In the recent Court of Appeal decision of Urban Mechanical Contracting Ltd. v. Zurich Insurance Company Ltd., 2022 ONCA 589, the Court of Appeal considered whether rescission is ever available as a matter of law when the rights of innocent third parties intervene and restitutio in integrum (putting the parties back to their original position) is impossible.
The court answered in the affirmative.
In the case the appellants brought two applications seeking a determination of whether, as a matter of law, a bond issuer can rescind a bond agreement on the basis of fraudulent misrepresentations and collusion when doing so would affect the rights of innocent parties.
Background
The case dealt with a public-private redevelopment project with infrastructure Ontario to build a new 17-storey patient care tower (the Project). The construction was to be financed and carried out by the private sector. The Project was subject to Ontario’s procurement process to ensure a fair, open and transparent process and was ultimately awarded to a subsidiary of Bondfield Construction Company Limited (Bondfield). Bondfield was obligated to obtain and maintain surety bonds for labour services and materials.
On January 27, 2015, Zurich Insurance Company Ltd. (Zurich) issued a performance bond of approximately $156 million, constituting roughly half the contract price; and a payment bond in the amount of approximately $142 million (the Bonds).
Bondfield struggled to meet the payment deadlines as early as 2017. Zurich paid the subcontractors and suppliers to keep the Project going.
A dispute arose over whether the Bank of Montreal (BMO) could demand payment pursuant to the Bonds without exercising step-in rights under the construction contract. While the dispute was ongoing in March 2020, one of Zurich’s consultants uncovered numerous email communications between Bondfield and Hospital representatives disclosing allegedly fraudulent misrepresentation sand collusion which appeared to have enabled Bondfield to secure the contract for the Project.
The Application
Zurich sought a declaration that the Bonds be rescinded due to fraud in the construction procurement process. Zurich claimed that the fraud occurred prior to the issuance of the Bonds and that, by virtue of the fraudulent misrepresentations, it was induced into issuance of the Bonds. It seeks recovery of all money paid out pursuant to the Bonds and rescission from the alleged principal fraudsters, taking the position that had it known about the fraud it would never have issued the Bonds.
Subtrades on the project joined to bring the subject applications seeking a declaration that, as a matter of law, Zurich could not rescind the Bonds because, inter alia, doing so would affect their rights as innocent third parties. The subcontractors had unpaid claims under the payment bond. The application was permitted to proceed on this discrete legal issue.
The Superior Court Ruling
The Honourable Justice Cory A. Gilmore of the Superior Court of Justice, in her ruling reported at 2021 ONSC 2535, concluded that equitable remedies are not determined in a vacuum and must be decided on a factual record. Without a complete record, including all of the allegations related to the fraud implicating various parties, the Court was unable to determine at this stage whether or not the remedy is available to Zurich. Justice Gilmore opined that it had not been shown that rescission is unavailable as a matter of law.
The Court of Appeal Ruling
The Court of Appeal determined the question of law on a correctness standard of review, and assuming that the appellants were “innocent third parties”.
The Court of Appeal affirmed that rescission is an equitable remedy that is meant to put the contracting parties back in the position they were before entering into the contract. It is a remedy available to a party that has been improperly induced into entering the contract, for instance, by fraudulent misrepresentation and requires proof that the misrepresentation was material and was relied on by the party seeking the remedy.
Rescission and the Construction Act
In addressing whether rescission as an equitable remedy can co-exist with the Construction
Lien Act (now the Construction Act), the Court of Appeal recognized that legislation supersedes a common law remedy and acknowledged that the sub contractors were beneficiaries of a statutory trust created under the Act and would have valid claims against Zurich pursuant to the Bonds. However, the Court of Appeal held that the equitable remedy could only be ousted where the legislature expressed its intention to do so with “irresistible clearness”. The Court of Appeal held there was no basis to conclude that the Construction Lien Act explicitly addressed the right of action of subtrades on a payment bond when the bond agreement was founded on fraud and held that the determination of that issue should be left to the trial judge to decide on a complete record.
Rescission and the Rights of Innocent Third Parties
On the issue of whether rescission can be granted when there are innocent third parties who may be impacted, the Court of Appeal examined many cases put forward for the proposition that rescission is only possible where such remedy would not operate to the prejudice of innocent third parties.
The Court recognized that this line of cases reveals to concerns that the court must consider when applying a rescission remedy. First whether it is still possible to put the parties back into the pre-contractual position (achieve restitutio in integrum) and whether there would be unavoidable prejudice or adverse effects on third parties. The Court of Appeal ruled that neither of the two concerns were a complete bar to the remedy.
The Court of Appeal clarified that since rescission is an equitable remedy, the courts have considerable discretion to employ alternative methods to grant relief aimed at restoring the aggrieved party to its pre-contractual position. Rescission is a practical remedy and operates to relieve and prevent unconscionability and unfairness, such as fraud, and allows the courts to take a flexible approach to determining whether restitutio in integrum can be achieved.
The Court of Appeal held that the remedy is available even where a third party acquires an interest in the contract property which renders technical rescission impossible and rejected the appellant’s submission that once third-party rights intervene the remedy is no longer available as a matter of law.
In dismissing the appeal, the Court of Appeal concluded that the issue in this particular case would need to be determined after a full consideration of the factual record.
The lawyers at Gilbertson Davis LLP have experience with contractual disputes, including commercial litigation; real estate litigation; construction litigation; and other types of litigation which can involve fraudulent misrepresentation and rescission. Please contact us for an initial consultation.
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