision is to be

treated as a penalty is a matter of construction to be resolved by asking whether at the time the contract was entered

into the predominant contractual function of the provision was to deter a party from breaking the contract or to

compensate the innocent party for breach”). Australia: In AMEV – UDC Finance Ltd. v. Austin, 162 C.L.R. 170, 190

(1986), Justices Mason and Wilson of the Australian High Court constructed a definition with a strong objective

component: “[T]here is much to be said for the view that the courts should [allow] ... parties to a contract greater

latitude in determining what their rights and liabilities will be, so that an agreed sum is only characterised as a penalty

if it is out of all proportion to damages likely to be suffered as a result of breach”. Justices Mason and Deane, in

Legione v. Hateley, [1983] HCA 11, ¶32; 152 C.L.R. 406, 445, gave the term this meaning: “A penalty ... is in the

nature of a punishment for non-observance of a contractual stipulation; it consists of the imposition of an additional or

different liability upon breach of the contractual stipulation”. United States: Interstate Industrial Uniform Rental

Service, Inc. v. Couri Pontiac, Inc., 355 A. 2d 913, 921 (Me. Sup. Jud. Ct. 1976)(“This Court has often said that an

agreement made in advance of breach, fixing the damages thereon, is not enforceable unless the damages caused by

the breach are very difficult to estimate accurately and the amount so fixed is a reasonable forecast of the amount

necessary to justly compensate one party for the loss occasioned by the breach”) Has the Maine Supreme Judicial

Court not fashioned contradictory markers? How can both coexist? How can one reasonably forecast damages if it is

very difficult to forecast damages?

⁹⁰Rickman v. Carstairs, 110 Eng. Rep. 931, 935 (K.B. 1833) (“in ... cases of construction of written instruments [the

question] is, not what was the intention of the parties, but what is the meaning of the words they have used”).

⁹¹Wallis v. Smith, 21 Ch. D. 243, 267 (C.A. 1882) per Cotton L.J. (“liquidated damages ... means ... the sum which the

parties have by the contract assessed as the damages to be paid, whatever may be the actual damage”) & T. Sedgwick,

A Treatise on the Measure of Damages, or, an Inquiry into the Principles Which Govern the Amount of Pecuniary

Page: 42

that the contract-breaker must pay the stipulated sum? Or does the text support the conclusion that

its purpose was only to incentivize the promisor to keep its commitment and the parties never

contemplated that the contract-breaker would pay the stipulated sum?

[164] The intention school of thought is without merit. The proposition that the parties intended

that the contract-breaker would be relieved of the obligation under

a

stipulated-consequence-on-breach term strikes me as impractical and artificial. Why would a party

agree to an important term inserted for its benefit that it knows is unenforceable? This does not

accord with commercial standards with which I am familiar.

Compensation Awarded by Courts of Justice 411 (3d rev. ed.1858) (“[liquidated damages:] where the contracting

parties fix or liquidate the amount that shall furnish the measure of compensation in case of non-fulfillment of the

agreement”).

⁹²Canada: Canadian General Electric Co. v. Canadian Rubber Co. of Montreal, 52 S.C.R. 349, 352 (1915)(“There

are innumerable cases in which it has been necessary, in particular cases, to decide whether the parties intended that

the payment provided for by the contract should be in the nature of a penalty or liquidated damages”) (emphasis

added); United Kingdom: Peachy v. Duke of Somerset, 93 Eng. Rep. 626, 630 (Ch. 1720) (“The true ground of relief

against penalties is from the original intent of the case, where the penalty is designed only to secure money, and the

Court gives him all that he expected or desired”); Reynolds v. Bridge, 119 Eng. Rep. 961, 966 (Q.B. 1856)(“[a]ll that

the Courts have done has been only to lay down a canon for establishing the intention of the parties”) 967 per

Crompton, J (“[N]o decision ever went so far as to say that the Courts would not follow what they considered to be the

meaning of the parties”); Clydebank Engineering and Shipbuilding Co. v. Castaneda, [1905] A.C. 6, 16 (H.L. 1904)

per Lord Davey (“if you find a sum of money made payable for the breach, not of an agreement generally which might

result in either a trifling or a serious breach, but a breach of one particular stipulation in an agreement, and when you

find that the sum payable is proportioned to the amount ... or the rate of non-performance of the agreement ... then you

infer that primâ facie the parties intended the amount to be liquidate damages and not penalty. 1 say ‘primâ facie’

because it is always open to the parties to show that the amount ... is so exorbitant and extravagant that it could not

possibly have been regarded as damages for any possible breach which was in the contemplation of the parties”) &

Photo Production Ltd. v. Securicor Transport Ltd., [1980] UKHL 2, ¶9; [1980] A.C. 827, 850 per Lord Diplock (“[a

term] must not offend against the equitable rule against penalties; that is to say, it must not impose upon the breaker of

a primary obligation a general secondary obligation to pay to the other party a sum of money that is manifestly

intended to be in excess of the amount which would fully compensate the other party for the loss sustained by him in

consequence of the breach of the primary obligation”); Australia: O’Dea v. Allstates Leasing System (W.A.) Pty. Ltd.,

[1983] HCA 3, ¶5; 152 C.L.R. 359, 378 per Wilson, J. (“ In essence the task of a court in such a case is to discern the

true intention of the parties: is the clause under challenge a genuine pre-estimate of damage, or is it a penal sanction

imposed on the observance of the agreement by the lessee?”) & Lamson Store Service Co. v. Russell Wilsons & Sons

Ltd., [1906] HCA 87; 4 C.L.R. 672, 686 per Griffith, C.J. (“On the whole, to use the words of Jessel M.R. in Wallis v.

Smith, ‘I am glad to find that I do not feel myself compelled to decide contrary to what is the plain meaning of the

terms by any of the decisions’”); United States: Sun Printing and Publishing Assoc. v. Moore, 183 U.S. 642, 662

(1902)(“this court has consistently maintained the principle that the intention of the parties is to be arrived at by a

proper construction of the agreement ... and that whether a particular stipulation to pay a sum of money is to be treated

as a penalty, or as an agreed ascertainment of damages, is to be determined by the contract, fairly construed”).

Page: 43

[165] Courts decline to enforce stipulated-consequence-on-breach terms in spite of the obvious

fact that the parties intended them to be enforced.⁹³

[166] Many modern courts have held that the term the parties use to describe the

stipulated-consequence-on-breach provision – “penalty”, “forfeiture” or “liquidated damages” – is

not determinative. ⁹⁴Does this orientation not completely undermine the validity of the intention

⁹³Wilmington Housing Authority v. Pan Builders, Inc., 665 F. Supp. 351, 354 (D. Del 1987)(“Courts adopting this

intention criterion have been criticized by numerous commentators for merely paying lip service to the intention of the

parties while deciding the cases based on ... the certainty of damages and the reasonableness of the stipulated amount.

... [T]his Court declines to adopt the intention criterion”) & Interstate Industrial Uniform Rental Service, Inc. v. Couri

Pontiac, Inc., 355 A. 2d 913, 921 (Me. Sup. Jud. Ct. 1976) (“This Court has held that the question of whether a

stipulated amount is liquidated damages or a penalty shall be resolved by finding the intent of the parties. ... Clearly

that ... does not mean that the Court must follow the intent as it appears on the face of the contract, for so doing would

require the Court to uphold any provision designated ‘liquidated damages’ since the parties have clearly stated that

they intend to pay that amount in the event of breach”).

⁹⁴Canada: Waugh v. Pioneer Logging Co., [1949] S.C.R. 299, 311 per Estey J. (“the mere use of the words ‘liquidated

damages’ or ‘penalty’ is not conclusive. In this case the language used is not particularly helpful as both the words

‘forfeited’ and ‘liquidated damages’ appear in the text”); Canadian General Electric Co. v. Canadian Rubber Co., 52

S C.R. 349, 366 (1915) per ldington, J. (“It is not for the law ... to act upon the name given or name assigned the

amount of reduction”); J. McCamus, The Law of Contracts 965 (2012)(“The fact that the parties may describe the

stipulated sum as ‘liquidated damages’ or, as is often stipulated, ‘as liquidated damages and not as a penalty’ is not

dispositive”); United Kingdom: Cavendish Square Holding BV v. EI Makdessi, [2015] UKSC 67, ¶15; [2016] A.C.

1172, 1197 (“the classification of terms for the purpose of the penalty rule depends on the substance of the term and

not on its form or on the label which the parties have chosen to attach to it”); Jeancharm Ltd. v. Barnet Football Club

Ltd., [2003] EWCA Civ 58, ¶ 27 per Peter Gibson L.J. (“the court looks at the substance of the matter, rather than the

form of words, to determine what was the real intention of the parties”); Dunlop Pneumatic Tyre Co. v. New Garage

and Motor Co, [1915] A.C. 79, 86 (H.L. 1914) (“Though the parties to a contract who use the words ‘penalty’ or

‘liquidated damages’ may prima facie be supposed to mean what they say, yet the expression used is not conclusive.

The Court must find out whether the payment stipulated is in truth a penalty or liquidated damages”); Commissioner of

Public Works v. Hills, [1906] A.C. 368, 375 (P.C.) (Cape of Good Hope) (“it is well settled law that the mere form of

expression ‘penalty’ or ‘liquidated damages’ does not conclude the matter”); Clydebank Engineering and

Shipbuilding Co. v. Castaneda, [1905] A.C. 6, 9 (H.L. 1904) per Earl of Halsbury, L.C.) (“Both in England and

Scotland it has been pointed out that the Court must proceed according to what is the real nature of the transaction, and

that the mere use of the word ‘penalty’ ... or ‘damages’ ... would not be conclusive as to the right of the parties”);

Thompson v. Hudson, L.R.4 H.L.1, 30 (1869)(“if the sum described as liquidated damages be a very large sum, and the

title to that sum is to arise upon some very trifling consideration, then it follows plainly that the large sum never could

have been meant to be the real measure of damages”); Forrest and Barr v. Henderson, Coulborn & Co., 7 Scot. L.

Rptr. 112, 115 (Ct. Sess. 1869)(“even where parties stipulate that a sum of this kind shall not be regarded as a penalty,

but shall be taken as an estimate and ascertainment of the amount of damage to be sustained in a certain event, equity

will interfere to prevent the claim being maintained to an exorbitant and unconscionable amount)”; Astley v. Weldon,

126 Eng. Rep. 1318, 1321 (Common Pleas 1801) per Lord Eldon (“A principle has been said to have been stated in

several cases, the adoption of which one cannot but lament, namely, that if the sum would be very enormous and

excessive considered as liquidated damages, it shall be taken to be a penalty though agreed to be paid in the form of

contract”); Australia: Paciocco v. Australia and New Zealand Banking Group Ltd., [2016] HCA 28, ¶46 per Kiefel, J.

(“The fact that the sum was called a penalty was not, of course, conclusive”); Hong Kong: Polyset Ltd. v. Panhandat

Ltd., [2002] HKCFA 15, ¶8 (“Even if the sum so specified is described as liquidated damages, it may be seen upon

examination to have been fixed as a threat to be held over a party’s head with a view to compelling him to perform. If

so, the specified sum will be regarded as a penalty and therefore not recoverable”) & United States: United States v

Page: 44

test? How can an adjudicator assert that the parties’ intention is important and then proclaim that

the text unequivocally proclaiming that intention is not determinative? One must assume that the

ordinary and plain meaning of the text conveys what the parties intended.

[167] Second, because the penalty rule is confusing, it produces inconsistent results that cannot

be rationally explained.⁹⁵This is not a trait of a useful norm. It is the mark of a misleading and

suspect measure.

[168] Third, even if the benchmarks of a penalty term were universally acknowledged, it is not

readily apparent that the penalty concept captures the essence of judicial reluctance to enforce

some contract terms and provides much assistance in deciding whether a contested term should be

enforced or not. A determination that a provision is a penalty provides little assistance to an

adjudicator who must decide whether it is appropriate to relieve a promisor of a contractual

obligation. How does the knowledge that a term is a penalty assist a court to decide whether it

should be enforced? Characterizing a stipulated-consequence-on-breach term as a penalty is no

more helpful than describing it as a remedial term or written in English. Suppose that a Casablanca

Bethlehem Steel Co., 205 U.S. 105, 120 (1907)(“Either expression [penalty or liquidated damages] is not always

conclusive as to the meaning of the parties”); Truck Rent-A-Center, Inc., v. Puritan Farms 2nd, Inc., 361 N.E. 2d

1015, 1018 (N.Y. Ct. App. 1977) (“it is not material whether the parties themselves have chosen to call the provision

one for ‘liquidated damages,’ or have styled it as a penalty.. ... Such an approach would put too much faith in form and

too little substance”); Caesar v. Robinson, 67 N.E. 58, 59 (N.Y. Ct. App. 1903) (“The circumstance that the deposit is

described in the lease as liquidated damages ... is not at all conclusive”); Willson v. Mayor of Baltimore, 34 A. 774, 775

(Md. Ct. App. 1896)(“the intention of the parties at the time the contract was entered into is often, though not always,

given weight; and whilst the language they have used in the instrument, if they declare that the damages shall be

liquidated, is a circumstance that may have its influence ... yet even their explicit words will be sometimes

disregarded”); Jaquith v. Hudson, 5 Mich. 123, 138 (Sup. Ct. 1858)(“Thus, though the word ‘penalty’ be used ... or

‘forfeit’ ... or ‘forfeit and pay’ ... it will still be held to be stipulated damages if, from the whole contract, the subject

matter, and the situation of the parties, it can be gathered that such was their intention”) & T. Sedgwick, A Treatise on

the Measure of Damages, or, an Inquiry into the Principles Which Govern the Amount of Pecuniary Compensation

Awarded by Courts of Justice 419 (3d rev. ed. 1858) (“The language of the contract is not controlling. If, indeed, the

word ‘Penalty’ is used ... it will never be construed as a sum absolutely fixed. But the reverse is by no means the case;

and the phrase ‘liquidated damages’, has often been made to read ‘penalty’”). Some contracts use both terms. E.g.,

Commissioner of Public Works v. Hills, [1906] A.C. 368, 375 (P.C.) (Cape of Good Hope) (“Indeed, the form of

expression here, ‘forfeited as and for liquidated damages’, if literally taken, may be said to be self-contradictory, the

word ‘forfeited’ being peculiarly appropriate to penalty, and not to liquidated damages”).

⁹⁵Cavendish Square Holdings BV v. El Makdessi, [2015] UKSC 67, ¶31; [2016] A.C. 1172, 1204 per Lord Neuberger

& Lord Sumption (“the law relating to penalties has become the prisoner of artificial categorisation, itself the result of

unsatisfactory distinctions: between a penalty and genuine pre-estimate of loss, and between a genuine pre-estimate of

loss and a deterrent”); Evans v. Moseley, 114 P. 377 (Kan. 1911) (“There is no branch of the law on which a unanimity

of decision is more difficult to find or on which more illogical and inconsistent holdings may be found”); Gobble v.

Linder, 76 Ill. 157, 158 (Sup. Ct. 1875) (“No branch of the law is involved in more obscurity, by contradictory

decisions, than whether the sum named in an agreement to secure performance will be treated as liquidated damages or

as penalty”) & Jaquith v. Hudson, 5 Mich. 123, 133 (Sup. Ct. 1858) (“It is not to be denied that there is some conflict,

and more confusion, in the cases; judges have been long and constantly complaining of the confusion and want of

harmony in the decisions upon this subject”) (emphasis in original).

Page: 45

visitor gets lost in the Kasbah, the vast labyrinth of market lanes, and cannot remember the name

or address of his or her hotel. A good Samaritan cannot help the tourist find his or her hotel when

all the tourist can say is that he or she is lost. The knowledge that the tourist is lost does not

contribute to the solution of the problem.

[169] Fourth, the distinction between a penalty and a pre-estimate of damages is of limited value.

There are fact patterns which make it exceedingly difficult, if not impossible, to estimate

damages.⁹⁶This might mean that a stipulated-consequence-on-breach term is unenforceable even

though it makes sound business sense.⁹⁷

[170] Fifth, the penalty aspect of a provision can often be camouflaged by clever drafting. An

onerous obligation can be transformed into a beneficial option, as Justice Heath explained more

than 200 years ago in Astley v. Weldon:⁹⁸

It is a well-known rule in equity, that if a mortgage covenant be to pay £5 per cent.,

and if the interest be paid on certain days, then to be reduced to £4 per cent. The

Court of Chancery will not relieve if the early day be suffered to pass without

payment; but if the covenant be to pay £4 per cent, and if the party do not pay at a

certain time it shall be raised to £5 per cent., there the Court of Chancery will

relieve.

[171] Professor Farnsworth made the same point:⁹⁹

Although it is beyond the parties’ power to provide for a penalty of, say, $1,000 for

every day’s delay in performance, up to a maximum of $10,000, they can shape

their substantive rights and dates through a provision for a premium by setting the

completion date ten days later and providing that the price shall be increased by

$1,000 for each day the work is finished early, up to a maximum of $10,000.

[172] A doctrine that can so easily be manipulated must be carefully scrutinized. It is like a snow

bridge – not as useful as it appears. In fact, it is downright dangerous.

⁹⁶Cavendish Square Holdings BV v. El Makdessi, [2015] UKSC 67, ¶31; [2016] A.C. 1172, 1204 per Lord Neuberger

& Lord Sumption (“The real question ... is whether [a stipulated-consequence-on-breach term] ... is penal, not whether

it is a pre-estimate of loss”).

97

Scottish Law Commission, Review of Contract Law: Discussion Paper on Penalty Clauses 6-7 (No. 162)

(November 2016). Contra Paciocco v. Australia and New Zealand Banking Group Ltd., [2016] HCA 28, ¶30; 258

C.L.R. 525, 547 per Kiefel, J. (“[a stipulated-payment-on-breach term may be enforceable even] if no pre-estimate is

made at the time the contract is entered into”).

⁹⁸126 Eng. Rep. 1318, 1322-23 (Common Pleas 1801). See also Wallingford v Mutual Society, 5 A.C. 685, 702 (H.L.

1880) per Lord Hatherley.

⁹⁹E. Farnsworth, Contracts 818 (4^thed. 2004). See Banta v. Stamford Motor Co., 92 A. 665 (Conn. Sup. Ct. 1914)(the

yacht-construction contract featured a premium for advance delivery).

Page: 46

[173] Sixth, it is not obvious why a promisor’s commitment in a commercial agreement to pay a

sum for breach of another term of the agreement that may bear no relationship to the damages that

a court would award for nonperformance is contrary to public policy. A

stipulated-consequence-on-breach term in a commercial contract and the common law damages

principle serve completely different purposes. The former is adopted to avoid the need to utilize

the common law damages protocol to resolve the consequences of nonperformance of a contract

promise. The latter is resorted to because the parties have been unable to resolve the obligation of

the promisor to the promisee on the former’s breach of a contractual obligation.

[174] Here is an example of a contract that is the product of careful negotiations that contain a

stipulated-consequence-on-breach term that does not incorporate common law damage values.

Suppose that A, a public undertaking responsible for the provision of healthcare services in E, a

metropolitan area, enters into an agreement with B, a multi-national medical-testing services

enterprise. B agrees to build in E a modern laboratory and provide medical-testing services for a

twenty-five year period. A promises to pay B an annual minimum fee with escalating factors based

on the number of test results produced for each of the twenty-five years of the contract. The

price-per-test declines as the quantity of annual tests escalates. ¹⁰⁰A and B are satisfied that once

the laboratory is up and running and meeting A’s needs, C and D, public undertakings responsible

for the provision of health care services in E’s satellite communities, will want to do business with

B and ultimately allow B to operate at maximum capacity. A expects that its needs will rise

significantly over the contract term. If B operates at a maximum capacity A’s per test costs drop.

Both A and B appreciate that a change in government may affect A’s willingness to do business

with B. B insists that A undertake onerous commitments if A terminates the contract before the

end date. A knows that B requires a guaranteed minimum income stream to justify B’s upfront

investment and that without A’s business B could not attract other customers. A and B recognize

that a change in service provider may leave B with a special-design facility that may have no

market value; would leave B with an unprofitable business in E; would greatly inconvenience both

sides; and consume large amounts of their leadership teams’ time to secure a smooth transition. A

accepts that B’s concerns are reasonable and agrees to pay B three times the total minimum

amount due over the unexpired portion of the contract. A understands that the likelihood a court

would order A to pay a sum this large if A terminated the agreement prematurely is low. There is a

change of government after five years and A terminates the agreement with B after year eight. B

sues A for three times the minimum amount that A was obliged to pay B in the period covering

years nine to twenty-five inclusive. A refuses to pay on the ground the

stipulated-consequence-on-breach term is an unenforceable penalty.

[175] There is no good reason to relieve A of its obligation to pay the stipulated sum set out in the

contract. A voluntarily made the agreement with B. It was the product of negotiations between

parties with contracting capacity who fully understood their obligations and responsibilities under

100

Davis, “Penalty Clauses Through the Lens of the Unconscionability Doctrine”, 55 McGill L.J. 151, 158

(2010)(“[the penalty doctrine] ignores the possibility that the prejudicial impact of a penalty clause on a breaching

party has been offset by a benefit such as a price reduction conferred by another term of the contract”).

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the contract. Each side had top-notch lawyers. Both believed the relationship was in their best

interests.

[176] It would be a disservice to A, the promisor, to assume that it was unaware of this onerous

obligation and that it did not extract from B, the beneficial promisee of this

stipulated-consequence-on-breach term, compensating concessions that offset this detriment. ¹⁰¹

The correlation between B’s fees and the volume of testing may fall in this category.

[177] I now mention the deleterious consequence of the penalty rule – the detriment the penalty

rule does to contract-interpretation principles. It forces courts to make indefensible claims about

the meaning of contract text and to give text implausible meanings that the text cannot bear.¹⁰²

Courts considering the enforceability of a stipulated-consequence-on-breach term frequently

conclude that the parties did not intend a promisor to comply with a promise on breach when it is

incontrovertible that they did.¹⁰³Justice Christiancy of the Michigan Supreme Court adverted to

the damages this charade causes to the principles of text interpretation:¹⁰⁴“But, as a rule of

construction, or interpretation of contracts, it is radically vicious, and tends to a confusion of ideas

in the construction of contracts generally”. This is undoubtedly true.

¹⁰¹L/3 Communications/ Spar Aerospace Ltd. v. International Association of Machinists and Aerospace Workers, 127

L.A.C. 4^th225, 246 (Wakeling, Q.C. 2004) (“Or some issues may not be dealt with because a concession secured its

absence from the agreement”).

¹⁰²Composite Technologies Inc. v. Shawcor Ltd., 2017 ABCA 160, ¶107; [2017] 8 W.W.R. 427, 468 (“It is not the role

of a court to inflict on the parties' contract text an implausible meaning. Courts that do so torture and destroy the text”);

Lenz v. Sculptoreanu, 2016 ABCA 111, ¶4; 399 D.L.R. 4^th1, 6 (“A contrary interpretation would give the text an

implausible meaning. A court may never do this”); Valard Construction Ltd. v. Bird Construction Co., 2016 ABCA

249, ¶184; 57 C.L.R. 4^th171, 236 per Wakeling, J.A. (“This interpretation was not one that the words may bear. It is

implausible”); Lawson Store Service Co. v. Russell Wilkins & Sons Ltd., [1906] HCA 87; 4 C.L.R. 672, 685 & Sun

Printing and Publishing Assoc. v. Moore, 183 U.S. 642, 673 (1902)(both courts approved the following statement in

Clement v. Cash, 21 N.Y. 253, 257 (Ct. App 1860): “a court of law has no right to erroneously construe the intention of

the parties, when clearly expressed, in the endeavour to make better contracts for them than they have made for

themselves. In these, as in all other cases, the courts are bound to ascertain and carry into effect the true intent of the

parties”) & A. Scalia & B. Garner, Reading Law: The Interpretation of Legal Texts 31 (2012)(“A fundamental rule of

textual interpretation is that neither a word nor a sentence may be given a meaning that it cannot bear. Without the

concept of permissible meanings, there is no such thing as a faithful interpretation of legal texts”).

¹⁰³Interstate Industrial Uniform Restore Service, Inc. v. Couri Pontiac, Inc. 355 A. 2d 913, 921 (Me. Sup. Jud. Ct.

1976)(“this Court has held that the question of whether a stipulated amount is liquidated damages or a penalty shall be

resolved by finding the intent of the parties. ... Clearly that ... does not mean that the Court must follow the intent as it

appears on the face of the contract, for so doing would require the Court to uphold any provision designated

‘liquidated damages’ since the parties have clearly stated that they intend to pay that amount in the event of breach”).

¹⁰⁴Jaquith v. Hudson, 5 Mich. 123, 136 (Sup. Ct. 1858). See also Willson v. Mayor of Baltimore, 34 A. 774, 775 (Md.

Ct. App. 1896)(“Whether a sum named in a contract to be paid by a party in default on its breach is to be considered

liquidated damages or merely a penalty, is one of the most difficult and perplexing inquiries encountered in the

construction of written agreements. The solution of that question ... [is] to some extent controlled by artificial general

rules which are not wholly in harmony with the ordinary canons of construction”).

Page: 48

[178] The real explanation for nonenforcement is the manifest oppressiveness or

unconscionability of the term.¹⁰⁵Courts do not wish to lend their office to such a reprehensible

task. Justice Christiancy of the Michigan Supreme Court recognized the diversionary nature of the

intention model:¹⁰⁶“[T]hough the parties actually intended the sum to be paid, as the damages

agreed upon between them, yet it being clearly unconscionable, the court would disregard the

intention and refuse to enforce the stipulation”.

[179] In my opinion, the true explanation for the cases in which modern courts decline to give

effect to a stipulated-consequence-on breach term in a commercial case is the courts’ belief that the

¹⁰⁵A. Swan & J. Adamski, Canadian Contract Law 950, 951 (3d ed. 2012) (“The more elaborate catalogue presented

by Lord Dunedin [in Dunlop Tyre] was necessary only as long as the common law rejected the general power to police

contracts for unconscionability”).

¹⁰⁶Jaquith v. Hudson, 5 Mich. 123, 136 (Sup. Ct. 1858). See Bildfell, “Exculpatory Clauses and Liquidated Damages

Clauses: Two Sides of the Same Coin?”, 78 Sask. L. Rev. 347, 357 (2015)(“the test applied to penalties prima facie

appears more focused on the reasonableness of the clause itself”).

Page: 49

terms are so one-sided that the courts ought not to enforce them.¹⁰⁷The wisdom of this standard

should be directly confronted.¹⁰⁸

[180] Courts do not decline to enforce bargained stipulated-consequence-on-breach terms in a

commercial agreement to protect the interest of an improvident or incompetent promisor. The promisor

is a fortunate beneficiary of a rule not crafted for the promisor’s advantage.¹⁰⁹Courts declare these

¹⁰⁷Dunlop Pneumatic Tyre Co. v. New Garage and Motor Co., [1915] A.C. 79, 101 (H.L. 1914) per Lord Parmoor

(“The agreed sum … is held to be a penalty if it is extravagant or unconscionable”); Clydebank Engineering and

Shipbuilding Co. v. Castaneda, [1905] A.C. 6, 10 (H.L. 1904)(“whether [this stipulated-payment-on-breach term] ... is

... unconscionable and extravagant, and one which no court ought to allow to be enforced”); O’Dea v. Allstates

Leasing System (W.A.) Pty. Ltd., [1983] HCA 3, ¶1; 152 C.L.R. 359, 374 per Murphy, J. (“These provisions permit the

lessor to recover grossly in excess of any genuine pre-estimate of its loss. They are a trap for an unwary or unfortunate

lessee. They are unenforceable because, by modern standards, they are unconscionably harsh”); Truck Rent-A-Center,

Inc., v. Puritan Farms 2nd, Inc., 361 N.E. 2d 1015, 1019-20 (N.Y. Ct. App. 1977) (the Court upheld an onerous

stipulated-payment term, noting that “[t]he agreement was fully negotiated ... . There is no indication of any disparity

of bargaining power”); Hutchison v. Tompkins, 259 So. 2d 129, 132 (Fla. Sup. Ct. 1972) (“The better result, ... is to

allow the liquidated damage clause to stand if the damages are not readily ascertainable at the time the contract is

drawn, but to permit equity to relieve against the forfeiture if it appears unconscionable in light of the circumstances

existing at the time of breach”); Jaquith v. Hudson, 5 Mich. 123, 133 (Sup. Ct. 1858)(“courts of justice will not

recognize or enforce a contract, or any stipulation of a contract, clearly unjust and unconscionable; a principle of

common sense and common honesty so obviously in accordance with the dictates of justice”) & T. Sedgwick, A

Treatise on the Measure of Damages, or, an Inquiry into the Principles Which Govern the Amount of Pecuniary

Compensation Awarded by Courts of Justice 420 (1858) (“if ... the contract is such that the strict construction ... would

work ... oppression, the use of the term liquidated damages will not prevent the courts from inquiring into the actual

injury sustained and doing justice between the parties”). See also Tercon Contractors Ltd. v. British Columbia, 2010

SCC 4, ¶¶108 & 122; [2010] 1 S.C.R. 69, 116 (“The situations in which the doctrine [ of fundamental breach] is

invoked could be addressed more directly and effectively through the doctrine of "unconscionability", as assessed at

the time the contract was made”) & 122 (“What was demonstrated in Plas-Tex was that the defendant Dow was so

contemptuous of its contractual obligations and reckless as to the consequences of the breach as to forfeit the

assistance of the court”); Hunter Engineering Co. v. Syncrude Canada Ltd., [1989] 1 S.C.R. 426, 455-56 per Dickson,

C.J. (“the courts should not disturb the bargain the parties have struck, and I am inclined to replace the doctrine of

fundamental breach with a rule that holds the parties to the terms of their agreement [liability-exclusion term],

provided the agreement is not unconscionable”).

¹⁰⁸Hunter Engineering Co. v. Syncrude Canada Ltd., [1989] 1 S.C.R. 426, 462 per Dickson, C.J (“there is much to be

gained by addressing directly the protection of the weak from over-reaching by the strong, rather than relying on the

artificial legal doctrine of “fundamental breach”); Tercon Contractors Ltd. v. British Columbia, 2010 SCC 4, ¶120;

[2010] 1 S.C.R. 69, 122 (“a plaintiff who seeks to avoid the effect of an exclusion clause must identify the overriding

public policy that it says outweighs the public interest in the enforcement of the contract”) & Wallis v. Smith, 21 Ch. D.

243, 274 (C.A. 1882) per Lindley, L.J. (“Whether relief was given on the theory of oppression, or on the theory that the

parties could not have meant what they said — that it was too absurd — or whether relief was given by reason of the

usury laws, I do not know — it is an antiquarian research which I have not prosecuted”).

¹⁰⁹The recipient of punitive damages also derives a secondary benefit to which he or she would not ordinarily be

entitled by the application of normal damage principles. Hill v. Church of Scientology, [1995] 2 S.C.R. 1130, 1208

(“Punitive damages may be awarded in situations where the defendant’s misconduct is so malicious, oppressive and

high-handed that it offends the court’s sense of decency: Punitive damages bear no relation to what the plaintiff should

receive by way of compensation”).

Page: 50

terms invalid to protect the reputation of the administration of justice.¹¹⁰The reputation of the judiciary

would be jeopardized if it gave its imprimatur to oppressive terms – terms that were manifestly

one-sided and grossly unfair.¹¹¹I agree with Justice Story of the United States Supreme Court when he

declared extrajudicially¹¹²

that the folly of one man cannot authorize gross oppression on the other side. And

law, as a science, would be unworthy of the name, if it did not, to some extent,

provide the means of preventing the mischiefs of improvidence, rashness, blind

confidence, and credibility on one side: and of skill, avarice, cunning and gross

violation of the principles of morals and conscience on the other.

2.

In 1978 the Supreme Court of Canada Rejected the Penalty Rule and

Adopted the Oppression Standard

[181] In 1978 the Supreme Court of Canada, in Elsley v. J.G. Collins Insurance Agencies Ltd.,¹¹³

jettisoned¹¹⁴the classic penalty rule: “[T]he power to strike down a penalty clause is a blatant

interference with freedom of contract and is designed for the sole purpose of providing relief

110

Websters v. Bosanquet, [1912] A.C. 394, 398 (P.C.) (Ceylon) (“the question must always be whether the

construction contended for renders the agreement unconscionable and extravagant and one which no Court ought to

allow to be enforced”) & Clydebank Engineering and Shipbuilding Co. v. Castaneda, [1905] A.C. 6, 10 (H.L. 1904)

per Earl of Halsbury (“whether it is ... unconscionable and extravagant and one which no Court ought to allow to be

enforced”).

¹¹¹Priebe & Sons, Inc. v. United States, 332 U.S. 407, 418 (1947) per Frankfurter, J. (“But one man’s default should

not lead to another man’s unjust enrichment”).

¹¹²2 J. Story, Commentaries on Equity Jurisprudence as Administered in England and America 743 (4^thed. 1846).

¹¹³[1978] 2 S.C.R. 916, 937.

¹¹⁴Some commentators have suggested that this portion of Justice Dickson’s opinion is obiter and not binding on

lower courts. I disagree. First, this statement is part of the ratio decidendi of the case. Second, even if the statement

was obiter, there is a presumption that obiter statements supported by a majority of the Court are binding on lower

courts. The presumption is at its strongest if the proposition in dispute plays a central role in the legal regime fashioned

by the Supreme Court and is consistent with fundamental legal principles. The Supreme Court not only resolves the

particular dispute that an appeal presents for resolution but creates a legal structure that accounts not only for the

disposition of the appeal before it but all related matters as well. If Justice Dickson’s opinion was obiter, the

presumption kicks in. The presumption is at its weakest if the proposition plays only a minor role in the legal regime

the Supreme Court has constructed and is inconsistent with fundamental legal principles. See generally The Queen v.

Henry, 2005 SCC 76, ¶57; [2005] 3 S.C.R. 609, 642 (“The weight [of obiter] decreases as one moves from the

dispositive ratio decidendi to a wider circle of analysis which is obviously intended for guidance and which should be

accepted as authoritative. Beyond that, there will be commentary, examples or exposition that are intended to be

helpful and may be found to be persuasive, but are certainly not ‘binding’”) & The Queen v. Prokofiew, 2010 ONCA

423, ¶20; 100 O.R. 3d 401 (“Obiter dicta will move along a continuum. A legal pronouncement that is integral to the

result or the analysis that underlies the determination of the matter in any particular case will be binding. Obiter that is

incidental or collateral to that analysis should not be regarded as binding, although it will obviously remain

persuasive”). The presumption is nonexistent if an observation is nothing more than an off-hand or a “throw-away”

remark. Cavendish Square Holding BV v. El Makdessi, [2015] UKSC 67, ¶42; [2016] A.C. 1172, 1209 per Lord

Neuberger & Lord Sumption.

Page: 51

against oppression for the party having to pay the stipulated sum. It has no place where there is no

oppression.” A judgment declining to enforce a stipulated-consequence-on-breach term is an

obvious abridgment of the autonomy of the parties and the freedom of contract.¹¹⁵

[182] Elsley clarified the law on the enforceability of a stipulated-consequence-on-breach term in

a commercial contract between parties that had sufficient resources to retain legal counsel. It was

enforceable unless oppressive. ¹¹⁶

¹¹⁵Cavendish Square Holding BV v. El Makdessi, [2015] UKSC 67, ¶33; [2016] A.C. 1172, 1205 per Lord Neuberger

& Lord Sumption (“The penalty rule is an interference with freedom of contract. It undermines the certainty which

parties are entitled to expect of the law”) & S. Waddams, The Law of Contracts 313 (7^thed. 2017).

¹¹⁶Many Canadian courts have enforced stipulated-consequence-on-breach terms using the oppression standard. E.g.,

32262 BC Ltd. v. See-Rite Optical Ltd., 1998 ABCA 89, ¶16; 39 B.L.R. 2d 102 (the Court enforced a

stipulated-payment-on-breach default term because it was not oppressive); Fern Investments Ltd. v. Golden Nugget

Restaurant (1987) Ltd., 1994 ABCA 153; 149 A.R. 303 (the Court declared that a $100,000 security deposit was not

refundable unless it was oppressive); City of Calgary v. Northern Construction Co., 1985 ABCA 285; [1986] 2

W.W.R. 426 (the Court enforced a stipulated-payment-on-breach term because it was not oppressive); RCAP Leasing

Inc. v. Martin, 2016 ABQB 542;62 B.L.R. 5^th336 (Masters chambers) (the Master refused to enforce an administrative

fee payable on the lessee’s default in an equipment lease agreement because it was unconscionable and oppressive);

Precision Drilling Canada Ltd. Partnership v. Yangarra Resources Ltd., 2015 ABQB 649; 46 B.L.R. 5^th327

(Master)(the Court enforced a promisor’s obligation in a commercial contract to pay eighteen percent interest on

unpaid accounts, having determined that the term was not extravagant or unconscionable); Bucci Xenex Project Ltd. v.

Ramasiuk, 2010 ABQB 389 (the Court enforced a forfeiture term in a condominium purchase agreement because it

was not oppressive); Markdale Ltd., v. Ducharme, 235 A.R. 283, 293 (Q.B. 1998) (“[Elsley] states that the rule that for

a sum to be considered a penalty rather than liquidated damages, it must be oppressive”); City of Edmonton v. Triple

Five Corp., 158 A.R. 293 (Q.B. 1994)(the Court enforced a term allowing the City to draw on a letter of credit if the

promisor did not complete a subdivision on time because the term was not oppressive); Liu v. Coal Harbour

Properties Partnership, 2006 BCCA 385; 273 D.L.R. 4th 508 (the Court held that condominium deposits totalling

$391,000 were forfeited as the term was not oppressive); Prudential Insurance Co. of America v. Cedar Hills

Properties Ltd., [1995] 3 W.W.R. 360, 369-70 (B.C.C.A. 1994)(the Court enforced a $100,000 interest-rate-standby

fee in a $6.4 million commercial loan agreement because it was not unconscionable, extravagant or oppressive);

Bankers Mortgage Corp. v. Plaza 500 Hotels Ltd., 2016 BCSC 722; 65 R.P.R. 5^th120 (the Court enforced a $96,000

exit fee in a loan retainer agreement on the basis that it was not an unenforceable penalty); GL&V Canada Inc. v.

Deramore Construction Services Inc., 2015 BCSC 2534; 50 C.L.R. 4^th108 (the Court applied Elsley and enforced a

stipulated-payment-on-breach term in a commercial contract); Schindler Elevator Corp. v. New Vista Society, [1998]

B.C.J. No. 2327, ¶18 (Sup. Ct.)(the Court enforced a stipulated-payment-on-breach term in a commercial contract

because it was not “excessive, extravagant or unconscionable”). Volvo Truck Finance Canada Ltd. v. Premier Pacific

Holdings Inc., 2002 BCSC 1137; 29 B.L.R. 3d 213 (the Court enforced an interest-escalation-on-default term in a

commercial contract because the promisor had not demonstrated that it was oppressive); Wolf Chevrolet Oldsmobile

Ltd. v. 552234 B.C. Ltd., 2004 BCPC 154; 49 B.C.C.R. 3d 247 (the Court enforced a term in a vehicle-sale agreement

that obliged the purchaser to pay the vendor $5000 if he resold the vehicle in the United States); Canadian Wheat

Board v. Pigeon Hill Elk Farm Ltd., 2009 SKQB 437; 345 Sask. R. 144 (the Court enforced a

stipulated-payment-on-breach term in a commercial contract in the absence of oppression); Carnoustie Holdings Ltd.

v. Brennan Educational Supply Ltd., 2008 SKQB 257; 319 Sask. R. 53 (the Court enforced

stipulated-payment-on-breach term in a commercial contract in the absence of oppression); Lac- La Ronge Indian

Band v. Dallas Contracting Ltd., 2001 SKQB 135; 206 Sask. R. 13 (the Court missed a stipulated-payment-on-breach

term in a commercial contract - $1000/day the projected completion date was missed); Peachtree II Associates -

Dallas LP v. 857486 Ontario Ltd, 256 D.L.R. 4th 490, 500 (Ont. C.A. 2005)(“courts should, whenever possible,

Page: 52

[183] This was a surprising development.

[184] Just four years earlier, in H.F. Clarke Ltd. v. Thermidiare Corp.,¹¹⁷the Supreme Court, by a

three-to-two majority, ¹¹⁸refused to enforce an important term in an exclusive-distribution

commercial contract between two businesses.¹¹⁹H.F. Clarke Ltd., in breach of the agreement, sold

products manufactured by others than Thermidaire that served the same purpose as Thermidaire’s

products. The promisee invoked the stipulated-consequence-on-breach term and demanded that

H.F. Clarke Ltd. pay the “gross trading profit” that it gained from the sale of the competition’s

products.

favour analysis on the basis of equitable principles and unconscionability over the strict common law rule pertaining to

penalty clauses”); Birch v. Union of Taxation Employees, 2008 ONCA 809, ¶39; 305 D.L.R. 4^th64, 77 (“I can discern

nothing in the unique contractual relationship between a union member and his or her union which would suggest to

the court that we should refuse to apply the doctrine of unconscionability in appropriate circumstances”); Zander Sod

Co. v. Solmar Development Corp., 2011 ONSC 7; 6 R.P.R. 5^th116 (the Court enforced a

stipulated-payment-on-breach term in a commercial contract, noting the import of Elsley); Nortel Networks Corp. v.

Jervis, 18 C.C.E.L. 3d 100 (Ont. Super. Ct. 2002)(the Court enforced a stipulated-payment-on-breach term because it

was not unconscionable or vexatious); Lee v. OCCO Developments Ltd., 5 R.P.R. 3d 203 (N.B.C.A. 1996)( the Court

enforced a default term in a large condominium purchase agreement because it was not unconscionable); Beton

Brunsuick Ltee v. Martin, 176 N.B.R. 2d 81 (C.A. 1996)(the court opined that a noncompetition agreement would be

unenforceable only if it was oppressive) & Federal Business Development Bank v. Fredericton Motor Inn, 32 N.B.R.

2d 108 (Q.B. 1980)(the Court enforced a $5000 commitment fee payable in the event the hotel decided not to conclude

the loan transaction). See also Davis, “Penalty Clauses Through the Lens of Unconscionability Doctrine: Birch v.

Union of Taxation Employees, Local 70030”, 55 McGill L.J. 151, 164 (2010). So have Hong Kong courts. E.g., Chow

Kee James v. Transway Construction and Engineering Ltd., [2006] HKCFI 1433 (the Court enforced a

late-completion change in a large public works contract, in part, because it was not unconscionable); First

Commercial Bank v. The Owners of “Liberty Container”, [2004] HKCFI 7013, ¶13 (“the modern approach to penalty

clauses is to look at whether in respect of a commercial contract, the disputed provision can be said to be

unconscionable or oppressive by reason of its being extravagant, exorbitant or excessive and that the court should be

slow to find terms agreed by the parties to be in terrorem rather than genuine agreement providing for fixed formula of

loss”) & Vintech Co. v. Radio-Holland Hong Kong Co., [2001] HKDC 36 (the Court enforced a

stipulated-payment-on-breach-term because it was not oppressive). Some post-1978 judgments determining the

enforceability of stipulated-consequence-on-breach terms never refer to Elsley. E.g., B.L.T. Holdings Ltd. v. Excelsior

Life Insurance Co., [1986] 6 W.W.R. 534 (Alta. C.A. 1986); Dial Mortgage Corp. v. Baines, 15 Alta. L.R. 2d 211

(Q.B. 1980); Dezcam Industries Ltd. v. Kwak, [1983] 5 W.W.R. 32 (B.C.C.A.); Colliers Macaulay Nicolls Inc. v. Park

Georgia Properties Ltd., 2003 BCSC 1785; 15 R.P.R. 4^th132; Dundas v. Schafer, 2014 MBCA 92; 377 D.L.R. 4^th

485; Infinite Maintenance Systems Ltd. v. ORC Management Ltd., 139 O.A.C. 331 (C.A. 2001) & Place Concorde

East Ltd. Partnership v. Shelter Corp. of Canada, [2003] O.J. No. 5437; 43 B.L.R. 3d 54 (Sup. Ct).

¹¹⁷[1976] 1 S.C.R. 319 (1974).

¹¹⁸Justices Martland and Dickson dissented. [1976] 1 S.C.R. 319, 339 (1974). They adopted the unanimous reasons of

the Court of Appeal for Ontario. [1973] 2 O.R. 57, 70 (“The parties knew and appreciated these factors [the damage

formula may exceed by a large margin the actual damages] and chose this method to establish compensation for a loss,

the amount of which was difficult to determine and, no doubt, very costly to establish. I am convinced that they agreed

upon a method which they both regarded as one which would lead to a fair and just determination of Thermidaire's

damages and losses in the event of a breach of the covenant”). This position is hard to criticize.

¹¹⁹A. Swan & J. Adamski, Canadian Contract Law 952 (3d ed. 2012) (“Thermidaire Corporation ... was a small

one-person corporation dealing with a much larger corporation”).

Page: 53

[185] The trial court¹²⁰and the Ontario Court of Appeal¹²¹granted Thermidaire what it bargained

and paid for. The Supreme Court did not.¹²²Chief Justice Laskin and two of his colleagues refused

to enforce the stipulated-consequence-on-breach term because the “gross trading profit” was twice

the amount the promisee would have received had the promisor promised to disgorge its net

profits, the sum the Court believed was the loss it suffered as a result of H.F. Clarke Ltd.’s breach.

[186] Chief Justice Laskin substituted the Court’s assessment of the fairness of the term for that

of the contracting parties and ignored the fact that the stipulated-payment-on-breach term was a

part of a bargain between two businesses:¹²³

The courts may be quite content to have the parties fix the damages in advance and

relieve the courts of this burden in cases where the nature of the obligation upon the

breach of which damages will arise, the losses that may reasonably be expected to

flow from a breach and their unsusceptibility to ready determination upon the

occurrence of a breach provide a base upon which a pre-estimation may be made.

But this is only the lesser half of the problem. The interference of the courts does

not follow because they conclude that no attempt should have been made to

predetermine the damages or their measure. It is always open to the parties to make

the predetermination, but it must yield to judicial appraisal of its reasonableness in

the circumstances.

[187] Had it not been for the H.F. Clarke Ltd. v. Thermidaire Corp.¹²⁴aberration, the decision in

Elsley would have been consistent with a trend that started in England early in the twentieth

century and was immediately followed in Canada.

3.

Freedom of Contract Is a Fundamental Value in Societies Whose

Welfare Depends on a Free-Market Economy

[188] Although Justice Dickson did not explain in Elsley why the Supreme Court rejected the

much maligned penalty rule and endorsed an oppression principle that so unreservedly promoted

freedom of contract values in commercial contracts, his reasoning is implied.

¹²⁰5 C.P.R. 2d 108.

¹²¹[1973] 2 O.R. 57.

¹²²A. Swan & J. Adamski, Canadian Contract Law 951 (3d ed. 2012) (the authors referred to H.F. Clarke Ltd. v.

Thermidaire Corp. as a “bad detour”).

¹²³[1976] 1 S.C.R. 319, 331 (emphasis added).

¹²⁴H.F. Clarke Ltd. v. Thermidaire Corp. now rests on the judicial sea floor. Elsley did it in. A. Swan & J. Adamski,

Canadian Contract Law 952 (3d ed. 2012) (“The approach adopted by Laskin C.J. ... was implicitly rejected by the

Court in Elsley Estate v. J.G. Collins Insurance Agencies Ltd.”).

Page: 54

[189] There is no compelling reason to decline to enforce stipulated-consequence-on-breach

terms in commercial contracts.¹²⁵

[190] Freedom of contract is a fundamental value in Canada and any other society whose

members’ welfare is largely dependent on a thriving free-market economy. ¹²⁶Canadian, ¹²⁷

English¹²⁸Australian,¹²⁹Hong Kong¹³⁰and American¹³¹courts have frequently recognized the

importance of freedom of contract.

¹²⁵Harvest Operations Corp. v. Canada, 2017 ABCA 393, ¶51; [2018] 3 W.W.R. 51, 65 (“Legal documents are

important. They set out the rights and responsibilities of their signatories. They should be enforced as written unless

there is a compelling reason to modify them”).

¹²⁶See P. Atiyah, The Rise and The Fall of Freedom of Contract (1979). Contracts are also important mechanisms in

planned economies. But not freedom of contract. Grossfeld, “Money Sanctions for Breach of Contract in a Communist

Economy”, 72 Yale L.J. 1326, 1327 (1963) (“The function of the contract ... is to implement in detail the directives of

governmental policy as expressed in the plan”).

¹²⁷E.g., Tercon Contractors Ltd. v. British Columbia, 2010 SCC 4, ¶¶82 & 123; [2010] 1 S.C.R. 69, 107 & 123 per

Binnie J. (“the principle is that a court has no discretion to refuse to enforce a valid and applicable contractual

exclusion clause unless the plaintiff ... can point to some paramount consideration of public policy sufficient to

override the public interest in freedom of contact and defeat what would otherwise be the contractual rights of the

parties”) & (“[Canada recognizes] the very strong public interest in the enforcement of contracts”); Elsley v. J.G.

Collins Insurance Agencies Ltd., [1978] 2 S.C.R. 916, 937 (“the power to strike down a penalty clause is a blatant

interference with freedom of contract”); Hittinger v. Turgeon, 2005 ABQB 257, ¶115; [2006] 3 W.W.R. 699, 716

(“The case law is replete with references to the need to maintain the integrity of contracts”) & Prudential Insurance

Co. of America v. Cedar Hills Properties Ltd., [1995] 3 W.W.R. 360, 369 (B.C.C.A. 1994) (“To single out this

provision in the absence of any circumstances suggesting oppression or overreaching is ... an unwarranted interference

with freedom of contract”); MTK Auto West Ltd. v. Allen, 2003 BCSC 1613, ¶22 (“A court should not strike down a

penalty clause as being unconscionable lightly because it is a significant intrusion on freedom of contract”); 869163

Ontario Ltd. v. Torrey Springs II Associates Ltd. Partnership,256 D.L.R. 4^th490, 500 (Ont. C.A. 2005)(“Judicial

enthusiasm for the refusal to enforce penalty clauses has waned in the face of a rising recognition of the advantages of

allowing parties to define for themselves the consequences of breach”); Zander Sod Co. v. Solmar Development Corp.,

2011 ONSC 7, ¶96; 6 R.P.R. 5^th116, 143 (“The common law has long recognized and respected private ordering. ...

[P]arties generally enjoy the freedom to contract with one another as they see fit. That freedom includes the right to

agree on a limit of damages or even a fixed sum to be paid in the event of breach”) & S. Waddams, The Law of

Contracts 320 (7^thed. 2017) (“It is often in the interests of both parties to make the cost of non-performance

predictable in advance”).

¹²⁸Cavendish Square Holding BV v. EI Makdessi, [2015] UKSC 67, ¶257; [2016] A.C. 1172, 1278 per Lord Hodge

(“The rule against penalties is an exception to the general approach of the common law that parties are free to contract

as they please and that the courts will enforce their agreements”); Belmont Park Investments Pty Ltd. v. BNY

Corporate Trustee Services, [2011] UKSC 38, ¶103; [2012] 1 A.C. 383, 421 per Lord Collins (“party autonomy is at

the heart of English commercial law”); Philips Hong Kong Ltd. v. Hong Kong, [1993] UKPC 3a, ¶23;[1993] 1

H.K.L.R. 269, 280 (“bear in mind that what the parties have agreed should normally be upheld. Any other approach

will lead to undesirable uncertainty, especially in commercial contracts”); Scandinavian Trading Tanker Co. v. Flota

Petrolera Ecuatoriana (Scaptrade), [1983] 2 A.C. 694, 703 (H.L.) per Lord Diplock (“Prima facie parties to a

commercial contract bargaining on equal terms can make ‘time to be of the essence’ of the performance of any primary

obligation under the contract that they please, whether the obligation be to pay a sum of money or to do something

else”); Scandinavian Trading Tanker Co. v. Flota Petrolera Ecuatoriana (Scaptrade), [1983] Q.B. 529, 540-41 (C.A.

1982)(“It is of the utmost importance in commercial transactions that, if any particular event occurs which may affect

Page: 55

[191] Whenever parties with capacity and sufficient resources to retain legal counsel make

commercial bargains the law is predisposed to enforce their bargains. This is so whether or not

they actually retained counsel. There is a legal presumption that commercial parties know the

burdens and benefits their bargain bestows on them and whether the terms are improvident or

suspect for other reasons.¹³²

the parties’ respective rights under a commercial contract, they should know where they stand. The court should so far

as possible desist from placing obstacles in the way of either party ascertaining his legal position, if necessary with the

aid of advice from a qualified lawyer, because it may be commercially desirable for action to be taken without delay,

action which may be irrevocable and which may have far-reaching consequences”); Dunlop Pneumatic Tyre Co. v.

New Garage and Motor Co, [1915] A.C. 79, 103 (H.L. 1914) per Lord Parmoor, (“I can see no reason why ... the law

should interfere with freedom of contract”); E. Underwood & Son Ltd. v. Barker, [1899] 1 Ch. 300, 305 (C.A.) per

Lindley, M.R. (“If there is one thing more than another which is essential to the trade and commerce of this country it

is the inviolability of contracts deliberately entered into; and to allow a person of mature age, and not imposed upon, to

enter into a contract, to obtain the benefit of it, and then to repudiate it and the obligations which he has undertaken is,

prima facie at all events, contrary to the interests of any and every country”) & Wallis v. Smith, 21 Ch. D. 243, 266

(C.A. 1882) per Jessel, M.R. (“it is of the utmost importance as regards contracts between adults – persons not under

disability and at arm’s length – that the Courts of Law should maintain the performance of the contracts according to

the intention of the parties; that they should not overrule any clearly expressed intention on the ground that Judges

know the business better than the people know it themselves”).

¹²⁹Ringrow Pty. Ltd. v. BP Australia Pty. Ltd., [2005] HCA 71, ¶31; 224 C.L.R. 656, 669 (“there is much to be said for

the view that the courts should [allow]… parties to a contract greater latitude in determining what their rights and

liabilities will be, so that an agreed sum is only characterized as a penalty if it is out of all proportion to damage likely

to be suffered as a result of breach”).

¹³⁰Philips Hong Kong Ltd. v. Hong Kong, [1993] UKPC 3a, ¶17;[1993] 1 H.K.L.R. 269, 277 (“courts have always

avoided claiming that they have any general jurisdiction to rewrite the contracts that the parties have made”); Polyset

Ltd. v. Panhandat Ltd., [2002] HKCFA 15, ¶156 per Litton, J (“where business people are dealing with each other at

arm’s length, their freedom to contract as they please is something the courts respect and protect”); Bank of East Asia

Ltd. v. Yip Chi Wai, [2011] HKCFI 844, ¶66 (High Ct.) (“At present, the public policy is to respect parties’ freedom to

contract, allow them to make the agreed compensation in specific circumstances and restrict judicial intervention to

cases where the penalty is excessive, exorbitant and unreasonable”) & Luen Wai Crane Engineering Co. v. AJAX Pong

Construction Equipment Ltd., [1994] HKCFI 22, ¶8 (High Ct.) (“the court should be disinclined to put asunder the

bargain struck between ... contractual parties on a level playing field. Neither of the parties in this case was under

oppression nor ... [did] either of them ... [suffer] from any disadvantage at the negotiation table).

¹³¹Wise v. United States, 249 U.S. 361, 365 (1919)(“There is no sound reason why persons competent and free to

contract may not agree upon this subject as fully as upon any other, or why their agreement ... should not be

enforced”); Lochner v New York, 198 U.S. 45, 76 (1905) (the Court struck down a statute limiting the number of days

a bakery employee could work in a day or week on the basis of freedom of contract) & ABRY Partners v. F&W

Acquisitions LLC, 891 A. 2d 1032, 1036 (Del. Ch. 2006) (the Court expressly acknowledged that public policy

promotes freedom of contract). See E. Farnsworth, Contracts 313 (4th ed. 2004) (“The principle of freedom of contract

rests on the premise that it is in the public interest to accord individuals broad powers to order their affairs through

legally enforceable agreements. In general, therefore, parties are free to make such agreements as they wish, and

courts will enforce them without passing on their substance”).

¹³²Dunlop Pneumatic Tyre Co. v. New Garage and Motor Co., [1915] A.C. 79 (H.C. 1914)(the Court upheld a

stipulated-payment-on-breach provision to enforce a price-maintenance regime in a tire-distribution contract);

Webster v. Bosanquet, [1912] A.C. 394 (P.C.) (Ceylon) (the Privy Council upheld a stipulated-payment-on-breach

Page: 56

[192] Sir George Jessel, M.R., a strong advocate of the merits of freedom of contract said this:

“[M]en of full age and competent understanding [must] ... have the utmost liberty of contracting,

and that their contracts when entered into freely and voluntarily shall be held sacred and shall be

enforced by courts of justice”.¹³³

[193] This is a principle of fundamental importance.

[194] Moreover, judicial enforcement of stipulated-consequence-on-breach terms in commercial

bargains has salutary effects.

[195] At a general level, it encourages contracting parties to discharge their obligations by

introducing a sufficiently high degree of certainty that the other contracting party will honour its

commitments. It also means that if the promisor does not act as promised the disappointed

promisee may invoke the assistance of the court and secure a predictable remedy for contract

breach.¹³⁴This element of certainty and predictability promotes essential commercial activity.

Commercial actors will be more inclined to do business with enterprises with whom they have no

prior satisfactory working relationships. This is a positive development. Most commercial actors

can accomplish more working together than they can on their own. The interaction would be at a

minimal level if commercial actors could not proceed on the valid assumption that promises are a

valuable commodity to the promisee.

[196] More specifically, there is no valid reason why commercial actors should not be able to

agree on the consequences of nonperformance. Professor Farnsworth states that “[t]he advantages

of stipulating in advance a sum payable as damages are manifold”.¹³⁵A promisor who agrees to

accept substantially less if it fails to perform at a specified level may have a competitive advantage

term in a commercial tea-purchase contract); Clydebank Engineering and Shipbuilding Co. v. Castaneda, [1905] A.C.

6 (H.C.) (the Court enforced the shipbuilder’s promise to pay £500 per week for late delivery of torpedo boats to the

Spanish navy even though the agreement described the payment as a penalty); Lordsvale Finance PLC v. Bank of

Zambia, [1996] Q.B. 752 (the Court upheld a default-uplift interest term in a syndicated loan agreement because a

valid business purpose accounted for its presence); Sun Printing and Publishing Assoc. v. Moore, 183 U.S. 642, 673

(1901) (the Court enforced the charter-party’s promise to pay a stipulated amount if it failed to return the chartered

yacht safe and sound) & United States v. Bethlehem Steel Co., 205 U.S. 105, 121 (1907)(the Court upheld a late

payment term for the delivery of gun carriages to the American military).

¹³³Printing and Numerical Registering Co. v. Sampson, L.R. 19 Eq. 462, 465 (Ch. 1875). See also E. Underwood &

Son Ltd. v. Barker, [1899] 1 Ch. 300, 305 (C.A.) per Lindley, M.R. (“If there is one thing more than another which is

essential to the trade and commerce of this country it is the inviolability of contracts deliberately entered into”).

¹³⁴Robophone Facilities, Ltd. v. Blank, [1966] 2 All E.R. 128, 142 (C.A.) per Diplock L.J. (“It is good business sense

that parties to a contract should know what will be the financial consequences to them of a breach on their part, for

circumstances may arise when further performance of the contract may involve them in a loss. ... Not only does it

enable the parties to know in advance what their position will be if a breach occurs and so avoid litigation at all, but, if

litigation cannot be avoided, it eliminates what may be the very heavy legal costs of proving the loss actually sustained

which would have to be paid by the unsuccessful party”).

¹³⁵E. Farnsworth, Contracts 811 (4^thed. 2004).

Page: 57

over other businesses that are unprepared to agree to such a stipulated-consequence-on-breach

term.¹³⁶In some cases, it will be exceedingly difficult to prove damages. What damages has the

armed-forces promisee suffered if the ship-builder promisor failed to deliver torpedo boats on

time?¹³⁷Torpedo boats do not generate revenue for their naval owners. The promisor may insist on

a stipulated-consequence-on-breach term to place a cap on the consequences of

nonperformance.¹³⁸Without this concession the promisor may have declined to do business with

the promisee. It may have been unwilling to assume an unknown substantial risk. Provisions of

this nature relieve the commercial actors and the state of the costs associated with litigation

conducted to measure the common law damages to which the promisee is entitled.¹³⁹Corporate

executives much prefer to devote their energies to activities that will generate future wealth, as

opposed to reconstructing past events that are critical to the assessment of damages. There are very

few business leaders who are prepared to litigate only to enforce a principle.

[197] It goes without saying that a judicial disposition in favor of the enforcement of commercial

bargains will serve as a significant stimulus to due diligence by the parties – they will carefully

consider the merits and demerits of each and every term.

[198] Freedom of contract is a fundamental feature in a community whose widespread prosperity

depends on an efficient and productive market economy.

¹³⁶Graham v. Wagman, 89 D.L.R. 3d 282, 285 (Ont. C.A. 1978)(“And, finally, we think it is entirely possible that

other considerations may have motivated the defendant in accepting the $5 [ per parking space instead of $25], such as

the continuation of good business relations with the plaintiff”).

¹³⁷Clydebank Engineering and Shipbuilding Co. v. Castaneda, [1905] A.C. 6, (H.L. 1904) (counsel for the ship

builder argued that the Spanish navy could not prove any losses attributable to the defendant’s late delivery of the

torpedo-boat destroyers). See also Brio Electronic Commerce Ltd. v. Tradelink Electronic Commerce Ltd., [2016]

HKCA 164, ¶17 (“to require such a comparison to be made would remove one of the commercial advantages that a

liquidated damages clause is recognised as achieving – the dispensation with the need to adduce evidence on damages

and to calculate them, particularly in cases where proof of the amount of damages suffered may be difficult to achieve

to any degree of precision”).

¹³⁸S. Waddams, The Law of Contracts 319 (7^thed. 2017) (“the power to [agree to a stipulated-consequence-on-breach

term] ... gives flexibility to the process of negotiation by enabling the promisor to give an assurance of performance,

while limiting liability for consequential damages and thereby making the cost of breach predictable”); Scottish Law

Commission, Review of Contract Law: Discussion Paper on Penalty Clauses 6 (No. 162)(November 2016)(“The

advantage of [stipulated-consequence-on-breach-terms] for the contracting parties are the facilitation of contingency

planning, the avoidance of disputes and litigation and the consequent reduction of uncertainty about the outcomes of

breach”) & E. Farnsworth, Contracts 811 (4th ed. 2004) (“For the party in breach, it may have the effect of limiting

damages to the sum stipulated”).

¹³⁹Mortgage Makers Inc. v. McKeen, 2009 NBCA 61, ¶18; 312 D.L.R. 4^th82, 92; Craig and Son v. M’Beath, 1 M.

1016, 1019 (Scot. Ct. Sess. 1863) per Inglis, L.J.-Clerk; S. Waddams, The Law of Contracts 319-20 (7^thed. 2017); J.

McCamus, The Law of Contracts 897 (2005) & E. Farnsworth, Contracts 811 (4^thed. 2004).

Page: 58

[199] While freedom of contract is a bedrock community value, it is not the only ideal our society

cherishes and protects.¹⁴⁰

[200] Some contract terms may promote objectives that are contrary to other important

community interests of equal or transcendent importance¹⁴¹and so objectionable that courts will

refuse to give effect to them. A court of justice must not be the vehicle to promote injustice.¹⁴²

[201] The law will not enforce contracts that advance the interests of criminals¹⁴³or other

anti-social actors who blatantly disregard the interests of others with whom they have a contractual

relationship.¹⁴⁴

¹⁴⁰Shafron v. KRG Insurance Brokers (Western) Inc., 2009 SCC 6, ¶16; [2009] 1 S.C.R. 157, 166 (“Restrictive

covenants give rise to a tension in the common law between the concept of freedom to contract and public policy

considerations against restraint of trade”) & Sternaman v. Metropolitan Life Insurance Co., 62 N.E. 763, 764 (N.Y. Ct.

App. 1902)(“The power to contract is not unlimited. While as a general rule there is the utmost freedom of action in

this regard, some restrictions are placed upon the right by legislation, by public policy and by the nature of things.

Parties cannot make a binding contract in violation of law or of public policy”).

¹⁴¹Tercon Contractors Ltd. v. British Columbia, 2010 SCC 4, ¶117; [2010] 1 S.C.R. 69, 121 (“freedom of contract

will often, but not always, trump other societal values. The residual power of a court to decline enforcement exists but,

in the interest of certainty and stability of contractual relations, it will rarely be exercised”) & Re Millar Estate, [1938]

S.C.R. 1, 4 per Duff, C.J. (“It is the duty of the courts to give effect to contracts ... according to the settled rules and

principles of law ...; but there are cases in which rules of law cannot have their normal operation because the law itself

recognizes some paramount consideration of public policy which over-rides the interest and what otherwise would be

the rights and powers of the individual”).

¹⁴²J. Côté, An Introduction to the Law of Contract 107 (1971) (“no rational system of law could enforce contracts

which call for cheating or the commission of crimes or other serious infractions of the rules of that very legal system”)

& Bank of the United States v. Owens, 27 U.S. 527, 538-39 (1829) (“no court of justice can ... be ... the handmaid of

iniquity. Courts are instituted to carry into effect the laws of a country, how can they then become auxiliary to the

consummation of violations of law?”).

¹⁴³Suppose that C promises A and B that he will drive the getaway car in a bank robbery A and B plan to perpetrate on

a designated date in return for payment of a $25,000 fee. If C subsequently informs A and B a week before the planned

bank heist that he will not be available to drive the getaway car and A and B have to pay D $30,000 to provide this

service, a court will not enforce the bargain between A and B and C. A court will not order C to pay A and B $5000 in

damages. The law recognizes that criminal activity is inimical to the welfare of the community and will do nothing to

promote it. Printing and Numerical Registering Co. v. Sampson, L.R. 19 Eq. 462, 465 (Ch. 1875)(“there is no doubt

public policy may say that a contract to commit a crime, or a contract to give a reward to another to commit a crime, is

necessarily void”); S. Waddams, The Law of Contracts 389 (7^thed. 2017) (“Even though an agreement does not

actually require... the commission of an illegal act, it may be struck down if it tends to facilitate an illegality”); G.

Fridman, The Law of Contract in Canada 338 (6th ed. 2011)(“A contract for an illegal purpose, i.e., a purpose

regarded by the law as improper, though it conforms to all other requirements of a valid transaction, will... be void”) &

A. Swan & J. Adamski, Canadian Contract Law 985 (3d ed. 2012) (“Canadian courts have an inherent power to

prevent an abuse of their process and may refuse to give effect to contracts that are illegal”). Enforcement of this

bank-robbery term would adversely affect the interests of others besides the contracting parties. Tercon Contractors

Ltd. v. British Columbia, 2010 SCC 4, ¶120; [2010] 1 S.C.R. 69, 122 per Binnie, J. (“Conduct approaching serious

criminality or egregious fraud are ... examples of well-accepted and ‘substantially incontestable’ considerations of

public policy that may override the countervailing public policy that favours freedom of contract”). See also Irwin v.

Page: 59

[202] Vice-Chancellor Stine of the Delaware Chancery Court refused to enforce a contractual

term that rewarded fraudsters:¹⁴⁵

The public policy against fraud is a strong and venerable one that is largely founded

on the societal consensus that lying is wrong. Not only that, it is difficult to identify

an economically-sound rationale for permitting a seller to deny the remedy of

rescission to a buyer when the seller is proven to have induced the contract’s

formation or closing by lying about a contractually-represented fact.

For these reasons, when a seller intentionally misrepresents a fact embodied in a

contract – that is when a seller lies – public policy will not permit a contractual

provision to limit the remedy of the buyer to a capped damage claim. Rather, the

buyer is free to press a claim for rescission or for full compensatory damages. By

this balance, I attempt to give fair and efficient recognition to the competing public

policies served by contractual freedom and by the law of fraud.

[203] The Delware Chancery Court understandably concluded that lying is harmful in commerce

and other spheres and that it ought not to receive judicial approbation.

[204] Sometimes courts refuse to enforce a term that is inimical to fundamental economic values

of the community.¹⁴⁶

[205] Most employers will be unable to enforce a noncompetition covenant that is part of an

employment agreement and is not an integral component of a sale of business agreement.¹⁴⁷

Williar, 110 U.S. 499, 510 (1884)(“In England, it is held that the contracts, although wagers, were not void at common

law, ... while generally, in this country, all wagering contracts are held to be illegal and void as against public policy”).

¹⁴⁴Plas-Tex Canada Ltd. v. Dow Chemical of Canada Ltd., 2004 ABCA 309, ¶49; 245 D.L.R. 4^th650, 665 (“Alberta

Courts have generally held that contracts should be enforced regardless of the stringency of their terms limiting

liability because parties require certainty that negotiated provisions in a contract will be legally enforceable... .

However, this principle is subject to an important caveat: the court will intervene when the party desiring to enforce a

liability limiting clause has engaged in unconscionable conduct”).

¹⁴⁵ABRY Partners v. F&W Acquisitions LLC, 891 A. 2d 1032, 1035-36 (2006).

¹⁴⁶E.g., Shafron v. KRG Insurance Brokers (Western) Inc., 2009 SCC 6, ¶16; [2009] 1 S.C.R. 157, 166 (“At common

law, restraints of trade are contrary to public policy because they interfere with individual liberty of action and because

the exercise of trade should be encouraged and should be free”); Elsley v. J.G. Collins Insurance Agencies Ltd., [1978]

2 S.C.R. 916, 923 (“There is an important public interest in discouraging restraints on trade, and maintaining free and

open competition unencumbered by the fetters of restrictive covenants”) & Nordenfelt v. Maxim Nordenfelt Guns and

Ammunition Co., [1894] A.C. 535, 592 (H.L.) per Lord Watson (“the general policy of the law is opposed to all

restraints upon liberty of individual action which are injurious to the interests of the State or community”).

¹⁴⁷Elsley v. J.G. Collins Insurance Agencies Ltd., [1978] 2 S.C.R. 916, 925 (“In a conventional employer/employee

situation [the court will enforce a nonsolicitation covenant, but not a noncompetition covenant]”) & T. Lucas & Co. v.

Page: 60

[206] These examples¹⁴⁸are exceptions to the general rule that a court will enforce a bargain

between parties with capacity to contract. The reasons for these three special cases are clear and

cogent. They constitute compelling reasons for abridging the freedom of contract principle.¹⁴⁹

[207] A compelling case cannot be made for the penalty rule.

[208] Professor Waddams, one of Canada’s leading academic contract lawyers, favours its

destruction:¹⁵⁰

[T]here can be no doubt that in relieving against penalty clauses, the courts are

limiting the freedom of contract.

It appears that the underlying criterion of enforceability in this area is, and must

eventually be recognized to be the fairness of the provision sought to be enforced.

The courts, however, here as elsewhere, retreated from the recognition of so vague

a test, and have resorted instead to a supposed distinction between penal clauses

held “in terrorem” over the obligor (which are unenforceable) and “genuine

pre-estimates” liquidating damages for breach (which are enforceable).

…

…It is not suggested that a rule of universal enforceability should be adopted – only

that, first, a test of unfairness or unconscionability is the only workable and just

test, and, secondly, that in applying the test, the considerations that weigh in favour

of enforcement should not be underestimated.

[209] Party autonomy should not be abridged on account of public policy¹⁵¹in the absence of a

compelling reason.¹⁵²

Mitchell, [1974] 1 Ch. 129, 135 (C.A.)(the Court declared a noncompetition provision in an employment agreement

unenforceable because a nonsolicitation agreement would have adequately protected the promisee’s interests).

¹⁴⁸See generally E. Farnsworth, Contracts 313-343 (4th ed. 2004).

¹⁴⁹Ringrow Pty. Ltd. v. BP Australia Pty. Ltd., [2005] HCA 71, ¶12; 224 C.L.R. 656, 663 (“Exceptions from ...

freedom of contract require good reason to attract judicial intervention to set aside the bargains upon which parties of

full capacity have agreed”).

¹⁵⁰S. Waddams, The Law of Contracts 313 & 320 (7^thed. 2017).

¹⁵¹See Richardson v. Mellish, 130 Eng. Rep. 294, 299 per Best, C.J. (Ex. 1824)(“I am not much disposed to yield to

arguments of public policy ... the courts of Westminster-hall ... have gone much further than they were warranted in

going in questions of policy: ... courts of law look only at the particular case and have not the means of bringing before

them all those considerations which ought to enter into the judgment of those who decide on questions of policy”) &

303 per Burroughs, J. (“public policy ... is a very unruly horse, and when once you get astride it you never know where

it will carry you. It may lead you from the sound law”).

Page: 61

153

[210] A compelling reason exists if a court is asked to enforce an oppressive

stipulated-consequence-on-breach term, the standard Elsley adopted.

[211] An oppressive term in a commercial contract is one that is so manifestly grossly one-sided

that its enforcement would bring the administration of justice into disrepute.

[212] Judges should not use the authority of their office to enforce

stipulated-consequence-on-breach terms of this nature.

[213] This is a theme that can be traced to the extrajudicial writings of Justice Story of the United

States Supreme Court¹⁵⁴and the opinions of the Earl of Halsbury in Clydebank Engineering and

Shipbuilding Co. v. Castandea¹⁵⁵and the Privy Council in Webster v. Bosanquet.¹⁵⁶

[214] This is a very onerous test, as it should be.¹⁵⁷It will seldom be met.

[215] Parties to commercial contracts have the means to look after their own interests. The public

knows this and there is no danger that their confidence in the ability of the courts to administer

justice will be eroded if courts decline to enforce contract terms only if they are oppressive.

4.

This Disposition Continues the Trend Established in the Previous

Centuries

a.

Canadian Jurisprudence

[216] The Supreme Court of Canada decided Canadian General Electric Co. v. Canadian

Rubber Co. of Montreal¹⁵⁸on December 29, 1915, roughly eighteen months after the House of

152

Hunter Engineering Co. v. Syncrude Canada Ltd., [1989] 1 S.C.R. 426, 462 (“Only where the

[limitation-of-liability term in the] contract is unconscionable, as might arise from situations of unequal bargaining

power between the parties, should the courts interfere with agreements the parties have freely concluded.”).

153

According to Webster’s Third New International Dictionary of the English Language Unabridged (2002),

“oppressive” may mean “unjustly severe, rigorous or harsh: constituting oppression: < ~ legislation> < ~ taxes> <~

exactions>”.

¹⁵⁴2 J. Story, Commentaries on Equity Jurisprudence as Administered in England and America 743 (4^thed. 1846).

¹⁵⁵[1905] A.C. 6, 10 (H.L. 1904).

¹⁵⁶[1912] A.C. 394, 398 (P.C.) (Ceylon).

¹⁵⁷See Bildfell, “Exculpatory Clauses and Liquidated Damages Clauses: Two Sides of the Same Coin”. 78 Sask. L.

Rev. 347, 354 (2015)(“courts are highly reluctant – and rightly so, in my opinion – to interfere with freedom of

contract in cases involving exclusions”).

¹⁵⁸52 S.C.R. 349.

Page: 62

Lords released its well-known Dunlop Pneumatic Tyre Co. v. New Garage and Motor Co.¹⁵⁹

judgment.

[217] At issue in the Canadian case was the enforceability of a stipulated-consequence-on-breach

term that reduced the $33,000 purchase price of electrical equipment that Canadian General

Electric had agreed to manufacture for the Canadian Rubber Company.

[218] Canadian General Electric commenced an action seeking judgment for the sum Canadian

Rubber withheld under the stipulated-consequence-on-breach term.

160

[219] Both the trial and the appeal courts upheld the defendant’s position.

The

stipulated-consequence-on-breach term was enforceable.

[220] So did the Supreme Court. Any other result would have been indefensible. On what basis

could a court have declared of no force an essential term in a commercial agreement between two

very substantial corporations with access to first-class legal talent?

[221] Chief Justice Fitzpatrick, after noting that the “contract ... relates to a purely business

transaction”¹⁶¹and quoting Sir George Jessel’s famous admonition to judges about meddling in

business contracts, ¹⁶²said this:¹⁶³

In the contract in the present case there is a clear agreement for the deduction from

the contract price for delay in delivery; there is no objection to such an agreement

being entered into and no reason why effect should not be given to the agreement

by the courts. …

…

… [T]he amount fixed is not alleged to have been an extravagant one; and the

provision was in every respect a reasonable and proper one which both parties may

perfectly well be supposed to have intended.

[222] Justice Davies thought it important to note that the stipulated-consequence-on-breach term

was not “unconscionable”.¹⁶⁴So did Justice Anglin. “[I]t cannot be said that the sum agreed upon

is extravagant or unconscionable”.¹⁶⁵

¹⁵⁹[1915] A.C. 79 (H.L. 1914).

¹⁶⁰52 S.C.R. 349, 354.

¹⁶¹Id. 351.

¹⁶²Id. 353.

¹⁶³Id. (emphasis added).

Page: 63

[223] Other Canadian courts have followed the Dunlop Pneumatic Tyre philosophy and accorded

commercial contracting parties great latitude in ordering their own affairs.¹⁶⁶They undoubtedly

appreciated that there is no sound reason to characterize stipulated-consequence-on-breach terms

as unenforceable penalties when the businesses that must live with the contracts regarded the terms

as a central part of the transactions.

b.

United Kingdom Jurisprudence

[224] Before reviewing the United Kingdom’s post-1800 contribution to the law on this topic, it

is helpful to record the significant events that preceded it.

i.

The Ancient Equitable Origins of the Penalty Rule¹⁶⁷

[225] By no later than the fourteenth century there existed a well-established commercial

practice designed to avoid the canonical prohibition against usury¹⁶⁸and at the same time provide

the lender with a satisfactory form of security. This was the defeasible penal bond.¹⁶⁹

[226] A penal bond had two principal characteristics.¹⁷⁰The first obliged the borrower to pay the

lender an amount larger than the amount that the lender advanced to the borrower and the borrower

promised to repay in accordance with an agreed upon time schedule – the primary obligation. The

second benchmark relieved the borrower of the obligation to pay this larger amount if the borrower

¹⁶⁴Id. 356.

¹⁶⁵Id. 371.

¹⁶⁶E.g., Reimer v. Rosen, 45 D.L.R. 1 (Man. C.A. 1919) & Infinite Maintenance Systems Ltd. v. ORC Management

Ltd., 139 O.A.C. 331 (C.A. 2001).

¹⁶⁷See T. Sedgwick, A Treatise on the Measure of Damages, or, an Inquiry into the Principles Which Govern the

Amount of Pecuniary Compensation Awarded by Courts of Justice 412-16 (3d rev. ed. 1858); Loyd, “Penalties and

Forfeitures”, 29 Harv. L. Rev. 117 (1915); Simpson, “The Penal Bond with Conditional Defeasance”, 82 Law Q. Rev.

392 (1966); 5 W. Holdsworth, A History of English Law 330-32 (3d. ed. 1945) & Scott & Triantis, “Embedded

Options and the Case Against Compensation in Contract Law”, 104 Colum. L. Rev. 1428, 1440-42 (2004).

¹⁶⁸The common law prohibited usury. An Acte Against Usurye, 37 Hen. 8, c. 9, s. 3 (1545) made it lawful.

¹⁶⁹See also Biancalana, “Contractual Penalties in the King’s Court 1260-1360”, 64 Cambridge L.J. 212, 215 (2005)

(“By 1348 the penal bond with conditional defeasance endorsed on the back of the bond had been invented”) & Loyd,

“Penalties and Forfeitures”, 29 Harv. L. Rev. 117, 122 (1915)(“the scrivener [avoided the word ‘penalty’]; the

obligation will be for ‘lawful money’ and the conditions for the payment of a ‘just sum’ or ‘full sum’ ...; although court

and counsel, long assured of the validity of the transaction, have not hesitated to call the instrument by its true name –

a penal obligation”).

170

Loyd, “Penalties and Forfeitures”, 29 Harv. L. Rev. 117, 121 (1915) & Simpson, “The Penal Bond with

Conditional Defeasance”, 82 Law Q. Rev. 392, 395 (1966) (“Suppose Hugo proposes to lend Robert £100. Robert will

execute a bond in favour of Hugo for a larger sum, normally twice the sum lent, thus binding himself to pay Hugo £200

on a fixed day; the bond will be made subject to a condition of defeasance, which provides that if he pays £100 before

the day the bond is to be void”).

Page: 64

honoured his primary obligation and paid the lender the smaller amount in accordance with a

separate promise to pay.

[227] The following passage provides an historical account of the larger forces at play when

penal bonds were introduced into England: ¹⁷¹

So, when Britannia had grown sufficiently cosmopolitan to become a borrower, it

was the mediaeval Italian banker who seems to have brought into common use in

England the penal bond … .

The rapid spread of this form of obligation is explained by the fact that it was well

adopted to evade the canonical prohibition of interest on loans, regarded as usury

and therefore unlawful for a Christian, and that by the time interest was made

lawful it had become firmly established as a common form of conveyancing.

…

With medieval subtlety the careful conveyancer endeavors to avoid the perils of the

defense of usury by unscrupulous debtors. A contingency is essential; the single bill

under seal is… the most efficacious instrument of the day; so let the obligation be

drawn for a round sum – say twice the amount of the loan – with a clause of

defeasance… declaring the obligation void on payment of the loan on a particular

day; then the condition or defeasance will be collateral to the bond… [C]ourt and

counsel, long assured of the validity of the transaction, have not hesitated to call the

instrument by its true name – a penal obligation.

[228] For centuries, courts ordered borrowers who failed to strictly comply with the defeasible

term to pay the larger sum set out in the penal bond.¹⁷²This outcome was consistent with other

ancient legal practices. During this period courts “did not look with disfavour on the strict

enforcement of forfeitures and interests in land for condition broken”.¹⁷³

¹⁷¹Loyd, “Penalties and Forfeitures”, 29 Harv. L. Rev. 117, 119 & 121-22 (1915).

¹⁷²Id. 122 (“Contract and property law were swept along together, bound by ever tightening chains of precedent, in the

development of doctrines, harsh and narrow perhaps, but capable of being understood and applied, a point not

altogether to be despised in times of disorder and low credit. If the law bore heavily upon the individual, at least there

was a known law, the certainty of which had become the ‘safety of all’”) & Simpson, “The Penal Bond with

Conditional Defeasance”, 82 Law Q. Rev. 392, 411 (1966) (“The law governing bonds is tough law, inspired by the

general philosophy that it is not the business of the courts to remake private contracts; having made their bed the

contracting parties must lie in it”).

¹⁷³Loyd, “Penalties and Forfeitures”, 29 Harv. L. Rev. 117, 122 (1915).

Page: 65

[229] Over time equity smoothed these sharp common law edges.¹⁷⁴Chancery gave attention to

other interests besides the importance of contract enforcement. Equity was not insensitive to the

plight of the defaulters and the disparity between the nature of the breach and the severity of the

consequences attached to the breach for the defaulter.

[230] After 1660 equity introduced new regimes to soften the lot of defaulting mortgagors and

penal bond obligors.¹⁷⁵Equity invented a mortgagor’s right of redemption and a defence for a

penal bond obligor – payment of the amount due had the defeasance term been activated, along

with interest and costs.¹⁷⁶Chancery judges decided that these new solutions were fairer to the

defaulting mortgagor¹⁷⁷and penal bond obligor.¹⁷⁸The interests of the mortgagee and obligee were

not ignored. The new protocol ensured that the mortgagee and obligee were made whole.

Equitable doctrines required the mortgagor and obligor to pay mortgagee and obligees the sum that

they would have received had the primary obligations been honored and to cover mortgagee’s and

obligee’s legal costs.

¹⁷⁴T. Sedgwick, A Treatise on the Measure of Damages, or, an Inquiry into the Principles Which Govern the Amount

of Pecuniary Compensation Awarded by Courts of Justice 413 (3d rev. ed. 1858)(“this severe rule of the common law

was only mitigated by the practice of the courts of chancery, which interposed, and would not allow a man to take

more than in conscience he ought”). See generally C. Rossiter, Penalties and Forfeitures: Judicial Review of

Contractual Penalties and Relief Against Forfeiture of Property Interests (1992) & E. Farnsworth, Contracts 812 (4th

ed. 2004).

¹⁷⁵Wyllie v. Wilkes, 99 Eng. Rep. 331, 333 (K.B. 1780) (“Sir Thomas More ... in the reign of Henry VIII ... summoned

[the common law judges] to a conference concerning the granting of relief at law, after the forfeiture of bonds upon

payment of principal, interest and costs; and when they said they could not relieve against the penalty, he swore... he

would grant an injunction”) & Friend v. Burgh, 23 Eng. Rep. 238 (Ch. 1679)(the Court ordered the obligee under a

penal bond to refund to the obligor an amount equal to the difference between the penalty less the principal, interest

and costs). See Loyd, “Penalties and Forfeitures”, 29 Harv. L. Rev. 117, 125 (1915)(“Certainly by the time of the

Restoration it could be said: ‘it is a common case to give relief against the penalty of such bonds to perform covenants

... and to send it to a trial at law to ascertain the damages in a quantum damnificatus’”) & Simpson, “The Penal Bond

with Conditional Defeasance”, 82 Law Q. Rev. 392, 417 (1966) (“After the Restoration it rapidly became established

that the Chancery would grant relief against penalties due on money bonds on the payment of principal, interest and

costs, and against penalties due for failure to perform covenants on payment of costs and damages”).

¹⁷⁶Cavendish Square Holding BV v. Talal EI Makdessi, [2015] UKSC 67, ¶4; [2016] A.C. 1172, 1192.

¹⁷⁷6 W. Holdsworth, A History of English Law 663-65 (2d ed. 1937)(“The result had been to make the mortgagor’s

equity to redeem a right of property. He had an equitable estate in the land; and subject to the legal rights of the

mortgagee, was, in equity, regarded as its owner. It was during [the seventeenth century] that the consequences of this

new right of the mortgagor began to be worked out”).

¹⁷⁸5 W. Holdsworth, A History of English Law 330-31 (3d. ed. 1945) (“the type of mortgage [that became prevalent in

the latter half of the fifteenth century] gave the mortgagee the fee simple ... with a proviso that, if the debt was paid by

a fixed-date, the land should be reconveyed. The strictness with which this proviso was construed made a recourse to

equity very necessary”).

Page: 66

[231] Two enactments codified the new penalty bond protocol.¹⁷⁹As a result, common law courts

alone heard penal bond cases; an obligor did not have to invoke the jurisdiction of Chancery to

relieve against the harshness of the common law.¹⁸⁰Chancery no longer had a platform from which

it could influence the traits of the penalty law.

[232] The common law reshaped the law dealing with penalties when resolving the

enforceability of a stipulated-consequence-on-breach term.¹⁸¹Lord Neuberger and Lord Sumption,

in Cavendish Square Holding BV v. EI Makdessi,¹⁸²describe its contribution:

With the gradual decline of the use of penal defeasible bonds, the common law on

penalties was developed almost entirely in the context of damages clauses – ie

clauses which provided for payment of a specified sum in place of common law

damages. … If the agreed sum was a penalty, it was treated as unenforceable.

Starting with the decisions in Astley v Weldon… in 1801 and Kemble v Farren, …

[in 1829], the common law courts introduced the now familiar distinction between

a provision for the payment of a sum representing a genuine pre-estimate of

damages and a penalty clause in which the sum was out of all proportion to any

damages liable to be suffered. …

The distinction between a clause providing for a genuine pre-estimate of damages

and a penalty clause has remained fundamental to the modern law, as it is currently

understood. The question whether a damages clause is a penalty falls to be decided

as a matter of construction, therefore as at the time that it is agreed. … It is a species

of agreement which the common law considers to be by its nature contrary to the

policy of the law.

¹⁷⁹An Act for the better preventing frivolous and vexatious Suit, 8 & 9 Will. 3, c. 11, s. 8 (1696) & An Act for the

Amendment of the Law and better Advancement of Justice, 4 & 5 Anne, c. 16, ss. 12 & 13 (1705). See T. Sedgwick, A

Treatise on the Measure of Damages, or, an Inquiry into the Principles Which Govern the Amount of Pecuniary

Compensation Awarded by Courts of Justice 414 (3d rev. ed. 1858)(“this discretionary power was confirmed by

statutory regulation, which provided that in actions on bonds with penalties, the defendant might bring in the principal

debt, interest and costs, and be discharged”).

¹⁸⁰Smith v. Bond, 131 Eng. Rep. 853, 855 (Common Pleas 1833) (“The great object of the statute was to take away the

necessity of applying for relief to a court of equity”).

¹⁸¹See Law v. Local Board, [1892] 1 Q.B. 127, 134 per Kay, L.J. (C.A. 1891)(“it became a settled rule in equity that,

where a sum was agreed to be paid in respect of the performance or non-performance of a collateral matter, the actual

damage for which could be estimated, the penalty would be cut down, and only the actual damages sustained would be

allowed. It was for that very reason that the words “as and for liquidated damages” and similar words, came to be

inserted in contracts. The contracting parties meant by the use of them to exclude this rule of equity ... . It was to avoid

the interference of Courts of Equity that such words were introduced. But then the Courts of Law interfered, and, as it

seems to me, went further than Courts of Equity had done originally”).

¹⁸²[2015] UKSC 67, ¶¶8 & 9; [2016] A.C. 1172, 1194 (emphasis added).

Page: 67

[233] The common law deprived the parties of the freedom to construct remedial provisions that

served their needs.

[234] Not all the judges agreed that the diminution of the scope of freedom of contract was a

positive development.

[235] As noted above, Lord Eldon, Lord Parmoor, Lord Neuberger, Lord Sumption, Lord

Carnwath and Sir George Jessel recorded their opposition to the penalty rule.

ii.

English Common Law Judges Refined the Penalty Rule

[236] In a 1907 judgment Justice Peckham of the United States Supreme Court offered this

historical perspective:¹⁸³

The Courts at one time seemed to be quite strong in their views and would scarcely

admit that there ever was a valid contract providing for liquidated damages. Their

tendency was to construe the language as a penalty, so that nothing but the actual

damages sustained by the party aggrieved could be recovered. Subsequently the

courts became more tolerant of such provisions, and have now become strongly

inclined to allow parties to make their own contracts, and to carry out their

intentions, even when it would result in the recovery of an amount stated as

liquidated damages, upon proof of the violation of the contract, and without proof

of the damages actually sustained.

[237] I agree.

iii.

The Penalty Rule in the Twenty-First Century

[238] In Cavendish Square Holding BV v. El Makdessi,¹⁸⁴a 2015 judgment, the United Kingdom

Supreme Court revisited the merits of the penalty rule. It rejected the appellant’s argument to

abandon the penalty rule completely, or at least in commercial cases. ¹⁸⁵But Lord Neuberger, Lord

Sumption and Lord Carnwath acknowledged that a modern court would not assess the

¹⁸³United States v. Bethlehem Steel Co., 205 U.S. 105, 119 (1907). See T. Sedgwick, A Treatise on the Measure of

Damages, or, an Inquiry into the Principles Which Govern the Amount of Pecuniary Compensation Awarded by

Courts of Justice 419 (1858)(“the courts, especially in this country, have generally shown a marked desire to lean

towards that construction which excludes the idea of liquidated damages, and permits the party to recover only the

damages which he has actually sustained”).

¹⁸⁴[2015] UKSC 67; [2016] A.C. 1172.

¹⁸⁵Id. at ¶162 (Lord Neuberger, Lord Sumption & Lord Carnwath), ¶168 (Lord Mance & Lord Toulson) & ¶261 (Lord

Hodge); [2016] A.C. at 1251, 1253 & 1279.

Page: 68

enforceability of a stipulated-consequence-on-breach term using the same standard that courts

constructed “three centuries ago”.¹⁸⁶

[239] I will review three of the five speeches delivered by the Supreme Court justices. Lord

Neuberger and Lord Sumption gave an extensive joint opinion with which Lord Carnwath agreed.

Lord Mance and Lord Hodge each wrote thorough separate judgments. Lord Clark and Lord

Toulson gave short speeches adopting portions of their colleagues’ views.

[240] Lord Neuberger and Lord Sumption were troubled by the assumption underlying the

classic penalty rule that the concept of penalty and preestimate of damages were mutually

exclusive concepts and that characterizing a term as a deterrent provided assistance in assessing

the enforceability of a stipulated-consequence-on-breach term.¹⁸⁷They were satisfied that these

were not helpful analytical tools; that they provided useless information.¹⁸⁸They concluded that

the key query was this:¹⁸⁹“[w]hether the means by which the contracting party’s conduct is to be

influenced are ‘unconscionable’ or (which will usually amount to the same thing) ‘extravagant’ by

reference to some norm”.

[241] And what are the benchmarks of these characteristics? Lord Neuberger and Lord Sumption

provide this answer:¹⁹⁰“The true test is whether the impugned provision ... imposes a detriment on

the contract-breaker out of all proportion to any legitimate interest of the innocent party in the

enforcement of the primary obligation”.

[242] Lord Mance understood the penalty rule to make unenforceable terms that “attach

exorbitant or unconscionable consequences following from breach”.¹⁹¹

[243] Lord Hodge held that a stipulated-consequence-on-breach term is unenforceable if the

consequence of a breach of contract is exorbitant or unconscionable when regard is

had to the innocent party’s interest in the performance of the contract. Where the

test is to be applied to a clause fixing the level of damages to be paid on breach, an

extravagant disproportion between the stipulated sum and the highest level of

damages that could possibly arise from the breach would amount to a penalty, and

thus be unenforceable. In other circumstances the contractual provision that applies

on breach is measured against the interest of the innocent party which is protected

¹⁸⁶Id. at ¶36; [2016] A.C. at 1206.

¹⁸⁷[2015] UKSC 67, ¶31; [2016] A.C. 1172, 1204.

¹⁸⁸Id.

¹⁸⁹Id.

¹⁹⁰Id. at ¶32; [2016] A.C. at 1204.

¹⁹¹Id. at ¶¶162, 181 & 185; [2016] A.C. at 1251, 1257 & 1258.

Page: 69

by the contract and the court asks whether the remedy is exorbitant or

unconscionable.¹⁹²

[244] It is fair to say that the Supreme Court all but abandoned the penalty rule. The only

similarity between the modern penalty rule and the classic penalty rule is its name. Lord Hodge’s

speech amply illustrates this claim:¹⁹³“[T]he rule against penalties [does not prevent] parties from

reaching sensible arrangements to fix the consequences of a breach of contract and thus avoid

expensive disputes. The criterion of exorbitance or unconscionableness should prevent the

enforcement of only egregious contractual provisions”.

iv.

The Penalty Rule in the Twentieth Century

[245] The House of Lords and the Privy Council issued four important commercial judgments on

the enforceability of stipulated-consequence-on-breach terms in the twentieth century that merit

careful consideration.

[246] The House of Lords released Dunlop Pneumatic Tyre Co. v. New Garage and Motor Co.¹⁹⁴

and Clydebank Engineering and Shipbuilding Co. v. Castaneda¹⁹⁵within ten years of each other

early in the twentieth century. The Privy Council issued Webster v. Bosanquet¹⁹⁶in 1912 and

Philips Hong Kong Ltd. v. Hong Kong¹⁹⁷in 1993.

[247] These four appeals upheld the enforceability of stipulated-consequence-on-breach terms.

The law lords, in effect, declared the primacy of freedom of contract principles in commercial

contracts between parties that had the resources to retain legal counsel.



Dunlop Pneumatic Tyre Co. v. New Garage and Motor Co.

[248] A 1914 judgment of the House of Lords, Dunlop Pneumatic Tyre Co. v. New Garage and

Motor Co.¹⁹⁸, is one of the best-known Commonwealth penalty cases¹⁹⁹. It has been cited with

approval in Canada,²⁰⁰Australia,²⁰¹New Zealand²⁰²and Hong Kong.²⁰³

¹⁹²Id. at ¶255; [2016] A.C. at 1278.

¹⁹³Id. at ¶266; [2016] A.C. at 1280.

¹⁹⁴[1915] A.C. 79 (H.L. 1914). English courts continued to rely on Dunlop Pneumatic Tyre in the twenty-first century.

E.g., Murray v. Leisureplay Plc, [2005] EWCA Civ 963, ¶34 per Arden, L.J. (“The classic statement of the law on

penalties [is] by Lord Dunedin in the Dunlop case”) & ¶44 (“The judgments in the Cine case show the continued

usefulness of the authoritative guidance given by Lord Dunedin in ... Dunlop”).

¹⁹⁵[1905] A.C. 6 (H.L. 1904).

¹⁹⁶[1912] A.C. 394 (P.C.)(Ceylon).

¹⁹⁷[1993] UKPC 3a; [1993] 1 H.K.L.R. 269.

¹⁹⁸[1915] A.C. 79 (H.L. 1914).

Page: 70

[249] Dunlop manufactured tires and related products. It distributed them through a network of

retailers who agreed not to sell Dunlop products to the public at a price below that set out in a

schedule.²⁰⁴Retailers who breached the price-maintenance agreement “agree[d] to pay ... Dunlop

... the sum of 5£ for each and every tyre, cover or tube sold or offered [for sale] in breach of this

agreement, as and by way of liquidated damages and not as a penalty ... .”²⁰⁵

[250] New Garage and Motor Co., the retailer, breached the price-maintenance provision.²⁰⁶

Dunlop secured an injunction. The Master ordered the defendant to pay 250£ as damages, applying

the stipulated-payment-on-breach term.²⁰⁷The Court of Appeal reversed. It held that the term was

a penalty²⁰⁸and allowed only nominal damages.

[251] The House of Lords disagreed with the Court of Appeal.

¹⁹⁹Mortgage Makers, Inc. v. McKeen, 2009 NBCA 61, ¶18; 312 D.L.R. 4th 82, 92 (“Inevitably, everyone turns to the

reasons of Lord Dunedin in Dunlop Pneumatic Tyre Ltd. v. New Garage and Motor Co.”); Prince Albert Credit Union

Ltd. v. Johnson, 131 D.L.R. 3d 710, 713 (Sask. Q.B. 1982)(“the judgment in Dunlop Pneumatic Tyre Co. v. New

Garage and Motor Car Co. Ltd. ... still stands as the definitive statement of the law”); Jeancharm Ltd. v Barnet

Football Club, 2003 EWCA Civ. 58, ¶9 per Jacob, J. (“The classic statement of the law is to be found in the speech of

Lord Dunedin in Dunlop v. New Garage”); S. Waddams, The Law of Contracts 314 (7^thed. 2017)(“[Dunlop Tyre is ]

generally cited as the leading case”); A. Swan & J. Adamski, Canadian Contract Law 949 (3d ed. 2012)(“The

principles of the common law developed for dealing with penalties are generally based on the judgment of the House

of Lords in Dunlop Tyre Co. v. New Garage and Motor Co. Ltd.”); Bildfell, “Exculpatory Clauses and Liquidated

Damages Clauses: Two Sides of the Same Coin”, 78 Sask. L. Rev. 347, 355 (2015) (“Dunlop Pneumatic Tyre ... is a

leading authority on the penalty doctrine”) & Veel, “Penalty Clauses in Canadian Contract Law”, 66 U. Toronto L.

Rev. 229, 233 (2008)(“Dunlop Pneumatic Tyre ... represents the traditional starting point for Canadian courts’

analyses of penalty clauses”).

²⁰⁰E.g., Waugh v. Pioneer Logging Co., [1949] S.C.R. 299; Canadian General Electric Co. v. Canadian Rubber Co.

of Montreal, 52 S.C.R. 349, 352 (1915); Newman, Hill, Duncan & Lacoursiere v. Murray, [1987] B.C.J. No. 2326

(C.A.); Shatilla v. Feinstein, [1923] 3 D.L.R. 1035 (Sask. C.A.); Reimer v. Rosen, [1919] 1 W.W.R. 429 (Man. C.A.);

Canadian Acceptance Corp. v. Regent Park Butcher Shop Ltd., 3 D.L.R. 3d 304, (Man. C.A. 1969) & Infinite

Maintenance Systems Ltd. v. ORC Management Ltd., 139 O.A.C. 331 (C.A. 2001).

²⁰¹E.g., Paciocco v. Australia and New Zealand Banking Group Ltd., [2016] HCA 28; 258 C.L.R. 525; Ringrow Pty.

Ltd. v. BP Australia Pty. Ltd., [2005] HCA 71, ¶ 12; 224 C.L.R. 656, 663.

²⁰²E.g., T.K. (Hong Kong) Ltd. v. Diamond Milk Formulas Ltd., [2016] NZHC 2642, ¶47.

²⁰³E.g., Polyset Ltd. v. Panhandat Ltd., [2002] HKCFA 15, ¶73; Evergreen (FIC) Ltd. v. Golden Cup Industries Ltd.,

2016 WL 1664247, ¶30 (H.K.C.F.I.); First Commercial Bank v. “Liberty Container”, [2004] HKCFI 1013, ¶7 &

Patrick Ho & Assoc. v. Fook Kong Trading Co., [1988] HKCFI 77, ¶29 (High Ct.).

²⁰⁴[1915] A.C. 79, 80 (H.L. 1914).

²⁰⁵Id. 81.

²⁰⁶Id.

²⁰⁷Id. 82.

²⁰⁸Id.

Page: 71

[252] Four law lords heard the appeal and delivered speeches that were sufficiently varied that it

is difficult to identify much common ground.

[253] Lord Dunedin made several points. In assessing the significance of these, one must note

that none of his three colleagues stated that they agreed with him.²⁰⁹

[254] First, “[t]he Court must find out whether the payment stipulated is in truth a penalty or

liquidated damages”.²¹⁰This required an adjudicator to search for the most important or leading

feature or aspect of the term. ²¹¹If the leading feature of a term is its penalty aspect, the term is

unenforceable. If it is in truth a liquidated damages term, it is enforceable.

[255] Second, “[t]he essence of a penalty is a payment of money stipulated as in terrorem of the

offending party; the essence of liquidated damages is a genuine covenanted pre-estimate of

damage”.²¹²The utility of the “in terrorem” concept²¹³is hard to understand. In any event, it is not

obvious to me why the law should disapprove of a term that serves to deter a party from breaching

a contractual promise.²¹⁴

[256] Third, in order to characterize the stipulated-consequence-on-breach term a court must

study “the terms and inherent circumstances of each particular contract, judged of as at the time of

the making of the contract, not as at the time of the breach”.²¹⁵

²⁰⁹Cavendish Square Holding BV v. El Makdessi, [2015] UKSC 67, ¶22; [2016] A.C. 1172, 1199 per Lords Neuberger

and Sumption (“none of the other three Law Lords expressly agreed with Lord Dunedin’s reasoning”).

²¹⁰[1915] A.C. 79, 86 (H.L. 1914). See 5 S. Williston, A Treatise on the Law of Contracts 668 (3d ed. W. Jaeger

1961)(“Liquidated damage ... is a sum fixed as an estimate made by the parties at the time when the contract is entered

into, of the extent of the injury which a breach of the contract will cause”).

²¹¹See Lordsvale Finance Plc v. Bank of Zambia, [1996] Q.B. 752, 762 (“whether a provision is to be treated as a

penalty is a matter of construction to be resolved by asking whether at the time the contract was entered into the

predominant contractual function of the provision was to deter a party from breaking the contract or to compensate the

innocent party for breach”).

²¹²[1915] A.C. 79, 86 (H.L. 1914).

²¹³Websters Third New International Dictionary of the English Language Unabridged 1182 (2002)(“by way of threat

or intimidation < if, after becoming aware of the other party’s offence, the injured party could hold it in terrorem over

his or her head >”) & Black’s Law Dictionary (10th ed. 2014 B. Garner ed. in chief) [“Latin ‘in order to frighten’]

(17c) (By way of threat; as a warning <the demand letter was sent in terrorem; the client has no intention of actually

suing>”). See Campbell Discount Co. v. Bridge, [1962] A.C. 600, 622 (H.L.)(“I do not find that that description adds

anything of substance to the idea conveyed by the word ‘penalty’ itself, and it obscures the fact that penalties may

quite readily be undertaken by parties who are not in the least terrorised by the prospect of having to pay them”).

²¹⁴Mortgage Makers Inc. v. McKeen, 2009 NBCA 61, ¶39; 312 D.L.R. 4^th82, 100 (“there is nothing inherently wrong

in the parties agreeing to a penalty clause inserted for in terrorem purposes”).

²¹⁵[1915] A.C. 79, 87 (H.L. 1914).

Page: 72

[257] Fourth, there are three criteria that are either conclusive or presumptive indicia of a

penalty. A stipulated-consequence-on-breach term must be adjudged to be a penalty “if the sum

stipulated for is extravagant and unconscionable in amount in comparison with the greatest loss

that could conceivably be proved to have followed from the breach”.²¹⁶The same result follows if

the stipulated sum payable is triggered only by a failure to pay a sum of money and the stipulated

sum is “greater than the sum which ought to have been paid”.²¹⁷A term that obliges a promisor to

pay the same sum regardless of whether the contract breach imposes “serious [or] trifling

damage”²¹⁸is presumed to be a penalty. Lord Dunedin also believed that a term may be classified

as liquidated damages if “the consequences of the breach are such as to make precise

pre-estimation almost an impossibility”.²¹⁹

[258] This last observation accounts for Lord Dunedin’s conclusion that the contested term was a

pre-estimate of liquidated damage:²²⁰

[T]he damage apprehended by … [Dunlop] owing to the breaking of the agreement

was an indirect and not a direct damage. So long as [Dunlop] … got their price from

the respondents for each article sold, it could not matter to them directly what the

respondents did with it. Indirectly, it did. … But though damage as a whole from …

[underselling] would be certain, yet damage from any one sale would be impossible

to forecast. It is just, therefore, one of those cases where it seems quite reasonable

for parties to contract that they should estimate that damage at a certain figure, and

provided that figure is not extravagant there would seem no reason to suspect that it

is not truly a bargain to assess damages, but rather a penalty to be held in terrorem.

[259] Dunlop’s evidence proved that cost-cutting by some retailers in its retail distribution

network may cause loyal retailers who honored their price-maintenance commitments to Dunlop

and sold at the stipulated prices to cease to do business with Dunlop and start to sell competitor’s

²¹⁶Id. This concept is frequently mentioned. E.g., Lord Elphinstone v. Monkland Iron and Coal Co., 11 A.C. 332, 345

(H.L. 1886)(“There is nothing whatever to shew that the compensation is exorbitant or extravagant”); Forrest & Barr

v. Henderson, Colbourne & Co., 8 M. 187, 193 (Scot. Ct. Sess. 1869)(“equity will interfere to prevent the claim being

maintained to an exorbitant or unconscionable amount”); Charterhouse Leasing Corp. v. Sanmac Holdings Ltd., 57

W.W.R. 615, 621 (Alta. Sup. Ct. 1966)(the Court concluded that an accelerated lease obligation was extravagant and

unconscionable) & Cracknell v. Jeffrey, 2001 ABPC 11, ¶16; 284 A.R. 372, 376 (“Payment of $5.00 per day [as a late

payment fee] which results in a return over the course of 30 days of 46% on $325.00 in arrears ... is extravagant and

unconscionable in comparison with the greatest loss that could possibly flow from the tenant’s breach”).

²¹⁷[1915] A.C. 79, 87 (H.L. 1914).

²¹⁸Id.

²¹⁹Id. 87-88. The complete sentence reads as follows: “It is no obstacle to the sum stipulated being a genuine

pre-estimate of damages, that the consequences of the breach are such as to make a precise pre-estimation almost an

impossibility”. How can a term be a pre-estimate of damages if it is impossible to pre-estimate damages?

²²⁰Id. 88.

Page: 73

products.²²¹This contraction of the number of retail outlets selling Dunlop products would be

inimical to the welfare of Dunlop’s business.²²²

[260] Lord Atkinson held that the price-maintenance agreement was an enforceable pre-estimate

of liquidated damages.²²³He did so for two principal reasons. First, Dunlop insisted that retailers

adhere to a maintenance-price term to protect the integrity of Dunlop’s distribution network. It

made good business sense to adopt this strategy. Lord Atkinson concluded that Dunlop’s “interest

was … [commensurate] with the sum agreed to be paid”.²²⁴This certainly provides a commercial

explanation for Dunlop’s bargaining position. Second, the stipulated-consequence-on-breach term

was not “unreasonable, unconscionable, or extravagant”.²²⁵This last criterion gives Lord Dunedin

and Lord Atkinson some common ground.

[261] Lord Parker was convinced that any breach of the price-maintenance agreement harmed

Dunlop’s product-distribution system.²²⁶He saw “nothing to justify the Court in refusing to give

effect to this bargain”. ²²⁷There was a sound business reason to justify the impugned term.

[262] Lord Parmoor, unlike his colleagues, started from this perspective:²²⁸“[W]hen competent

parties by free contract are purporting to agree a sum as liquidated damages there is no reason for

refusing a wide limit of discretion”. A contraction of the freedom of contract principle is only

justified if there is “an extravagant disproportion between the agreed sum and the amount of any

damage capable of pre-estimate”.²²⁹The disproportionality would have to be of such a magnitude

as to be unconscionable, extortionate or extravagant. ²³⁰Such disproportionality was not in

evidence here.²³¹

²²¹Id. 91.

²²²Id.

²²³Id. 96.

²²⁴Id. 92.

²²⁵Id. 97.

²²⁶Id. 99.

²²⁷Id.

²²⁸Id. 101.

²²⁹Id.

²³⁰Id.

²³¹Id. 105.

Page: 74

[263] These speeches, with the exception of Lord Parker’s, all emphasized the importance of the

fact that the stipulated-consequence-on-breach term was not unconscionable, extravagant or

extortionate.²³²

[264] Dunlop Pneumatic Tyre Co. reveals the law lords’ sound understanding of Dunlop’s

business and the commercial realities that accounted for the price-maintenance agreement. The

case’s modern appeal is the ultimate disposition – enforce a commercial bargain that imposes a

burden on a promisee if it is not unconscionable, extravagant or extortionate. The unspoken

message is that freedom of contract must be respected in commercial transactions barring

extraordinary circumstances.



Clydebank Engineering and Shipbuilding Co. v.

Castaneda

[265] In Clydebank Engineering and Shipbuilding Co. v. Castaneda²³³, a 1904 judgment, the

House of Lords upheld a decision of Scotland’s Second Division of the Court of Sessions ordering

the shipbuilder to pay the Spanish government £500 per week for each torpedo-boat destroyer not

delivered on time.

[266] The Earl of Halsbury, L.C. disposed of the appeal on a very narrow ground. He asked

whether the stipulated-consequence-on-breach term was “unconscionable and extravagant” so that

no court should enforce it.²³⁴The example he gave to illustrate this proposition reveals how

unconscionability would be an extraordinary assessment:²³⁵“[I]f you agreed to build a house in a

year, and agreed that if you did not build the house for 50£, you were to pay a million of money as

a penalty, the extravagance of that would be at once apparent”. I agree with the observation of

Justice Kiefel of the High Court of Australia that this standard constitutes a “high hurdle”.²³⁶No

competent commercial contracting party would make a promise of this nature.

[267] The other law lords – Lord Davey²³⁷and Lord Robertson²³⁸– dismissed the appeal because

the stipulated-consequence-on-breach term incorporated a proportionate payment schedule. The

²³²Id. 87, 97 & 101. See Cavendish Square Holding BV v. El Makdessi, [2015] UKSC 67, ¶143; [2016] A.C. 1172,

1244 per Lord Mance (“The qualification and safeguard is that the agreed sum must not have been extravagant,

unconscionable or incommensurate with any possible interest in the maintenance of the system”).

²³³[1905] A.C. 6 (H.L. 1904).

²³⁴Id. 10.

²³⁵Id.

²³⁶Paciocco v. Australia and New Zealand Banking Group Ltd., [2016] HCA 28, ¶53; 258 C.L.R. 525, 553.

²³⁷Clydebank Engineering and Shipbuilding Co. v. Castaneda, [1905] A.C. 6, 16 (H.L. 1904.

²³⁸Id. 19.

Page: 75

payments due for late delivery were a function of the length of the delay. But both of them

acknowledged that exorbitant, extravagant or unconscionable consequences would be penalties.²³⁹



Webster v. Bosanquet

[268] Webster v. Bosanquet,²⁴⁰in my opinion, is the most important of the three pre-1915

judgments. Not only did the Privy Council uphold an essential term of a commercial contract, it

clearly explained why: ²⁴¹“[W]hatever be the expression used in the contract in describing the

payment, the question must always be whether the construction contended for renders the

agreement unconscionable and extravagant and one which no Court ought to allow to be

enforced.” Lord Mersey, in a succinct judgment, approved an idea that the Earl of Halsbury

championed in Clydebank Engineering and Shipbuilding Co.²⁴²No reference is made to penalties

or liquidated damages in the quoted sentence. I place special emphasis on the clause “one which no

court ought to allow to be enforced”. This is a bold declaration that a commercial term should be

given effect unless it is so one-sided that doing so would damage the reputation of the courts. In

addition, the committee fully appreciated the business purpose that accounted for the contentious

term:²⁴³

When making the [tea partnership dissolution] contract it was impossible to foresee

the extent of the injury which might be sustained by the plaintiff if sales of the tea

were made to third parties without his consent. That such sales might seriously

affect his business was obvious, and the very uncertainty of the loss likely to arise

made it most reasonable for the parties to agree beforehand as to what the damages

should be. And, furthermore, it is well known that damages of this kind, though

very real, may be difficult of proof, and that the proof may entail considerable

expense.

[269] Surprisingly, courts have seldom applied Webster v. Bosanquet. It is not very well

known.²⁴⁴

²³⁹Id. 16 per Lord Davey & 20 per Lord Robertson.

²⁴⁰[1912] A.C. 394 (P.C.) (Ceylon).

²⁴¹Id. 398 (emphasis added).

²⁴²[1905] A.C. 6, 10 (H.L. 1904).

²⁴³[1912] A.C. 394, 398 (P.C.) (Ceylon).

²⁴⁴It has been cited sixteen times in the last 106 years. E.g., Luen Yick Co. v. Tang Man Kee Machinery Workshop,

[1958] H.K.L.R. 405 (O.J). By comparison Philips Hong Kong Ltd. v Hong Kong, [1993] UKPC 3a; [1993] 1

H.K.L.R. 269 has been cited in forty-two judgments in the last twenty-five years.

Page: 76



Philips Hong Kong Ltd. v. Hong Kong

[270] In Philips Hong Kong Ltd. v. Hong Kong,²⁴⁵a 1993 opinion, the Privy Council upheld the

decision of the Hong Kong Court of Appeal that a sophisticated stipulated-consequence-on-breach

term in a contract part of a HK $649 million major highway construction project was enforceable.

The Hong Kong Government entered into seven separate contracts with seven different

construction companies, including Philips. ²⁴⁶Each of these contracts contained key dates

identifying certain milestones that had to be met so that the ability of the others to proceed with

their distinct construction obligation would not be compromised, and a final completion date.²⁴⁷

The per day financial consequences for failure to meet key dates varied depending on the number

of other contractors that would be adversely affected by the failure of the contractor to meet its

milestones – the amount ranged from a low daily rate of HK $60,655 to a high daily rate of HK

$77,818.²⁴⁸

[271] Lord Woolf gave the committee’s judgment. His opinion gave prominence to Lord

Dunedin’s speech in Dunlop Pneumatic Tyre and implicitly equated Lord Dunedin’s opinion as

the “Dunlop approach”.²⁴⁹This is surprising given that the other law lords expressed positions

different than that advanced by Lord Dunedin. While one may legitimately question this aspect of

Lord Woolf’s judgment, his dominant theme is appealing. He unequivocally upheld freedom of

contract values when he pronounced that “the court has to be careful not to set too stringent a

standard and bear in mind that what the parties have agreed should normally be upheld. Any other

approach will lead to undesirable uncertainty especially in commercial contracts”.²⁵⁰

[272] There are two important propositions that I derive from these four appeals.

[273] The first is that the House of Lords and Privy Council favoured the enforcement of

commercial contracts between entities that had sufficient resources to retain counsel and advise

them on their obligations under the contracts that they signed. ²⁵¹

²⁴⁵[1993] UKPC 3a; [1993] 1 H.K.L.R. 269.

²⁴⁶Id. 273.

²⁴⁷Id.

²⁴⁸Id.

²⁴⁹Id. 279.

²⁵⁰Id. 280. He also quoted Lord Justice Diplock’s statement in Robophone Facilities Ltd. v. Blank, [1966] 1 W.L.R.

1428, 1447 (C.A.) with approval: “[A] Court should not be astute to descry a ‘penalty clause’”. Id. 279.

²⁵¹See AMEV-UDC Finance Ltd. v. Austin, [1986] HCA 63; 162 C.L.R. 170, 190 per Mason & Wilson, JJ. (“there is

much to be said for the view that the courts should return to the Clydebank and Dunlop concept, thereby allowing

parties to a contract greater latitude in determining what their rights and liabilities will be, so that an agreed sum is only

characterized as a penalty if it is out of all proportion to damage likely to be suffered as a result of breach”) & Ringrow

Page: 77

[274] Second, most of the law lords thought it improper for courts of justice to enforce one-sided

bargains.

v.

The Penalty Rule in the Nineteenth Century

[275] The receptiveness of twentieth-century judges to the freedom of contract principle did not

distinguish them from their nineteenth-century colleagues.

[276] Many nineteenth-century judges vigorously proclaimed England’s commitment to validate

agreements voluntarily entered into by contracting parties with capacity.²⁵²

[277] The French Code Civil adopted in 1804 featured the primacy of contracting parties

independence: “When the agreement provides that the party who fails to perform shall pay a

certain sum on account of damages, no smaller or larger sum can be awarded to the other party”.²⁵³

[278] Reynolds v. Bridge,²⁵⁴an 1856 appeal, is an excellent example.

[279] Two surgeons carried on the practice of surgery in partnership for roughly five years before

they entered into an 1852 agreement whereby Dr. Reynolds agreed to employ Dr. Bridge for a

three-year period. The agreement obliged each of the surgeons to undertake certain activities

during the three year period in order to increase the likelihood that at the end of the three-year

period Dr. Bridge’s patients would become Dr. Reynold’s patients. The agreement also prevented

Dr. Bridge from practising surgery within a designated area after the expiration of the employment

agreement. Dr. Bridge promised to pay as liquidated damages defined sums for breaches of

specific contractual obligations.

[280] The Court, having found Dr. Bridge to be in contravention of the agreement, ordered Dr.

Bridge to pay to Dr. Reynolds the sum he promised to pay if he breached specific obligations.

[281] Of particular interest is the opinion of Justice Erle. He strongly endorsed the principle that

held promisors to account:²⁵⁵

Pty. Ltd. v. BP Australia Pty. Ltd., [2005] HCA 71, ¶31; 224 C.L.R. 656, 669 (the Court approved Justices Mason and

Wilson’s position in AMEV).

²⁵²Astley v. Weldon, 126 Eng. Rep. 1318, 1322 (Common Pleas 1801) per Lord Eldon, C.J. (“ I do not understand why

one brandy merchant who purchases the lease and goodwill of a shop from another may not make it matter of

agreement, that if the vendor trade in brandy within a certain distance, he shall pay 600£; and why the party violating

such agreement should not be bound to pay the sum agreed for”).

²⁵³Art. 1152.

²⁵⁴119 Eng. Rep. 961 (Q.B. 1856). See also Atkyns v. Kinnier, 154 E.R. 1429 (Ex 1850)(the Court enforced a

surgeon’s promise to pay £1000 as liquidated damages to his former partner if he left the partnership and commenced

the practice of surgery within a defined area).

Page: 78

[It is] an important principle of law … that parties are to assign such limits as they

please to their own liability. If parties choose to lay down such a limit, I do not see

why the Judges are to substitute another; and the tendency latterly has been very

much to restrict the rule of construction. Certainly in some of the cases it was a very

large exercise of the power of the Court, to say, we will see what we should have

thought reasonable, and to construe the contract accordingly... .

[282] Chief Justice Tindal fervently believed in the importance of enforcing contractual bargains.

In Kemble v. Farren²⁵⁶he stated that “we see nothing illegal or unreasonable in the parties, by their

mutual agreement, settling the amount of damages, uncertain in their nature, at any sum upon

which they may agree”.

[283] In Wallis v. Smith²⁵⁷Sir George Jessel, M.R. and Lord Justice Cotton unequivocally

expressed their support for a restrained judicial approach to penalties.

[284] Most nineteenth-century English judges focussed on the contract’s text.²⁵⁸They asked if

the key term demonstrated an intention to liquefy the damages that nonperformance would cause

the innocent promisee, in which case the term would be accorded effect, or an intention to

introduce a term that had no compensatory component but was designed to coerce contractual

compliance, in which case the court would not enforce it, characterizing the term as a penalty.²⁵⁹

²⁵⁵119 Eng. Rep. 961, 967 (Q.B. 1856).

²⁵⁶130 Eng. Rep. 1234, 1237 (Common Pleas 1829).

²⁵⁷21 Ch. D. 243, 266 & 268 (C.A. 1882) (“I have always thought … that it is of the utmost importance as regards

contracts between adults – persons not under disability, and at arm’s length – that the Courts of Law should maintain

the performance of the contracts according to the intention of the parties; that they should not overrule any clearly

expressed intention on the ground that Judges know the business of the people better than the people know it

themselves”) & (“[T]he sounder view … is … to leave persons who are competent and under no disability to make

their own contracts, and then to act on those contracts, whatever the true interpretation might be, without assuming on

behalf of the Court, either of Law or Equity, to say, ‘This is unreasonable and we will make another and different

contract between the parties. They did not mean what they have said in their contracts’”).

²⁵⁸Rickman v. Carstairs, 110 Eng. Rep. 931, 935 (K.B. 1833)(“in ... cases of construction of written instruments [the

question] is not what was the intention of the parties, but what is the meaning of the words they have used”). This is

still the law. Sattva Capital Corp. v. Creston Moly Corp., 2014 SCC 53, ¶47; [2014] 2 S.C.R. 633, 657 (“a

decision-maker must read 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”) & Re

Lubberts Estate, 2014 ABCA 216, n. 21; [2014] 10 W.W.R. 41, n. 21 per Wakeling, J.A. (“Multiparty documents

cannot have multiple meanings which are a function of the subjective understanding of each party ... . There must be

an enforceable meaning attached to the oral or written language which the parties acknowledge captures their

consensus. It must be the product of an objective inquiry”).

²⁵⁹Law v. Local Board of Redditch, [1892] 1 Q.B. 127, 130 per Lord Esher, M.R. (“where the sum agreed to be paid is

... so large as to make the idea that it was intended to be payable by way of liquidated damages so absurd that the Court

would be compelled to arrive at the conclusion that it was to be paid, not as liquidated damages, but as a penalty”) &

Page: 79

[285] Why judges of this era believed that this inquiry assisted them in any way in deciding

whether there was a compelling reason to justify ignoring the clear meaning of a contract’s text

escapes me.

[286] Why would a contract party enter into an agreement that contained a term inserted for its

benefit knowing that it would be unenforceable? This makes no sense.

c.

The Penalty Rule in the United States

[287] Many twentieth-century decisions of the United States Supreme Court turned on the

Court’s response to a promisor’s argument that the law relieved it of its obligation to honor a

paid-for promise.

[288] This body of work fully justifies Justice Peckham’s 1907 assertion that modern courts are

predisposed to enforce stipulated-consequence-on-breach terms.

[289] I will refer to only four in detail. ²⁶⁰

[290] The first two arose as a result of the Spanish-American War of 1898.

i.

Sun Printing and Publishing Association v. Moore

[291] Sun Printing and Publishing Association v. Moore,²⁶¹decided in 1902, dealt with a

charterer’s obligation after the yacht it chartered to cover the Spanish-American hostilities sank.

The charter agreement contained a promise by the charterer to pay the yacht owner $75,000, the

agreed value of the vessel, if it failed to return the yacht in good repair on the return date.

[292] The charterer failed to return the yacht and the yacht owner commenced an action against

the charterer for $75,000. The trial and two appeal courts sided with the yacht owner. So did the

Supreme Court.

[293] Justice White, after conducting a thorough review of the leading English and American

cases, declared that the Court must examine the text of the charterparty and determine whether the

132 per Lopes L.J. (“The distinction between penalties and liquidated damages depends on the intention of the parties

to be gathered from the whole of the contract”).

²⁶⁰Priebe & Sons, Inc. v. United States, 332 U.S. 407 (1947); Wise v. United States, 249 U.S. 361 (1919); United

States v. Bethlehem Steel Co., 205 U.S. 105 (1907) & Sun Printing and Publishing Assoc. v. Moore, 183 U.S. 642

(1902). See also Robinson v. United States, 261 U.S. 486 (1923) (the Court upheld a liquidated damages term to the

detriment of the promisor-plaintiff); J.E. Hathaway & Co. v. United States, 249 U.S. 460, 464 (1919) (“there is no

reason why parties competent to contract may not agree that certain elements of damage difficult to estimate shall be

covered by a provision for liquidated damages ... . Provisions ... clearly expressed do not cease to be binding upon the

parties, because they relate to the measure of damages”).

²⁶¹183 U.S. 642 (1902).

Page: 80

parties intended “bona fide to fix the damages”²⁶²in which case the promisor must discharge its

obligation or whether they intended “to stipulate the payment of an arbitrary sum as a penalty, by

way of security”, ²⁶³in which case the promisor is relieved of the obligation to honor its

commitment. Justice White quoted with approval Justice Wright’s opinion in Clement v. Cash²⁶⁴to

this effect:

When [the contracting parties] declare, in distinct and unequivocal terms, that they

have settled and ascertained the damages to be $500.00, or any other sum, to be

paid by either failing to perform, it seems absurd for a court to tell them that it has

looked into the contract and reached the conclusion that no such thing was

intended; but that the intention was to name the sum as a penalty to cover any

damages that might be proved to have been sustained by a breach of the agreement.

ii.

United States v. Bethlehem Steel Co.

[294] United States v. Bethlehem Steel Co.²⁶⁵is the second case. It was a 1907 judgment.

[295] In 1898 Bethlehem Steel promised to construct six gun carriages for the United States

armed forces for $216,000. The United States anticipated that it would soon be at war with Spain

and was prepared to pay a premium for expedited delivery. A late-delivery provision reduced the

purchase price by a sum equal to a daily amount multiplied by the period of late delivery measured

in days. Bethlehem Steel delivered the gun carriages after the promised delivery date. For this

reason, the United Stated paid Bethlehem Steel $195,000 instead of $216,000. Bethlehem Steel

sued in the Court of Claims for the $21,000 shortfall. The Court of Claims found in favour of

Bethlehem Steel. The United States Supreme Court reversed.

[296] Justice Peckham, for the Court, concluded that the parties intended the

stipulated-consequence-on-breach term to liquidate the damages and not to serve as a penalty:²⁶⁶

The acceptance of the proposal at the highest price for the delivery of the carriages

in the shortest time is also evidence of the importance with which the Government

officers regarded the element of speed. … In the light of this fact an examination

of the language of the contract itself upon the question of deductions for delay in

delivery renders its meaning quite plain.

²⁶²Id. 673.

²⁶³Id.

²⁶⁴21 N.Y. 253, 257 (Ct. App. 1860).

²⁶⁵205 U.S. 105 (1907).

²⁶⁶Id. 119-20.

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[297] In coming to this conclusion, the Court also recognized the fact that it would be very

difficult to prove damages for late delivery of armaments.

iii.

Wise v. United States

[298] Wise v. United States,²⁶⁷released in 1919, is the third case.

[299] In 1904 a builder promised to erect two laboratory buildings for the Department of

Agriculture in Washington. The price tag was $1,171,000. There was a price-reduction term in the

contract that the United States invoked to withhold $20,000 of the construction price. The builder

claimed that the United States was not entitled to rely on the stipulated-consequence-on-breach

term.

[300] The Supreme Court of the United States concluded that the contract unequivocally

demonstrated an intention to fix the damages that the United States would endure if the two

buildings were not constructed on time.²⁶⁸Justice Clarke, for a court that included Justice Oliver

Wendell Holmes, provided this clear account of the law:²⁶⁹

When that intention is clearly ascertainable from the writing, effect will be given to

the provision as freely as to any other, where the damages are uncertain in nature or

amount or are difficult of ascertainment or where the amount stipulated for is not so

extravagant, or disproportionate to the amount of property loss, as to show that

compensation was not the object aimed at or as to imply fraud, mistake,

circumvention or oppression. There is no sound reason why persons competent and

free to contract may not agree upon this subject as fully as upon any other, or why

their agreement, when fairly and understandingly entered into with a view to just

compensation for the anticipated loss, should not be enforced.

iv.

Priebe & Sons, Inc. v. United States

[301] Priebe & Sons, Inc. v. United States²⁷⁰is the fourth case. It was decided in 1947.

[302] After Congress enacted the Lend-Lease Act²⁷¹in 1941, the Department of Agriculture

decided to ship dried eggs to England and Russia to ameliorate the wartime food shortage these

countries were experiencing. Priebe & Sons, Inc. was one the suppliers. Priebe & Sons agreed to

deliver a designated amount of dried eggs along with an inspection certificate within a specified

²⁶⁷249 U.S. 361 (1919).

²⁶⁸Id. 365.

²⁶⁹Id.

²⁷⁰332 U.S. 407 (1947).

²⁷¹55 Stat. 31, 22 U.S.C. (Supp. V. 1946).

Page: 82

time. There was also a term that allowed the purchaser to pay ten cents less per pound of dried eggs

if the supplier failed to meet designated milestones on time.²⁷²Priebe & Sons delivered the

requested quantity of dried eggs on time but missed the deadline for the inspection certificate. The

United States invoked the liquidated damages provision and paid the supplier ten cents less per

pound. The supplier sued alleging that the term the United States relied on was an unenforceable

penalty. The Court of Claims dismissed the action, holding that the contested term was not a

penalty. The Supreme Court reversed, satisfied that the term was a penalty.

[303] Justice Douglas wrote for the five justices who constituted the majority. He opined that

“The provision was included not to make a fair estimate of damages to be suffered but to serve

only as an added spur to performance. ... [A]n exaction of punishment for a breach which could

produce no possible damage has long been deemed oppressive and unjust”.²⁷³While Justice

Frankfurter disagreed with the majority because he was convinced that federal statutes compelled

judicial validation of terms like the one under review, he agreed that the contested term was a

penalty under common law.²⁷⁴

[304] Justices Black and Murphy parted company with their colleagues. They classified the

stipulated-consequence-on-breach term as a liquidated damages provision.²⁷⁵They gave great

weight to the fact that this was a commercial transaction and concluded that there was “no

persuasive reason why [the promisor] should now be relieved of the obligation it advisedly

assumed which was, in effect, to charge less for its goods if they were not ready for delivery on the

date it promised”.²⁷⁶

[305] Justice Frankfurter’s statement that “one man’s default should not lead to another man’s

unjust enrichment”²⁷⁷is perhaps the most significant contribution these four cases make to the

development of the jurisprudence. This assertion clearly suggests that some

stipulated-consequence-on-breach terms will be invalid because they are unconscionable and that

no court should use its power in a way that would bring the administration of justice into disrepute.

²⁷²It reads as follows: “Inasmuch as the failure of the vendor to deliver the quantity of the commodity ... specified in

the contract in accordance with the terms of this announcement will, because of the urgent need for the commodity by

the purchaser arising from the present emergent conditions, cause serious and substantial damages to the purchaser,

and it will be difficult, if not impossible, to prove the amount of such damages, the vendor agrees to pay ... liquidated

damages as stated in this paragraph. The sum is agreed upon as liquidated damages and not as a penalty and shall be in

the amount set forth below for each pound of dried egg product undelivered in accordance with the terms of this

announcement ... . The parties have computed, estimated, and agreed upon this sum as an attempt to make a reasonable

forecast of probable actual loss because of the difficulty of estimating with exactness the damages which result”.

²⁷³332 U.S. 407, 413 (1947).

²⁷⁴Id. 419.

²⁷⁵Id. 417.

²⁷⁶Id.

²⁷⁷Id. 418.

Page: 83

[306] A general survey of state and federal jurisprudence ²⁷⁸and academic literature ²⁷⁹

demonstrates that most American jurists recognize that commercial actors are the best judges of

the merits and demerits of the burdens they incur and the benefits they enjoy by entering into a

contract²⁸⁰and that in the absence of extraordinary terms – those that are unconscionable,

manifestly and grossly unfair or will unjustly enrich the promissee – they should be allowed to

agree upon stipulated-payment terms that they adjudge to be in their best interests.

5.

The Contested Term Passes Both the Elsley and Dunlop Pneumatic

Tyre Standards and Is Enforceable

[307] Regardless of which standard is applied – Elsley or Dunlop Pneumatic Tyre – s. VII Q(d) is

enforceable.

a.

Elsley Standard

[308] This is a commercial contract.

[309] There is no evidence that Capital Steel Inc. had insufficient resources to retain legal

counsel before it signed the agreement with Chandos Construction.

[310] Nor is there any basis whatsoever to conclude that s. VII Q(d) is oppressive. A term is

oppressive if it is so manifestly grossly one-sided that its enforcement would bring the

administration of justice into disrepute. This is not such a term.

[311] Section VII Q(d) reflects the fact that Chandos Construction will incur administrative costs

associated with completing the work that Capital Steel failed to do and monitoring the work during

the warranty period. Chandos Construction will have to find another enterprise that is willing to

accept a modest assignment and complete it on a time path acceptable to Chandos Construction.

There is no evidence that suggests its enforcement will bestow a windfall on Chandos

Construction.

²⁷⁸Lion Overall Co., 55 F. Supp. 789, 791 (S.D.N.Y 1943) (“The present rule is to look with candor, if not with favor,

upon such provisions in contracts when deliberately entered into between parties who have equality of opportunity for

understanding and insisting upon their rights, as promoting prompt performance, and because adjusting in advance,

and amicably, matters the settlement of which through courts would involve difficulty, uncertainty, delay and

expense”).

²⁷⁹E. Farnsworth, Contracts 820 (4th ed. 2004).

²⁸⁰Jewett, Bigelow & Brooks v. Detroit Edison Co., 274 F. 30, 37-38 (6^thCir. 1921) (“this court must not overlook the

fact that the contracting parties were both familiar with the coal business in all its details ... Therefore no reason

appears from the evidence in this case why this court should set aside and hold for naught a solemn contract, entered

into between men of affairs, largely experienced and fully advised as to conditions and incidents of the business to

which the contract relates and substitute its own judgment for the judgment of the contracting parties”).

Page: 84

[312] The term also documents the parties’ agreement that there is a correlation between Capital

Steel’s performance and its remuneration. “There is no reason in principle why a contract should

not provide for a party to earn his remuneration, or part of it, by performing his obligations”.²⁸¹

[313] This is a compensatory provision that makes commercial sense.

b.

Dunlop Pneumatic Tyre Standard

[314] Dunlop Pneumatic Tyre Co. v. New Garage and Motor Co.²⁸²stands for the proposition

that a commercial bargain is unenforceable if it is unconscionable, extravagant or extortionate.

Section VII Q(d) is none of these. The sum of money the ten percent fee represents will probably

cover some or all of the administrative costs Chandos Construction will incur as a result of the

administrative time that it must devote to finding others to complete the tasks Capital Steel had left

undone, including monitoring the project for warranty purposes. There is no reason to believe that

this fee is disproportionate to the actual costs Chandos Construction will actually incur because of

Capital Steel’s failure to complete the work. There is no evidence supporting such a conclusion.

C.

Section VII Q(d) Is Not Contrary to Any Common Law Values Related to

Bankruptcy or Any Provision of the Bankruptcy and Insolvency Act and Is

Enforceable

1.

Introduction

[315] Canada’s Bankruptcy and Insolvency Act,²⁸³like the national insolvency enactments of the

United Kingdom,²⁸⁴the United States,²⁸⁵Australia²⁸⁶and New Zealand,²⁸⁷catalogues most of the

important principles and rules governing insolvency regimes.²⁸⁸

²⁸¹Cavendish Square Holding BV v. El Makdessi, [2015] UKSC 67, ¶73; [2016] A.C. 1172, 1216 per Lord Neuberger

& Lord Sumption.

²⁸²[1915] A.C. 79 (H.L. 1914).

²⁸³R.S.C. 1985, c. B-3.

²⁸⁴Insolvency Act 1986, c. 45.

²⁸⁵Bankruptcy Code, 11 U.S.C.

²⁸⁶Bankruptcy Act 1966, No. 33 (Cth) & Corporations Act 2001, No. 50 (Cth).

²⁸⁷Companies Act 1993, No. 105 & Insolvency Act 2006, No. 55.

²⁸⁸R. Wood, Bankruptcy and Insolvency Law 11 (2d ed. 2015)(“most of the insolvency regimes are overwhelmingly

legislative in character”); Wood, “Direct Payment Clauses and the Fraud Upon the Bankruptcy Law Principle: Re

Horizon Earthworks Ltd. (Bankrupt)”, 52 Alta. L. Rev. 171, 171 (2014) (“Bankruptcy law is overwhelmingly

statutory in character”); C. Tabb, The Law of Bankruptcy 2 (2d ed. 2009) (“The current Bankruptcy Code

encompasses a wide spectrum of possible measures. These range from a straight liquidation bankruptcy (chapter 7), to

the reorganization of businesses (chapter 11), to the adjustment of family farmer debts (chapter 12), to the adjustment

Page: 85

[316] The Bankruptcy and Insolvency Act, again, like most of its foreign counterparts,²⁸⁹displays

three fundamental features.

[317] The first is the utilization of one procedural vehicle to advance the claims of the creditors

against the bankrupt. Professor Wood explains the first benchmark this way: ²⁹⁰“The creditors’

remedies are collectivized in order to prevent the free-for-all that would otherwise prevail if

creditors were permitted to exercise their remedies”. This is accomplished by a statutory ban on

the commencement of proceedings against a bankrupt. Section 69.3(1) of the Bankruptcy and

Insolvency Act²⁹¹provides that “on the bankruptcy of any debtor, no creditor has any remedy

of the debts of individual consumers (chapter 13), and even to the adjustment of the debts of a municipality (chapter 9).

Cross-border cases are dealt with in chapter 15”) & Re Potts, [1893] 1 Q.B. 648, 657 (C.A.) per Lord Esher, M.R. (“the

bankruptcy law is not the common law of England; it is an enacted law, and all the rights under it are determined by

statute”).

²⁸⁹While insolvency regimes frequently incorporate common critical components, they sometimes adapt different

implementation solutions. E.g., Century Services Inc. v. Canada, 2010 SCC 60, ¶29; [2010] 3 S.C.R. 379, 400

(“Claims of priority by the state in insolvency situations receive different treatment across jurisdictions worldwide”).

²⁹⁰R. Wood, Bankruptcy and Insolvency Law 3 (2d ed. 2015). See C. Tabb, The Law of Bankruptcy 4 (2d ed.

2009)(“the core function of bankruptcy is as a collective creditors’ remedy that furthers the goals of efficiency and of

distributive justice”) (emphasis in original); D. Epstein & S. Nickles, Principles of Bankruptcy Law 3 (2007) (“State

law focuses on individual action by a particular creditor and puts a premium on prompt action by a creditor. ...

Bankruptcy, on the other hand, compels collective creditor collection action and emphasizes equality of treatment,

rather than a race of diligence”) & Allied Concrete Ltd. v. Meltzer, [2015] NZSC 7, ¶96; [2016] 1 N.Z.L.R. 141, 174

(“As the material ... demonstrates, both the Government and Parliament understood that there was a conflict between

the concept of collective realisation and individual justice in particular cases”).

²⁹¹R.S.C. 1985, c. B-3. See also s. 69(1)(“[O]n the filing of a notice of intention under section 50.4 by an insolvent

person, (a) no creditor has any remedy against the insolvent person’s property, or shall commence or continue any

action, execution, or other proceedings, for the recovery of a claim provable in bankruptcy”). See R. Wood,

Bankruptcy and Insolvency Law 5 (2d ed. 2015)(“The commencement of insolvency proceedings will typically

prevent a claimant from pursuing a claim through an ordinary civil action before a court or enforcing it through the

judgment enforcement system”). See also Insolvency Act 1986, c. 45, s. 126(1) (U.K.) (“At any time after the

presentation of a winding-up petition, and before a winding-up order has been made, the company, or any creditor or

contributory may... where any action or proceeding against the company is pending in the High Court or Court of

Appeal ... apply to the court in which the action or proceeding is pending for a stay of proceedings therein ... and the

court to which the application is so made may (as the case may be) stay, sist or restrain the proceedings accordingly on

such terms as it thinks fit”) & s. 130(2) (“When a winding-up order has been made ... , no action or proceeding shall be

proceeded with or commenced against the company or its property, except by leave of the court and subject to such

terms as the court may impose”); Bankruptcy Act 1966, No. 33, s. 60(1)(b)(Austl. Cth) (“The Court may, at any time

after the presentation of a petition, upon such terms and conditions as it thinks fit … stay any legal process … against

the person or property of the debtor”); Corporations Act 2001, No. 50, s. 471B (Austl. Cth) (“While a company is

being wound up in insolvency or by the Court, or a provisional liquidator of a company is acting, a person cannot

begin or proceed with … a proceeding in a Court against the company or in relation to property of the company; or …

enforcement process in relation to such property; except with the leave of the Court and in accordance with such terms

(if any) as the Court imposes”); Insolvency Act 2006, No. 55, s. 76(1)(N.Z.)(“On adjudication [of bankruptcy], all

proceedings to recover any debt provable in the bankruptcy are halted”); Companies Act 1993, No. 105, s. 239 ABE

(N.Z.) (“During the administration of a company, a proceeding in a court against the company or in relation to any of

its property must not be begun or continued, except ... (a) with the administrator’s written consent; or (b) with the

Page: 86

against the debtor or the debtor’s property, or shall commence or continue any action, execution or

other proceedings, for the recovery of a claim provable in bankruptcy”. “The automatic stay is one

of the most important parts of any ... bankruptcy case”.²⁹²

[318] A single-procedure-vehicle model probably maximizes the size of the bankrupt’s property

pool for the ultimate benefit of the creditors. It may reduce the risk that some of the bankrupt’s

property may not be tracked as effectively by debtors acting alone. Collective bargaining between

the bankrupt’s creditors and the bankrupt increases the likelihood that an acceptable remedial plan

will be produced and reduces the need for the plaintiff creditors and the defendant bankrupt to

complete duplicitous litigation steps.²⁹³

[319] The second benchmark is a provision that identifies the bankrupt’s property as of a

designated date and creates a mechanism that collects in the bankruptcy trustee’s hands the

bankrupt’s property. ²⁹⁴“‘Property of the estate’ is one of the most important, most basic

permission of the court”); Bankruptcy Code, 11 U.S.C. §362(a)(“Except as provided under subsection (b) of this

section, a petition filed under section 301, 302 or 303 of this title ... operates as a stay, applicable to all entities of ... the

commencement or continuation, including the issuance or employment of process, of a judicial, administrative, or

other action or proceeding against the debtor that was or could have been commenced before the commencement of

the case under this title”) & C. Tabb, The Law of Bankruptcy 244 (2d ed. 2009)(“An integral structural component of

a bankruptcy case is the ‘automatic stay’ against creditor collection actions. ... It arises automatically upon the filing of

a bankruptcy petition”).

²⁹²D. Epstein & S. Nickles, Principles of Bankruptcy Law 15 (2007). See also Newfoundland and Labrador v.

AbitibiBowater Inc., 2012 SCC 67, ¶21; [2012] 3 S.C.R. 443, 458 (“Under this [single proceeding] model, the court

can stay the enforcement of most claims against the debtor’s assets in order to maintain the status quo during

negotiations with the creditors”).

²⁹³Century Services Inc. v. Canada, 2010 SCC 60, ¶22; [2010] 3 S.C.R. 379, 397 (“The single proceeding model

avoids the inefficiency and chaos that would attend insolvency if each creditor initiated proceedings to recover its

debt. Grouping all possible actions against the debtor into a single proceeding controlled in a single forum facilitates

negotiation with creditors because it places them all on an equal footing”); Schreyer v. Schreyer, 2011 SCC 35, ¶19;

[2011] 2 S.C.R. 605, 615-16 (“Legislation that establishes an orderly liquidation process for situations in which

reorganization is not possible, that averts races to execution and that gives debtors a chance for a new start is generally

viewed as a wise policy choice”); R. Wood, Bankruptcy and Insolvency Law 3 (2d ed. 2015) (“The race to grab assets

in the absence of a collective insolvency regime does not provide an environment within which an efficient and

orderly liquidation can occur”) & C. Tabb, The Law of Bankruptcy 4 (2d ed. 2009) (“the core function of bankruptcy

is a collective creditors’ remedy that furthers the goals of efficiency and of distributive justice”) (emphasis in original).

²⁹⁴Bankruptcy and Insolvency Act, R.S.C. 1985, c. B-3, s. 2 (“property means any type of property, whether situated in

Canada or elsewhere, and includes money, goods, things in action, land and every description of property, whether

real or personal, legal or equitable, as well as obligations, easements and every description of estate, interest and profit,

present or future, vested or contingent in, arising out of or incident to property”) & Bankruptcy Code, 11 U.S.C.

§541(a)(1) (“The commencement of a case ... creates an estate. Such estate is comprised of all the following property,

wherever located and by whomever held: ... all legal or equitable interests of the debtor in property as of the

commencement of the case”). This obviously sweeps in accounts receivables. See also Re Barrington & Vokey Ltd., 48

C.B.R. 3d 270, 279 (N.S. Sup. Ct. 1996)(“On the date of bankruptcy ... , all of the assets of B&V vested in the Trustee

for the benefit of the general body of creditors ... . The Trustee became obligated and empowered to take possession of

the property of the bankrupt ... , the intention being that all creditors would receive the distribution to which they were

Page: 87

bankruptcy concepts”.²⁹⁵Section 71 of the Bankruptcy and Insolvency Act²⁹⁶is one provision that

serves this purpose: “On a bankruptcy order being made ... a bankrupt ceases to have any capacity

to dispose of or otherwise deal with their property, which shall, subject to this Act and to the rights

of secured creditors, immediately pass to and vest in the trustee named in the bankruptcy order ... .”

[320] The third distinguishing feature is the equitable distribution of the bankrupt’s property to

the bankrupt’s creditors. Section 141 of the Bankruptcy and Insolvency Act²⁹⁷declares that

“[s]ubject to this Act, all claims proved in a bankruptcy shall be paid rateably.”

entitled”) & C. Tabb, The Law of Bankruptcy 394 & 401 (2d ed. 2009) (“The bankruptcy ‘estate’ is a separate and

distinct legal entity. It is comprised initially of all of the debtor’s property at the time the case is commenced. ... [T]he

instant of the bankruptcy filing is the magic moment at which the extent of the estate initially is determined. Section

541(a)(1) takes a snapshot of the debtor’s assets at the moment of filing, bringing all of those assets into the estate”).

²⁹⁵D. Epstein & S. Nickles, Principles of Bankruptcy Law 9 (2007).

²⁹⁶R.S.C. 1985, c. B-3. See Bankruptcy Code, 11 U.S.C. §323(a) (“The trustee in a case under this title is the

representative of the estate”); Insolvency Act 1986, c. 45, s. 306(1) (U.K.) (“The bankrupt’s estate shall vest in the

trustee immediately on his appointment taking effect”) & s. 145(1) (“When a company is being wound up by the court,

the court may on the application of the liquidator by order direct that all or any part of the property of whatsoever

description belonging to the company or held by trustees on its behalf shall vest in the liquidator by his official name;

and thereupon the property to which the order relates vests accordingly”); Corporations Act 2001, No. 50, s. 474(1)(a)

(Austl. Cth) (“If a company is being wound up in insolvency or by the Court, or a provisional liquidator of a company

has been appointed … in a case in which a liquidator … has been appointed … the liquidator .. must take into his or her

custody, or under his or her control, all the property which is, or which appears to be, property of the company”);

Bankruptcy Act 1966, No. 33, s. 58(1)(a) (Austl. Cth) (“Subject to this Act, where a debtor becomes a bankrupt … the

property of the bankrupt, not being after-acquired property, vests forthwith in the Official Trustee”); Companies Act

1993, No. 105, s. 239U (N.Z.) (“While a company is in administration, the administrator ... (a) has control of the

company’s business, property and affairs; and (b) may carry on that business and manage that property and those

affairs; and (c) may terminate or dispose of all or part of that business, and may dispose of any of that property”) &

Insolvency Act 2006, No. 55, s. 101(1)(a) (N.Z.) (natural person: “On adjudication ... all property ... belonging to the

bankrupt or vested in the bankrupt vests in the Assignee without the Assignee having to intervene or take any other

step in relation to the property, and any rights of the bankrupt in the property are extinguished”).

²⁹⁷R.S.C. 1985, c. B-3. See Insolvency Act 1986, c. 45, s. 107 (U.K.) (“Subject to the provisions of this Act as to

preferential payments, the company’s property in a voluntary winding up shall on the winding up be applied in

satisfaction of the company’s liabilities pari passu”) & s. 328(3) (“Debts which are neither preferential debts nor debts

to which the next section applies also rank equally between themselves and, after the preferential debts, shall be paid in

full unless the bankrupt’s estate is insufficient for meeting them, in which case they abate in equal proportion”);

Corporations Act 2001, No. 50, s. 559 (Austl. Cth) (“The debts of a class referred to in each of the paragraphs of

subsection 556(1) rank equally between themselves and must be paid in full, unless the property of the company is

insufficient to meet them, in which case they must be paid proportionately”); Bankruptcy Act 1966, No. 33, s. 108

(Austl. Cth) (“Except as otherwise provided by this Act, all debts proved in a bankruptcy rank equally and, if the

proceeds of the property of the bankrupt are insufficient to meet them in full, they shall be paid proportionately”);

Insolvency Act 2006, No. 55, s. 280(2) (N.Z.) (“The [general creditors’] claims ... rank equally among themselves and

must be paid in full, unless the money is insufficient to meet them, in which case they abate in equal proportions”);

Companies Act 1993, No. 105, s. 313(2) (N.Z.) (“The [general creditors’] claims ... rank equally among themselves

and must be paid in full, unless the assets are insufficient to meet them, in which case payment shall abate rateably

among all claims”); Bankruptcy Code, 11 U.S.C. §726 (b) (“Payment on claims of a kind [described in numerous

Page: 88

[321] These three features serve as the foundation upon which a complete and sophisticated

insolvency and bankruptcy structure rests.

[322] I will now use several hypotheticals to illustrate how these basic features affect some

concrete fact patterns.

[323] Suppose that M, a municipality, enters into a contract with a highway construction

company, HC Co., to build a road within the municipality. M agrees to pay HC Co. $5 million,

payable in instalments on the completion of designated milestones. Before HC Co. completes the

project and after M has paid HC Co. $3 million, HC Co. goes bankrupt. M owes HC Co. $750,000

for work that HC Co. has performed and billed. M is aware that HC Co. has not paid invoices

submitted by subcontractors D, E and F for services and material. HC Co. owes each of the

subcontractors $250,000 and other creditors $750,000. T, HC Co.’s bankruptcy trustee, has served

M with a demand that M pay T the $750,000 due under the accounts rendered by HC Co.. M asks

its lawyer if it can discharge its obligation to HC Co. by paying $250,000 to each of D, E and F. M

is aware that if it pays T $750,000, D, E and F will likely receive less than $250,000 on any

subsequent payout to HC Co.’s creditors. M wants to make D, E and F whole so that they will be

willing in the future to work on M’s infrastructure projects. M’s lawyer advises M to pay T the

$750,000 T demands. M’s lawyer informs M that T owns all HC Co.’s property,²⁹⁸including the

account receivable that HC Co.’s outstanding bill to M represents. M has a legal obligation to pay

T²⁹⁹and cannot choose to ignore it without incurring adverse financial consequences.³⁰⁰This is so

even though payments to D, E and F would not have had the effect of diminishing the size of the

pool of assets available for distribution to HC Co.’s creditors. D, E and F are all creditors of HC

Co. The real problem was the advantage these payments bestowed on D, E and F, compared to HC

Co.’s other unsecured creditors.

provisions] ... shall be made pro rata among claims of the kind specified in each such particular paragraph”). See also

R. Wood, Bankruptcy and Insolvency Law 44-45 (2d ed. 2015) (“the proceeds of the liquidation of the debtor’s assets

are distributed to the proving creditors according to a statutory scheme of distribution. Although this scheme of

distribution provides for pari passu sharing among ordinary creditors, certain kinds of claims are promoted and given

more favourable treatment than the ordinary creditors (preferred creditors) while other kinds of claims are demoted

and given less favourable treatment (postponed creditors)”); C. Tabb, The Law of Bankruptcy 674 (2d ed. 2009) (“For

all of the general unsecured creditors, the controlling bankruptcy principle is equality of distribution”) (emphasis in

original) & D. Epstein & S. Nickles, Principles of Bankruptcy Law 3 (2007) (“While bankruptcy law does not require

equal treatment for all creditors, all creditors within a single class are treated the same”).

²⁹⁸The Bankruptcy and Insolvency Act, R.S.C. 1985, c. B-3, s. 2 defines “property” in very broad terms. See F.

Bennett, Bennett on Bankruptcy 51-52 (19^thed. 2017) (“property in a business would include cash in the bank,

receivables, inventory, equipment, real property, tax claims, refunds and tax losses, industrial property including

patents, trademarks and copyright, customer lists, hedging contracts, options, equity in unexpired leases of premises

and equipment, choses in action and third-party claims”).

²⁹⁹Bankruptcy and Insolvency Act, R.S.C. 1985, c. B-3, s. 71.

³⁰⁰M would have to pay the same amount to T.

Page: 89

[324] The Supreme Court of Canada dealt with this issue in A.N. Bail Co. v. Gingras.³⁰¹A general

construction contractor, relying on a contract term binding the general contractor and the

subcontractor, paid the bankrupt subcontractor’s creditor the amount due the subcontractor and

refused to pay the bankrupt subcontractor’s trustee. “Property” was a broadly defined term under

the Bankruptcy Act³⁰²and indisputably included the subcontractor’s accounts receivable. Because

the subcontractor had an interest in the accounts receivable, it was the subcontractor’s property and

the general contractor had an obligation to pay the bankruptcy trustee. The general contractor’s

payment to the bankrupt subcontractor’s creditor did not discharge the general contractor’s

obligation under the statute:³⁰³“It would be to disregard the Bankruptcy Act and deprive it of all

meaning if the debtor of a bankrupt, instead of paying the trustee, were authorized by contract or

some other means, to pay one or other of the creditors of the bankrupt as he saw fit”.

[325] There are other business structures that give an owner more control.³⁰⁴

[326] Suppose that M decided to revise the business model it used for the construction of its

infrastructure projects. M retained a project manager to provide it with services on a

fee-for-service basis. The project manager recommends service providers and suppliers and M

enters into contracts with each enterprise that contributes to the infrastructure project. M follows

this model for the construction of a community fitness center. M enters into twenty-five separate

agreements with service providers and suppliers, as well as an agreement with FC Co., the project

manager. FC Co. becomes bankrupt before the project is completed. M pays T, FC Co.’s

bankruptcy trustee, the amount of FC Co.’s last bill, and continues to discharge its obligations

under its other infrastructure project contracts. M is entitled to proceed in this manner because it

has honored its obligations to T, as set out in the Bankruptcy and Insolvency Act.³⁰⁵It has paid to T

FC Co.’s outstanding accounts receivable. This is FC Co.’s property, as defined in the Bankruptcy

and Insolvency Act.³⁰⁶

³⁰¹[1982] 2 S.C.R. 475. See also Municipal District of Greenview No. 16 v. Bank of Nova Scotia, 2013 ABCA 302; 5

C.B.R. 6^th69 (the Court confirmed the chamber judge’s conclusion that the municipality could not rely on a contract

term that allowed it to pay directly an unpaid subcontractor to discharge its obligations to a bankrupt general

contractor’s trustee because the unpaid accounts receivable is the property of the bankrupt) & International Air

Transport Assoc. v. Ansett Australia Holdings Ltd.(Subject to Deed of Company Arrangement), [2008] HCA 3, ¶76;

234 C.L.R. 157 (“the critical point is that there was ‘property’ of British Eagle to which s. 302 applied and a

contractual provision negating that outcome could not prevail against the terms of the statute”).

³⁰²R.S.C. 1970, c. B-3, s. 2.

³⁰³[1982] 2 S.C.R. 475, 487.

³⁰⁴E.g., Phillips Hong Kong Ltd. v. Hong Kong, [1993] UKPC 3a; [1993] 1 H.K.L.R. 269 (Hong Kong entered into

seven contracts with seven different contractors for the construction of a major highway project).

³⁰⁵R.S.C. 1985, c. B-3, s. 71.

³⁰⁶Id. s. 2.

Page: 90

[327] These hypotheticals highlight the obligations of a bankrupt’s debtor under the Bankruptcy

and Insolvency Act³⁰⁷to deliver the bankrupt’s property to the bankrupt’s trustee. They did not

involve contract terms that had the effect of diminishing the size of the bankrupt’s property pool.³⁰⁸

[328] The next example introduces this feature.

[329] Suppose that A Co. and B Co. are the sole shareholders of C Co. Each shareholder owns

fifty shares of C. Co. C Co. owns a golf course with a fair market value of $4 million. The

shareholders’ agreement between A Co. and B Co. stipulates that in the event one of the

shareholders becomes bankrupt, the nonbankrupt shareholder has the option to purchase the

bankrupt’s C Co. shares for eighty percent of the shares’ fair market value. Their shareholder

agreement documents the commercial reasons that account for this provision. First, A Co. and B

Co. do not want to do business with a trustee in bankruptcy.³⁰⁹Involving a bankruptcy trustee in the

day-to-day operations of an enterprise that has to routinely make difficult decisions quickly just to

survive would be disastrous. A bankruptcy trustee would not be able to respond fast enough.

Second, the nonbankrupt shareholder may have a difficult time securing the funds needed to pay

the bankrupt shareholder fair market value for its shares. No financial institution would do

business with them when they applied for a construction loan. Funds borrowed from family and

friends allowed them to build the course. Lenders will be difficult to find and more difficult to deal

with. They know that owners of golf courses often go bankrupt and are poor credit risks. A small

reduction in the purchase price provides the nonbankrupt shareholder with some relief from the

onerous burden of paying fair market value for the bankrupt company’s shares in C Co. B Co. goes

bankrupt. A Co. offers to purchase B Co.’s shares in C. Co. for $1.6 million. A Co. insists that T, B

Co.’s bankruptcy trustee, honor the shareholders’ agreement and transfer B Co.’s shares in C Co.

to A Co. T, is willing to sell B Co.’s shares in C Co. for fair market value of $2 million. A Co.

³⁰⁷R.S.C. 1985, c. B-3, s. 71.

³⁰⁸Niven, “The Anti-deprivation Rule and the Pari Passu Rule in Insolvency”, 25 Insolvency L.J. 5, 16 (2017)(“The

anti-deprivation rule concerns attempts to remove assets from insolvency proceedings, which reduces the value of the

bankrupt estate to the detriment of creditors. The pari passu rule concerns attempts to contract out of the statutory

provisions for pro rata distribution, so that one creditor receives more than his or her proper share of the available

assets”).

³⁰⁹A prudent lawyer may wish to incorporate a term that provides the commercial validation for an ipso facto term.

See Les Coopérants Société mutuelle d'assurance-vie (Liquidateur) v. Dubois, [1996] 1 S.C.R. 900, 911-12 (“The

undivided co-owners recognize that they have thus waived an action in partition or for a sale by licitation for a number

of reasons of common utility, including the possibility of obtaining hypothecary financing on the office tower and the

desire to avoid the costs, delays, administrative difficulties and low realized prices that would result from an action in

partition or for a sale by licitation”); Brooks v. Bankson, 445 S.E. 2d 473, 481 (Va. Sup. Ct. 1994)(“And, although the

Sellers seek to justify their insertion of the $24,500 claim based on their real estate agent's advice that they should

receive this amount as compensation for the loss of less than four months of the ‘best selling season,’ no such

justification is found in the contract”) & Worthington, “Good Faith, Flawed Assets and the Emasculation of the UK

Anti-Deprivation Rule”, 75 Mod. L. Rev. 112, 121 (2012)(“[After Belmont] [t]here will be a dramatic increase in

defensive drafting as parties attempt to ensure their deprivation provisions are well justified as commercially sensible

arrangements entered into in good faith”).

Page: 91

cannot raise $2 million. T takes the position that the ipso facto clause on which A Co. relies is

unenforceable. T seeks advice and direction from the court.

[330] The enforcement of this term does not adversely affect the proportionate interest of each of

the bankrupt shareholder’s creditors. It is not an equitable distribution problem. The enforcement

of the ipso facto term reduces the size of the pie³¹⁰– a fundamentally different complaint.

[331] This controversy arose in a 1995 Ontario case, Canadian Imperial Bank of Commerce v.

Bramalea Inc.³¹¹The solvent shopping mall partner was entitled to purchase the bankrupt partner’s

interest for the lesser of book value or fair market value. The difference was several million

dollars.

[332] In a very brief opinion, Justice Blair³¹²held that the impugned partnership term violated the

“fraud upon the bankruptcy law” principle and was unenforceable.

[333] Needless to say, Justice Blair decided this case roughly fourteen years before the 2009

amendments to the Bankruptcy and Insolvency Act and the Companies’ Creditors Arrangement

Act³¹³came into force. There is good reason to believe, based on another bankruptcy judgment of

Justice Blair, that had he heard this matter after the 2009 amendments were in force he may have

come to a different conclusion.³¹⁴

[334] Justice Blair did not assess the state of the Canadian common law on ipso facto clauses. He

assumed that ipso facto terms were unenforceable if their effect was the diminution of the debtor’s

property pool. He referred to two English cases³¹⁵and three Canadian cases,³¹⁶one of which the

³¹⁰This example engages what English judges and lawyers call the “anti-deprivation rule”. Belmont Park Investments

Pty v. BNY Corporate Trustee Services Ltd., [2011] UKSC 38, ¶1; [2012] 1 A.C. 383, 397 per Lord Collins of

Mapesbury (“The anti-deprivation rule is aimed at attempts to withdraw an asset on bankruptcy or liquidation or

administration, thereby reducing the value of the insolvent estate to the detriment of creditors”). I think of it as the

“bankrupt’s property pool preservation principle”.

³¹¹33 O.R. 3d 692 (Gen. Div. 1995). He relied on Borland’s Trustee v. Steel Bros. & Co., [1901] 1 Ch. 279, 291

(1900)(obiter: “If I came to the conclusion that there was any provision in these articles compelling persons to sell

their shares in the event of bankruptcy at something less than the price that they would otherwise obtain, such a

provision would be repugnant to the bankruptcy law”).

³¹²33 O.R. 3d 692, 694 (Gen. Div. 1995).

³¹³R.S.C. 1985, c. C-36.

314

Thibodeau v. Thibodeau, 2011 ONCA 110, ¶37; 104 O.R. 3d 161, 172 (Justice Blair applied the

negative-implication cannon and refused to treat a claim for a family equalization payment in the same manner as

other family law claims expressly accorded preferential status under the Bankruptcy and Insolvency Act).

³¹⁵Re Harrison, 14 Ch. D. 19 (C.A. 1880)(the Court declared unenforceable a term in an agreement between Ms.

Meade, land owner, and Mr. Harrison, builder, that upon the latter’s bankruptcy all improvements and materials on the

land would vest in the former).

Page: 92

Supreme Court of Canada subsequently reversed. Had he the benefit of the Supreme Court’s

opinion he may have come to another conclusion.³¹⁷

[335] Justice Blair concluded that it was dispositive that the partnership term devalued the

bankrupt’s interest solely because of the partner’s status as a bankrupt and violated the “‘fraud on

the bankruptcy law’ principle”.³¹⁸The diminished value of the bankrupt’s partnership interest had

a direct impact on the size of the pool representing the value of the bankrupt’s property available

for distribution to the bankrupt’s creditors. It was not consequential that the term had no adverse

impact on the percentage recovery of each debtor. This was not a pari passu problem. The

percentage claim of each creditor remained the same, only the pool was reduced.

[336] As the bankrupt’s creditors have a statutory interest in the bankrupt’s property, it is of

central importance to the creditors that the bankruptcy trustee properly identifies the bankrupt’s

property and asserts control over it. It is this pool from which the bankrupt’s creditors will recover

a portion or all of the bankrupt’s obligation to them.³¹⁹

[337] Capital Steel did not complete the work it promised Chandos Construction that it would

perform. The estimated completion costs are $22,800. There is no suggestion that Capital Steel has

any claim against Chandos Construction for this amount and that it constitutes part of the

bankrupt’s property.

[338] The controversy is whether the contract provision that allows Chandos Construction to

set-off the forfeiture amount of $137,330 and that eliminates the $126,818.39 account receivable,

is unenforceable.³²⁰

³¹⁶Re Frechette, 138 D.L.R. 3d 61 (Que. Super. Ct. 1982)(in obiter the Court concluded that an ipso facto term

entitling solvent shareholders to purchase a bankrupt’s shares at a twenty percent discount was contrary to public

policy and unenforceable); Les Cooperants Société mutuelle d'assurance-vie (Liquidateur) v. Dubois, 37 C.B.R. 3d

207 (Que. C.A. 1993)(the Court, in a Winding-Up Act application, held that an ipso facto term allowing a solvent

co-owner to purchase the insolvent co-owner’s interest at a discount was contrary to public policy and unenforceable),

rev’d [1996] 1 S.C.R. 900 & Re Knechtell Furniture Ltd., 56 C.B.R. (N.S.) 258 (Ont. Super. Ct. 1985)(the Court

refused to enforce a pension plan ipso facto term).

³¹⁷Ho, “The Treatment of Ipso Facto Clauses in Canada”, 61 McGill L.J. 139, 167 (2015)(“One can only speculate

whether the result in Bramalea might have been different had Justice Blair had the benefit of knowing the result in

Coopérants”).

³¹⁸33 O.R. 3d 692, 693 (Gen. Div. 1995).

319

Bankruptcy and Insolvency Act, R.S.C. 1985, c. B-3, s. 71; Insolvency Act 1986, c. 45, s. 306(1)(U.K.);

Corporations Act 2001, No. 50, s. 474(1)(a) (Austl. Cth); Bankruptcy Act 1966, No. 33, s. 58 (Austl. Cth); Companies

Act 1993, No. 105, s. 239U (N.Z.); Insolvency Act 2006, No. 55, s. 101(1)(a) (N.Z.) & Bankruptcy Code, 11 U.S.C.,

§323(a).

³²⁰The respondent did not argue that Chandos Construction could not set-off the forfeiture amount. It did not allege

that if Chandos Construction had a claim for the forfeiture amount that it could only advance it as a general creditor. I

Page: 93

2.

The Common Law Does Not Provide a Principled Basis for Declaring

Section VII Q(d) Unenforceable

a.

There Is No Canadian Common Law Rule Precluding the

Enforcement of Ipso Facto Terms

[339] There is not now and probably never has been a Canadian common law rule that precludes

the enforcement of ipso facto terms.³²¹

[340] When amendments made to the Bankruptcy and Insolvency Act and the Companies’

Creditors Arrangement Act that denied any force or effect to the natural person bankruptcy and

corporate restructuring ipso facto terms became law in 2009 they occupied the field and displaced

any common law norms regarding ipso facto clauses.

[341] I am also satisfied that in the period preceding the date the 2009 amendments came into

force that the English fraud-on-the-bankruptcy law principle had never been a generally accepted

feature of the Canadian common law. ³²²

[342] Why would it be necessary for Canadian judges to introduce norms that Parliament never

considered necessary to protect the core features of the Bankruptcy and Insolvency Act? Most

judge-made law that is inspired by public-policy considerations does not buttress statutory

proceed on the assumption that Chandos Construction is entitled to set-off the forfeiture amount if s. VII Q(d) is

enforceable. See P.I.A. Investments Inc. v. Deerhurst Ltd. Partnership, 20 C.B.R. 4^th116, 123-24 (Ont. C.A. 2000)(the

Court allowed Canadian Pacific Hotels Corporation to claim an equitable set off to defeat a claim of the receiver) & Re

Brunswick Chrysler Plymouth Ltd., 2005 NBQB 83, ¶42; 11 C.B.R. 5^th10, 17 (“A valid set-off will inevitably affect

and alter the priorities in a bankruptcy but that is what... [s. 97(3) of the] BIA contemplates”).

³²¹Professor Wood notes that “the ‘fraud upon the bankruptcy law’ principle … can be traced back to the eighteenth

century in England but … has been applied [in Canada] in only a handful of cases over the past century”. Wood,

“Direct Payment Clauses and the Fraud Upon the Bankruptcy Law Principle: Re Horizon Earthworks Ltd.

(Bankrupt)”, 52 Alta. L. Rev. 171, 171 (2014). Ms. Ho made the same point in her excellent article “The Treatment of

Ipso Facto Clauses in Canada”, 61 McGill L.J. 139, 164 (2015): “Despite the principle’s longstanding history in

English jurisprudence, the rule has not been widely applied by Canadian courts. ... [There is] little Canadian law that

applies the anti-deprivation rule”. This condition no doubt prompted her observation that the “validity [of the

anti-deprivation rule] in Canada ... is debatable”. Id. 163.

³²²Judge-made law evolves to meet the modern needs of the community it serves. States separated by thousands of

miles and developments reflecting unique social, economic and political patterns may have special needs that demand

the emergence of features that distinguish their judge-made law from that in force in another common law country that

has many shared values. See Paciocco v. Australia and New Zealand Banking Group Ltd., [2016] HCA 28, ¶¶7 & 9;

258 C.L.R. 525, 539 per French, C.J. (“The countries of the common law world have a shared heritage which they owe

to the unwritten law of the United Kingdom. That shared heritage offers the undoubted advantage, but does not import

the necessity, of development proceeding on similar lines. ... The common law in Australia is the common law of

Australia”).

Page: 94

frameworks. ³²³It modifies other judge-made laws. Judicial refusal to enforce contract terms that

promote criminal conduct³²⁴or racist values³²⁵are examples of this condition.

[343] Perhaps the explanation for the English judges’ decision to introduce the

fraud-on-the-bankruptcy law principle several centuries ago³²⁶was the skeletal nature of early

English bankruptcy statutes compared to their modern counterparts. “The anti-deprivation rule

originally developed before the enactment of the modern statutory schemes governing bankruptcy,

including in particular the wide statutory powers for the challenge of pre-bankruptcy

transactions”.³²⁷In addition, the early bankruptcy models were very decidedly pro-creditor in their

orientation³²⁸and the judges of that time may have believed that the fraud-on-the-bankruptcy-law

principle was consistent with the thrust of the statutory model.

[344] Regardless of the reasons why seventeenth and eighteenth century English judges thought

public policy compelled them to act, it is undeniable that the conditions that exist in Canada today

are fundamentally different from those that were present in England hundreds of years ago.³²⁹

³²³E. Farnsworth, Contracts 318 (4^thed. 2004) (“These policies have many bases. Some are grounded on moral values,

as are the policies against the impairment of family relationships and against gambling. Some are based on economic

notions, as are the policies against restraint of trade and against restraints on alienation of property. Some arise from a

desire to protect the institutions of government, as do the policies against encouraging litigation or otherwise

interfering with the judicial process and those against improperly influencing legislators and other government

officials”).

³²⁴See J. Côté, An Introduction to the Law of Contract 107-26 (1974).

³²⁵Re Drummond Wren, [1945] 4 D.L.R. 674, 679 (Ont. H.C.) (the Court refused to enforce a restrictive covenant

under which the land purchaser promised not to sell “to Jews or persons of objectionable nationality” on the basis that

it was “void as against public policy”).

³²⁶Higinbotham v. Holme, 34 Eng. Rep. 451 (Ex. Ct. 1812).

³²⁷Niven, “The Anti-deprivation Rule and the Pari Passu Rule in Insolvency”, 25 Insolvency L.J. 5, 19 (2017).

³²⁸C. Tabb, The Law of Bankruptcy 40 (2d ed. 2009). Courts could sentence fraudulent bankrupts to death after the

1705 passage of An Act to prevent Frauds frequently committed by Bankrupts. 4 & 5 Anne, c. 4, s. 19. The Capital

Punishment Act 1820, 1 Geo. 4, c. 115, s. 1 repealed the death penalty provisions. See generally B. Montagu, Thoughts

upon the Abolition of the Punishment of Death, in Cases of Bankruptcy (1821).

³²⁹Pope Manufacturing Co. v.Gormully, 144 U.S. 224, 233-34 (1892) per Brown J. (“It is impossible to define with

accuracy what is meant by that public policy for an interference and violation of which a contract may be declared

invalid. It may be understood in general that contracts which are detrimental to the interests of the public as understood

at the time fall within the ban. The standard of such policy is not absolutely invariable or fixed, since contracts which

at one stage of our civilization may seem to conflict with public interests, at a more advanced stage are treated as legal

and binding”) & Newfoundland and Labrador v. AbitibiBowater Inc., 2012 SCC 67, ¶47; [2012] 3 S.C.R. 443, 467

(the Court acknowledged that insolvency legislation often responds to evolving social conditions). See Reben,

“Legislative and Judicial Confusion Concerning Executory Contracts in Bankruptcy”, 89 Dick. L. Rev. 1029, 1034

(1985)(“In ancient India and Nepal ... a creditor fasted at his debtor’s door pending satisfaction of the debt, presuming

that no debtor would allow his creditor to starve to death. Ancient Hindu law allowed a creditor to seize his debtor and

force him to work off his debt. Alternatively, a creditor could maim or kill the debtor, confine his wife, sons, or cattle,

or besiege him in his own home”).

Page: 95

[345] In any event, the Supreme Court of Canada has never recognized and applied the

fraud-on-the-bankruptcy-law principle.³³⁰Indeed, it has implicitly held that it does not exist.³³¹

[346] My research reveals that only one provincial appeal court – the Court of Appeal of

Ontario³³²– has applied this norm. It did so in a very short opinion without explaining why.

[347] There are only a few lower court decisions that have applied or acknowledged the

existence of this principle. ³³³“The anti-deprivation rule ... has not been widely used [in

Canada]”.³³⁴

[348] I will first examine the top court’s jurisprudence.

³³⁰In Hobbs, Osborne & Hobbs v. Ontario Loan and Debenture Co., 18 S.C.R. 483, 504, an 1890 appeal, Justice

Strong referred to the fraud-on-the-bankruptcy-law principle in English common law when there was no bankruptcy

legislation in Canada. This was not an insolvency case. Professor Wood reports that “Canada had no bankruptcy law at

all during the period from 1880 to 1919.” R. Wood, Bankruptcy and Insolvency Law 34 (2d ed. 2015).

³³¹Les Coopérants Société mutuelle d'assurance-vie (Liquedateur) v. Dubois, [1996] 1 S.C.R. 900.

³³²Trustee of Aircell Communications Inc. v. Bell Mobility Cellular Inc., 2013 ONCA 95; 14 C.B.R. 6^th276. See also

P.I.A. Investments Inc. v. Deerhurst Ltd. Partnership, 20 C.B.R. 4^th116, 127 (Ont. C.A. 2000)(the Court

acknowledged that Canadian Imperial Bank of Commerce v. Bramalea Inc. discussed the fraud-on-the-bankruptcy

law principle) & Re Wetmore, [1924] 4 D.L.R. 66, 76 (N.B. Sup. Ct. App. Div.) (the Court, in obiter, acknowledged

the fraud-on-the-bankruptcy-law principle).

³³³See National Bank of Canada v. Scollard Energy Ltd., 2018 ABQB 126, ¶55 (the Court, relying on Canadian

Imperial Bank of Commerce v. Bramalea Inc., assumed that the anti-deprivation principle was a feature of the current

Canadian common law); Re Westerman (Bankrupt), 1998 ABQB 946; 8 C.B.R. 4^th313 (Master Quinn held that a

partnership term reducing a bankrupt partner’s capital payout by fifty percent could not thwart a claim by the

bankrupt’s trustee for payout of the full capital account), rev’d on other grounds, 1999 ABQB 708; 275 A.R. 114 (the

Court of Queen’s Bench expressed its agreement with Canadian Imperial Bank of Commerce v. Bramalea Inc.);

1183882 Alberta Ltd. v. Valin Industrial Mill Installations Ltd., 2011 ABQB 440, ¶44; 521 A.R. 281, 289 (the Court

did not recognize the “fraud upon the bankruptcy law” as a principle with broad effect: “In my view, it is inappropriate

to paint all insolvency proceedings with the same broad brush without regard to the nature of the proceedings, the

effects of the impugned covenant, and all other relevant circumstances”), aff’d, 2012 ABCA 62, ¶8; 64 Alta. L.R. 5^th

163, 170 (the Court expressly declined to comment on any bankruptcy or insolvency issues); Canadian Imperial Bank

of Commerce v. Bramalea Inc., 33 O.R. 3d 692, 694 (Gen. Div. 1995) (“The principle is sometimes referred to as that

of ‘fraud upon the bankruptcy law’, by which is meant not necessarily ‘fraud’ in the sense of dishonesty or

impropriety, but fraud in the effect”); Re Knechtel Furniture Ltd., 56 C.B.R. (N.S.) 258 (Ont. Super. Ct. 1985) (the

Court held that a pension plan term allocating a surplus to the pension plan beneficiaries on the bankruptcy of the

employer could not be invoked to deny the bankrupt’s trustee claim to the portion of the surplus attributable to the

bankrupt’s contribution); Re Frechette, 42 C.B.R. (N.S.) 50 (Que. Super. Ct. 1982)(the Court held that a shareholders

agreement term that obliged a bankrupt shareholder to sell his shares for eighty-percent of their fair market value could

not be enforced against the bankrupt shareholder’s bankruptcy trustee) & Re Barrington & Vokey Ltd., 48 C.B.R. 3d

270 (N.S. Sup. Ct. 1996) (the Court refused to enforce a construction subcontract term that allowed a general

contractor to use subcontractor property that was on the site when the subcontractor became bankrupt).

³³⁴Ho, “The Treatment of Ipso Facto Clauses in Canada”, 61 McGill L.J. 139, 170 (2015). See also Niven, “The

Anti-deprivation Rule and the Pari Passu Rule in Insolvency”, 25 Insolvency L.J. 5, 6 (2017) (“There is little case law

in New Zealand on the anti-deprivation rule”).

Page: 96

[349] In A.N. Bail Co. v. Gingras,³³⁵the case referred to earlier, there was no dispute as to what

amounts the general contractor owed the bankrupt subcontractor. The controversy turned on

whether the general contractor could pay these undisputed amounts to the bankrupts’ creditors as

opposed to the bankruptcy trustee, notwithstanding the bankrupt’s proprietary interest in the

accounts receivable. There was a leap-frogging term in the contract that sanctioned this payment.

Section 71 of the Bankruptcy and Insolvency Act expressly stipulates that the bankrupt’s property

immediately vests in the bankruptcy trustee and, without a doubt, prohibited this payment. There

was no need to resort to the common law to resolve the question.³³⁶And the Court did not.

[350] The Supreme Court of Canada’s opinion in Les Coopérants Société mutuelle

d'assurance-vie (Liquidateur) v. Dubois³³⁷leads me to conclude that that Canadian common law

does not incorporate the English fraud-on-the-bankruptcy law principle. Co-owners of Quebec real

property agreed that there would be no partition of the properties for thirty-five years and that if

one of the co-owners obtained a court liquidation order, the solvent co-owner could purchase the

insolvent co-owner’s interest for seventy-five percent of the market value. A co-owner, under the

Winding-Up Act,³³⁸applied for the appointment of a liquidator, no doubt convinced that the ipso

facto term was prejudicial to the bankrupt’s creditors’ interests.³³⁹The solvent co-owner invoked

the sale provision. The liquidator applied to the Quebec Superior Court for a declaration that the

mandatory-sale term was unenforceable against the liquidator.

³³⁵[1982] 2 S.C.R. 475.

336

See International Air Transport Assoc. v. Ansett Australia Holdings Ltd. (subject to a Deed of Company

Arrangement), [2008] HCA 3, ¶76; 234 C.L.R. 151, 181 (“the Clearing House arrangements ... operated as to give

British Eagle an asset, the money claim against Air France, and that in the face of the mandatory operation of s. 302 of

the Companies Act 1948 (UK), this asset could not be captured for the netting-off system. ... No recourse to ‘public

policy’ would be called for”).

³³⁷[1996] 1 S.C.R. 900.

³³⁸R.S.C. 1985, c. W-11. “The Winding Up Act had been enacted in 1882 in order to deal with insolvent companies”.

R. Wood, Bankruptcy and Insolvency Law 35 (2d ed. 2015). The Winding-Up Act became the Winding-Up and

Restructuring Act in 1996. An Act to Amend, Enact and Repeal Certain Laws Relating to Financial Institutions, S.C.

1996, c. 6, s. 133. “The Winding-Up and Restructuring Act ... is the only insolvency regime that can be used in

connection with the insolvency of banks, insurance companies, trust companies, and loan companies”. R. Wood,

Bankruptcy and Insolvency Law 16 (2d ed. 2015).

³³⁹See Perpetual Trustee Co. v. BNY Corporate Trustee Services Ltd., [2009] EWCA Civ 1160, ¶¶86 & 148; [2010]

Ch. 347, 384-85 per Lord Neuberger, M.R. (“as BBCW must pay market value (indeed, at least market value) for the

shares, the [anti-deprivation] rule cannot be engaged”) & 401 per Patten L.J. (“An option to acquire shares in the event

of bankruptcy is not objectionable on the grounds of public policy unless the price paid for the shares would constitute

an undervalue”).

Page: 97

[351] Justice Trudel declared that the mandatory-sale term was binding and enforceable against

the insolvent co-owner and the liquidator. In effect, he concluded that the bankrupt co-owner did

not have a property interest in the twenty-five percent discount. Part of his reasons follow:³⁴⁰

[T]he undivided co-owners took care that disorder would not ensue and protected

themselves from the difficulties that would result should one of them become

insolvent. They … [protected] themselves from the coerciveness of a judicial sale

and [avoided] having a new partner imposed on them. They limited or eliminated

the right to assign their shares and included in the contracts a mechanism and

conditions for terminating the indivision.

There was no reason they could not provide … for the future resolution of the

contract in the event that either of them failed to fulfil his or its obligations.

Bankruptcy and winding-up are events upon which an obligation may validly be

conditional and there was nothing to prevent the co-owners from providing in

advance for the termination of indivision in such a case. …

In addition, the clauses ... relating to default, mandatory or default sale and partition

or sale by licitation are in no way contrary to public order or good morals.

[352] The likelihood that Justice Trudel would have referred to both bankruptcy and winding-up

regimes when discussing an insolvency topic had he not assumed that they share fundamental

feature is very low.

[353] The Quebec Court of Appeal allowed the liquidator’s appeal.³⁴¹Justice Beauregard, for the

Court, opined that “[i]f this way of proceeding were allowed, security law would serve no

purpose”.³⁴²He stated that there must be an orderly distribution of a debtor’s property under both

the Winding-Up Act and the Bankruptcy and Insolvency Act.³⁴³

[354] Justice Beauregard must have concluded that the contested ipso facto term deprived the

bankrupt co-owner of its interest in the full value of the property and that this term was

unenforceable.

[355] Nothing in Justice Beauregard’s opinion suggests that he disagreed with the proposition

that the Bankruptcy and Insolvency Act and the Winding-Up Act have comparable foundational

values.

³⁴⁰[1992] R.J.Q. 2574, 2577-78 (emphasis added).

³⁴¹[1994] R.J.Q. 55; 37 C.B.R. 3d 207.

³⁴²Id. 57.

³⁴³Id. 58.

Page: 98

[356] The Supreme Court agreed with Justice Trudel and reversed the Quebec Court of Appeal.³⁴⁴

[357] Justice Gonthier wrote for the Court.

[358] His judgment displays two themes.

[359] First, he emphasized at the outset the fact that the terms to which the liquidator objected

were “the contractual will of the two parties, both of whom were knowledgeable about real estate

investments”.³⁴⁵Later, he again emphasized the underlying importance of freedom-of-contract

values:³⁴⁶

The principle that must guide the court in exercising its discretion in such a case is

that of respect for contracts signed in good faith prior to the winding-up, unless the

obligations contained therein are prejudicial to the other creditors and give rise to

an unjust preference in light of all the circumstances, in which case equitable relief

will be available.

[360] Second, Justice Gonthier confirmed that the purpose of the Winding-Up Act “is to arrange

for the closing down of the company’s business in an orderly and expeditious manner while

minimizing, as far as possible, the losses and harm suffered by both the creditors and other

interested parties and by distributing the assets in accordance with the Act”.³⁴⁷

[361] Justice Gonthier adopted a common-sense approach to this problem. He asked whether

“the harm caused to the other unsecured creditors would be disproportionate to the harm caused to

the appellant, given the nature of his claim, by a failure to comply with the agreements and would

create an unjust preference in his favour”.³⁴⁸

[362] Satisfied that the enforcement of the contested terms would not impose on the unsecured

creditors of the insolvent co-owner a measure of harm disproportionate to that the solvent

co-owner would endure if deprived of the right to rely on the contested term, Justice Gonthier

found in the solvent co-owner’s favour.

[363] There is no direct or indirect reference to the fraud-on-the-bankruptcy principle or any of

the case law on the topic, including the Bramalea case, in Justice Gonthier’s opinion. It is hard to

square this with the notion that the fraud on the bankruptcy principle plays an important role in

Canada’s insolvency law.

³⁴⁴[1996] 1 S.C.R. 900.

³⁴⁵Id. 912.

³⁴⁶Id. 918.

³⁴⁷Id. 915-16.

³⁴⁸Id. 919.

Page: 99

[364] I will now refer to the one case out of the Ontario Court of Appeal that does acknowledge

the fraud-on-the-bankruptcy principle.

[365] In Trustee of Aircell Communications Inc. v. Bell Mobility Cellular Inc., ³⁴⁹the Court, in a

fourteen-paragraph opinion, declared that a term in a dealership contract relieving Bell Mobility of

the obligation to pay Aircell Communications $188,981 for outstanding commissions upon the

latter’s bankruptcy was unenforceable against the bankrupt’s trustee. The Court, relying on

Canadian Imperial Bank of Commerce v. Bramalea Inc., ³⁵⁰assumed that there was a

fraud-on-the-bankruptcy-law principle in force in Canada. But, as noted above, the 1995 judgment

also assumed that the principle should be applied in Canada. The Court of Appeal gave no

consideration to the effect s. 84.2 of the Bankruptcy and Insolvency Act or s. 34 of the Companies’

Creditors Arrangement Act had on the enforceability of corporate ipso facto terms or the effect of

Les Coopérants Société mutuelle d'assurance-vie (Liquidateur) v. Dubois³⁵¹on the issue before it.

Neither of these statutory provisions were in force when Justice Blair decided Bramalea.

[366] There is only one Alberta case the outcome of which turned on the application of the

fraud-on-the-bankruptcy law principle.³⁵²

[367] It is Re Westerman (Bankrupt), a 1998 case.³⁵³At issue was the enforceability of a

law-partnership term that reduced a bankrupt partner’s capital account by fifty percent. Master

Quinn ordered the law firm to pay the bankrupt’s trustee 100 percent of the former partner’s capital

account. He did so because “[t]o allow the partnership to take 50% of what is probably the

bankrupt’s largest available asset would be to grant an unjust preference to the partnership”.³⁵⁴To

have reached this conclusion the Master must have concluded that the ipso facto term did abridge

the bankrupt’s property interest in his capital account and that the term was unenforceable.

[368] The law firm successfully appealed to the Court of Queen’s Bench.³⁵⁵While Justice Agrios

sided with the law firm on another ground and disposed of the appeal on that basis, he made this

³⁴⁹2013 ONCA 95; 14 C.B.R. 6^th276.

³⁵⁰33 O.R. 3d 692 (Gen. Div. 1995).

³⁵¹[1996] 1 S.C.R. 900.

352

Justice Topolniski adverted to the fraud-on-the-bankruptcy law principle in 1183882 Alberta Ltd. v. Valin

Industrial Mill Installations Ltd., 2011 ABQB 440, ¶¶34-42; 521 A.R. 281, 288-89, but she did not apply it. Whether

a lessee had a right to acquire the leased premises or not would have no impact on any creditors of the lessee. Justice

Topolniski held that “the only persons affected by the Insolvency Clause are [the lessee] and ... [the lessor]. The

creditors have not been prejudiced. Consequently, the higher principle of safeguarding the integrity of the insolvency

system in these circumstances does not override the parties' freedom of contract”. 2011 ABQB 440, ¶47; 521 A.R.

281, 290.

³⁵³1998 ABQB 946; 8 C.B.R. 4^th313.

³⁵⁴Id. at ¶23; 8 C.B.R. 4^that 318.

³⁵⁵1999 ABQB 708; 275 A.R. 114.

Page: 100

obiter observation:³⁵⁶“I accept the proposition that a provision in a partnership agreement which

reduces value from creditors is void as it violates the public policy of equitable and fair distribution

amongst unsecured creditors in insolvency situations”. He cited the Bramalea case as authority for

this proposition.

[369] Justice Agrios made this observation roughly ten years before s. 84.2 of the Bankruptcy

and Insolvency Act and s. 34 of the Companies’ Creditors Arrangement Act came into force.

[370] Enforcing the law partnership insolvency term would not in any way adversely affect the

percentage payment the bankrupt’s creditors would receive, assuming that the law partnership was

not a creditor of the bankrupt. But its enforcement as against the bankruptcy trustee would reduce

the size of the bankrupt’s property pool. This must have been the concern that troubled Justice

Agrios.

b.

The English Common Law Has Changed

[371] There is no historical consensus as to the scope of the English fraud-on-the-bankruptcy law

principle.³⁵⁷

[372] Some judges have held that it has sufficient vigor to deprive contract terms of their plain

and ordinary meaning if the effect of the term is the diminution of the bankrupt’s property pool to

358

the detriment of the bankrupt’s creditors.

For these judges there is a bankrupt’s

³⁵⁶Id. at ¶6; 275 A.R. at 115.

³⁵⁷Money Markets Ltd. v. London Stock Exchange, [2002] 1 W.L.R. 1150, 1182 (Ch. 2001) (“it is not possible to

discuss a coherent rule, or even an entirely coherent set of rules, to enable one to assess in any particular case whether

such a provision (a ‘deprivation provision’) falls afoul of the principle”).

³⁵⁸Re Johns, [1928] 1 Ch. 737, 748 (Ch.) (the Court declared unenforceable a mortgage term that benefitted the

mortgagee if the mortgagor declared bankruptcy: “[A mortgagee] cannot make a bargain with the mortgagor which

secures to him, the mortgagee, a greater advantage if the mortgagor becomes bankrupt than he would get if he does

not”); Ex p. Barter, 26 Ch. D. 510 (C.A. 1884) (the Court declared void and unenforceable a provision in a

shipbuilding contract that allowed the buyer, on the bankruptcy of the ship builder, to claim control of the ship and

ownership of any materials of the ship builder intended for use in constructing the ship); Ex p. Jay, 14 Ch. D. 19, 25

(C.A. 1880)(the Court declared unenforceable a term in the building agreement that transferred title to the owner to all

building material on the property on the bankruptcy of the builder: “a simple stipulation that, upon a man’s becoming

bankrupt, that which was his property up to the date of the bankruptcy should go over to someone else and be taken

away from his creditors, is void as being a violation of the policy of the bankrupt law”); Ex p. Mackay, L.R. 8 Ch. App.

643 , 647 (1873)(the Court declared unenforceable a term that allowed the bankrupt’s creditor to maintain all royalties

payable to the bankrupt until the bankrupt’s debt to the creditor was extinguished: “a man is not allowed, by stipulation

with a creditor, to provide for a different distribution of his effects in the event of bankruptcy from that which the law

provides. ... [T]his is a clear attempt to evade the operation of the bankruptcy laws”); Whitmore v. Mason, 70 Eng.

Rep. 1031, 1034 (Ch. 1861) (the Court declared unenforceable a mining partnership agreement that transferred a

bankrupt partner’s interest to the solvent partners for a discounted rate: “the law is too clearly settled to admit of a

shadow of a doubt that no person possessed of property can reserve that property to himself until he shall become

bankrupt, and then provide that, in the event of his coming bankrupt, it shall pass to another and not to his creditors”)

& Higinbotham v. Holme, 34 Eng. Rep. 451, 453 (Ch. 1811) (the Court declared unenforceable a trust provision that

Page: 101

property-pool-preservation rule that has teeth. A contract term that has the effect of reducing the

bankrupt’s property pool is unenforceable.

[373] On the other hand, there is a group of judges who gave the contested text its plain and

ordinary meaning unless it is obvious that the parties set out to defeat the purpose of the

bankruptcy status.³⁵⁹This cohort denies there is an ipso facto rule.

[374] The House of Lord’s 1975 judgment in British Eagle International Airlines Ltd. v.

Compagnie Nationale Air France³⁶⁰illustrates the nature of the judicial divide.

[375] British Eagle was an airline operator that held a membership in the International Air

Transportation Association. IATA operated a clearing house that on a monthly basis tabulated

whether each member was in a positive or negative position with another member airline. An

airline that provided services of a greater value than the other member provided to it was in a

positive position with respect to the other airline. That same airline might be in a negative position

with other airlines. At the end of the month IATA would assess the overall position of all the

member airlines. It would collect funds from members in a negative position and pay the members

in a positive position.³⁶¹By the term of the clearing house rules a member could not maintain a

claim against another; the claim was against IATA. The clearing house rules functioned the same

way without regard to whether a member was in liquidation.

terminated the settlor’s interest in the trust property on his becoming a bankrupt, in favour of his wife: “this is a direct

fraud upon the Bankrupt Laws ... I cannot assimilate this to the case of the wife’s property limited until the bankruptcy

of her husband; or to the case of a lease made determinable by the bankruptcy of the lessee”).

³⁵⁹Money Markets International Stockbrokers Ltd. v. London Stock Exchange Ltd., [2002] 1 W.L.R. 1150 (Ch. D.

2001)(the Court declared enforceable a rule of the London Stock Exchange that cancelled the membership of a

member that failed to fulfil its obligation to a fellow L.S.E. member and transferred the bankrupt’s share to the L.S.E.

for no consideration); Re Apex Supply Co., [1942] Ch. 108, 114 (Ch. 1941) (the Court upheld a term in a hire-purchase

agreement that obliged the hirer to pay an additional sum if the hirer went into liquidation and the owner retook

possession of the goods: “[I]t would be extravagant, in my view, to suggest that the clause is aimed at defeating the

bankruptcy laws or at providing for a distribution differing from that which the bankruptcy laws permit”); Bombay

Official Assignee v. Shroff, 48 T.L.R. 443, 446 (P.C. 1932)(Bombay)(the Privy Council held that a stock broker whose

membership in the stock exchange was terminated because he was unable to meet his obligations to his fellow

members had no interest that could be passed on to an insolvency assignee); Borland’s Trustee v. Steel Bros. & Co.,

[1901] 1 Ch. 279 (Ch. 1900)(the Court enforced a term in a company’s articles of incorporation compelling a bankrupt

shareholder to sell its shares to a particular person at a fair price) & Ex p. Newitt, 16 Ch. D. 522, 531 (C.A. 1881)(the

Court enforced a term in a lease agreement between the lessor/owner and the lessee/builder providing that the

lessor/owner may terminate the lease on the bankruptcy of the lessee and claim ownership of all the builder/lessee’s

property left on the premises: “The broad general principle is that the trustee in bankruptcy takes all the bankrupt’s

property, but takes it subject to all the liabilities which affected it in the bankrupt’s hands, unless the property which he

takes as the legal personal representative of the bankrupt is added to by express provision of the bankruptcy law”).

³⁶⁰[1975] 1 W.L.R. 758.

³⁶¹Id. 762-63 per Lord Morris & 772 & 775 per Lord Cross.

Page: 102

[376] British Eagle went into liquidation in 1968. The liquidator of British Eagle commenced an

action against Air France for the difference of the value of the services British Eagle rendered to

Air France and the value of the services Air France rendered to British Eagle in an accounting

period during which British Eagle was insolvent. It alleged that this amount was the property of

British Eagle under s. 302 of the Companies Act 1948.³⁶²Air France denied that it owed British

Eagle anything.

[377] Both the trial judge,³⁶³the Court of Appeal³⁶⁴and two law lords³⁶⁵were of the view that the

IATA clearing house rules that deprived British Eagle of any property interests against member

airlines were enforceable as against British Eagle’s liquidator.

[378] Three law lords held the opposite view. They ignored the ordinary meaning of the clearing

house rules, convinced that these provisions were contrary to public policy, and classified Air

France’s obligation to British Eagle as s. 302 property.³⁶⁶As a result, the creditors of British Eagle

were declared to be entitled to the positive differential as between British Eagle and Air France.

The effect of the clearing house rules on other creditors of British Eagle was the litmus test for

invalidity.

[379] Lord Cross gave the judgment that reflected the majority’s opinion. The key passage in his

speech follows:³⁶⁷

[T]he respondents are saying …that the parties to the "clearing house"

arrangements by agreeing that simple contract debts are to be satisfied in a

particular way have succeeded in "contracting out" of the provisions contained in

section 302 [of the Companies Act 1948] for the payment of unsecured debts “pari

passu”. In such a context it is to my mind irrelevant that the parties to the "clearing

house" arrangements had good business reasons for entering into them and did not

direct their minds to the question how the arrangements might be affected by the

insolvency of one or more of the parties. Such a "contracting out" must, to my

mind, be contrary to public policy.

³⁶²Companies Act 1948, c. 38, s. 302 (“Subject to the provision of this Act as to preferential payments, the property of

a company shall, on the winding-up, be applied in satisfaction of its liabilities pari passu”).

³⁶³[1973] 1 Lloyd’s Rep. 414.

³⁶⁴[1974] 1 Lloyd’s Rep. 429, 434 (“[Insolvency] laws require that the property of an insolvent company shall be

distributed pro rata among its unsecured creditors: but the question here is whether the claim asserted against Air

France is property of British Eagle. In our judgment it is not”).

³⁶⁵Lord Morris & Lord Simon. The Australian High Court, in International Air Transport Assoc. v. Ansett Australian

Holdings Ltd., [2008] HCA 3; 234 C.L.R. 151, held that IATA was the creditor of an insolvent airline member, unlike

the majority of the House of Lords.

³⁶⁶[1975] 1 W.L.R. 758, 781 per Lord Cross.

³⁶⁷Id. 780.

Page: 103

[380] Lord Morris followed a different path.³⁶⁸He was satisfied that “[t]here is no trace in the

scheme of any plan to divert money in the event of a liquidation”.³⁶⁹He gave effect to the ordinary

meaning of the clearing house rule. Lord Morris held that Air France was not indebted to British

Eagle and that British Eagle had no property interest that the liquidator could attach:³⁷⁰

I see no reason to think that the contracts which were entered into by the members

of the Clearing House offended against the principles of our insolvency laws. ...

Services rendered during October and the first few days of November were in my

view rendered under perfectly lawful contracts which were made in the same way

as contracts had been made for years past. Because of the terms of the contracts

which were made the Appellants had no claims against and no rights to sue other

individual members of the Clearing House. It is a general rule that a trustee or

liquidator takes no better title to property than that which was possessed by a

bankrupt or a company. In my view the liquidator ... cannot remould contracts

which were validly made.

[381] Lord Simon of Glaisdale expressed his “entire” agreement with Lord Morris and added this

gloss:³⁷¹

Since this was a bona fide commercial transaction, and not a “deliberate device” to

give a preference on liquidation, nor was that “the whole scope and object” of the

interline agreement, nor its “dominant intention”, nor was it “aimed at anything of

that kind”, the liquidator of British Eagle has no higher claim than the company had

before liquidation.

[382] In 2011 the United Kingdom Supreme Court abandoned the ground the majority of the

House of Lords occupied when deciding British Eagle International Airlines Ltd. v. Compagnie

Nationale Air France.³⁷²Writing for six of the seven justices hearing Belmont Park Investments

Pty Ltd. v. BNY Corporate Services Ltd.,³⁷³Lord Collins adopted a new test that increased the

likelihood significantly that ipso facto terms would be enforced.³⁷⁴This new standard placed much

³⁶⁸Id. 769.

³⁶⁹Id. 763.

³⁷⁰Id. 769.

³⁷¹Id. 771.

³⁷²[1975] 1 W.L.R. 758.

³⁷³[2011] UKSC 38; [2012] 1 A.C. 383. For an excellent discussion of Belmont see Niven, "The Anti-deprivation

Rule and the Pari Passu Rule in Insolvency", 25 Insolvency L.J. 5 (2017).

³⁷⁴Professor Worthington much prefers the American approach to ipso facto clauses. “The pivotal issue ... is defining

when party autonomy must give way to the insolvency-triggered deprivation rule ... . The answer, surely, and as Lord

Mance would have it, is that it must give way every time the parties’ agreement avoids the normal operation of the

Page: 104

greater importance on the freedom of contract values and much less emphasis on the

anti-deprivation or pool-protection rule that underlies bankruptcy legislation. Now a court must

ask if the contract under review reveals an intention to evade the insolvency laws, as the following

extract from Lord Collin’s speech documents:³⁷⁵

[C]ommercial sense and absence of intention to evade insolvency laws have been

highly relevant factors in the application of the anti-deprivation rule. Despite

statutory inroads, party autonomy is at the heart of English commercial law. Plainly

there are limits to party autonomy … because the interests of third party creditors

will be involved. But … it is desirable that, so far as possible, the courts give effect

to contractual terms which parties have agreed. And there is a particularly strong

case for autonomy in cases of complex financial instruments ... .

No doubt that is why, except in the case of a blatant attempt to deprive a party of

property in the event of liquidation ... the modern tendency has been to uphold

commercially justifiable contractual provisions which have been said to offend the

anti-deprivation rule ... . The policy behind the anti-deprivation rule is clear, that

the parties cannot, on bankruptcy, deprive the bankrupt of property which would

otherwise be available for creditors. It is possible to give that policy a common

sense application which prevents its application to bona fide commercial

transactions which do not have as their predominant purpose, or one of their main

purposes, the deprivation of the property of one of the parties on bankruptcy.

…

The security was in commercial reality provided by the noteholders to secure what

was in substance their own liability, but subject to terms, including the provisions

for noteholder priority and swap counterparty priority, in a complex commercial

transaction entered into in good faith. There has never been any suggestion that

those provisions were deliberately intended to evade insolvency law.

[383] The Supreme Court was keenly aware that the law already enforced

forfeiture-on-bankruptcy terms in land leases³⁷⁶and terms that identified the bankruptcy of the

insolvency statute”. Worthington, “Good Faith, Flawed Assets and the Emasculation of the UK anti-Deprivation

Rule”, 75 Mod. L. Rev. 112, 115-16 (2012).

³⁷⁵Id. at ¶¶103, 104 & 109; [2012] 1 A.C. at 421 & 422. See also id at ¶151; [2012] 1 A.C. at 434 per Lord Mance

(“The more difficult question concerns the character of transaction and the state of mind which will attract the

operation of the anti-deprivation principle. In my opinion, the court has to make an objective assessment of the

purpose and effect of the relevant transaction or provision in bankruptcy”).

³⁷⁶Id. at ¶85; [2012] 1 A.C. at 417 per Lord Collins (“The lease cases show that such a provision is regarded by the law

as effective to bring the lease to an end whether the lease is expressed (a) to run “until bankruptcy” or (b) as a lease

with "a proviso for forfeiture" in that event. The result has not depended upon linguistic differences of expression”) &

Page: 105

grantee or beneficiary as the event terminating the grantee’s or beneficiary’s interest.³⁷⁷In other

words, the new Belmont Park Investment test increases the likelihood that ipso facto terms would

be enforced and complements specific rules that had been in force for centuries.³⁷⁸

[384] The English common law anti-deprivation rule did not apply to limited interests. This

meant that ipso facto terms relating to leases and licenses could be enforced.³⁷⁹

c.

The Common Law Should Enforce Corporate Ipso Facto Terms

That Serve Reasonable and Defensible Commercial Purposes

[385] If I erred in concluding that the fraud-on-bankruptcy principle is not a part of the Canadian

common law after 2009, I would adopt the essential components of the standard that Lord Collins

introduced in Belmont Park Investments Pty. Ltd. v. BNY Corporate Services Ltd. ³⁸⁰His

formulation celebrates the primacy of party autonomy and freedom of contract values.

id at ¶123; [2012] 1 A.C. at 425 per Lord Walker (“There are some reasonably well demarcated areas in which it is

clear that the [anti-deprivation rule] principle does not apply. One is the grant of a lease, in which the reservation of a

power of re-entry and forfeiture in the event of bankruptcy is standard practice, is unquestionably valid, and is

recognised by statute”).

³⁷⁷Id. at ¶86; [2012] 1 A.C. at 417 per Lord Collins (“licences of intellectual property expressed to determine (or to be

determinable on notice) on bankruptcy of the licensee are valid; and interests under protective trusts granted by the

settlor to a beneficiary until the beneficiary's bankruptcy”) & id. at ¶124; [2012] 1 A.C. at 425 per Lord Walker (“a

settlor can validly settle his own property so as to confer on another person an interest terminable on the bankruptcy of

that other person”). See Re Bailey, 11 C.B.R. 399 (Ont. H. Ct. 1930), aff’d, 11 C.B.R. 444 (App Div. 1930)(the Court

enforced a provision in a will that paid trust fund income to the testator’s son so long as the son was not a bankrupt and

the testator’s grandson if the son became a bankrupt).

³⁷⁸Judge Peck of the Bankruptcy Court of the Southern District of New York came to the opposite conclusion on the

same facts in Lehman Brothers Holdings Inc. v. BNY Corporate Trustee Services Ltd., 422 B.R. 407 (S.D.N.Y 2010).

The Bankruptcy Code compelled this result. 422 B.R. 407, 420 (“The Court finds that the provision in the Transaction

Documents purporting to modify LBSF’s right to a priority distribution solely as a result of a chapter 11 filing

constitute unenforceable ipso facto clauses”).

³⁷⁹Sections 65.1(2) and 84.2(2) of the Bankruptcy and Insolvency Act specifically state that ipso facto terms relating to

leases are of no force or effect. While s. 65.1(2) also refers to licensing agreements, no mention is made of them in s.

84.2, the bankruptcy ipso facto provision. Ms. Ho suggests that the omission may be inconsequential “Although it is

only section 65.1(2) of the BIA that mentions licenses, it is unlikely that ipso facto provisions would be enforceable

under ... [s. 84.2(2) because it uses] the term “agreement” ... Licenses might fall under the term “agreement”. Section

65.1 was enacted first, as part of the 1992 amendments, and so it may have been overly careful drafting”. Ho, “The

Treatment of Ipso Facto Clauses in Canada”, 61 McGill L.J. 139, 180 (2015).

³⁸⁰[2011] UKSC 38; [2012] 1 A.C. 383. Professor Wood, one of Canada’s leading insolvency scholars, favors the

effects-based test. Professor Wood is of the view that the effects-based test is consistent with the “tide of legislative

reform in Canada” and Justice Blair’s 1995 Bramalea decision. R. Wood, Bankruptcy and Insolvency Law 89-90 (2d

ed. 2015). But this argument cuts both way. While it is true that s. 84.2 of the Bankruptcy and Insolvency Act denies

the force of natural person ipso facto clauses, because of their adverse effects on the bankrupt’s estate, it is equally true

that the Bankruptcy and Insolvency Act does not declare corporate ipso facto terms unenforceable. As I assert below, if

Page: 106

[386] Lord Collins’ model denies enforceability only to ipso facto clauses that manifest a blatant

attempt to hijack the bankrupt’s property and defeat the legitimate interests of the bankrupt’s

creditors memorialized in the bankruptcy statute. It accords full force and effect to ipso facto terms

that serve reasonable and defensible commercial purposes.

[387] There is no compelling reason to deny a corporate bankruptcy ipso facto term its full effect

if its most important feature is the advancement of a reasonable and defensible commercial

purpose and it bestows on the nonbankrupt party a benefit that is not significantly greater than is

necessary to promote the nonbankrupt party’s legitimate commercial interests.

[388] This formulation represents a modest infringement on party autonomy and freedom of

contract values and it acknowledges the legislative primacy on a topic that is the subject of

comprehensive statutory regulation both by the Bankruptcy and Insolvency Act ³⁸¹and the

Companies’ Creditors Arrangement Act.³⁸²

[389] Under these circumstances, an effects-based test is not very appealing.

[390] I return to the golf course example to illustrate the application of this norm. Both A Co. and

B Co. agreed that the bankruptcy of one would trigger an option to purchase the bankrupt’s shares

in C Co. for eighty percent of fair market value - $1.6 million. This strikes me as an eminently

defensible transaction that ought not to be set aside. There were reasonable and defensible

commercial purposes that explained the term’s value to A Co. and B Co. The enforcement of the

corporate bankruptcy ipso facto term did not bestow on A Co. a benefit that was significantly

greater than is necessary to promote A Co.’s legitimate commercial interests. Its presence was not

a sign of a blatant attempt to undermine important interests of the bankrupt’s creditors.

[391] But suppose that the corporate bankruptcy ipso facto term gave A Co. the option to

purchase the bankrupt’s shares for one-tenth of fair market value. In the absence of a cogent

explanation in the shareholders agreement for this significant haircut, the likelihood that an

adjudicator would conclude that the benefit this bestows on A Co. is significantly greater than is

necessary to protect A Co.’s legitimate commercial interests increases significantly.

Parliament had intended to ban corporate ipso facto provisions, it would have said so. It is also important to remember

that Justice Blair decided Bramalea fourteen years before the 2009 amendments came into force. There is a good

reason to question whether Justice Blair would have come to a different conclusion had the case been resolved after

2009.

³⁸¹R.S.C. 1985, c. B-3, s. 84.2.

³⁸²R.S.C. 1985, c. C-36, s. 34.

Page: 107

[392] If this standard were applied to the facts in Canadian Imperial Bank of Commerce v.

Bramalea Inc.,³⁸³the ipso facto term relied on by the nonbankrupt partner may well be suspect.

[393] Commercial certainty is a neutral factor when assessing both the effects-based and

commercial-purposes tests. Each of them contain features that make the result predictable. They

are bright-line standards. The difference is that they rest at opposite ends of the

likelihood-of-enforcement spectrum. Utilization of an effects-based test will deny most ipso facto

terms of any force. Adoption of the commercial-purposes standard will have the opposite impact –

most corporate ipso facto terms will be enforced.

d.

Section VII Q(d) Serves a Reasonable and Defensible

Commercial Purpose and Is Enforceable

[394] Section VII Q(d) is enforceable.

[395] Its only purpose is to promote the commercial interests of Chandos Construction. Capital

Steel’s bankruptcy will undoubtedly inconvenience Chandos Construction and cause it to divert

management and administrative resources to deal with Capital Steel’s unexpected absence from

the condominium project.

[396] There is no basis whatsoever to support an allegation that this term is the embodiment of an

intention to undermine the statutorily recognized interests of Capital Steel’s creditors.

[397] I am satisfied that s. VII Q(d)’s most important feature is the advancement of a reasonable

and defensible commercial purpose and that its enforcement does not bestow a benefit on Chandos

Construction that is significantly greater than is necessary to protect Chandos Construction’s

legitimate commercial interests.

3.

The Bankruptcy and Insolvency Act Does Not Provide a Statutory Basis

for Declaring Section VII Q(d) Unenforceable

[398] If there is a Canadian common law relating to ipso facto terms and the Ontario Court of

Appeal’s judgment in Trustee of Aircell Communications Inc.³⁸⁴correctly states the common law,

views I reject, it follows that s. VII Q(d) is inconsistent with this effects-based standard.

[399] Under this scenario, and only this scenario, is it necessary to consider whether the

Bankruptcy and Insolvency Act provides a complete code for the regulation of bankruptcy ipso

³⁸³33 O.R. 3d 692 (Gen. Div. 1995).

³⁸⁴2013 ONCA 95; 14 C.B.R. 6^th276. Contra Perpetual Trustee Co. v. BNY Corporate Trustee Services Ltd., [2009]

EWCA Civ 1160; [2010] Ch. 347 (the Court rejected the effects-based test) & International Air Transport Assoc. v.

Ansett Australia Holdings Ltd. (Subject to Deed of Company Arrangement), [2008] HCA 3, ¶¶27-29; 234 C.L.R. 151,

168-69 per Gleeson CJ (the Court rejected the effects-based test).

Page: 108

facto terms and deprives the common law relating to bankruptcy ipso facto clauses of any residual

force.

[400] There is no express provision in the Bankruptcy and Insolvency Act that declares corporate

bankruptcy ipso facto terms of no force.

[401] A fundamental principle of bankruptcy law is that it does not alter private law rights unless

a specific provision in the Bankruptcy and Insolvency Act has this effect.³⁸⁵

[402] There are three important statutory interpretation principles that must be considered.

[403] The first is that legislators are presumed to know the law – statutory and judge made.³⁸⁶

Legislation designed to ameliorate the effect of the common law cannot be effective unless the

legislators have a sound understanding of its strengths and weaknesses. The common law is

frequently the backdrop for legislative forays.³⁸⁷

[404] The first principle explains why I canvassed the Canadian jurisprudence to ascertain

whether there was a generally recognized common law fraud-on-the-bankruptcy-law principle,

and if so, its characteristics.³⁸⁸I concluded that there was no generally recognized Canadian

common law on this topic.

[405] No more need be said about the first principle.

[406] The second sound principle is that a statute does not change the common law unless the

text clearly reveals this purpose.³⁸⁹

³⁸⁵R. Wood, Bankruptcy and Insolvency Law 6 (2d ed. 2015).

³⁸⁶Frame v. Smith, [1987] 2 S.C.R. 99, 112 per La Forest J. (“There is ... [a] presumption that the Legislature must be

taken to have known the pre-existing law”).

387

Cuthbertson v. Rasouli, 2013 SCC 53, ¶18; [2013] 3 S.C.R. 341, 356 (“The Common Law Backdrop”) &

2747-3174 Québec Inc. v. Quebec, [1996] 3 S.C.R. 919, 972 per L'Heureux-Dubé, J. (the common law is a “basic

fabric” or “background canvas”).

388

2747-3174 Québec Inc. v. Quebec, [1996] 3 S.C.R. 919, 978 per L'Heureux-Dubé, J. (“To determine what

interaction there is between the common law and statute law, it is necessary to begin by analysing, identifying and

setting out the applicable common law, after which the statute law's effect on the common law must be specified by

determining what common law rule the statute law codifies, replaces or repeals, whether the statute law leaves gaps

that the common law must fill and whether the statute law is a complete code that excludes or supplants all of the

common law in the specific area of law involved”) & Cuthbertson v. Rasouli, 2013 SCC 53, ¶22; [2013] 3 S.C.R. 341,

358 (“Many provinces found the common law regime for the treatment of incapable patients unsatisfactory and

devised new approaches through legislation”).

³⁸⁹Slaight Communications Inc. v. Davidson, [1989] 1 S.C.R. 1038, 1077 (“in the absence of a clear provision to the

contrary, the legislator should not be assumed to have intended to alter the pre-existing ordinary rules of common

law”); The Queen v. Corbett, [1988] 1 S.C.R. 670, 700-01 per McIntyre J. (“To admit such a discretion would be

Page: 109

[407] If my determination that the fraud-on-the-bankruptcy-law principle is not a part of the

Canadian common law is correct, this principle does not come into play. There is no common law

to change.

[408] But if this assessment is incorrect and the fraud-on-the-bankruptcy-law principle is an

integral part of the Canadian common law, the next logical inquiry is this: Does the text of the

Bankruptcy and Insolvency Act clearly reveal an intention to alter the common law?

[409] In order to answer this query, consideration must be given to the third important statutory

interpretation principle – the negative-implication canon. A text that attaches either positive or

negative consequences to one thing and makes no mention of related things implies that the

consequences linked to the existence of other things does not attach to the unmentioned other

thing.³⁹⁰

tantamount to holding that Parliament could not by clear legislative enactment alter the common law”); Schiell v.

Morrison, [1930] 2 W.W.R. 737, 741 (Sask. C.A. 1930) (“if it is clear that [the legislature intended] ... to abrogate the

common law ... the provisions of the statute must prevail”); Canada v. Khosa, 2009 SCC 12, ¶50; [2009] 1 S.C.R. 339,

373 per Binnie, J. (“I readily accept, of course, that the legislature can by clear and explicit language oust the common

law in this as in other matters”); Ocean Port Hotel Ltd. v. British Columbia, 2001 SCC 52, ¶27; [2001] 2 S.C.R. 781,

796 (“Where the intention of the legislature, as here, is unequivocal, there is no room to import common law doctrines

of independence”); Valard Construction Ltd. v. Bird Construction Co., 2016 ABCA 249, n. 150; 57 C.L.R. 4^th171,

n. 150 per Wakeling, J.A. (“A statute does not alter the common law unless a fair reading supports the contrary

conclusion”); R. Sullivan, Sullivan on the Construction of Statutes 538-39 (6^thed. 2014)(“Although legislation is

paramount, it is presumed that legislatures do not intend to interfere with common law rights ... or generally to change

the policy of the common law”) & A. Scalia & B. Garner, Reading Law: The Interpretation of Legal Texts 319

(2012)(“statutes will not be interpreted as changing the common law unless they effect the change with clarity. ...

[T]he alteration of prior law must be clear – but it need not be express, nor should its clear implication be distorted”).

³⁹⁰Century Services Inc. v. Canada, 2010 SCC 60, ¶¶45-46; [2010] 3 S.C.R. 379, 406-07 (“there is no express

statutory basis for concluding that GST claims enjoy a preferred treatment under the ... [Companies’ Creditors

Arrangement Act] or the ... [Bankruptcy and Insolvency Act]. Unlike source deductions, which are clearly and

expressly dealt with under both these insolvency statutes, no such clear and express language exists in these Acts

carving out an exception for GST claims. ... The internal logic of the ... [Companies’ Creditors Arrangement Act] also

militates against upholding the ... [Excise Tax Act] deemed trust for GST. The ... [Companies’ Creditors Arrangement

Act] imposes limits on a suspension by the court of the Crown’s rights in respect of source deductions but does not

mention the ... [Excise Tax Act] ... . Since source deductions deemed trusts are granted explicit protection under the ...

[Companies’ Creditors Arrangement Act], it would be inconsistent to afford a better protection to the ... [Excise Tax

Act] deemed trust absent explicit language in the ... [Companies’ Creditors Arrangement Act]”); Schreyer v. Schreyer,

2011 SCC 35, ¶20; [2011] 2 S.C.R. 605, 617 (the Court expressly approved the following statement from Thibodeau v.

Thibodeau, 2011 ONCA 110, ¶37; 104 O.R. 3d 161, 172: “unsecured creditors are to be treated equally and the

bankrupt’s assets to be distributed amongst them equally subject to the scheme provided in s. 136 of the ... [Bankruptcy

and Insolvency Act]. Parliament has not accorded any preferred or secured position to a [family law] claim for an

equalization payment. While it has recently chosen to amend the ... [Bankruptcy and Insolvency Act] to give certain

debts or liabilities arising in relation to claims for support and/or alimony a preferred status, Parliament has made no

such provision for equalization claims in relation to family property”) (emphasis in original); Newfoundland and

Labrador v. AbitibiBowater Inc., 2012 SCC 67, ¶33; [2012] 3 S.C.R. 443, 462 (“If Parliament had intended that the

debtor always satisfy all remediation costs, it would have granted the Crown a priority with respect to the totality of

Page: 110

[410] Suppose that railway-safety legislation declares that railroads must equip locomotives and

passenger cars with heart defibrillator machines. The negative-implication canon supports the

conclusion that the statute lists all the rolling stock that must have heart defibrillators on them and

that no other type of rolling stock must be so equipped. This means that the railroads have no

statutory obligation to place these expensive machines on freight cars or any other rolling stock

that is not either a locomotive or a passenger car. A related inference is that the text would have

listed freight cars and cabooses had the legislators intended the statute to apply to them.

[411] Section 84.2(1) of the Bankruptcy and Insolvency Act attaches specific consequences to a

natural person’s bankruptcy.³⁹¹It prohibits a party who has a contract with a bankrupt natural

the debtor’s assets. ... [T]he fact that the Crown’s priority under s. 11.8(8) of the ... [Companies’ Creditors

Arrangement Act] is limited to the contaminated property and certain related property leads me to conclude that to

exempt environmental orders would be inconsistent with the insolvency legislation”); Grigby v. Oakes, 126 Eng. Rep.

1420, 1422 (Ex. Ct. 1801) per Heath J. (“the several provisions of the [recently passed Bank Act] making ... [Bank of

England notes] good legal tender in certain excepted cases excludes the idea of their being so generally in cases not

provided for by the act”) & per Chambre, J. (“If the legislature have not gone far enough, it is for them, not for us to

remedy the defect. Indeed, making bank notes a good tender in certain cases specifically provided for, they appear to

me to have negatived the construction we are now desired to put upon the act”); Patrolmen’s Benevolent Assoc. v. City

of New York, 359 N.E. 2d 1338, 1341 (N.Y. Ct. App. 1976)(“Had the Legislature intended that the wage freeze also

apply to situations involving judicially mandated salary increases, they were free, assuming arguendo constitutional

validity, to draft appropriately worded legislation … . We could but note that the statute in question was adopted some

two months after the July 1 judgment requiring that the city pay the salary increase and we must assume the

Legislature was well aware of this fact when the statute was passed. Other statutes, adopted at the same time as the

wage freeze law and also seeking to alleviate the financial plight of the city, by their very terms have specific

application to judgments”); R. Sullivan, Sullivan on the Construction of Statutes 248 (6^thed. 2014) (“An implied

exclusion argument lies whenever there is reason to believe that if the legislature had meant to include a particular

thing within its legislation, it would have referred to that thing expressly. Because of this expectation, the legislature’s

failure to mention the thing becomes grounds for inferring that it was deliberately excluded. Although there is no

express exclusion, exclusion is implied”); Corry, “Administrative Law and the Interpretation of Statutes”, 1 U.

Toronto L.J. 286, 298 (1936) (“if Parliament in legislating speaks only of specific things and specific situations, it is a

legitimate inference that the particulars exhaust the legislative will”) & A. Scalia & B. Garner, Reading Law: The

Interpretation of Legal Texts 107 (2012) (“The [negative-implication] doctrine applies only when ... the thing

specified ... can reasonably be thought to be an expression of all that shares in the grant or prohibition involved”)

(emphasis in original).

³⁹¹Sections 365(e)(1) and 541(c)(1)(B) of the Bankruptcy Code does so for natural person and corporate ipso facto

terms. See Lehman Brothers Holdings Inc. v. BNY Corporate Trustee Services Ltd., 422 B.R. 407, 414-15 (S.D.N.Y

2010)(“The Bankruptcy Code of 1978 effected a change in the treatment of contract or lease clauses that would seek to

modify the relationships of contracting parties due to the filing of a bankruptcy petition-so-called ipso facto clauses. ...

It is now axiomatic that ipso facto clauses are, as a general matter, unenforceable”); Reloeb Co. v. LTV Corp, 1993

U.S. Dist. LEXIS 6130, 15-16 (“Section 365 [of the Bankruptcy Code] abrogates the power of ipso facto clauses. No

default may occur pursuant to an ipso facto clause and no reliance may be placed upon an alleged default where the

only cause for default is the debtor’s commencement of a bankruptcy case”) & Lyons Savings & Loan Assoc. v.

Westside Bancorporation, Inc., 828 F. 2d 387, 393 n 6 (7^thCir. 1987) (“Section 365(e) of the Bankruptcy Code

invalidates ipso facto or bankruptcy termination clauses which permit one contracting party to terminate or even

modify an executory contract or unexpired lease in the event of the bankruptcy of the other contracting party”). See

also Bankruptcy Act 1966 (Cth), No. 33, s. 301 (1)(a) (Austl.) (“A provision in a contract or agreement for the sale of

Page: 111

person from terminating or amending the agreement “by reason only of the individual’s

bankruptcy”. It also prohibits a counterparty from invoking a provision in the agreement that

obliges the bankrupt natural person to make an accelerated payment or forfeit something to which

the bankrupt natural person is otherwise entitled. Section 84.2(5) expressly declares that “[a]ny

provision in an agreement that has the effect of providing for, or permitting, anything that, in

substance, is contrary to this section is of no force or effect”.³⁹²

[412] No other provision of the Bankruptcy and Insolvency Act attached comparable

consequences like those recorded in s. 84.2 to corporate ipso facto clauses.

[413] Section 34 of the Companies’ Creditors Arrangement Act declares that corporate

restructuring ipso facto terms are of no force or effect.

[414] Parliament’s decision to treat corporate bankruptcy and receiverships differently than

natural person bankruptcies and corporate restructuring might be attributable, as Ms. Ho suggests,

to the fact that “the debtor is not expected to continue as a going concern and its assets are simply

awaiting liquidators. In contrast, in a proceeding under the CCAA, the objective is for the debtor

company to successfully restructure, so there is greater concern to maintain the statutes quo.”³⁹³

[415] What is the consequence of this disparate treatment of natural person and corporate ipso

facto clauses and corporate restructuring ipso facto terms?

[416] Professor Wood opines that “[i[f the debtor is a corporation or other artificial entity, the

validity of the provision will be determined through the application of the common law

anti-deprivation principle”.³⁹⁴

[417] I cannot agree.

[418] Parliament, with the introduction in 2009³⁹⁵of s. 84.2 of the Bankruptcy and Insolvency Act

and s. 34 of the Companies Creditors’ Arrangement Act, has occupied the field³⁹⁶and the common

property, in a lease of property, in a hire-purchase agreement, in a licence or in a PPSA security agreement to the effect

that ... the contract, agreement, lease, hire-purchase agreement, license or PPSA security agreement is to terminate ... if

the purchaser, lessee, hirer, licensee or PPSA grantor or debtor becomes a bankrupt or commits an act of bankruptcy ...

under this Act is void”).

³⁹²This is an example of a statutory provision that explicitly declares an agreement inconsistent with the statute

unenforceable. As Professor Farnsworth explains, “[t]he court’s function ... is merely statutory interpretation”). E.

Farnsworth, Contracts 315 (4^thed. 2004).

³⁹³Ho, “The Treatment of Ipso Facto Clauses in Canada”, 61 McGill L.J. 139, 182 (2015).

³⁹⁴R. Wood, Bankruptcy and Insolvency Law 179 (2d ed. 2015). No explanation is provided for this assertion.

³⁹⁵Economic Recovery Act (Stimulus), S.C. 2009, c. 31, s. 64.

³⁹⁶Century Services Inc. v. Canada, 2010 SCC 60, ¶13; [2010] 3 S.C.R. 379, 393 (“The [Bankruptcy and Insolvency

Act] ... offers a self-contained legal regime providing for both reorganization and liquidation”). See also Perpetual

Page: 112

law on ipso facto clauses, whatever form it assumed, is not applicable. Because the Bankruptcy

and Insolvency Act does not declare corporate ipso facto terms unenforceable, they must be

enforced as written.³⁹⁷

[419] I am unable to conclude that Parliament’s failure to declare corporate ipso facto terms

unenforceable supports any other inference but that it came to the conclusion that these provisions

were not sufficiently harmful, if at all, to the integrity of the bankruptcy regime to warrant the

same treatment as s. 84.2 accords natural person ipso facto terms and s. 34 gives corporate

restructuring ipso facto terms.³⁹⁸

[420] Parliament’s decision to establish a separate regime for natural person and corporate

bankruptcy ipso facto terms and not follow the framework American ³⁹⁹and Australian ⁴⁰⁰

legislators favor is indisputable evidence that Parliament does not regard corporate ipso facto

clauses as a significant threat to the welfare of Canada’s corporate bankruptcy regime.⁴⁰¹

[421] If Parliament had intended the skeletal Canadian common law on ipso facto terms to apply

to corporate ipso facto clauses, it would have said so.⁴⁰²Given the paucity of pre-2009 cases on this

Trustee Co. v. BNY Corp. Trustee Services Ltd.,[2009] EWCA Civ 1160, ¶172; [2010] Ch. 347, 410 per Patten L.J.

(“Whatever may have been the position in the nineteenth century, the Insolvency Act now contains a detailed code for

determining and regulating the property of a bankrupt or insolvent company for the benefit of its general creditors. The

Act itself says and does all that is necessary. ...When Parliament has expressly considered the categories of

transactions which should not be allowed to survive bankruptcy or liquidation I can see no proper basis on which the

court can arrogate to itself the right to widen the sanction of invalidity so as to encompass transactions which the

application of the Insolvency Act would leave untouched. That should be something for the legislature alone to

decide”).

³⁹⁷Bankruptcy Code, 11 U.S.C. §§ 365(e) & 541(c) (most corporate ipso facto terms are unenforceable); Lehman

Brothers Holdings Inc. v. BNY Corporate Trustee Services Ltd., 422 B.R. 407, 415 (S.D.N.Y. 2010)(“It is now

axiomatic that ipso facto clauses are, as a general matter, unenforceable”) & Treasury Laws Amendment (2017

Enterprise Incentives No. 2) Act, No. 112 (Austl. Cth)(prohibits the enforcement of some corporate ipso facto clauses).

³⁹⁸See Century Services Inc. v. Canada, 2010 SCC 60, ¶¶45-46; [2010] 3 S.C.R. 379, 406-07 (the Court refused to

grant the Crown priority to GST claims, given that the applicable insolvency legislation expressly accorded priority to

Crown claims over source deduction funds held by the insolvent debtor and made no mention of GST claims) &

Newfoundland and Labrador v. AbitibiBowater Inc., 2012 SCC 67; [2012] 3 S.C.R. 443(the Court concluded that the

Crown’s priority under the Companies’ Creditors Arrangement Act was restricted to contaminated property, as

expressly stated in the Act, and not all remediation costs, which was not stated in the Act).

³⁹⁹Bankruptcy Code, 11 U.S.C. §§ 363, 365(e) & 541(c).

⁴⁰⁰Bankruptcy Act 1966, No. 33, s. 301 (Cth) & Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Act,

No. 112 (Cth).

⁴⁰¹See Parliament of the Commonwealth of Australia, House of Representatives, Treasury Laws Amendment (2017

Enterprise Incentives No. 2) Bill 2017 Explanatory Memorandum, Chptr 2.

⁴⁰²E.g., Bankruptcy Code, 11 U.S.C. §510(c)(1) (“the Court may ... under principles of equitable subordination,

subordinate for purposes of distribution all or part of an allowed claim to all or part of another allowed claim”). See C.

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topic, I cannot conclude that the common law was sufficiently developed to justify

Parliamentarians relying on it for any purpose. If the common law was hostile to ipso facto

provisions, why did Parliament have to legislate in 2009 to prohibit their enforcement in the

context of natural person bankruptcies?⁴⁰³In the United States a comprehensive ban on the

enforcement of ipso facto terms was introduced in 1978 because courts regularly applied ipso facto

terms.⁴⁰⁴

[422] As well, there are several mechanisms built into the Bankruptcy and Insolvency Act that are

designed to protect the bankrupt’s estate or property pool. For example, as Professor Wood notes

“[t]he trustee has a variety of powers that can be used to impeach pre-bankruptcy transactions”.⁴⁰⁵

If Parliamentarians believed that the prohibition of corporate bankruptcy ipso facto terms was a

sound pool-preservation measure, would the Bankruptcy and Insolvency Act not have said so? Yes.

[423] In short, the Bankruptcy and Insolvency Act occupies the field. ⁴⁰⁶Natural person

bankruptcy ipso facto terms captured by s. 84.2 are unenforceable. Corporate bankruptcy ipso

Tabb, The Law of Bankruptcy 723 (2d ed. 2009) (“Codification of the doctrine of equitable subordination ... was not

intended either to alter existing practice or to freeze the doctrine in place”).

⁴⁰³I accept Professor Wood’s observation that s. 84.2 of the Bankruptcy and Insolvency Act rejected “the traditional

exclusion of determinable interests such as leases and intellectual property licences”. R. Wood, Bankruptcy and

Insolvency Law 90 (2d ed. 2015). But s. 84.2 has wider scope than this.

⁴⁰⁴The Bankruptcy Reform Act of 1978, Pub. L. No. 95-598, 92 Stat. 2549 prohibited the enforcement of ipso facto

terms. Previously courts had routinely enforced ipso facto clauses. C. Tabb, The Law of Bankruptcy 854 (2d ed. 2009)

& In Re Chateaugay Corp., 1993 U.S. Dist. LEXIS 6130, 14 (S.D.N.Y) (“The Bankruptcy Code of 1978 effected a

change in the treatment of contract or lease clauses that modify the relationships of contracting parties due to the filing

of a bankruptcy petition. Although such clauses were enforced prior to 1978, the new code rendered unenforceable

contract provisions that altered the rights or obligations of a debtor as a result of the debtor’s commencement of a case

under the Bankruptcy Code. ... Section 365 [of the Bankruptcy Code] abrogates the power of ipso facto clauses”).

⁴⁰⁵R. Wood, Bankruptcy and Insolvency Law 188 (2d ed. 2015).

⁴⁰⁶Frame v. Smith, [1987] 2 S.C.R. 99, 112 (“It seems obvious to me that the Legislature intended to devise a

comprehensive scheme for dealing with these [family law custody] issues. If it had contemplated additional support by

civil action, it would have made provision for this, especially given the rudimentary state of the common law”);

1183882 Alberta Ltd. v. Valin Industrial Mill Installation Ltd., 2012 ABCA 62, ¶34; 64 Alta. L.R. 5^th163, 176 per

McDonald, J.A. (“This principle [common law anti-deprivation rule] has been largely codified in section 65.1 of the ...

Bankruptcy and Insolvency Act”) & Foley v. Imperial Oil Ltd., 2011 BCCA 262, ¶29; [2011] 9 W.W.R. 652, 661-62

(“The [Occupier’s Liability] Act provides a complete code regarding the duty of an occupier of land. Reference to

earlier common law cases ... may ... result in legal error if the wrong standard of care (one based on the common law

categories) is applied, rather than the statutory standard of care”). The United Kingdom Supreme Court came to a

different conclusion in Belmont Park Investments Pty Ltd. v. BNY Corporate Trustee Services Ltd.,[2011] UKSC 38;

[2012] 1 A.C. 383. Lord Collins of Mapesbury said this: “The anti-deprivation rule is too well-established to be

discarded despite the detailed provisions set out in modern insolvency legislation, all of which must be taken to have

been enacted against the background of the rule”. Id at ¶102; [2012] 1 A.C. at 421. As noted above, the

anti-deprivation is not a “well-established” feature of Canadian bankruptcy law. Several lower court opinions that

apply a principle does not justify the claim that the principle is “well-established”. Valard Construction Ltd. v. Bird

Construction Co., 2016 ABCA 249, ¶172; 57 C.L.R. 4^th171, 231 per Wakeling, J.A. (“It is not obvious to me that

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facto terms that do not contravene any provisions of the Bankruptcy and Insolvency Act are valid

and enforceable.⁴⁰⁷

[424] A prohibition against corporate bankruptcy ipso facto clauses may be sound, but this is an

assessment that Parliament must make.⁴⁰⁸Until Parliament acts, the courts must respect party

autonomy and the freedom of contract and enforce corporate bankruptcy ipso facto terms.

VII. Conclusion

[425] I would dismiss the appeal.

Appeal heard on November 28, 2017

Reasons filed at Edmonton, Alberta

this 29th day of January, 2019

Wakeling J.A.

Alberta courts have ever applied Dominion Bridge and that Alberta's construction community has proceeded on the

assumption that a labour and material performance bond trustee has no obligation to take reasonable measures to bring

the bond's existence to the attention of beneficiaries or potential beneficiaries”) & 2018 SCC 8, ¶23 per Brown, J.

(“case authorities from a single province [do not constitute a practice in an industry]”). See also Official Assignee v.

NZL Life Superannuation Nominees Ltd., [1995] 1 N.Z.L.R. 684, 691-92 (H. Ct. 1994)(the Court rejected the

defendant’s argument that the Insolvency Act 1867 constituted a complete code and that an ipso facto term was

enforceable unless the enactment said otherwise).

⁴⁰⁷Ho, “The Treatment of Ipso Facto Clauses in Canada”, 61 McGill L.J. 139, 173 (2015)(“Corporate bankrupts and

receiverships are notable exceptions from these provisions governing ipso facto clauses in the BIA and CCAA, which

suggests that such clauses are still enforceable in both of these cases”).

⁴⁰⁸Schreyer v. Schreyer, 2011 SCC 35, ¶38; [2011] 2 S.C.R. 605, 625 (“The best way to address the potentially

inequitable impact of bankruptcy law on the division of family assets would be to amend the ... [Bankruptcy and

Insolvency Act]”); Sun Indalex Finance, LLC v. United Steelworkers, 2013 SCC 6, ¶82; [2013] 1 S.C.R. 271, 316

(“courts should not use equity to do what they wish Parliament had done through legislation”); Zeitel v. Ellscheid,

[1994] 2 S.C.R. 142, 152 (“It is beyond the power of a court to interfere in a carefully crafted legislative scheme

merely because it does not approve of the result produced by a statute in a particular case”) & Money Markets Ltd. v.

London Stock Exchange, [2002] 1 W.L.R. 1150, 1175 (Ch. 2001)(“This argument could be said to have particular

force in light of the sophisticated and detailed legislative apparatus enshrined in the Insolvency Act 1986 and

Insolvency Rules 1986”).

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Appearances:

V.L. Merritt

for the Appellant

D.R. Bieganek, Q.C.

for the Respondent