A Clarified Approach to Exclusion Clauses in Contracts for Sale of Goods

June 07, 2024

Written By Gannon Beaulne, Ethan Schiff and Douglas Fenton

Exclusion clauses are a common feature of agreements of purchase and sale and other commercial contracts. While often subject to negotiation, parties sometimes proceed with standard form exclusion clauses that may inject uncertainty into what claims or implied statutory obligations are excluded from the parties’ agreement. In the event of a later dispute, the scope and import of the exclusion clause will be of considerable importance.

In EarthCo Soil Mixtures Inc v Pine Valley Enterprises Inc, 2024 SCC 20, the Supreme Court of Canada has clarified the interpretation of exclusion clauses, including when they purport to oust implied conditions under the Sale of Goods Act, RSO 1990, c S.1 (SGA). In finding that the exclusion clause at issue excluded implied conditions under the SGA, a majority of the Supreme Court rejected a technical or legalistic approach to interpreting exclusion clauses and confirmed that the paramount consideration is the objective intention of the contracting parties.

Background

At issue on appeal was whether the parties had contracted out of certain implied conditions under the SGA. Section 53 of the SGA provides that parties can contract out of those implied conditions by “express agreement” or through the “course of dealing” between the parties.

In this case, Pine Valley Enterprises Inc. was hired to work on a municipal project. Pine Valley contracted with EarthCo Soil Mixtures Inc. to obtain topsoil with a specified composition for the project. EarthCo provided laboratory results from different topsoil samples, taken several weeks earlier. Since Pine Valley was behind on the project, it sought immediate delivery and waived its right to test and approve the soil beforehand.

As a result, the parties negotiated an addition to EarthCo’s standard terms and conditions. That language provided: “[Pine Valley] has the right to test and approve the material at its own expense at [EarthCo’s] facility before it is shipped and placed. If [Pine Valley] waives its right to test and approve the material before it is shipped, EarthCo will not be responsible for the quality of the material once it leaves [EarthCo’s] facility.”

After delivery, Pine Valley discovered substantially more clay in the topsoil than earlier tests had shown. Pine Valley sued EarthCo, claiming that the goods delivered did not correspond with the description set out in the agreement. On this basis, Pine Valley argued that EarthCo had breached an implied term under section 14 of the SGA. That provision states that, in a sale of goods by description, “there is an implied condition that the goods will correspond with the description”.

EarthCo argued that the parties had contracted out of that implied condition when Pine Valley agreed that EarthCo would “not be responsible for the quality of the material” if Pine Valley waived its right to further testing.

The trial judge dismissed Pine Valley’s action, finding that the parties had contracted out of the implied term related to the description of the topsoil. The Court of Appeal for Ontario reversed, finding that the parties had not “explicitly, clearly and directly” excluded the relevant implied term. While the Court of Appeal accepted that the language added to the contract in this case was enough to contract out of another implied condition dealing with the quality or fitness of the goods under section 15 of the SGA, it concluded that the contract did not oust the implied term that the goods delivered would conform to the description in the contract (here, soil of a particular composition).

The Supreme Court of Canada’s Decision

By a 6-1 majority, the Supreme Court allowed EarthCo’s appeal.

Writing for the majority, Justice Martin emphasized that the paramount consideration when a court interprets a contract is the parties’ objective intentions. The Supreme Court acknowledged that the words of the agreement help determine the parties’ objective intentions. But the leading Supreme Court of Canada case, Sattva Capital Corp v Creston Moly Corp, 2014 SCC 53, allows a court to consider those words in the context of their surrounding circumstances at the time of contracting.

The approach does not change when interpreting an exclusion clause, including one contemplated by section 53 of the SGA. The Supreme Court found that the breadth and permissiveness of section 53 “conveys that, at its core, section 53 is concerned with the parties’ intention to remove themselves from the application of certain SGA provisions—however that intention is conveyed”. Thus, in interpretating the scope and effect of an exclusion clause, a court should not invoke “universal legal rules or rigid verbal formulas”. Rather, it should consider the contractual language holistically in the circumstances of each case.

Here, while the exclusion clause did not refer to section 14 of the SGA or the “description” of the topsoil, the reference to “quality” had to be considered in context. Pine Valley was an experienced purchaser and knew the test results were outdated, but it insisted on delivery of the topsoil without further testing for its own business reasons.

To reflect this reality, the parties (without lawyers) drafted and agreed to the relevant exclusionary language. From the surrounding context, including correspondence exchanged by the parties, the intention of the exclusion clause was to shift the risk to Pine Valley that the topsoil would not conform to its precise specifications. The meaning of the exclusion clause was informed by the overall commercial reality of the transaction and the parties’ objective intentions determined with reference to the surrounding circumstances.

In dissent, Justice Côté would have dismissed the appeal. In her view, the exclusion clause was not an “express agreement” under section 53 because it did not use “clear and direct language” to limit defects in “identity” rather than in quality.

Key Takeaways

In EarthCo, the Supreme Court continues to reject a technical or legalistic approach to contractual interpretation for an approach grounded in a contract’s surrounding circumstances at the time of contracting. The paramount consideration in all questions of contractual interpretation will be the parties’ objective intentions when entering into the contract.

In this way, EarthCo reminds parties to exercise care in negotiations with potential contractual counterparties. Absent clear, unambiguous language in the text of the parties’ agreement, many issues of contractual interpretation will be won or lost with reference to the surrounding circumstances, as determined by the trial judge. Many parties may find value in obtaining legal advice at an early stage of negotiations, to ensure that the text of the agreement reflects the parties’ intentions. Otherwise, disputes about the meaning and effect of a particular clause will fall to be determined with reference to the surrounding circumstances, which may admit of more than one outcome, and which an appeal court will be loath to review. In Earthco, if Pine Valley intended to preserve its rights under section 14 of the SGA, clear and express language to that effect was required.

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