Court of Appeal for Ontario

Date: 2022-08-17 Docket: C69416, C69440 and C69448

Fairburn A.C.J.O., Thorburn and Favreau JJ.A.

Docket: C69416

Between:

Urban Mechanical Contracting Ltd., OZZ Electric Inc., Oakdale Drywall & Acoustics Ltd., NORR Limited, WSP Canada Group Limited, Noram Building Systems Inc. and Safway Services Canada, Inc. Applicants (Appellants)

And:

Zurich Insurance Company Ltd. Respondent (Respondent)

Docket: C69440

And Between:

Urban Mechanical Contracting Ltd., OZZ Electric Inc., Oakdale Drywall & Acoustics Ltd., NORR Limited, WSP Canada Group Limited, Noram Building Systems Inc. and Safway Services Canada, Inc. Applicants (Appellant)

And:

Zurich Insurance Company Ltd Respondent (Respondent)

Docket: C69448

And Between:

Bank of Montreal, as Administrative Agent Applicant (Appellant)

And:

Zurich Insurance Company Ltd. Respondent (Respondent)

Heard: March 1-2, 2022 by video conference

On appeal from the judgment of Justice Cory A. Gilmore of the Superior Court of Justice, dated April 8, 2021, with reasons reported at 2021 ONSC 2535.

Counsel:

Emilio Bisceglia and Fernando Souza, for the appellants Urban Mechanical Contracting Ltd. and Oakdale Drywall & Acoustics Ltd. Michael Tamblyn and Marco P. Falco, for the appellant OZZ Electric Inc. Sandra Astolfo and Philip Cho, for the appellant NORR Limited Howard Borlack and Ben Tustain, for the appellant WSP Canada Group Limited Howard Wise and Julie Rosenthal, for the appellant Noram Building Systems Inc. Adam Wainstock, for the appellant Safway Services Canada, Inc. Harvey Chaiton, Stephen Schwartz, and Darren Marr, for the appellant Bank of Montreal, as Administrative Agent Matthew Lerner, Brian Kolenda, Jonathan McDaniel, and Sarah Bittman, for the respondent Zurich Insurance Company Ltd. Mark Wiffen, for the respondent Zurich Insurance Company Ltd. (in respect of NORR Limited)

Thorburn J.A:

Overview

[1] 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 third parties.

[2] The application judge determined that, as a matter of law, rescission may be possible even when it would affect the rights of innocent third parties. She therefore held that the issue of whether the respondent Zurich was entitled to rescind its bonds on the basis of fraudulent misrepresentation should be determined at trial on a full factual record and not disposed of summarily by way of application.

[3] The appellants appeal the application judge’s order and submit that, as a matter of law, rescission is not available where there are innocent third parties.

[4] I would dismiss the appeal.

[5] Prejudice to the rights of third parties may be, but is not always, a bar to rescission. This is particularly true in the case of fraudulent misrepresentation and in cases where it is possible to provide restitution in other ways.

[6] As the application judge made no error of law, deference is owed to her conclusion that the issue of rescission should proceed to trial on a full factual record so that the court may consider all the circumstances and equities of the case. This determination accords with the principles of rescission as an equitable remedy and the high degree of flexibility courts exercise in rescinding contracts in cases of fraud.

How the Applications to Determine the Right to Rescission Arose

[7] In 2011, St. Michael’s Hospital (the “Hospital”) entered into a public-private redevelopment project with Infrastructure Ontario to build a new 17-storey patient care tower (the “Project”). Construction was to be financed and carried out by the private sector. The Construction Contract was to be awarded to a bidder chosen through Infrastructure Ontario’s procurement process, which was subject to rules that were designed to ensure a fair, open and transparent process.

[8] The Construction Contract was ultimately awarded to 2442931 Ontario Inc., a.k.a. “ProjectCo”, a wholly owned single-purpose subsidiary of Bondfield Construction Company Limited. ProjectCo was responsible for designing, constructing and financing the Project for the sum of $301,189,863. Bondfield was made the general construction contractor.

[9] A syndicate of lenders financed the Project by way of a $230 million loan to ProjectCo as memorialized in the Credit Agreement. The Credit Agreement named the appellant Bank of Montreal (“BMO”) administrative agent for the Lenders.

[10] Both the Construction Contract and Credit Agreement required ProjectCo to obtain and maintain surety bonds: a Performance Bond for the construction and design contract, and a Labour and Material Payment Bond (“Payment Bond”) for labour, services and materials (collectively, the “Bonds”).

[11] Surety bonds, such as the ones in this case, are financial instruments which transfer project risk to a third party insurer, thereby providing assurance to purchasers, lenders, subcontractors and suppliers.

[12] A performance bond is issued by an insurance company and guarantees completion of the project in respect of which the bond is issued in the event the contractor (in the language of the bond, the “principal”) defaults on its obligations: Truro (Town) v. Toronto General Insurance Co., [1974] S.C.R. 1129. A payment bond protects those supplying services and materials to the general contractor from the risk of non-payment should, for instance, the general contractor become insolvent. In Ontario, such bonds are required to secure a minimum of 50% of the contract price for public contracts exceeding $500,000: Construction Act, R.S.O. 1990, c. C.30, s. 85.1 and O. Reg. 304/18, s. 12.

[13] Surety bonds of both kinds are common in public infrastructure projects. There are at least three parties to a surety bond: (1) the surety (typically the insurance company) that acts as a guarantor and issues the bond; (2) the principal (typically the general contractor) whose contractual obligations are guaranteed by the surety; and (3) the obligee who requires the bond as a condition of its contract with the principal/general contractor and who can make a claim on the bond in the event of default by the principal. A payment bond also contemplates other claimants such as the suppliers of labour and materials to a construction project pursuant to agreements with the bond’s principal.

[14] On January 27, 2015, Zurich issued the Performance Bond in the amount of approximately $156 million, or half the contract price; and the Payment Bond in the amount of approximately $142 million. The Bonds name Zurich as surety, Bondfield as principal, and ProjectCo, BMO, and the Hospital as obligees.

[15] The Performance Bond provides that if the principal defaults on its obligations under the Construction Contract, any one of the obligees may declare it to be in default. The declaration triggers an election by the surety to remedy the default, complete the contract, arrange for bids to complete, or pay the obligee the lesser of the remaining balance of the Bond Amount or the obligee’s reasonable estimate of the cost to complete the contract.

[16] The Payment Bond sets up an express trust with the obligee ProjectCo as trustee. The trustee holds the right to claim on the Payment Bond in trust for the appellant subcontractors, Urban Mechanical Contracting Ltd., OZZ Electric Inc., Oakdale Drywall and Acoustics Ltd., NORR Limited, WSP Canada Group Limited, Norman Building Systems Inc. and Safway Services Canada, Inc. (collectively, the “Trades”).

[17] Bondfield struggled to meet the payment deadlines as early as 2017. Zurich paid the subcontractors and suppliers to keep the Project going. It also signed Ratification Agreements with some Trades to ensure that they would keep working on the Project.

[18] The Ratification Agreements set out that payment was being made with respect to that Trade’s claim under the Payment Bond. They also confirm the statement of account owing; provide that the Trades will recommence work; require the Trades to discharge their lien rights; and perhaps most importantly, provide that the Trades agree to be bound by the subcontract to Zurich to the same extent as if it they had entered into the subcontract with Zurich or a successor contractor.

[19] Bondfield continued experiencing difficulties meeting deadlines through 2017 and 2018. On November 2, 2018, the Hospital issued a Notice of Default under the Project Agreement, which had been entered into by the Hospital and ProjectCo in January 2015 to provide for services, labour and materials in relation to the construction and financing of the Project. On November 16, BMO, as the obligee, informed Zurich that Bondfield was in default and demanded payment of the Performance Bond.

[20] After a dispute over whether BMO could demand payment without exercising step-in rights under the Construction Contract, BMO obtained a court order appointing a receiver to make a call on the Performance Bond, which Zurich did not dispute. The receivership order did not modify Zurich’s liability under the Bonds.

[21] Zurich elected to pay the lesser of the remaining balance of the Bond Amount or the obligee’s reasonable estimate of the cost to complete the contract. Zurich requested an adjournment until April 2020 to file materials, but before it could do so, it discovered the events which led to this appeal.

[22] In March 2020, five years after Zurich entered into the agreements to provide bonds, one of its consultants uncovered numerous email communications between Bondfield and Hospital representatives disclosing allegedly fraudulent misrepresentations and collusion which appeared to have enabled Bondfield to secure the contract for the Project. The evidence spans many years and includes communications among many people.

[23] In April 2020, Zurich ceased paying the Trades and started an action (the “Zurich action”) seeking a declaration that both Bonds be rescinded due to fraud in the construction procurement process. Zurich claims the fraud occurred prior to the issuance of its Bonds and that, by virtue of the fraudulent misrepresentations, it was induced to issue the Bonds. It seeks to recover the money paid out under the Bonds prior to rescission from the alleged principal fraudsters.

[24] Zurich takes the position that, had it known about the fraud, it would never have issued the Bonds.

[25] The appellant Trades have unpaid claims under the Payment Bond. The appellant BMO represents the syndicate of lenders who were given payment and performance guarantees provided by the Performance Bond which, they claim, induced them to lend funds to the Project. None of these funds have been repaid.

The Applications to Deny Rescission

[26] Examinations for discovery were commenced but not concluded in the Zurich rescission action.

[27] The appellants then brought two applications seeking declarations that, as a matter of law, Zurich may not rescind the Bonds because, inter alia, doing so would affect their rights as innocent third parties. [1] In the first application, the Trades sought a declaration that Zurich cannot rescind the Payment Bond. In the second application, BMO sought a declaration that Zurich cannot rescind the Performance Bond.

[28] The case management judge allowed the applications to proceed, reasoning as follows:

I see no reason why the non-party lenders and subtrades should not be entitled to seek this court's determination of whether, as a matter of law, rescission is or is not an available remedy where (as they claim) the rights of innocent third parties are at stake.

[29] In a later endorsement, another case management judge explained, “In my view, [the applications] involve a discrete legal issue that can be decided on an application” (emphasis added).

[30] It was on this basis that the applications were permitted to proceed. The applications were argued on a paper record only.

[31] The application judge began her reasons by noting that, “In the two Applications before the Court, the question that must be answered is whether rescission is available as a matter of law on a construction bond where there has been fraud and collusion in the procurement process.” She noted that Zurich defended both applications on the basis that the appellants “are seeking to have the Court pre-emptively decide Zurich’s Rescission Action and that the legal propositions on which both Applicants rely are wrong.” She went on to say that:

[T]he Legislature [in enacting the Construction Lien Act] cannot have intended that the liability of a surety be absolute. That is, common law and equitable remedies are still available; otherwise, the section would stipulate that the Surety’s liability arose upon execution rather than when the Bond is “in effect.”

[S]ection [69] of the Construction Act also makes clear that the right of action by the claimant must be in accordance with the terms of the Bond. This means that the express trust created in the Payment Bond imposes limits on any statutory rights acquired by the Trades under the Construction Act. As such, the Trades’ rights as Claimants are subject to the provisions under the Payment Bond and through their Trustees ProjectCo and SMH. As ProjectCo and SMH are alleged to have engaged in fraudulent conduct, claims by the Trades are subject to Zurich’s equitable defences.

[32] She concluded her reasons dismissing both applications with the following:

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 the various parties, the Court is unable to determine at this stage whether or not the remedy is available to Zurich. Certainly it has not been shown that rescission is unavailable as a matter of law.

The Law of Rescission and Third-Party Rights

[33] The central issue on this appeal is whether, as a matter of law, an order for rescission can ever be made where an innocent party was induced to enter a contract by virtue of fraudulent misrepresentation and there are third parties who assert their rights. This is a question of law for which the standard of review is correctness.

[34] In order to answer the question of law for the purposes of this appeal, I must assume that the Trades and the Lenders are “innocent third parties”. Accordingly, I will not address whether the appellants’ rights are derivative or whether the appellants are beneficiaries or assignees. This is in part a factual determination that will have to be made by the trial judge. To this end, this matter was before the application judge strictly as a question of law. Accordingly, to the extent that the application judge engaged in findings of fact unnecessary to determining the narrow application that was before her, those findings of fact are not binding of the trial judge.

What is Rescission?

[35] Rescission is an equitable remedy that is meant to put the contracting parties back in the positions they were in before entering into the contract (restitutio in integrum): Guarantee Co. of North America v. Gordon Capital Corp., [1999] 3 S.C.R. 423, at para. 39; Place Concorde East Ltd. Partnership v. Shelter Corp. of Canada Ltd. (2006), 270 D.L.R. (4th) 181 (Ont. C.A.); and Gerald H.L. Fridman, The Law of Contract in Canada, 6th ed. (Toronto: Carswell, 2011), at p. 762.

[36] Rescission is available to a party that has been improperly induced to enter into a contract, for instance, by a fraudulent misrepresentation: Guarantee Co., at para. 39; Deschenes v. Lalonde, 2020 ONCA 304, 447 D.L.R. (4th) 132, at para. 29, leave to appeal to S.C.C. refused, 39288 (February 11, 2021); and Kingu v. Walmer Ventures Ltd. (1986), 10 B.C.L.R. (2d) 15 (C.A.), at pp. 6-8. Indeed, as Lord Wright noted in Spence v. Crawford, [1939] 3 All E.R. 271, at p. 288, the court will be more willing to order rescission when the plaintiff was induced to enter the contract by fraud:

[T]he court will be more drastic in exercising its discretionary powers in a case of fraud than in a case of innocent misrepresentation. … There is no doubt good reason for the distinction. A case of innocent misrepresentation may be regarded rather as one of misfortune than as one of moral obliquity. There is no deceit or intention to defraud. The court will be less ready to pull a transaction to pieces where the defendant is innocent, whereas in the case of fraud the court will exercise its jurisdiction to the full in order, if possible, to prevent the defendant from enjoying the benefit of his fraud at the expense of the innocent plaintiff.

[37] Rescission requires proof that the misrepresentation was material and was relied on by the party seeking to rescind the contract: Deschenes, at para. 29; Barclays Bank v. Metcalfe & Mansfield, 2011 ONSC 5008, 82 C.B.R. (5th) 159, at paras. 156-59, aff’d 2013 ONCA 494, 365 D.L.R. (4th) 15, leave to appeal refused, [2013] S.C.C.A. No. 374.

[38] A “material misrepresentation” is one that a reasonable person would consider to be relevant to the decision to enter the agreement, though it need not be the only reason to enter into the agreement: York University v. Markicevic and Brown, 2016 ONSC 3718, 33 C.C.E.L. (4th) 26, at para. 145, aff’d 2018 ONCA 893, 51 C.C.E.L. (4th) 30, leave to appeal refused, [2019] S.C.C.A. No. 134.

[39] Whether a contracting party relied on the misrepresentation, at least in part, to enter into the agreement is a “question of fact to be inferred from all the circumstances of the case and evidence at trial”: Barclays Bank, at para. 159.

Can Rescission Co-Exist with the Construction Lien Act?

[40] The appellant Trades argue that s. 69 of the Construction Lien Act, R.S.O. 1990, c. C.30, [2] prevents Zurich from rescinding the Payment Bond as they have valid claims against Zurich pursuant to the Bond. They claim that equitable remedies such as rescission cannot undermine their statutory right and that, if Zurich’s rescission action is sustained, their right to claim on the Payment Bond pursuant to s. 69, would be improperly extinguished.

[41] Zurich claims that the rights of the Trades are tainted by the fraud allegations and that some of the Trades were party to the alleged fraud.

[42] Sections 69(1) and (3) of the Construction Lien Act create a right of action on the part of subcontractors to recover from the surety in accordance with the terms of the Payment Bond, and subrogation of the rights of the surety to the subcontractor. Section 69 provides that:

(1) Where a labour and material payment bond is in effect in respect of an improvement, any person whose payment is guaranteed by that bond has a right of action to recover the amount of the person’s claim, in accordance with the terms and conditions of the bond, against the surety on the bond, where the principal on the bond defaults in making the payment guaranteed by the bond.

(3) The surety, upon satisfaction of its obligation to any person whose payment is guaranteed by the bond, shall be subrogated to all the rights of that person.

[43] Legislation supersedes a common law remedy, including equity where it has done so clearly and unambiguously: Ruth Sullivan, The Construction of Statutes, 7th ed. (Markham: LexisNexis Canada Inc., 2022), at pp. 530-32.

[44] As such, a statutory scheme may oust equitable rights that would otherwise be available but only where the legislature expressed its intention to do so with “irresistible clearness”: Moore v. Sweet, 2018 SCC 52, [2018] 3 S.C.R. 303, at para. 70; KBA Canada, Inc. v. Supreme Graphics Limited, 2014 BCCA 117, 59 B.C.L.R. (5th) 273; Zaidan Group Ltd. v. London (City) (1990), 71 O.R. (2d) 65 (C.A.), at para. 11, aff’d , [1991] 3 S.C.R. 593; and Neles Controls Ltd. v. Canada, 2002 FCA 107, 222 F.T.R. 319, at para. 15.

[45] In order to decide whether legislation ousts a common law remedy, the court must 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”: 2747-3174 Québec Inc. v. Québec (Régie des permis d’alcool), [1996] 3 S.C.R. 919, at para. 97, per L’Heureux-Dubé J.

[46] The Construction Lien Act clearly ousts certain equitable rights. For instance, it precludes a subcontractor who was entitled to, but did not register a construction lien for unpaid work as provided by the Construction Lien Act, from claiming the amount of the lien in unjust enrichment. This is the “precise sort of situation that the Construction Lien Act was designed to address and augmenting the scope of claims available would undercut the balance established by the Act”: Tremblar Building Supplies Ltd. v. 1839563 Ontario Limited, 2020 ONSC 6302, 454 D.L.R. (4th) 546, at para. 18.

[47] In deciding whether the legislative scheme in s. 69 ousts rescission, it is necessary to look at the situation s. 69 was designed to address. [3] At common law, tradespeople could not sue upon a payment bond because they were not parties to the bond, and had no privity of contract with the surety. To avoid this problem, modern payment bonds used trust language: Valard ConstructionLtd. v. Bird Construction Co. 2018 SCC 8, [2018] 1 S.C.R. 224, at para. 53, per Karakatsanis J. Additionally, at common law, a bond was “effective” when it was signed, sealed and delivered: Paul D’Aoust Construction Ltd. v. Markel Insurance Co. of Canada (1999), 120 O.A.C. 243 (C.A.), aff’d 2001 SCC 84, [2001] 3 S.C.R. 744.

[48] Section 69 was designed to replace the common law actions based on trust bonds with a direct statutory action between the surety and the trades. This served to resolve any potential problem arising from the lack of privity of contract between them. As explained in a report prepared by the Advisory Committee on the draft Construction Lien Act, in 1982:

While the purpose of the bond is to protect the suppliers of services or materials, those suppliers cannot sue upon it, at common law, because they have no contractual relationship with the bonding company. To remedy this problem a trust form of bond has recently become common. There may still be some doubt as to the effectiveness of this bond form. Section [69] removes all doubt and permits suppliers of services or materials to sue upon a labour and materials bond. [Emphasis added.]

[49] More recently, at Chapter 10 of their report to the Ministry of Attorney General of Ontario, Striking the Balance: Expert Review of Ontario's Construction Lien Act (delivered April 30, 2016), Bruce Reynolds and Sharon Vogel note that:

Surety bonds guarantee, among other things, payment of either fifty percent or one hundred percent of the amounts owed by general contractors to the suppliers of labour and materials, and guarantee the owner that, in the event of the insolvency of the general contractor, construction will be completed. [Emphasis added.]

[50] However, the Construction Lien Act does not explicitly address the trades’ right of action on the payment bond when the bond agreement was founded on fraud. Nor is there anything in the legislative record to show whether the legislature specifically intended s. 69 to sustain the bond even in the face of fraud. And finally, the parties have adduced no cases that specifically address the issue of fraud in the issuance of the bond. As such, it is not appropriate to foreclose this argument at this stage of the proceeding without hearing full submissions on this issue.

[51] In any event, Zurich has alleged that certain of the Trades have participated in the fraud. Discoveries are not complete and as such, the argument has not been fully developed. If it is established that the Trades were party to the fraud, it would be difficult to envisage that the legislature intended with “irresistible clearness” to protect the Trades who participated in fraud.

[52] The determination of this issue should therefore be left to the trial judge and decided on a complete record and full submissions to see what, if any, equitable claims may arise.

May Rescission be Granted where there are Innocent Third Parties?

[53] The appellants argue that rescission is unavailable as a matter of law whenever the rights of innocent third parties are engaged.

[54] The appellants note that in The Law of Contract in Canada, at pp. 762-63, Professor Fridman states that “[r]escission is only possible where to grant such remedy would not operate to the prejudice of a third-party, who was not implicated in the original contract … [I]f granting rescission would have such an effect, a court of equity will refuse that remedy”.

[55] The appellants also cite British authorities which have held that “the option to void the contract is barred where innocent third parties have, in reliance on the fraudulent contract, acquired rights which would be defeated by its rescission”: Tennent v. The City of Glasgow Bank (1879), 4 App. Cas. 615 (U.K.), at p. 621; Clough v. London and Northwestern Railway Company (1871), L.R. 7 Exch. 26 (U.K.). The court in Society of Lloyd’s v. Leighs, [1997] E.W.C.A. Civ. 2283 (U.K.), concluded that rescission would invalidate contracts with third parties, which could not be “accommodated within established legal principles” noting that restitutio in integrum was impossible because the court could not sever the contracts that had resulted from the original contract if the original contract were rescinded.

[56] The appellants note that in Foy v. Royal Bank (1995), 37 C.P.C. (3d) 262 (Ont. Gen. Div.), at p. 12, an Ontario court refused to order rescission of an agreement of purchase and sale where a bona fide mortgagee for value without notice would be prejudiced “in a manner which could not be compensated for by costs or by an adjournment.”

[57] The jurisprudence and academic literature reflect two concerns about the rights of third parties in rescission cases: first, the impossibility of achieving restitutio in integrum when third parties have acquired an interest in property subject to the contract; and second, unavoidable prejudice to, or adverse effect on, third parties. However, as further discussed below, neither concern presents an absolute bar to rescission.

1. Where third-party rights render restitutio in integrum impossible

[58] The first concern arises when some of the property subject to the contract has ended up in the hands of a third party, and the third party’s interest in it is superior to the original owner’s interest.

[59] As will be seen below, this scenario tends to arise when the third party has purchased and been conveyed the contract property. It is well established that when property is purchased by an innocent third party for value without notice, the pre-existing equitable interests of other parties are extinguished: i Trade Finance Inc. v. Bank of Montreal, 2011 SCC 26, [2011] 2 S.C.R. 360, at para. 60. [4] The property cannot be wrested from a party with a superior interest and restored to the original owner. As a result, the original owner cannot be restored to the pre-contracting position, and restitutio in integrum is technically impossible.

[60] However, this kind of technical impossibility does not pose an absolute bar to rescission. When the court cannot return specific property to its original owner (restitutio in specie) because a third party has acquired a superior interest in it, the court may award the original owner alternate relief aimed at restoring its pre-contractual position. As the Supreme Court wrote in Nesbitt v. Redican, [1924] S.C.R. 135, at p. 153:

[T]he practice has always been for a Court of Equity to give relief by way of rescission whenever by the exercise of its powers it can do what is practically just, though it cannot restore the parties precisely to the state they were in before the contract. [Emphasis added.]

[61] Even when the parties cannot be restored precisely to the state they were in before the contract was signed, courts may still grant and tailor rescission remedy because rescission is an equitable remedy focused on practical justice, not rigid technicalities: Fridman, The Law of Contract in Canada, at p. 761; Spence v. Crawford, [1939] 3 All E.R. 271, at pp. 280-88; Kiani v. Abdullah (1989), 70 O.R. (2d) 697 (C.A.); Carter v. Golland, [1937] O.R. 881 (C.A.), at para. 10; and Brown & Root v. Aerotech Herman Nelson Inc. et al., 2004 MBCA 63, 184 Man. R. (2d) 188, leave to appeal refused, [2004] S.C.C.A. No. 344.

[62] Rescission operates to relieve and prevent unconscionability and unfairness, such as fraud: Canada (Attorney General) v. Collins Family Trust, 2022 SCC 26, at paras. 9-11. The court may therefore order rescission so long as it avoids injustice between the parties, for instance by unjustifiably making the respondent worse off: Mitchell McInnes, The Canadian Law of Unjust Enrichment and Restitution (Markham: LexisNexis Canada, 2014), at p. 1433.

[63] Being focused on practical justice between the parties, the availability and form rescission may take will vary depending on the facts of the case. As noted, the court is more willing to exercise its discretionary power in cases of fraud than in cases of innocent misrepresentation: Spence, at p. 288.

[64] The principle of practical justice was at issue in Brown & Root. That case involved a claim for fraudulent misrepresentation in respect of heaters that had already been transferred to a third party and could not be returned. The Manitoba Court of Appeal, at paras. 57-60, concluded that the inability of the defrauded party to restore the heaters that had been sold and/or the inability to perfectly restore the parties to their original position did not bar rescission. The court rejected the view that “absolute restitutio is required in every case”: at para. 52. Instead, it took a flexible approach to determining whether restitutio in integrum could be achieved by considering what was “practically just”: at para. 66.

[65] This flexible approach fits with the Supreme Court of Canada’s approach to equitable compensation, endorsed in Rick v. Brandsema, 2009 SCC 10, [2009] 1 S.C.R. 295, at para. 66:

[W]hen rescission is unavailable because restitution, as a practical matter, cannot be made, damages in the form of "equitable compensation" are imposed to provide relief to the wronged party. This is because, as the British Columbia Court of Appeal said in Dusik v. Newton (1985), 62 B.C.L.R. 1: "Where rescission is impossible or inappropriate, it would be inequitable for the defendant to retain the benefits of the unconscionable bargain" (p. 47).

[66] Canadian courts have achieved practical justice between the parties when restitutio in specie is not possible by awarding monetary compensation approximating the value of that property to the contracting party owed the property: Peter D. Maddaugh and John D. McCamus, The Law of Restitution (Toronto: Thomson Reuters, 2021) (loose-leaf, release 2), at §5:18.

[67] Such relief was also ordered in Kupchak v. Dayson Holdings Ltd. (1965), 53 D.L.R. (2d) 482 (B.C.C.A.), at paras. 13-15. The Kupchaks were induced by fraud to transfer two properties to the defendant for shares and give mortgages to secure the difference in value between the two properties. By the time of trial, the defendant had already sold a half interest in one of the properties to an innocent third party without notice of the fraud and made substantial changes to that property. Restitutio in specie was therefore impossible. However, the court found that it could grant rescission by ordering the defendant to pay the Kupchaks the value of the properties. Davey J.A. for the majority held:

[E]quity has the same power, operating on the conscience of the parties, to order one to pay compensation to the other in order to effect substantial restitution under a decree for rescission, as it has to order one party to pay money on account, or by way of indemnity. The jurisdiction to order compensation is, I think, inherent in the decree for rescission and incidental to it.

[68] Similarly, in McCarthy v. Kenny, [1939] 3 D.L.R. 556 (Ont. S.C.), at p. 563, an Ontario court held that if fraud was found, “relief may be given to the plaintiff by the rescission of the transaction and compensation for loss in the event of her securities not being returned to her by the defendant”.

[69] In Trans-Canada Trading Co. v. M. Loeb Ltd., [1947] 2 D.L.R. 849 (Ont. H.C.J.), rescission was sought based on a fraudulent misrepresentation made at the time the agreement was entered into that the plaintiff would be the exclusive outlet for lighters for a defined district. This misrepresentation induced the plaintiff to enter into the contract. Restitutio in specie was no longer possible as some lighters had been sold to third parties before the discovery of the misrepresentation. Nevertheless, the court ordered rescission as it held that monetary compensation could cover the cost of lighters already sold.

[70] This reasoning was also followed in Stewart v. Complex 329 Ltd. (1990), 109 N.B.R. (2d) 115 (Q.B.), at p. 20. The plaintiff sought rescission of a contract due to fraudulent misrepresentation, but assets originally owned by the plaintiff had already been transferred to a third party. Notwithstanding that the assets were unrecoverable by their original owner, rescission was allowed as the court held:

[T]he bona fide interests of third parties in the assets can be protected … and the contract founded on fraudulent misrepresentation be deemed as existing, for third parties with an interest were also put at risk by the misrepresentations of the Defendants and the breaches of the covenants set out in the Agreement.

The results of an order of rescission can be held by him for the benefit of himself and all those who are creditors or who held a beneficial interest in the assets ….

Accordingly, I have decided that the fact that third parties had acquired for value an interest in the assets he had purchased prior to the time he elected to rescind the Agreement should not be seen as a bar to rescission in the circumstances of this case. [Emphasis added.]

[71] In short, where a third party is entitled to keep the property originally owned by one of the contracting parties, the court may still exercise its equitable power to do what is practically just and order a remedy that makes the original owner whole.

[72] “The court must fix its eyes on the goal of doing ‘what is practically just.’ How that goal may be reached must depend on the circumstances of the case”: Spence, at pp. 280-88; The Canadian Law of Unjust Enrichment and Restitution, Ch. 34, III.E. To achieve this goal, the court will typically need a full factual record before it.

[73] It is not possible to say, at this stage of the litigation and in the absence of a full factual record, whether rescission could be crafted to achieve practical justice for the appellants and respondents.

[74] I take no view on whether, in the event that rescission is ordered, the appellants have acquired interests under the Bond that they might be entitled to retain by virtue of being purchasers for value or because they acquired a beneficial interest in the Bond Amount. Nor do I take a view on whether the Trades acquired a statutory cause of action that was fully accrued before Zurich asserted its claim for rescission. If they have acquired and are entitled to retain such interests, a constellation of facts will need to be considered to determine how the contracting parties, deprived of the value of these interests, should be made whole. Finally, I also take no view on whether rescission would be able to achieve practical justice between the parties in the circumstances. These are fact-laden questions that are more appropriate for trial than an application.

[75] The question referred by the case management judge on this application was simply whether rescission is ever available as a matter of law when the rights of innocent third parties intervene and restitutio in integrum is impossible. For the reasons set out above, the answer is yes.

2. Where innocent third parties may suffer prejudice because of the rescission

[76] The appellants submit that rescission is not permitted where it causes unavoidable prejudice to innocent third parties. The appellant OZZ Electric argues that rescission must also be refused where it would adversely affect or prejudice an innocent third party such as itself. The appellants Urban Mechanical Contracting et al. and BMO add that the principle of restitutio in integrum requires the court to return third parties affected by the contract, such as themselves, to the positions they occupied prior to the contract, in effect protecting them from being adversely affected by the rescission.

[77] They also argue that the Credit and Ratification Agreements are interrelated such that the Bonds alone cannot be rescinded on their own as partial rescission is not permitted: Kingu. They note that, should a court conclude that the Credit Agreement or the Ratification Agreements are inseparably related to the Bonds, restitutio in integrum as between Zurich and the principal fraudsters may amount to impermissible partial rescission.

[78] Turning first to the appellants’ “prejudice to innocent third parties” argument, Urban Mechanical Contracting et al. and BMO misconstrue the effect of the principle of restitutio in integrum on third parties. Rescission unwinds the contractual relationship between the contracting parties: Spence, at p. 289. It does not unwind the contractual relationship with third parties. If it were otherwise, rescission would require a third party that purchased contract property to return it to its original owner in order to restore the third party’s pre-contract position. As demonstrated in the line of cases considered above, rescission does not require that outcome.

[79] All of the appellants point to the language in Professor Fridman’s The Law of Contract in Canada, at pp. 762-63, for the proposition that unavoidable adverse effect or prejudice to third parties poses an absolute bar to rescission:

Rescission is only possible where to grant such remedy would not operate to the prejudice of a third and innocent party, who was not implicated in the original contract and so ought not to be affected adversely by the subsequent, later avoidance of that transaction. If granting rescission would have such an effect, a court of equity will refuse that remedy, leaving the plaintiff to his common-law remedy, that is, damages if it is available in the circumstances. [Emphasis added.]

[80] The quoted passage cites cases that articulate the principle in Clough, at p. 35, that if “an innocent third party has acquired an interest in the property…it will preclude [the innocent contracting party] from exercising his right to rescind.”

[81] However, it is clear from the discussion of the Canadian cases above that rescission may sometimes be available even if a third party acquires an interest in the contract property which renders restitutio in specie impossible. Indeed, Professor Fridman recognized the limitation in the general proposition in his quoted passage. The third case cited by Professor Fridman, at p. 763, n. 185, is Stewart v. Complex 329 Ltd. As noted above, this case concerns a third party acquiring an interest in the contract property, which rendered restitutio in specie impossible, but rescission was nevertheless ordered.

[82] As Professor Stephen M. Waddams points out in The Law of Contracts, 7th ed. (Toronto: Thomson Reuters, 2017), at para. 422, while rescission “may be refused” if third party rights are significantly adversely affected, the bars to rescission are “flexible criteria”. In any event, a full factual record would be required to determine whether prejudice to the appellants would be unavoidable.

[83] I disagree with the appellant’s submission that Singh v. Trump, 2016 ONCA 747, 408 D.L.R. (4th) 235, leave to appeal refused, [2016] S.C.C.A. No. 548, stands for the proposition that once third-party rights intervene, the court must dismiss the claim for rescission. The court explained the following, at paras. 157-58:

Absent a finding of fraud, in the context of real estate transactions induced by misrepresentation, execution of the agreement has typically been held to constitute a barrier to rescission. The appellants have referred the court to more recent judicial support for the view that execution is a relevant but not decisive factor in determining whether rescission is available, at least in some limited contexts.

Even assuming without deciding that rescission could be a remedy available to Mrs. Lee after having executed her transaction, I would nevertheless not grant rescission in the circumstances of this case. It is not apparent from the record what effect rescission would have on innocent third parties such as Mrs. Lee’s mortgagor, who was not made a party to these proceedings. Further, the claim was issued more than two years after she closed the transaction. In these circumstances I view the award of damages as constituting the appropriate remedy for Mrs. Lee. [Emphasis added, citations omitted.]

[84] Before a court can determine what the rescission remedy would unwind, the possible interconnections among the various agreements must be explored. This is an issue of mixed fact and law that can only be determined by a trial judge upon consideration of the factual matrix and the parties’ intentions: De Molestina & Ors v Ponton & Ors, [2001] E.W.H.C. 521 (Comm) (U.K.).

[85] For these reasons, I disagree that rescission may never be ordered where it would adversely affect third parties and I disagree that this issue can be determined without consideration of the full factual record in this case.

Conclusion

[86] In sum, the application judge correctly concluded that, as a matter of law, the rights of innocent third parties are not an absolute bar to rescission in all cases where there is an allegation of fraudulent misrepresentation. The applications were permitted to be brought in the midst of an ongoing action only to determine this narrow issue of law.

[87] With the benefit of hindsight, it is unfortunate that this issue was addressed without a full record at trial as the full factual context is necessary to enable the court to make a final determination as to whether rescission is possible.

[88] Courts exercise flexibility in determining whether rescission can and should be ordered where it is alleged that fraudulent misrepresentation induced the innocent contracting party to enter into an agreement. In making this determination, courts take into account all the facts and circumstances of the particular case in order to do practical justice between the parties.

[89] The parties here have not completed examinations for discovery and there is therefore no full factual record available.

[90] The facts and circumstances of the case may determine important issues such as: (a) when Zurich knew or ought to have known of the fraud; (b) whether the Ratification Agreements with the Trades, the Credit Agreement, and the Bonds are inseparably related agreements; (c) if the Ratification Agreements are not inseparably connected to the Payment Bond, whether the Ratification Agreements are void for mutual mistake on the mistaken assumption the Payment Bond was in force and not void for fraud; (d) what knowledge, if any, the appellants had of the fraud; (e) whether some or all of the appellants are indeed third parties, beneficiaries or assignees and if so, whether they are innocent third parties; (f) whether any of the Trades participated in the alleged fraud; (g) whether any of the claims are derivative of the Obligee ProjectCo; and (h) whether the remedy of rescission is practical and just in cases such as this.

[91] Because there is no complete factual record, the application judge’s findings of fact are not binding on the trial judge.

[92] The narrow question of whether, as a matter of law, rescission may be available where an innocent party was induced to enter a contract by virtue of fraudulent misrepresentation and there are innocent third parties who assert their rights is answered in the affirmative.

[93] The appeals are therefore dismissed.

[94] On the agreement of the parties, costs of the Bank of Montreal’s appeal (C69448) are payable to Zurich in the all-inclusive amount of $50,000 and costs of the Trades’ appeals (C69440 & C69416) are payable to Zurich in the all-inclusive amount of $60,000.

Released: August 17, 2022 “J.M.F” “J.A. Thorburn J.A.” “I agree Fairburn A.C.J.O.” I agree L. Favreau J.A.”

[1] Numerous directions were made at various case conferences including allowing BMO and all but one of the Trades to intervene, plead, seek relief in the Rescission Action, and participate in examinations for discovery.

[2] Now repealed but continues to apply by virtue of s. 87.3(1) of the Construction Act.

[3] For instance, in KBA Canada Inc. v. 3S Printers Inc., 2014 BCCA 117, 59 B.C.L.R. (5th) 273, the legislature implemented a hierarchy of priorities between different securities interests. Equity would have prescribed a different hierarchy between the same security interests. The court held that the scheme ousted equity because the legislature, by establishing the statutory hierarchy for security interests, had intended that hierarchy to apply when those security interests were at issue. The purpose of the statute was to provide commercial certainty and predictability to personal property financing, and “[t]he statutory purpose of replacing those complex and convoluted principles with simple rules that provide certainty and predictability would be undermined”: KBA Canada Inc., at para. 24.

[4] It is conceivable that a third party which has acquired other interests, including equitable interests, could also have a superior claim: Mitchell McInnes, The Canadian Law of Unjust Enrichment and Restitution, (LexisNexis Canada, 2014), Ch. 34, II.B.2