COURT OF APPEAL FOR ONTARIO

CITATION: Energy Fundamentals Group Inc. v. Veresen Inc., 2015 ONCA 514

DATE: 20150708

DOCKET: C60196

Simmons, Epstein and Pardu JJ.A.

BETWEEN

Energy Fundamentals Group Inc.

Applicant

(Respondent)

and

Veresen Inc.

Respondent

(Appellant)

Mark A. Gelowitz and Eric Morgan, for the appellant

Orestes Pasparakis, Rahool P. Agarwal, and Stephen Taylor, for the respondent

Heard: May 27, 2015

On appeal from the order of Justice Michael A. Penny of the Superior Court of Justice, dated February 26, 2015, with reasons reported at 2015 ONSC 692.

Pardu J.A.:

[1] When can a court imply terms into a commercial contract, terms upon which the parties have not expressly agreed? Veresen Inc. appeals from the decision of an application judge implying a contractual obligation on its part to disclose information to enable Energy Fundamentals Group Inc. (“EFG”) to determine whether to exercise an option to acquire up to 20% of a limited partnership, the Jordan Cove Energy Project.

[2] EFG, an investment bank, introduced Veresen to the project, the development of a liquid natural gas terminal on the coast of Oregon.

[3] Between April and July 2005, EFG provided investment banking services pursuant to a “non-binding letter agreement” dated April 1, 2005 documenting the parties’ understanding that:

(a) the Jordan Cove development offered “an attractive investment opportunity”, “subject to our collective due diligence review of the project”;

(b) the “nature of [the] proposal is to work with [Veresen] through to project commissioning on a basis that aligns EFG’s and [Veresen’s] respective interests and objectives”;

(c) EFG would offer certain services and, in exchange, EFG would be compensated with a right to invest in the Project; and

(d) the parties would continue to “work together to develop an arrangement which fits both parties [sic] mutual objectives.”

[4] Veresen completed its acquisition of the project and on July 12, 2005 executed a limited partnership agreement, (“LPA”) through which it controlled the project.

[5] Two weeks later, Veresen and EFG executed a two-and-a-half page letter agreement. The letter agreement was not comprehensive and reference had to be made to the LPA to understand the scope of the letter agreement.

[6] Under the letter agreement, EFG was to provide assistance to Veresen’s exercise of due diligence in development of the project and “financial model development.” The letter agreement expressly stated that the parties were to work together to obtain financing for the project.

[7] The letter contemplated a continuing relationship. The letter agreement gave EFG an option to acquire up to a 20% interest in the project, contingent on successful financing. The letter agreement expressly recognized that EFG’s compensation was “an opportunity to realize value over time related to the successful development of the Project through the investment of capital into the Project.”

[8] In order to exercise the option, EFG had to pay a proportionate share of all development equity contributed by Veresen, plus a return on Veresen’s development equity, as that return was defined in the LPA. If EFG became a partner, it would also be obliged to pay a proportionate share of future project costs. All told, EFG would be required to contribute several hundred million dollars in order to exercise the option.

[9] The letter agreement expressly provides that Veresen “shall assign to EFG an interest in the project pursuant to the terms of the [LPA] Limited Partnership agreement.”

[10] The LPA expressly provides for the reasonable disclosure of confidential information to prospective transferees:

any Partner may disclose Confidential Information to the extent reasonably necessary, to … prospective transferees of such Partner’s interests in the Partnership as a Partner thereof; provided however that such Person or Persons shall be informed at the time of such disclosure of its confidential nature and provided with the confidentiality terms of this Agreement, and that such Person or Persons shall first agree in writing to comply with and be bound by all the terms and conditions of this Section 13.2.

[11] As Veresen’s financial advisor in 2005, EFG was at that time privy to confidential information about the project. This financial information was provided to EFG under the terms of a 2005 confidentiality agreement that seems to have expired. An EFG representative was also on the board of the general partner, but this position was terminated when EFG signaled an intention to explore exercise of the option and this litigation resulted.

[12] Due to fluctuations in the price of natural gas, the type of facility that would be built by Veresen changed from an LNG importation facility to a LNG export facility. Before the application judge, Veresen maintained that this change was so drastic that the original option no longer applied, since an export terminal was essentially different in nature from an import terminal.

[13] In the negotiations that preceded this litigation, Veresen repeatedly told EFG that the option was “out of the money” or “severely underwater” – in other words, Veresen represented to EFG that the cost of exercising the option would far outweigh the economic benefit of doing so. Despite making these express representations, Veresen refused to provide EFG with the documentation to verify either the pricing of the option or its likely economic value.

Application judge’s decision

[14] The application judge rejected Veresen’s argument that the option no longer existed because the originally contemplated LNG import facility had been changed into an LNG export operation. No appeal is taken from that finding.

[15] The application judge ordered Veresen to provide sufficient information to enable EFG:

(i) to confirm Veresen’s calculation of the Option exercise price (the “price information”); and

(ii) to make a reasonable determination of what an equity stake of up to 20% in the Project is currently worth (the “value information”) .

[16] Veresen agreed before the application judge that it would provide the price information, but argues on appeal that it is not legally obliged to provide either the value or the price information.

[17] The application judge correctly articulated the test for determining whether to imply terms in a contract and concluded that the option right would be illusory without the implied terms. The application judge noted that terms may be implied where necessary to give business efficacy to a contract, or where the terms were such that the parties would have considered too obvious to need express inclusion, citing M.J.B. Enterprises Ltd. v. Defence Construction (1951) Ltd., 1999 CanLII 677 (SCC), [1999] 1 S.C.R. 619. He found that it was “clear beyond peradventure” that a potential 20% investor in the project would require access to financial documents before making an investment that could amount to several hundred million dollars. In the application judge’s opinion, the obligation to disclose the valuation information was “a necessary incident to the existence of the Option right itself as, without it, the Option right is really no right at all.”

Veresen’s argument

[18] Veresen says that the application judge should not have implied terms requiring value and price disclosure. These were sophisticated parties; EFG chose not to bargain for a contractual right to disclosure even though it had done so in another context when it wanted that right. Implication of these terms rewrites and improves the contract for EFG’s benefit. Veresen submits that the context here is different from one where a vendor is wooing a prospective buyer, and anxious to entice the prospect with a promise of disclosure.

[19] Veresen argues that the application judge did not give sufficient weight to the evidence of a Veresen executive who said the company would never have agreed to such undefined disclosure terms.

[20] Veresen supports its position that the application judge erred in implying the term he did by pointing out that it has no idea what it is required to disclose. Veresen submits that to order “reasonable disclosure” when a trial may be necessary to define what must be disclosed and the scope of any undertaking as to confidentiality, goes beyond the limits of available court imposed contractual terms. Veresen contends that although the application judge correctly articulated the legal test, he refashioned the test to imply a term to which reasonable parties in general would have agreed, without regard for the actual intentions in this case.

[21] Finally, Veresen submits that the application judge erred in using a good faith basis to imply the terms. Bhasin v. Hrynew, 2014 SCC 71, [2014] 3 S.C.R. 494speaks to good faith performance of a contract, not to implication of terms.

[22] If this court upholds the implication of the disclosure term, Veresen does not object to the means chosen by the application judge to implement that proviso.

EFG’s arguments

[23] EFG submits that it and Veresen were allied in pursuit of a common goal, development of the LNG project. They contemplated that they could become partners. EFG was intimately familiar with Veresen’s finances and sat on the board of the corporation acting as general partner of the limited partnership managing the LNG project. It would have been obvious to the parties that EFG would not have invested hundreds of millions of dollars without verifying both Veresen’s calculation of the option price and reviewing Veresen’s records to assess the value of the option.

[24] The application judge was correct to conclude that the option right would have been illusory without the right to information, and that implication of the terms was necessary to give business efficacy to the letter agreement. The application judge concluded on the whole of the evidence that the parties must have intended that EFG would have the right to this disclosure. There is no suggestion on the evidence that anyone other than EFG would become a limited partner.

[25] The application judge did not rely on a requirement of good faith to imply the contractual terms, but observed the doctrinal link between the implication of contractual terms and good faith performance of contracts.

[26] Although a proposed term may require interpretation, EFG submits that a court may nonetheless imply such a term where it satisfies the necessary criteria for the implication of terms. Interpretation of a contractual term of “reasonableness” arises in many different contexts. Veresen itself has expressly agreed to “reasonable” disclosure to prospective investors in the LPA. The LPA also provides for “reasonable and just disclosure to limited partners.”

[27] The letter agreement does not purport to exhaustively define the relationship between the parties: the LPA is a necessary part of the context.

Analysis

(1) Did the application judge err in implying the term?

[28] The application judge’s largely factual conclusion that the right to value and price disclosure was necessary to give business efficacy of the agreement is owed deference. This flows from Olympic Industries Inc. v. McNeil, 1993 CanLII 318 (BC CA), 86 B.C.L.R. (2d) 273, [1993] B.C.J. No. 2565 (C.A.), at para. 31, cited more recently by Moulton Contracting Ltd v. British Columbia, 2015 BCCA 89, 381 D.L.R. (4th) 263, at para. 56, which held that “[t]he question as to what the parties must have intended as a matter of necessity is a question of fact to be decided in the circumstances of each case.” [Emphasis added]

[29] The issue of implication of contractual terms raises questions of mixed law and fact, as would interpretation of the contract, and the same standard of review should apply, palpable and overriding error, unless extricable errors of law are evident. (Sattva Capital Corp. v. Creston Moly Corp. 2014 SCC 53)

[30] As observed by the application judge, a contractual term may be implied “on the basis of the presumed intentions of the parties where necessary to give business efficacy to the contract or where it meets the ‘officious bystander test.’” (M.J.B. Enterprises Ltd. v. Defence Construction (1951) Ltd., 1999 CanLII 677 (SCC), [1999] 1 S.C.R. 619).

[31] The officious bystander test was most famously articulated in Shirlaw v. Southern Foundries (1926) Ltd., [1939] 2 K.B. 206 at 227, [1939] 2 All E.R. 113 at 124 (C.A.):

Prima facie that which in any contract is left to be implied and need not be expressed is something so obvious that it goes without saying. Thus, if while the parties were making their bargain, an officious bystander were to suggest some express provision for it in their agreement, they would testily suppress him with a common: “Oh, of course.”

[32] The business efficacy test in its modern form originated in The Moorcock (1889) 14 P.D. 64, [1886-90] All E.R. Rep. 530 (C.A.) at 68:

In business transactions such as this, what the law desires to effect by the implication is to give such business efficacy to the transaction as must have been intended at all events by both parties…

[33] The Moorcock concerned a contract between a wharf operator and a ship owner; the court implied a warranty that the ship could be safely moored at the wharf with “the object of giving to the transaction such efficacy as both parties must have intended” (p. 68, 70).

[34] The business efficacy test was reviewed more recently by the Privy Council in Attorney General of Belize v. Belize Telecom Ltd., [2009] UKPC 10, [2009] 2 All E.R. 1127, at para. 22:

Take, for example, the question of whether the implied term is "necessary to give business efficacy" to the contract. That formulation serves to underline two important points. The first, conveyed by the use of the word "business", is that in considering what the instrument would have meant to a reasonable person who had knowledge of the relevant background, one assumes the notional reader will take into account the practical consequences of deciding that it means one thing or the other. In the case of an instrument such as a commercial contract, he will consider whether a different construction would frustrate the apparent business purpose of the parties. …

[35] Implication of a contractual term does not require a finding that a party actually thought about a term or expressly agreed to it. Often terms are implied to fill gaps to which the parties did not turn their minds (Belize Telecom, para. 31).

[36] On the other hand, a court will not imply a term that contradicts the express language of the contract, or is unreasonable: G. Ford Homes Ltd. v. Draft Masonry (York) Co. Ltd. (1984), 1983 CanLII 1719 (ON CA), 43 O.R. (2d) 401 (C.A.).

[37] The conclusions drawn by the application judge were reasonably available to him on the evidence. Here, it is apparent that the letter agreement was not intended to comprehensively define the relationship between the parties. In a commercial setting, there may be contracts “where the parties to a contract may have been content to express only the most important terms of their agreement, leaving the remaining details to be understood” (H.G. Beale, ed., Chitty on Contracts, 31st ed. (London UK: Sweet & Maxwell, 2012) vol. 1 at 13-002).

[38] The application judge did not err in failing to give the evidence of the Veresen executive the conclusive weight urged upon this court on appeal. The subjective evidence of a party, often given years later, as to whether or not it would have agreed to the proposed implied term is of little value, amounting to a “barren argument over how the actual parties would have reacted to the proposed amendment.” (Belize Telecom, at para. 25) The analysis of whether to imply a term must be done on an objective basis, but having regard to the specific parties and specific contractual context.

[39] The application judge’s conclusions that the option was illusory unless a right to disclosure was implied, and that an implied term of disclosure was necessary to give business efficacy to the agreement are not tainted by reviewable error.

[40] In this context, the implication of the terms requiring disclosure is not rendered unnecessary because EFG could blindly exercise the option without knowing whether it would make economic sense to do so. Such an interpretation would frustrate the business purpose of the agreements. As Lord Hoffman observed in Belize Telecom, at para. 23:

The danger lies, however in detaching the phrase “necessary to give business efficacy” from the basic process of construction of the instrument. It is frequently the case that a contract may work perfectly well in the sense that both parties can perform their express obligations, but the consequences would contradict what a reasonable person would understand the contract to mean. [Emphasis added]

(2) Did the application judge depart from the correct test by determining the intentions of reasonable parties rather than the actual parties?

[41] Veresen’s argument that the application judge departed from the correct test for implication of a term (which requires analysis of the actual intentions of the parties) and instead used a test of what reasonable parties would have agreed is based on para. 85 of his reasons:

If Veresen was looking for a 20% equity partner in the Project, it is clear beyond peradventure that it would have to provide access to confidential financial information about the Project. No one would ever invest several hundred million dollars in this Project without performing detailed due diligence on the value of the stake in the Project being acquired.

[42] Veresen relies on para. 29 of M.J.B Enterprises Ltd., where Iacobucci J. said:

What is important in both formulations [the business efficacy test and the “officious bystander test”] is a focus on the intentions of the actual parties. A court, when dealing with terms implied in fact, must be careful not to slide into determining the intentions of reasonable parties… [Emphasis in the original]

[43] As observed in John D. McCamus, The Law of Contracts, 2nd ed. (Toronto: Irwin Law, 2012), at 781, reasonableness is an inescapable part of determining whether to imply a contractual term:

Thus, it is plainly the case that the implied terms must themselves be reasonable. One would not expect a court to imply terms into an agreement that it considered to be unreasonable. Further, keeping in mind that the implied in fact term rests on the presumed intentions of the parties, courts quite understandably presume intentions of the parties that are reasonable. In other words, in attributing to the parties hypothetical intentions as to what they would have agreed to if the matter had been raised at the time of contracting, courts assume that the parties would behave reasonably and would agree to a reasonable term. Indeed, in the absence of actual but unexpressed intentions it is inescapable that courts would apply a reasonable intentions standard. In other words, although necessity appears to be the threshold that must be met before engaging in the exercise of implying the term, the formulation of the term to be implied is very much an exercise that rests on a concept of reasonableness. At the same time, however, the implied term is tailored to the needs of the actual transaction of the actual parties rather than to some hypothetical reasonable transaction; accordingly, to the extent that relevant actual intentions of the parties are manifest in the transaction, they must form a basis for the implied term.

[44] The court’s warning in M.J. B. Enterprises about the need to be “careful not to slide into the intentions of reasonable parties,” mandated an analysis rooted in the actual relationship between the parties and the specific contractual context, rather than a detour into an abstract analysis of what in general, a reasonable person might have agreed. In M.J.B. Enterprises itself the court went on to assess the reasonableness of the proposed implied term in the specific context, but also relied on the general reasonableness of such a term, saying, at para. 30, “…I find it difficult to accept that the appellant, or any of the other contractors, would have submitted a tender unless it was understood by all that only a compliant tender would be accepted.”

[45] In my view the application judge did not depart from the proper test cited by him in the immediately preceding paragraph of his reasons. His analysis is in no way abstracted from an analysis of the specific relationship between these parties.

[46] The finding that no reasonable person would have embarked on an exercise of the option without disclosure, supports a finding of the necessity of the implied term for purposes of business efficacy.

(3) Did the application judge err by confounding the requirement of good faith performance of a contract with the test for implying contractual terms?

[47] In my view, the application judge’s references to good faith do not undermine his earlier factual conclusions as to necessity and business efficacy.

[48] As he indicated, in Bhasin, the court observed:

The implication of terms plays a functionally similar role in common law contract law to the doctrine of good faith in civil law jurisdictions by filling in gaps in the written agreement of the parties: Chitty on Contracts, at para. 1-051 [emphasis added].

[49] Reference to this common doctrinal underpinning, after concluding that implication of the term was necessary to give business efficacy to the contract, does not amount to error. As explained in Swan & Adamski, Canadian Contract Law, 3rd ed. (Markham: LexisNexis, 2012) at para.8, p.113:

Like custom and the device of the implied term or the imposed or supplied term to fill a gap in the agreement, good faith is a device for supplementing the terms of the contract to deal with aspects of the relation that have not been specifically dealt with by the parties.

[50] Given Veresen’s agreement before the application judge that it would provide the pricing information, there is no basis to revisit that conclusion on appeal. In any event, the same analysis would compel implication of a term requiring disclosure of pricing information. No one could have reasonably contemplated that EFG would have to blindly accept Veresen’s calculation of the option price.

Disposition

[51] For these reasons, the appeal is dismissed, with costs to EFG in the agreed sum of $50,000, inclusive of disbursements and applicable taxes.

Released: July 8, 2015

(GE)

“G. Pardu J.A.”

“I agree Janet Simmons J.A.”

“I agree Gloria Epstein J.A.”