6 Contract Law in Canada Part II: Defective Contracts
Learning Objectives
- Identify the legal principles related to defective contracts, such as misrepresentation, mistake, non est factum, and unconscionability.
- Analyze and apply the different types of mistakes and their effect on the enforceability of contracts.
- Understand the doctrine of non est factum where a party mistakenly signs a contract without understanding its nature or terms.
- Recognize the concept of unconscionability and evaluate its significance in determining the fairness and enforceability of contracts.
Just as a puzzle requires every piece to come together to form a cohesive image, a contract relies on all its components to create a legally binding agreement. A contractual defect occurs when an essential element is absent or flawed, rendering the contract incomplete or invalid. Without that final missing piece, the puzzle remains unfinished, just as a contract with a defect lacks the necessary completeness to be fully effective.
In this chapter we will examine the numerous defects which affect contractual enforceability. Most notably we will deal with misrepresentation, mistakes, and unconscionability.
Misrepresentation
Parties often make a variety of statements in the lead-up to a contract. Pre-contractual representations are statements made by one party to another before a contract is formed that are intended to be relied upon by the other party in deciding whether to enter into the deal.
Importantly, pre-contractual representations do not become terms in the contract, though they remain extremely important in law. If a pre-contractual representation turns out to be false, the party that made the representation may be liable for committing “misrepresentation” and owe damages to the mislead party. In some cases, misrepresentation can also lead to the unwinding of the contract which is legally known as rescission.
As a starting point, misrepresentation refers to a false statement of fact made by one party to another party, which has the effect of inducing that party into the contract. The statement does not need to be intentionally false to establish misrepresentation; if the person making the statement honestly believed it to be true, but it was in fact false, it can still be considered a misrepresentation.
What can be challenging about misrepresentation is the fact that, under common law, there are different types of misrepresentation including: innocent, negligent, and fraudulent misrepresentation. Each of these three types has its own legal test which the plaintiff must prove to establish liability.
Innocent Misrepresentation
Innocent misrepresentation occurs when a party makes a false statement without knowing it to be false, and without intending to deceive the other party. Accordingly, a party who innocently misrepresents the facts can be liable even though there was no intent to mislead or even carelessness on their part.
Legal Test for Innocent Misrepresentation
- a positive misrepresentation of an existing fact by the other party;
- made with the intention that the plaintiff should act on it;
- the representation must have induced the plaintiff to enter into the subject agreement;
- the plaintiff must have acted promptly after learning of the misrepresentation to disaffirm the contract;
- no innocent third parties must have acquired rights for value with respect to the contract property; and
- it must be possible to restore the parties substantially to their pre-contract position.
If the full legal test is met, the innocent party may be entitled to rescind the contract and seek damages for any losses suffered as a result of the misrepresentation.
Myth-Busting
Myth: “I can only be sued if I lie, not if I’m just wrong”
Incorrect. Innocent misrepresentation allows claims against a party for stating false facts, not necessarily lying. When a party represents something that is false, even if they genuinely believe it to be true, they are still committing innocent misrepresentation.
For example, I offer to sell you my laptop and represent that it is has an 8th generation computer processor chip — I represent this because I genuinely and honestly believe that. If the processor is actually a 7th generation, I have misrepresented you.
In terms of risk management, always ensure that before you represent a fact, make sure it is 100% correct.
As an example, imagine a person selling a used car honestly believes that the car has never been in an accident, however they later discover that it was in fact involved in a minor accident. The seller had no intention of misleading the buyer, and genuinely believed that the car had never been in an accident however, since that statement is false, the seller has still committed an innocent misrepresentation.
Given that intent or negligence is not required, parties need to be incredibly careful about the representations they give in the lead-up to a contract.
Negligent Misrepresentation
Negligent misrepresentation refers to a false statement or representation made by a party who ought to have known that the statement was false, and which was made with the intention of inducing another party to enter into a contract or take a particular action.
Legal Test for Negligent Misrepresentation
The legal test for negligent misrepresentation is the following:
- Is there a duty of care based on a “special relationship” between the representor and representee?
- Is the representation in question inaccurate, untrue, or misleading?
- did the representor act negligently in making that representation?
- did the representee rely, in a reasonable manner, on that representation?
- did the representee incur damages as a result of that reliance?
Queen v. Cognos Inc., 1993 CanLII 146 para. 65
If the plaintiff can successfully establish a claim of negligent misrepresentation, they may be entitled to damages to compensate for any losses suffered as a result of the misrepresentation.
For example, imagine a real estate agent who fails to do their appropriate diligence in searching the property records and incorrectly represents to the buyer that the property is free of liens and encumbrances. Assuming the buyer moved forward with the purchase and later discovered some charges or liens on the property, they could sue the real estate agent for negligently misrepresenting the clean title of the property. Importantly, it is no defence for the real estate agent to state that they did not intend to mislead, they were careless in making a false statement.
Foundational Law — Queen v Cognos Inc., [1993] 1 SCR 87
Cognos Inc., a software company, was looking to hire a new accountant to work on a major project which the company had recently landed. During the job interview, the manager of product development made representations about the project’s funding and that it would be for a relatively stable duration. Queen, a chartered accountant, accepted the job offer based on these representations and signed an employment contract.
Queen later discovered that the project actually faced significant funding challenges, and shortly after he was hired, he received notice of his termination. Queen filed a lawsuit against Cognos, alleging negligent misrepresentation. The trial judge ruled in favor of Queen, stating that Cognos had a duty not to misrepresent the project’s security to applicants when it was aware of funding uncertainties.
The Supreme Court of Canada upheld the trial judge’s decision, emphasizing that the pre-contractual representation about the project’s funding was negligently given. Cognos had a duty not to misrepresent the project’s security when it knew or should have known about the uncertainties involved. The court concluded that Queen was entitled to damages for the loss suffered due to the reliance on the misrepresentation.
Fraudulent Misrepresentation
The last form of misrepresentation is fraudulent misrepresentation. Unlike the other forms of misrepresentation where intent is not involved here, intent to deceive becomes a central requirement. Fraudulent misrepresentation occurs when a party makes a false statement intentionally, with the intent to deceive the other party, and the misled party relies on it to their detriment.
Legal Test for Fraudulent Misrepresentation
The legal test for fraudulent misrepresentation requires that the plaintiff prove the following:
- the defendant made a representation of fact to the plaintiff;
- the representation was, in fact, false;
- the defendant knew the representation was false when it was made, or made the false representation recklessly, not knowing if it was true or false;
- the defendant intended the plaintiff to act on the representation; and
- the plaintiff relied upon the false representation and thereby suffered a detriment.
Manning v Dhalla, 2018 BCSC 2148 para. 33
For example, in a bid to attract new investors, a company’s CEO falsely tells six high-worth individuals, that the company has secured a large contract with a major corporation. Relying on his representation, the six individuals invest $1,000,000 each into the company. Later, the six investors discover that the contract did not exist and the company has no real prospects for generating profits. The investors would sue the CEO for fraudulent misrepresentation because of the clear intent to deceive.
Mistake
It is not always the case that the parties have a full and correct understanding of the contract. Given the variety of statements that are exchanged and negotiations between the parties, it is possible that one or both of the parties may make a mistake about the contract.
For example, consider the case of parties entering into a transaction to purchase a piece of rare artwork. Unfortunately, the specific piece of art turns out to be a forgery. This has certainly happened in the past:
What should happen in the case of this transaction? Is the contract valid? Does it matter if neither party knew about the forgery?
Ultimately, there are several types of mistakes that can occur in a contract; they are classified as either common, mutual, unilateral, or non est factum. The distinction between the mistake depends on how many of the parties are under a mistaken assumption and if they share the same mistake. We will explore each of those types below.
Common Mistake
The doctrine of “common mistake” refers to a situation where both parties to a contract make the same fundamental error or share a mistaken assumption regarding a material aspect of the contract. This mistake must relate to a basic assumption upon which the contract was made, and it must be a mistake that would have a significant impact on the obligations and performance of the contract. If a contract is affected by a common mistake, the contract will be void and unenforceable.
For example, suppose a buyer is interested in purchasing a rare antique painting, and they approach a seller to negotiate a purchase. During their discussions, both parties mistakenly believe that the painting is an original work by a renowned artist. Based on this shared belief, they agree on a purchase price of $100,000. However, after the contract is executed, it is discovered that the painting is actually a high-quality reproduction and not an original artwork. Both the buyer and the seller were unaware of this fact at the time of entering into the contract; as a result of this common mistake, the contract would be void.
Mutual Mistake
A mutual mistake occurs when both parties to a contract make a different mistake about a fundamental aspect of the contract.
For example, imagine if two parties enter into a contract for the sale of a painting. The parties later discover that they were each mistaken about the transaction: one party believed the painting was from painter “Artist A” and the other believed it was from “Artist B”. As a result of the different mistakes, the parties have not achieved a consensus and the contract will be void.
One prominent example of a mutual mistake is the case of Raffles v Wichelhaus, [1864] EWHC Exch J19.
Foundational Law – Raffles v Wichelhaus, [1864] EWHC Exch J19
Raffles, the plaintiff, agreed to sell a shipment of cotton to Wichelhaus, the defendant. A key term in the contract was that the goods were to be delivered on the “ship Peerless from Bombay.” However, both parties were unaware that there were two ships named Peerless, both scheduled to depart from Bombay (now properly referred to as Mumbai) – one in October and the other in December.
When the cotton arrived in Liverpool, Wichelhaus refused to accept it, claiming that there was a mistake in the contract. Raffles argued that the contract was binding and that he had fulfilled his obligations by shipping the cotton on a ship called Peerless.
The English court held that there was a mutual mistake in the contract. They emphasized that for a contract to be binding, there must be a meeting of the minds between the parties on all essential terms. Since the parties had different ships in mind at the time of the agreement, their minds did not meet, and there was no consensus as to the subject matter of the contract. The court declared the agreement void because the mutual mistake regarding the identity of the ship undermined the common intention of the parties.
Unilateral Mistake
A unilateral mistake occurs when only one party to a contract makes a mistake about a fundamental aspect of the contract. For example, suppose that a seller agrees to sell a painting to a buyer for $1,000, believing that the painting is a copy of an original work by a famous artist. The buyer, however, knows that the painting is the original work and is worth $1,000,000. The buyer and the seller enter the contract. Should the seller’s mistake be relevant?
One form of unilateral mistake is where a party is mistaken about the identity about the other contractual party. Mistaken identity occurs when one party to the contract is under the mistaken belief that they are entering into a contract with a different person. This can happen when one party uses a false name, or when one party is unaware of the true identity of the other party.
Legal Test for Unilateral Mistake
The legal test for determining whether the mistaken party can void the contract due to the mistake of mistaken identity requires the following to be proven:
- A thinks they have agreed with C because they believe B, with whom they are negotiating, is C;
- B is aware that A did not intend to make any agreement with them; and
- A has established that the identity of C was a matter of crucial importance.
Shimoyama v. Frizzell, 2011 BCSC 446 para. 27
If the mistaken party can satisfy the legal test, they may be able to void the contract due to the mistaken identity.
Non Est Factum
Non est factum is a legal defense that is used in cases where an individual who has entered into a contract claims that they did not understand the terms or nature of the agreement at the time that it was signed. The principal behind non est factum is that if a person did not fully understand the nature or consequences of the contract, they should not be held responsible for it.
“Non Est Factum” = “This is Not My Deed”
Legal Test for Non Est Factum
To successfully assert the defense of non est factum, two main elements must be proven:
- the person invoking non est factum must show that the document signed is fundamentally different from what the person believed they were signing; and
- the court must examine whether the signer was careless in failing to take reasonable precautions in the execution of the document.
Farrell Estates Ltd. v. Win-Up Restaurant Ltd., 2010 BCSC 1752 at para. 100
As to the first part of the legal test, minor differences in a contract would not be considered a fundamental or radical difference in what was agreed. For example, if a party believed that they would be purchasing 30 crates of tomatoes from the seller, but instead, the contract specifies only 29 crates of tomatoes, this would not be a sufficient enough difference to rely on non est factum to void the contract. On the other hand, if the buyer believed it was a contract to purchase 30 crates of tomatoes when, in actuality, the contract is one which is for the sale of their home, this would be a radical difference permitting non est factum.
Secondly, a person who purports to rely on the defence of non est factum cannot be careless in failing to read the contract or taking steps to understand it. It makes sense that a party who fails to try to understand their agreement should not later be able to void the transaction. Accordingly, parties must act with diligence in reviewing their contracts prior to executing them.
Successfully relying on non est factum can be challenging however, there have been a few cases where it has been used to void a contact. One of the more interesting cases is the Ontario Superior Court of Justice case of Sutton Group-Admiral Realty Inc. v. Taborovska, 2021 ONSC 2837.
Foundational Law – Sutton Group-Admiral Realty Inc. v. Taborovska, 2021 ONSC 2837
The Sutton-Group case involved a real estate agent, Pavlo Antonenko, who worked with the plaintiff couple to find a house for their daughter, Ganna, who lived in Ukraine. Ganna signed a “representation agreement” with Antonenko on November 12, 2018. The representation agreement entitled the agent to a 2.5% commission on any single-family home Ganna bought in the Greater Toronto Area between November 12, 2018 and March 11, 2019.
Ganna’s father, who did not know enough English to read the offer documents, spoke with the Antonenko for about an hour on the night the representation agreement was signed. There was conflicting evidence on the facts as to if Ganna was also involved in that conversation. The judge ultimately found that it was more likely that Ganna was not involved in the conversation and therefore, the agent did not explain what the contract said with regards to the commission amount if Ganna bought a different home through another agent during the contract period.
Ganna made an offer on a Toronto property through a different real estate agent, which was accepted and closed on January 4, 2019. After learning of this, the Agent then demanded the 2.5% commission on the Toronto property transaction that they alleged was owed under the representation agreement. In response, Ganna alleged that the contract was void because of non est factum.
The court stated that the Antonenko had mislead Ganna and her father about the representation agreement and that the agent had failed to explain the documents to both. Additionally, Ganna was found to not be careless when she signed the representation because she relied on the information she received from the agent through her father as the basis of her understanding of the documents.
In the end result, Ganna’s reliance on non est factum was successful and she was able to void the contract. As such, no commission was owed on the property purchase under the representation agreement with the agent.
Unconscionability
A final defect that can affect enforceability is unconscionability. Unconscionability is where a contract or contract term is so one-sided or oppressive that it is considered commercially, morally, or ethically wrong. Where a contract is found to be unconscionable, it would be void and therefore, could not be enforced. Not every bad bargain will be unconscionable or allow the party to void the deal. Rather, the party alleging unconscionability will be required to satisfy a specific legal test.
Legal Test for Unconscionability
In order to rely on unconscionability, the party asserting it must prove the following elements:
- there must be an inequality of bargaining power between the contracting parties, and
- the contract must be an “improvident” bargain.
Uber Technologies Inc. v. Heller, 2020 SCC 16 at para. 64
As to the first component, it requires that there be a power imbalance between the parties such that there is a vulnerability of the weaker party to the stronger. Given the power imbalance, the weaker is not sufficiently capable of protecting their own interests. For example, if a consumer is dealing with a large corporation that has extensive legal resources, the consumer may be at a significant disadvantage in negotiating the terms of a contract.
The second element (improvidence) requires that the transaction between the contracting parties be substantially unfair. An improvident bargain is one that, when viewed on balance of reasonableness, the terms are clearly unfair and not commercially defensible. For example, imagine a lender gives an individual a $500 loan however, the fees for the loan amount to over $700. Given that the fees for the loan are actually greater then the loan itself, this would be an improvident bargain.
As another example, imagine a buyer who is in desperate need of a car to get to work. He finds a car dealership that offers him a loan to buy a car, but the terms of the loan are extremely unfair. The interest rate is 70%, and if the buyer misses a payment, the dealership can repossess the car immediately without any notice or chance to cure the default. In this case, the objective terms of the contract are substantially unfair and could give rise to an argument of unconscionability to void the contract.
One of the landmark Canadian cases dealing with unconscionability is the SCC case of Uber Technologies Inc. v. Heller, 2020 SCC 16.
Foundational Law – Uber Technologies Inc. v. Heller, 2020 SCC 16
The Uber case involved Joseph Heller who was an Uber driver and Uber Eats delivery driver. Heller attempted to bring a class action lawsuit against Uber in Ontario Superior Court alleging that the company had misclassified their drivers as independent contracts rather than employees (to be discussed later in the “Employment Law” chapter of the textbook).
In response to the lawsuit, Uber argued that Heller was not permitted to file a lawsuit in Ontario since the standard employment contract signed by Uber drivers required all disputes to be resolved through mandatory arbitration in the Netherlands. Here was the clause that all drivers were required to agree to:
In order to start the arbitration in the Netherlands, drivers were required to pay an upfront non-refundable fee of $14,500 USD. This arbitration fee was essentially Heller’s entire annual earnings from Uber. Heller argued that the mandatory arbitration clause was unconscionable and therefore, void.
In its decision, the SCC highlighted both the policy rationales of unconscionability and the importance of ensuring a party has access to seeking legal resolutions:
the rule of law, which, at a minimum, guarantees Canadian citizens and residents “a stable, predictable and ordered society in which to conduct their affairs” … Such a guarantee is meaningless without access to an independent judiciary that can vindicate legal rights. The rule of law, accordingly, requires that citizens have access to a venue where they can hold one another to account
…
Access to civil justice is a precondition not only to a functioning democracy but also to a vibrant economy, in part because access to justice allows contracting parties to enforce their agreements. A contract that denies one party the right to enforce its terms undermines both the rule of law and commercial certainty.
…
It really is this simple: unless everyone has reasonable access to the law and its processes where necessary to vindicate legal rights, we will live in a society where the strong and well‑resourced will always prevail over the weak.
Uber Technologies Inc. v. Heller, 2020 SCC 16 at paras. 111 and 112
In its decision on the merits, the majority of the SCC held that Uber possessed an unequal bargaining advantage over the driver. The contract between the company and driver was a contract of “adhesion” (standard form for all drivers) and there was no prospect of negotiating different term. Additionally, the contract was an improvident bargain because the requirement to pay $14,500 USD was effectively a bar to the drivers ever being able to pursue arbitration and ultimately, get a legal remedy. As such, the Uber arbitration clause was struck down as unconscionable and ruled unenforceable.
