SUPREME COURT OF CANADA

Citation: ABB Inc. v. Domtar Inc., [2007] 3 S.C.R. 461, 2007 SCC 50

Date: 20071122

Docket: 31176, 31177, 31174

Between:

ABB Inc. and Alstom Canada Inc.

Appellants

and

Domtar Inc.

Respondent

and between:

Chubb Insurance Company of Canada

Appellant

and

Domtar Inc.

Respondent

and between:

Domtar Inc.

Appellant

and

Arkwright Mutual Insurance Company

Respondent

Official English Translation

Coram: McLachlin C.J. and Bastarache, Binnie, LeBel, Deschamps, Fish, Abella, Charron and Rothstein JJ.

Joint Reasons for Judgment:

(paras. 1 to 121)

LeBel and Deschamps JJ. (McLachlin C.J. and Bastarache, Binnie, Fish, Abella, Charron and Rothstein JJ. concurring)

ABB Inc. v. Domtar Inc., [2007] 3 S.C.R. 461, 2007 SCC 50

ABB Inc. and Alstom Canada Inc. Appellants

v.

Domtar Inc. Respondent

‑ and ‑

Chubb Insurance Company of Canada Appellant

v.

Domtar Inc. Respondent

‑ and ‑

Domtar Inc. Appellant

v.

Arkwright Mutual Insurance Company Respondent

Indexed as: ABB Inc. v. Domtar Inc.

Neutral citation: 2007 SCC 50.

File Nos.: 31176, 31177, 31174.

2006: November 8; 2007: November 22.

Present: McLachlin C.J. and Bastarache, Binnie, LeBel, Deschamps, Fish, Abella, Charron and Rothstein JJ.

on appeal from the court of appeal for quebec

Sale — Latent defect — Limitation of liability — Damages — Purchase of recovery boiler by paper manufacturer — Leaks and cracks in boiler’s superheater caused by tie welds connecting its tubes together — Superheater repaired but subsequently replaced by paper manufacturer with product supplied by another boiler manufacturer — Action in damages for latent defects and for breach of duty to inform buyer — Whether conditions for existence of latent defect are met — Whether clause limiting seller’s liability is applicable where seller knew or is presumed to have known about latent defect — Whether seller breached its duty to inform or buyer its duty to inquire — Whether buyer is entitled to be reimbursed for losses sustained with respect to repairs and to recover costs incurred to replace superheater — Whether insurer was subrogated to buyer’s rights in respect of payment made to buyer, and whether damages awarded to buyer should be reduced proportionally to that payment — Civil Code of Lower Canada, art. 1527.

Sale — Duty to inform — Latent defect — Inclusion of seller’s duty to inform in warranty against latent defects.

Domtar built a new pulp and paper mill in Windsor, Quebec. In December 1984, it purchased a recovery boiler manufactured by C.E. (now ABB and Alstom) for $13,500,000. The contract of sale included a clause limiting the seller’s liability. The boiler’s design included a superheater with “H‑style” tie welds even though, at the time, C.E. was aware of problems resulting from the use of such welds and knew about the technology of hinge‑pin attachments. In March 1989, 18 months after the boiler was put into service, tests by Domtar revealed some leaks and hundreds of cracks in the superheater’s tubes. C.E. replaced a number of H‑style tie welds with hinge‑pin attachments, but there was disagreement as to a permanent solution to the problem. In October 1989, at Domtar’s request, a competitor of C.E. replaced the three banks of the superheater with elements installed using hinge‑pin attachments. Domtar brought an action in damages against C.E. that was based on the warranty against latent defects and the duty to inform. It also sued a number of insurers, including Chubb and Arkwright, the former on the basis of a performance bond granted to C.E. for latent defects, and the latter under an “all risk” insurance policy held by Domtar. However, Domtar discontinued its action against the insurer Lloyd’s pursuant to an agreement that included the payment of $1,578,900.

The Superior Court rejected the latent defect claim, but found that C.E. had not discharged its duty to inform as regards the risks associated with tie welds. It condemned C.E. to pay $13,366,583 in damages, less the $1,578,900 paid by Lloyd’s, on the basis that Lloyd’s was, as a result of that payment, subrogated to Domtar’s rights. Given that there was no latent defect, the court dismissed the action against Chubb; it also dismissed the claim against Arkwright on the basis that the cost of replacing the superheater was not insured. The Court of Appeal ruled that C.E. was liable on the basis of both the legal warranty against latent defects and the duty to inform. It held that the amount paid by Lloyd’s should not be deducted. It condemned the insurer Chubb, solidarily with C.E., to pay Domtar the amount provided for in the performance bond. It affirmed the decision to dismiss Domtar’s action against Arkwright.

Held: The appeals should be dismissed.

Given that all the facts alleged in support of Domtar’s action occurred before 1994, and in light of ss. 83 and 85 of the Act respecting the implementation of the reform of the Civil Code, the issues relating to the warranty against latent defects must be resolved by applying the Civil Code of Lower Canada (“C.C.L.C.”). [30]

In intervening, the Court of Appeal did not reassess the evidence in the record, but relied on the trial judge’s findings of fact to arrive at a different conclusion of law regarding the nature of the defect. That conclusion is therefore not inconsistent with the principle of deference for a trial judge’s assessment of the facts. Rather, the issue here is one of legal characterization. [37]

Article 1527 C.C.L.C. provides that any seller who knows or is legally presumed to know about the defects of the thing is obliged to pay for all damage suffered by the buyer. In Quebec civil law, manufacturers are considered to be the ultimate experts with respect to goods because they have control over the labour and materials used to produce them. Consequently, they are subject to the strongest presumption of knowledge and to the most exacting obligation to disclose latent defects. The buyer’s expertise is also relevant as it serves to assess whether the defect is latent or apparent. The more knowledge a buyer has of a good being purchased, the more likely it is that a defect in that good will be considered apparent. Buyers therefore have an obligation to inform themselves by carrying out a reasonable inspection of the good. The test is whether a reasonable buyer in the same circumstances could have detected the defect at the time of the sale. However, the buyer’s expertise does not nullify the presumption applicable to the manufacturer. The manufacturer will be unable to rely on a limitation of liability clause unless it can rebut the presumption of knowledge of the defect. [39] [41‑42] [44]

Regardless of whether the defect is a material defect, a functional defect or a conventional defect, it must have four characteristics, all of which are essential to the warranty: it must be latent, must be sufficiently serious, must have existed at the time of the sale and must have been unknown to the buyer. All these conditions are met in the case at bar. The trial judge erred in concluding that the cracking of the tubes was a design feature rather than a design defect. First, he limited the definition of a defect to a problem preventing the good from being used at all and, second, he confused the sale of a lower‑performance version of a good with the sale of a defective one. A defect will be considered to be serious if it renders the good unfit for its intended use or so diminishes its usefulness that the buyer would not have bought it at the price paid. Domtar would not have bought a boiler with H‑style tie welds if it had been informed of the risks associated with this type of attachment. C.E. used these attachments without having independent analyses conducted to determine whether they could withstand the stress placed on the tubes by the circulation of steam at high temperatures. It chose to rely on its customers’ assessments and delayed the adoption of hinge‑pin attachments in order to maintain its competitive position. Domtar was unaware of the defect at the time of the sale because C.E. had not shared the information it possessed on this subject with Domtar. Even though Domtar was described as a sophisticated operator, and however expert it was at using boilers, it cannot be characterized as a professional “of identical expertise” to C.E. Nor is the defect apparent simply because Domtar was assisted by an expert. The cause of the excessive cracking was unknown to both Domtar and its expert. [45] [50] [86‑88] [91] [93] [97] [99] [101]

To rebut the presumption of knowledge of the defect provided for in art. 1527 C.C.L.C., it is never open to a manufacturer to rely on its ignorance of the defect as its sole defence. The manufacturer must show that it did not know about the defect and that its lack of knowledge was justified, that is, that it could not have discovered the defect even if it had taken every precaution that the buyer would be entitled to expect a reasonable seller to take in the same circumstances. To absolve a manufacturer from liability will be justified only if the manufacturer shows that it had full knowledge of the technology in its field at the time the good was designed and that the defect in question cannot be attributed to it. In light of the strength of the presumption of knowledge applicable to it, the manufacturer must meet a high standard of diligence, and the range of defences available to it to rebut the presumption is very narrow. C.E.’s argument is based not on fault on the part of Domtar or a third party, or on superior force or development risk, but on its own good faith throughout its business relations with Domtar. In this case, it can be seen from the evidence that C.E. had known about the problems associated with tie welds since the early 1980s and that a better technology was available to it as of that time. [69‑72] [102] [104]

The duty to inform and the warranty against latent defects are two concepts that overlap, but the former derives from the general principle of good faith, whereas the latter is expressly provided for in the C.C.L.C. and the Civil Code of Québec. Furthermore, the scope of the general duty to inform is much broader than that of the disclosure of a latent defect. The duty to inform is subsumed in the analysis of the seller’s liability for latent defects, and there is no need for the court to conduct a separate analysis on the duty. [107‑109]

Because a clause in the insurance contract between Lloyd’s and Domtar expressly excluded damage resulting from a breakdown of or defect in the recovery boiler, the payment made by Lloyd’s could not have been related to the damages being claimed by Domtar. Lloyd’s was not, therefore, subrogated to Domtar’s rights and the damages claimed by Domtar should not be reduced by the amount of the payment. [113]

Chubb agreed to guarantee the performance of C.E.’s obligations under the contract of sale for the recovery boiler. Since there was a latent defect in the superheater, Chubb is solidarily liable for the amount of its guarantee. [114]

The “all risk” insurance policy issued by Arkwright for Domtar’s property contained a clause excluding damage resulting from latent defects. To accept Domtar’s contention that the welds can be dissociated from the superheater would render the exclusion clause meaningless. [115] [119]

Cases Cited

Applied: Desgagné v. Fabrique de St‑Philippe d’Arvida, 1984 129 (SCC), [1984] 1 S.C.R. 19; Placement Jacpar Inc. v. Benzakour, 1989 976 (QC CA), [1989] R.J.Q. 2309; Samson & Filion v. Davie Shipbuilding & Repairing Co., 1924 57 (SCC), [1925] S.C.R. 202; Touchette v. Pizzagalli, 1938 39 (SCC), [1938] S.C.R. 433; Manac inc./Nortex v. Boiler Inspection and Insurance Co. of Canada, 2006 QCCA 1395, [2006] R.R.A. 879; referred to: Marquis v. Saltsman, 2002 41228 (QC CA), J.E. 2002‑1729, SOQUIJ AZ‑50143509; Rousseau v. 2732‑1678 Québec inc., [1999] R.D.I. 565; Société en commandite A.C. enr. v. Wadieh, 1997 9977 (QC CA), [1997] R.D.I. 345; Bertrand v. Pelletier, [1997] R.D.I. 321; Poirier v. Martucelli, [1995] R.D.I. 319; Trottier v. Robitaille, [1994] R.D.I. 537; Cloutier v. Létourneau, 1992 3716 (QC CA), [1993] R.L. 530; Rousseau v. Gagnon, 1986 3706 (QC CA), [1987] R.J.Q. 40; Auto Peliss ltée v. Proulx Pontiac Buick ltée, 2001 5911 (QC CA), [2001] R.J.Q. 856; Garage Robert inc. v. 2426‑9888 Québec inc., 2001 9967 (QC CA), [2001] R.J.Q. 865; Trois Diamants Autos (1987) ltée v. M.G.B. Auto inc., 2001 39923 (QC CA), [2001] R.J.Q. 860; General Motors Products of Canada v. Kravitz, 1979 22 (SCC), [1979] 1 S.C.R. 790; Oakwood Construction Inc. v. Ratthé, [1993] R.D.I. 181; Blandino v. Colagiacomo, 1988 1193 (QC CA), [1989] R.D.I. 148; Oppenheim v. Forestiers R.P.G.M. inc., J.E. 2002‑1197, SOQUIJ AZ‑50133145; London & Lancashire Guarantee & Accident Co. of Canada v. Cie F.X. Drolet, 1944 46 (SCC), [1944] S.C.R. 82; Civ. 1^re, November 24, 1954, J.C.P. 1955.II.8565, obs. H. B.; Civ. 1^re, January 19, 1965, D. 1965.389, obs. Cornu; Com., November 6, 1978, J.C.P. 1979.II.19178, obs. Ghestin; Com., October 8, 1973, J.C.P. 1975.II.17927, obs. Ghestin; Civ. 3^e, October 30, 1978, J.C.P. 1979.II.19178; Tony’s Broadloom & Floor Covering Ltd. v. NMC Canada Inc. (1995), 1995 7153 (ON SC), 22 O.R. (3d) 244, aff’d (1996), 1996 680 (ON CA), 31 O.R. (3d) 481; Jenkins v. Foley (2002), 215 Nfld. & P.E.I.R. 257, 2002 NFCA 46; Parlby Construction Ltd. v. Stewart Equipment Co., 1971 1426 (BC SC), [1972] 1 W.W.R. 503; Guarantee Co. of North America v. Gordon Capital Corp., 1999 664 (SCC), [1999] 3 S.C.R. 423; Hunter Engineering Co. v. Syncrude Canada Ltd., 1989 129 (SCC), [1989] 1 S.C.R. 426; R. G. McLean Ltd. v. Canadian Vickers Ltd., 1970 386 (ON CA), [1971] 1 O.R. 207; Bank of Montreal v. Bail Ltée, 1992 71 (SCC), [1992] 2 S.C.R. 554.

Statutes and Regulations Cited

Act respecting the implementation of the reform of the Civil Code, S.Q. 1992, c. 57, ss. 4, 83, 85.

Civil Code of Lower Canada, arts. 1522, 1523, 1524, 1527, 1528, 2202.

Civil Code of Québec, S.Q. 1991, c. 64, arts. 6, 7, 1375, 1473, 1726, 1728, 1729, 1733, 2847.

Code civil (France), arts. 1641, 1642, 1643, 1644, 1645.

Authors Cited

Barreau du Québec. Cours de la formation professionnelle 1988‑1989. Droit civil et procédure civile, vol. 3, Contrats et vente. “La vente 1” par Jacques Deslauriers. Cowansville, Qué.: Yvon Blais, 1988, 51.

Barret, Olivier. “Vente”, dans P. Raynaud, dir., Répertoire de droit civil, t. X, 2^e éd. Paris: Dalloz, 1979 (mise à jour 2007).

Bénabent, Alain. Droit civil: Les contrats spéciaux civils et commerciaux, 5^e éd. Paris: Montchrestien, 2001.

Cornu, Gérard. Observation sous Civ. 1^re, 19 janvier 1965, Rev. trim. dr. civ. 1965.665.

Cornu, Gérard. Observation sous Com.,6 novembre 1978 et Civ. 3^e, 30 octobre 1978, Rev. trim. dr. civ. 1979.392.

Côté, Pierre‑André, et Daniel Jutras. Le droit transitoire civil: Sources annotées. Cowansville, Qué.: Yvon Blais, 1994 (mise à jour février 2006, envoi n^o 17).

Edwards, Jeffrey. La garantie de qualité du vendeur en droit québécois. Montréal: Wilson & Lafleur, 1998.

Fridman, G. H. L. The Law of Contract in Canada, 5th ed. Toronto: Thomson/Carswell, 2006.

Huet, Jérôme. Les principaux contrats spéciaux, 2^e éd. Paris: L.G.D.J., 2001.

Jobin, Pierre‑Gabriel. “Précis on sale”, in Reform of the Civil Code, vol. 3A, Sale. Texts written for the Barreau du Québec and the Chambre des notaires du Québec. Translated from the French by J. Daniel Phelan with assistance from Susan Altschul. Montréal: Barreau du Québec, 1993.

Lamontagne, Denys‑Claude. Droit de la vente, Cowansville, Qué.: Yvon Blais, 1995.

Langelier, F. Cours de droit civil de la province de Québec, t. V. Montréal: Wilson & Lafleur, 1909.

le Tourneau, Philippe. La responsabilité civile, 3^e éd. Paris: Dalloz, 1982.

Mignault, P.-B. Le droit civil canadien, t. VII. Montréal: Wilson & Lafleur, 1906.

Pothier, Robert Joseph. Œuvres de Pothier, t. II. Nouvelle édition publiée par M. Dupin. Paris: Béchet Ainé, 1823.

Pourcelet, Michel. La vente, 5^e éd. Montréal: Thémis, 1987.

Québec. Ministère de la Justice. Commentaires du ministre de la Justice — Le Code civil du Québec: Un mouvement de société, t. I et III. Québec: Publications du Québec, 1993.

Rousseau‑Houle, Thérèse. Précis du droit de la vente et du louage, 2^e éd. Québec: Presses de l’Université Laval, 1986.

Traité de droit civil du Québec, t. 11, par Léon Faribault. Montréal: Wilson & Lafleur, 1961.

APPEAL from a judgment of the Quebec Court of Appeal (Forget, Rochette and Bich JJ.A.), [2005] R.J.Q. 2267, [2005] Q.J. No. 11604 (QL), 2005 QCCA 733, setting aside in part a judgment of Hilton J., 2003 52306 (QC CS), [2003] R.J.Q. 2194, SOQUIJ AZ‑50181950, [2003] Q.J. No. 9442 (QL). Appeal dismissed.

APPEAL from a judgment of the Quebec Court of Appeal (Forget, Rochette and Bich JJ.A.), [2005] Q.J. No. 11601 (QL), 2005 QCCA 730, setting aside a judgment of Hilton J., 2003 52306 (QC CS), [2003] R.J.Q. 2194, SOQUIJ AZ‑50181950, [2003] Q.J. No. 9442 (QL). Appeal dismissed.

APPEAL from a judgment of the Quebec Court of Appeal (Forget, Rochette and Bich JJ.A.), [2005] R.R.A. 1046, [2005] Q.J. No. 11603 (QL), 2005 QCCA 732, affirming a judgment of Hilton J., SOQUIJ AZ‑50181803, [2003] Q.J. No. 13846 (QL). Appeal dismissed.

Éric Mongeau, Patrick Girard and Charles Nadeau, for the appellants ABB Inc., Alstom Canada Inc. and Chubb Insurance Company of Canada.

Olivier F. Kott, Gregory B. Bordan, André Legrand and Emmanuelle Demers, for the appellant/respondent Domtar Inc.

Gordon Kugler and Stuart Kugler, for the respondent Arkwright Mutual Insurance Company.

English version of the judgment of the Court delivered by

[1] LeBel and Deschamps JJ. — The development of Quebec’s law of obligations has been marked by efforts to strike a proper balance between, on the one hand, the individual’s freedom of contract and, on the other, adherence by contracting parties to the principle of good faith in their mutual relations. This trend in the law of obligations has had a profound influence on the choices made by the Quebec legislature and on the decisions of our courts. It should of course inform the approach of parties to a contract of sale to the exercise of their rights and the performance of their obligations.

[2] There are three appeals before the Court. The main case involves a claim concerning a latent defect and pits two major industrial concerns against one another. The other two cases involve incidental claims against insurance companies. This judgment deals with all three of these cases, but we will first discuss the main case, its origins and the issues it raises with regard to the nature and application of certain aspects of the legal framework of contracts of sale in Quebec civil law.

[3] Our analysis will focus on the legal warranty against latent defects. We will discuss, inter alia, the effect of the parties’ level of expertise on their mutual obligations, and the nature of the civil law presumptions regarding knowledge of certain defects. As part of this discussion, we will consider the right of sellers to set limitation of liability clauses up against buyers. Thus, after reviewing the facts and the judicial history, we will discuss the relevant principles and how they apply to the facts of the case at bar.

1. Facts

1.1 Acquisition of a Recovery Boiler by Domtar

[4] Domtar Inc. is a Canadian paper manufacturer whose principal activities consist of the production of pulp and paper and of related by‑products. In 1984, it decided to build a new pulp and paper mill in Windsor, Quebec. It retained H.A. Simons and Sandwell & Company Limited (“Simons‑Sandwell”) as consultants for all aspects of the construction of the mill, including the acquisition of a recovery boiler.

[5] Combustion Engineering Canada Inc. (“C.E.”) (now ABB Inc. and Alstom Canada Inc.) was an international company in the business of manufacturing and installing industrial equipment. It was the largest producer of recovery boilers in Canada. In August 1984, it offered to sell Domtar a recovery boiler with rigid “H‑style” tie welds for $13,500,000. Domtar accepted C.E.’s offer on December 31, 1984, and the boiler was put into service on September 21, 1987.

[6] The recovery boiler purchased by Domtar was a complex and massive piece of equipment. Its upper portion was equipped with a superheater divided into three banks: the Low Temperature Superheater (“LTSH”), the Intermediate Temperature Superheater (“ITSH”) and the High Temperature Superheater (“HTSH”). These banks consisted of 75 miles of tubes, which were connected together by approximately 48,000 tie welds. A recovery boiler, whose purpose is the recovery of black liquor, is designed to be in continuous use, apart from scheduled maintenance periods.

1.2 Appearance of Cracks in and Leaks from the Superheater’s Tubes

[7] In the 1970s, C.E. had noted that the design of the “A‑style” tie welds it was then using was causing cracks to form. To remedy this, it adopted a new design in 1977: the H‑style tie weld. Believing that it had in so doing solved the cracking problem, C.E. did not conduct a stress analysis of the new H‑style welds. Instead, it waited for comments from its buyers. Between January 1983 and the end of 1986, a number of internal memoranda were circulated at C.E., and at its parent company, regarding problems with the use of H‑style tie welds and the resulting dissatisfaction of their customers in the United States and Canada. Furthermore, C.E. had also been using flexible hinge‑pin attachments since the early 1980s, and these were recommended to one customer in 1985.

[8] Nevertheless, the technical specifications set out in the tender prepared by C.E. for Domtar in August 1984 did not propose a specific type of attachment. Only one discussion on this subject has been mentioned, and it took place during a meeting in October 1984. At that meeting, Domtar’s project manager asked C.E. if it would be possible to obtain hinge‑pin attachments instead of tie welds. C.E.’s answer was limited to confirming that this was possible and mentioning that this solution would cost an additional $500,000. Domtar did not pursue the matter further.

[9] According to Hilton J., the trial judge, it was mentioned in an internal C.E. memorandum in May 1987 that most of the proposals C.E. was submitting to customers involved the use of hinge pins. The author of the memorandum added that for C.E.’s engineering branch, which was responsible for preparing its proposals, hinge‑pin attachments had become the new standard. C.E. accordingly began offering hinge‑pin attachments in 1988, but to keep its prices competitive, it proposed them only where there were problems with the tie welds or if a buyer specifically requested hinge pins. It did not actually adopt hinge‑pin attachments as its standard until the following year. C.E. did not cease entirely to use H‑style tie welds, as it still uses them to this day for certain new boilers and for repairs to existing boilers that were delivered with tie welds.

[10] On March 24, 1989, 18 months after the boiler was put into service, Domtar shut it down for an unscheduled inspection after the superheater began making an unusual noise. Standard tests revealed 6 leaks and 97 cracks in the ITSH; another 667 cracks were detected in the HTSH. Domtar asked C.E. to make the necessary repairs. During this shutdown, only 20 percent of the welds were inspected in detail. C.E. replaced 99 tie welds in the ITSH and 690 in the HTSH with hinge‑pin attachments. The recovery boiler was not returned to service until April 6, 1989.

1.3 Decision to Replace the Superheater

[11] After the boiler was returned to service, the parties held discussions with a view to finding a permanent solution to the problem. Domtar asked C.E. to repair the superheater, but C.E. refused. It proposed to Domtar that the HTSH section be replaced with a new one using more hinge‑pin attachments, and that all tie welds in the LTSH and ITSH sections be inspected. Domtar instead decided to replace the entire superheater.

[12] Because of the disagreement, Domtar initiated legal proceedings against C.E. It also sued a number of insurers, including Underwriters at Lloyd’s (“Lloyd’s”), in respect of the damage resulting from the purchase of the boiler from C.E. On June 12, 2001, in an agreement entitled “Confidential Settlement Agreement and Release”, Domtar agreed to waive a series of insurance claims against Lloyd’s in exchange for a total payment of US$10,500,000, including US$1,000,000 expressly identified as being for the settlement “of all past, present and future claims of any and all other types” (Domtar inc. v. A.B.B. inc., 2003 52306 (QC CS), [2003] R.J.Q. 2194 (Sup. Ct.) (“Domtar”), at para. 228). In accordance with the agreement, it discontinued its action against Lloyd’s.

[13] Domtar also claimed the enforcement of a performance bond under which Chubb Insurance Company of Canada (“Chubb”) stood surety for C.E. in respect of its obligations to Domtar. In a second case, Domtar sued Arkwright Mutual Insurance Company (“Arkwright”) under an all risk insurance policy issued to it.

[14] In October 1989, Babcock & Wilcox (“B. & W.”), another recovery boiler manufacturer, replaced the three banks of the C.E. superheater with elements installed using hinge‑pin attachments. After this, a comprehensive analysis of the C.E. superheater revealed three new leaks and a tube failure in the ITSH, as well as 272 cracks in the HTSH, 463 in the ITSH and 124 in the LTSH. The depth of some of the cracks in the ITSH exceeded 50 percent of the thickness of one of the tubes. Domtar used the B. & W. superheater for 10 years without any reported leaks or unscheduled shutdowns because of leaks. This superheater was replaced in 1999.

2. Judicial History

2.1 Quebec Superior Court

[15] According to Hilton J., the cracks and leaks related to the use of tie welds did not constitute a design defect, but rather a design feature of the superheater, since the superheater could be used for its intended purpose despite the cracks. However, he found that C.E. had not discharged its duty to inform, since it had not given Domtar the information it possessed about the respective characteristics of tie welds and hinge‑pin attachments. The judge was satisfied that Domtar would have opted for hinge‑pin attachments had it received this information from C.E. He also felt that while it might have been open to C.E. to set up the limitation of liability clause against a latent defect claim, C.E. could not invoke the clause in the instant case to defend against the consequences of the breach of its duty to inform Domtar. The trial judge condemned C.E. to pay the damages agreed upon by the parties, less the $1,578,900 (US$1,000,000) paid by Lloyd’s, on the basis that Lloyd’s was, as a result of that payment, subrogated to Domtar’s rights.

[16] Finally, because he had found that there was no latent defect, the trial judge dismissed the action against Chubb relating to the performance bond: 2003 52306 (QC CS), [2003] R.J.Q. 2194. In a separate judgment, he also dismissed Domtar’s claim against its other insurer, Arkwright, on the basis that the damage connected with the superheater did not constitute an insured loss: SOQUIJ AZ‑50181803.

2.2 Quebec Court of Appeal

[17] Although it did not question the trial judge’s findings of fact, the Court of Appeal ruled that C.E. was liable on the basis of the legal warranty against latent defects. According to the Court of Appeal, the evidence clearly established that Domtar was looking for a reliable boiler that would operate without interruption, and that C.E. was aware of this. Domtar would not have purchased this boiler had it known that the tie welds would cause unscheduled shutdowns. The Court of Appeal then considered C.E.’s duty to inform. Like the trial judge, it held that C.E. had breached its duty to inform Domtar. Since C.E. knew or was presumed to have known about the defect, it could not rely on the limitation of liability clause. In the Court of Appeal’s opinion, Domtar was accordingly entitled to replace the entire superheater at C.E.’s expense. However, the Court of Appeal disagreed with the trial judge on deducting the $1,578,900 paid by Lloyd’s. It therefore allowed Domtar’s cross‑appeal and increased the quantum of the order against C.E. accordingly: [2005] R.J.Q. 2267, 2005 QCCA 733.

[18] The Court of Appeal condemned the insurer Chubb, solidarily with C.E., to pay Domtar $725,938.90 based on the performance bond: [2005] Q.J. No. 11601 (QL), 2005 QCCA 730. Finally, in the action against the insurer Arkwright, the Court of Appeal dismissed Domtar’s appeal on the basis of the clause excluding from coverage losses resulting from latent defects: [2005] R.R.A. 1046, 2005 QCCA 732.

3. Analysis

3.1 Issues

[19] In the main case, the parties put five questions to this Court. First, was there a latent defect in the superheater? Second, did C.E. breach its duty to inform or Domtar its duty to inquire? Third, in what circumstances may a limitation of liability clause be set up against a buyer? Fourth, is Domtar entitled to recover the costs it incurred to replace the superheater? Fifth, was Lloyd’s subrogated to Domtar’s rights in respect of the payment it made to Domtar?

[20] In the two incidental cases, the parties ask the Court to decide whether Domtar may require Chubb to execute its performance bond and whether the replacement of the superheater is a loss covered by Arkwright’s all risk insurance policy.

[21] We will begin by summarizing the parties’ arguments and reviewing the most important of the relevant statutory provisions. We will then turn to the questions of law raised in the three cases.

3.2 Arguments of the Parties in the Main Case

[22] C.E. has changed its arguments since the case began. At first, one of its main submissions was that the problems were due to improper use of the superheater. This defence has been abandoned. C.E. now submits that the rigidity of the attachments or the cracking inside the superheater does not constitute a latent defect. It argues that Domtar, as an informed user of recovery boilers, cannot claim to have been unaware of the characteristics of tie welds and hinge‑pin attachments and that Domtar breached its own duty to inquire.

[23] C.E. also submits that it was protected by a limitation of liability clause because Domtar had a power of negotiation equal to its own. In C.E.’s view, the voluntary agreement of the parties must therefore prevail. Finally, C.E. argues that Domtar failed to mitigate its damages and that the $1,578,900 payment by Lloyd’s to Domtar should reduce Domtar’s claim against C.E. accordingly.

[24] Domtar defends the Court of Appeal’s conclusion that there was a latent defect in the superheater. According to Domtar, C.E. knew or should have known at the time of the sale about the problem with the type of attachments to be used and should have proposed hinge‑pin attachments to Domtar. It therefore breached its duty to inform with regard to the likelihood of leaks and cracks associated with the use of tie welds. The decision to replace the superheater was reasonable in light of the information disclosed by C.E.

[25] Before turning to the merits of the case, we must resolve two preliminary questions. First, in light of the date and nature of the claim, is it the Civil Code of Lower Canada (“C.C.L.C.”) or the Civil Code of Québec, S.Q. 1991, c. 64 (“C.C.Q.”), that applies under the transitional law rules? Second, did the Court of Appeal have jurisdiction to interfere with the trial judge’s conclusion that there was no latent defect?

3.3 Transitional Law

[26] The main case concerns a contract of sale signed by the parties on December 31, 1984. As mentioned above, the parties’ arguments require that this Court determine whether there was a latent defect in the superheater and, if so, whether C.E. may rely on a limitation of liability clause.

[27] Section 83 of the Act respecting the implementation of the reform of the Civil Code, S.Q. 1992, c. 57 (“A.I.R.C.C.”), provides that the rules of the C.C.L.C. governing legal and conventional warranties continue to apply to a contract entered into before 1994. It reads as follows:

83. In any contract made before 1 January 1994, the former legislation continues to apply to the warranties, both legal or conventional, to which the contracting parties are obliged between themselves or in respect of their heirs or successors by particular title.

This provision represents a specific application of the general rule in s. 4 A.I.R.C.C. that the former supplementary legislation subsists for the purpose of determining the extent and scope of the parties’ rights and obligations and the effects of the contract: Commentaires du ministre de la Justice (1993), vol. 3, at p. 71.

[28] Section 83 A.I.R.C.C. is complemented in civil liability matters by s. 85 A.I.R.C.C. which reads as follows:

85. The conditions of civil liability are governed by the legislation in force at the time of the fault or act which causes the injury.

In his commentary on this provision (at p. 72), the Minister of Justice took care to specify

[translation] that since the conditions of civil liability are thus governed by the legislation in force at the time of the injurious fault or act, the grounds for exemption from liability, which are necessarily tied to the conditions of that liability, will also be governed by that same legislation . . . .

[29] Sections 83 and 85 A.I.R.C.C. belong to the chapter setting out special provisions (ss. 11 to 170). In the event of conflict, they take precedence over the Act’s general provisions (ss. 2 to 10): P.‑A. Côté and D. Jutras, Le droit transitoire civil: Sources annotées (loose‑leaf), at pp. I/3‑1 et seq.

[30] In the case at bar, Domtar has brought against C.E. an action in contract for damages that is based on the warranty against latent defects. All the facts alleged in support of this action occurred before 1994. In light of ss. 83 and 85 A.I.R.C.C., we conclude that in this case, the issues relating to the warranty against latent defects must be resolved by applying the C.C.L.C.

[31] This being said, whether it is the C.C.L.C. or the C.C.Q. that is applied will have no impact on the outcome of the case, since the C.C.Q. essentially reproduces the C.C.L.C.’s rules where the warranty against latent defects in issue here is concerned, despite certain changes in the wording of the provisions relating to the issues of this case. The relevant provisions are reproduced in the Appendix.

[32] Finally, the issue of subrogation in respect of the payment made by Lloyd’s and the incidental actions involving Chubb and Arkwright do not raise any special problems of transitional law. The answers to these questions depend essentially on a review of the stipulations in the contracts between the parties.

[33] At this point, it will be necessary to consider whether the Court of Appeal had the authority to interfere with the trial judge’s finding that there was no latent defect. C.E. contests the legitimacy of the Court of Appeal’s recharacterization of the defects as latent defects, which it sees as improper interference with the trial judge’s assessment of the facts.

3.4 Standard for Intervention by the Court of Appeal

[34] In discussing the Court of Appeal’s position, it is important to clearly understand the nature of its intervention with regard to the facts. Some fundamental distinctions must be drawn. In Desgagné v. Fabrique de St‑Philippe d’Arvida, 1984 129 (SCC), [1984] 1 S.C.R. 19, this Court distinguished the simple assessment of facts from the legal characterization of those facts. Thus, an appellate court has the power, in exercising its jurisdiction, to reach its own legal characterization of the facts even though it accepts the trial judge’s assessment of them. Beetz J. stated the following (at p. 31):

Counsel for the respondents and appellant Lauréanne Harvey Desgagné argued that the gradual appearance of the construction defects is a question of fact which is within the exclusive province of the trial judge. That is not my view. Rather, I think it is a question of characterization and so considerably more than a simple question of fact. It is necessary to apply to the facts the legal concept of gradual emergence under art. 2259, just as, for example, in a civil liability case the Court has to decide whether a person’s act or omission should be characterized as fault within the meaning of art. 1053. This requires making an essentially normative judgment. It therefore does not entail substituting my own view of the evidence for that of the trial judge, but drawing conclusions in law based on the facts which she herself considered to have been established. When an appellate court accepts all the conclusions of fact as such made by the trial judge, as I do, it is in as good a position as he is to characterize those facts.

[35] A few years later, in Placement Jacpar Inc. v. Benzakour, 1989 976 (QC CA), [1989] R.J.Q. 2309, at p. 2318, the Court of Appeal confirmed that the legal nature of the distinction between a latent defect and an apparent defect is also a question of law:

[translation] To [Benzakour], the characterization of a latent defect is essentially a question of fact. With respect for the opinion expressed in Lafontaine v. Audet, in which this question was seen primarily as one coming within the trier of fact’s power of assessment [p. 8 of the reasons of Monet J.A.], this Court’s position appears instead to be that this is a legal characterization issue. This Court is in as good a position as the trial judge to rule on it once the trial judge has established the facts on which the conclusions are based.

See to the same effect: Marquis v. Saltsman, 2002 41228 (QC CA), J.E. 2002‑1729 (C.A.), SOQUIJ AZ‑50143509, at para. 51; Rousseau v. 2732‑1678 Québec inc., [1999] R.D.I. 565 (C.A.), at pp. 568‑69; Société en commandite A.C. enr. v. Wadieh, 1997 9977 (QC CA), [1997] R.D.I. 345 (C.A.), at p. 348; Bertrand v. Pelletier, [1997] R.D.I. 321 (C.A.), at p. 325; Poirier v. Martucelli, [1995] R.D.I. 319 (C.A.), at p. 320; Trottier v. Robitaille, [1994] R.D.I. 537 (C.A.), at p. 538; Cloutier v. Létourneau, 1992 3716 (QC CA), [1993] R.L. 530 (C.A.), at p. 531; Rousseau v. Gagnon, 1986 3706 (QC CA), [1987] R.J.Q. 40 (C.A.), at p. 46.

[36] In the instant case, the Court of Appeal began by noting that the parties were not contesting the trial judge’s findings of fact (2005 QCCA 733, [2005] R.J.Q. 2267, at para. 42). Thus, because tie welds were used, it was inevitable that cracks would develop, and probable that leaks would occur (paras. 100‑101). According to the Court of Appeal, the trial judge had not attached enough importance to Domtar’s intention to keep the recovery boiler in continuous use. It noted that the trial judge had found even so that Domtar would not have purchased the boiler had it known that the tie welds were likely to cause unscheduled shutdowns. Because the unscheduled shutdowns of the boiler resulted in an inability to use it, the Court of Appeal characterized this defect as a latent defect.

[37] In intervening, the Court of Appeal did not reassess the evidence in the record. Rather, it relied directly on the trial judge’s findings of fact to arrive at a different conclusion of law regarding the nature of the defect (at para. 99):

[translation] The trial judge did not find that there was a latent defect in the equipment sold. With respect, we are of the opinion that his findings of fact should have led him to an affirmative conclusion on this point. [Emphasis added.]

This conclusion is not inconsistent with the principle of deference for a trial judge’s assessment of the facts. Rather, the issue here is one of legal characterization, and therefore a question of law. Consequently, the Court of Appeal had the power to vary the trial judge’s finding on the existence of a latent defect. Now that these preliminary issues have been settled, we will turn to the issue of the legal warranty against latent defects in a contract of sale governed by the C.C.L.C.

3.5 Effect of the Status of the Manufacturer and the Buyer on Their Obligations Under the Contract of Sale

[38] In the case at bar, C.E. argues that a separate scheme must govern contracts of sale between professional sellers and professional buyers. In its view, the seller’s warranty against latent defects should vary depending on the respective expertise of the seller and the buyer. It will therefore be necessary to consider the legal effect of this expertise on rights and obligations under a contract of sale.

[39] Where the warranty against latent defects is concerned, the characterization of a party as a manufacturer or a professional seller plays an important role in determining whether that party can be presumed to have known about the defects in the good offered for sale. Article 1527 C.C.L.C. provides that any seller who knows or is legally presumed to know about the defects of the thing is obliged to pay for all damage suffered by the buyer. This provision has been interpreted in Quebec civil law as recognizing three categories of sellers corresponding to the individual’s level of expertise: manufacturers, professional sellers (specialized or non‑specialized) and non‑professional sellers.

[40] This categorization will determine whether the presumption of knowledge on the seller’s part is applicable and will also, as a corollary, determine the scope of the seller’s duty to disclose latent defects. Thus, a non‑professional seller is not legally presumed to know about the defects of the good being sold, since selling the good in question is not this person’s usual occupation. Professional sellers, however, being far more aware of the characteristics of their merchandise, are subject to the presumption of knowledge.

[41] In the case at bar, the category of sellers that interests us most is that of the manufacturer. Manufacturers are considered to be the ultimate experts with respect to the goods, because they have control over the labour and materials used to produce them: J. Edwards, La garantie de qualité du vendeur en droit québécois (1998), at p. 289. Moreover, buyers are entitled to expect that manufacturers guarantee the quality of the products they design and market. Consequently, manufacturers are subject to the strongest presumption of knowledge and to the most exacting obligation to disclose latent defects.

[42] In the context of the warranty against latent defects, the buyer’s expertise is also relevant to the analysis, but for a different purpose than the seller’s expertise. Whereas the seller’s expertise serves to determine the scope of his or her obligation to disclose, that of the buyer serves, rather, to assess whether the defect is latent or apparent. Thus, the more knowledge a buyer has of a good being purchased, the more likely it is that a defect in that good will be considered apparent. An apparent defect is one that the buyer either detected at the time of the sale or could have detected given his or her knowledge (art. 1523 C.C.L.C. and art. 1726, para. 2 C.C.Q.). Buyers therefore have an obligation to inform themselves by carrying out a reasonable inspection of the good. In all cases, the test is whether a reasonable buyer in the same circumstances could have detected the defect at the time of the sale.

[43] We will conclude the discussion in this section with a few comments on the specific situation raised by the parties in the case at bar, that is, where the seller and the buyer are characterized as [translation] “professionals of identical expertise”, in which case they would be able to contract out of the warranty against latent defects. This argument is based on three judgments of the Quebec Court of Appeal: Auto Peliss ltée v. Proulx Pontiac Buick ltée, 2001 5911 (QC CA), [2001] R.J.Q. 856; Garage Robert inc. v. 2426‑9888 Québec inc., 2001 9967 (QC CA), [2001] R.J.Q. 865; Trois Diamants Autos (1987) ltée v. M.G.B. Auto inc., 2001 39923 (QC CA), [2001] R.J.Q. 860.

[44] The position taken by the Court of Appeal in this trilogy of cases does not support the appellants’ argument. The court’s decisions did not relate to the situation of a manufacturer. Nor did the court recognize a presumption of knowledge on the buyer’s part that would be incompatible with the warranty against latent defects. Furthermore, the position taken by this Court on the manufacturer’s warranty in General Motors Products of Canada v. Kravitz, 1979 22 (SCC), [1979] 1 S.C.R. 790, is clear. In that case, at pp. 798‑99, the Court confirmed that, for the purposes of art. 1527 C.C.L.C., a manufacturer and a professional seller are always presumed to be in bad faith and that the fraudulence associated with the manufacturer’s actual or presumed knowledge of a defect is unaffected by the professional status of a buyer who is a dealer. The implication of this line of reasoning is that the buyer’s expertise does not nullify the presumption applicable to the manufacturer. Even if a professional buyer is personally in the business of selling a manufacturer’s automobiles, he or she cannot be considered to have the same expertise as the manufacturer. Professional buyers, too, are protected by the warranty against latent defects. If a defect is latent, the manufacturer will be unable to rely on a limitation of liability clause unless it can rebut the presumption of knowledge of the defect.

[45] At any rate, in the case at bar, C.E. is a manufacturer of recovery boilers, and Domtar bought one of C.E.’s boilers for use in the production of pulp and paper. However expert Domtar may be at using boilers, it cannot be characterized as a professional “of identical expertise” to C.E. As a manufacturer, C.E. had greater expertise than Domtar as regards the characteristics of the recovery boiler in question. The warranty against latent defects is applicable in this case.

3.6 Manufacturer’s Liability for Defects in the Item Sold

[46] When enforcing a legal warranty, a court must first determine whether there was a latent defect in the good sold. At this stage, the analysis relates essentially to the good and to the buyer’s conduct. Second, the court will determine whether the seller is liable; this part of the analysis consists in establishing whether the seller knew or is legally presumed to have known about the alleged defect. This determination will enable the court to decide whether a clause limiting the seller’s liability can be set up against the buyer. It is therefore important to distinguish the conditions of the seller’s liability for a latent defect from the scope of his or her liability.

3.6.1 Conditions of Liability: Existence of a Latent Defect

3.6.1.1 Different Types of Latent Defects

[47] The legislature has not expressly defined what constitutes a “defect”. Article 1522 C.C.L.C. does, however, contain some useful information. For example, the first criterion for determining whether a latent defect exists is the loss of use it causes. The purpose of the warranty against latent defects is thus to ensure that the buyer of a good will be able to make practical and economical use of it.

[48] There are three main types of latent defects: the material defect, which relates to a specific good; the functional defect, which relates to the good’s design; and the conventional defect, which arises where the buyer has disclosed that the good is to be put to a particular use. Material and functional defects are assessed in light of the normal use to which buyers put the good, whereas a conventional defect is assessed in light of the particular use indicated by the buyer to the seller. However, it is necessary, in discussing this classification, to briefly consider the problem of technological change.

[49] Technological change is a modern‑day reality that is characterized by the rapid pace at which improvements are made to products. The trial judge rightly noted that manufacturers are constantly redesigning their products: 2003 52306 (QC CS), [2003] R.J.Q. 2194, at para. 161. He was wary, and rightly so, of a tendency to condemn a manufacturer simply because a different version of the original product has since emerged on the market. Selling an improved or better performing version of a product does not render the previous version defective. Differences in quality and possible use between these two versions of the product cannot be characterized as a latent defect. The key factor in the analysis resides in the loss of use, as assessed in light of the buyer’s reasonable expectations.

[50] The categories of defects can sometimes overlap. In the case at bar, Domtar complains that the tie welds, which were integral to the superheater, compromised the normal operation of the boiler by causing cracks and unforeseeable shutdowns. According to Domtar, the argument that it should not have to accept untimely shutdowns flows from the very nature of the equipment purchased and from the fact that this equipment operates continuously. In this sense, the defect of which Domtar complains is both functional and conventional. However, regardless of how the defect is characterized, it must have four characteristics, all of which are essential to the warranty: it must be latent, must be sufficiently serious, must have existed at the time of the sale and must have been unknown to the buyer.

3.6.1.2 Latency of the Defect

[51] The latency of the defect is assessed objectively, that is, by reviewing the buyer’s examination of the good in light of what a prudent and diligent buyer of identical expertise would have done: P.‑G. Jobin, “Précis on sale”, in Reform of the Civil Code (1993), vol. 3A, at p. 61; M. Pourcelet, La vente (5th ed. 1987), at p. 149. In other words, the issue is not limited to ignorance of the defect; it must also be determined whether a reasonable buyer in the same circumstances would have realized that there was a defect.

3.6.1.3 Seriousness of the Defect

[52] Loss of use does not in itself suffice to support the conclusion that a latent defect exists. The loss must also be serious, that is, it must render the good unfit for its intended use or must so diminish its usefulness that the buyer would not have purchased it at the price paid. This second criterion, the seriousness of the defect, flows from the words of art. 1522 C.C.L.C. However, the defect does not have to render the good completely unusable but simply has to reduce its usefulness significantly in relation to the legitimate expectations of a prudent and diligent buyer.

3.6.1.4 Existence of the Defect at the Time of the Sale

[53] The defect must also have existed at the time of the sale. This third criterion was developed by the courts and commentators before being codified in art. 1726, para. 1 C.C.Q.: Commentaires du ministre de la Justice (1993), vol. I, at p. 1078. What this basically means is that a seller cannot be held liable for a defect caused by abnormal use of the good by the buyer.

3.6.1.5 Defect Unknown to the Buyer

[54] It is not enough for the defect to be latent. It must also be unknown to the buyer, as is required by the concluding words of art. 1522 in fine C.C.L.C. This criterion is assessed subjectively. Unlike the seller, the buyer is not subject to a presumption of knowledge, since the buyer is always presumed to be in good faith. As a result, the burden of proving actual knowledge of the defect always rests on the seller: Jobin, at p. 60; Pourcelet, at p. 149; T. Rousseau‑Houle, Précis du droit de la vente et du louage (2nd ed. 1986), at p. 134.

[55] The seller’s liability is not the same in every latent defect case. It will accordingly be necessary to review the conditions that determine the scope and applicability of the seller’s liability.

3.6.2 Scope of the Seller’s Liability

3.6.2.1 Presumption of Knowledge of Latent Defects on the Seller’s Part

[56] According to art. 1524 C.C.L.C., when a buyer has shown that a latent defect exists, the seller will be held liable “unless it is stipulated that he shall not be obliged to any warranty”. However, even if the contract contains a limitation of liability clause, the seller will not always be able to invoke it. Presumed or actual knowledge of the defect can, in certain circumstances, bar the seller from relying on such a clause. Since actual or presumed knowledge of a defect on the seller’s part is an indication of bad faith, the seller, in such a case, has not only to repay the sale price, but also to compensate the buyer for any damage caused by the latent defect. A limitation of liability clause may not be set up against the buyer if the seller knew or is legally presumed to have known about the defect: J. Deslauriers, “La vente 1”, in Cours de la formation professionnelle du Barreau du Québec 1988‑1989, vol. 3, 51, at p. 82; Pourcelet, at p. 160; Rousseau‑Houle, at pp. 135 and 156. The presumption of knowledge is thus determinative not only of the issue of whether a seller may limit the warranty against latent defects, but above all of that of the scope of the seller’s liability.

[57] Although the warranty against latent defects originated in Ancient Rome, the presumption of knowledge made its first appearance only in old French law, in particular in the works of DuMoulin, Domat and Pothier: Edwards, at p. 275. Before then, a seller had to have actual knowledge of a defect to be liable for it since all sellers were presumed to be in good faith. The new presumption came into being as a result of the work of certain authors, who were of the opinion that manufacturers and specialized sellers, by reason of their occupations, should know about any defects in their goods. According to Pothier, manufacturers should be considered to be masters of their craft and specialized sellers should be presumed to have a detailed knowledge of the products they sell, and both should accordingly be deprived of the protection afforded sellers in good faith:

[translation] There is one case in which the seller, despite having no knowledge whatsoever of the defect in the thing sold, is nevertheless obliged to make reparation for the wrong this defect has caused to the buyer in respect of the buyer’s other property: where the seller is an artisan, or a merchant who sells works of his craft, or of the trade that is his profession. Even if this artisan or merchant should claim not to know about the defect, he is obligated to make reparation for any damage the buyer has sustained because of the defect in using the thing for its intended purpose. . . . The reason is that an artisan, by profession of his craft, spondet peritiam artis. He becomes liable to all who contract with him for the quality of his works, when they are put to the use for which they are by nature intended. His incompetence or lack of knowledge in any aspect of his craft is a fault on his part, since no one should publicly profess a craft if he does not possess all the knowledge needed to exercise it properly: Imperitia culpae annumeratur; l. 132, ff. Reg. J. The same is true of the merchant, whether or not he is also the manufacturer. By reason of his public profession of his trade, he becomes liable for the quality of the wares he sells, when they are put to their intended use. If he is a manufacturer, he must employ, to make his wares, only good artisans, and he is answerable for this. If he is not a manufacturer, he must display only good wares for sale; he must have expert knowledge of his wares and sell only good ones. [Emphasis added.]

(Œuvres de Pothier (new ed. 1823), vol. II, No. 214)

[58] This passage, sometimes referred to as [translation] “Pothier’s rule”, was regarded as the main source of art. 1527, para. 2 C.C.L.C.: Edwards, at pp. 280‑81; Traité de droit civil du Québec, vol. 11, by L. Faribault, 1961, at p. 295; P.-B. Mignault, Le droit civil canadien (1906), vol. VII, 1906, at p. 112. Inspired by the principles enunciated by Pothier, the commissioners who drafted the C.C.L.C. introduced presumed knowledge into Quebec civil law: Edwards, at p. 276. This attributed knowledge is provided for in arts. 1527 and 1528 C.C.L.C. In principle, sellers are presumed to be in good faith (art. 2202 C.C.L.C.), but they will be held liable if they had actual knowledge of defects (art. 1527, para. 1 C.C.L.C.). Moreover, art. 1527, para. 2 C.C.L.C. relieves the buyer of the burden of proving bad faith on the seller’s part if the seller is legally presumed to have known about the defects. What remains is to identify the sellers to whom this presumption applies.

3.6.2.2 Sellers to Whom the Presumption of Knowledge Applies

[59] The authors agree that the presumption of knowledge under the C.C.L.C. applies to manufacturers and to specialized professional sellers. Thus, they would not apply it to non‑specialized professional sellers or non‑professional sellers, since such sellers lack technical expertise or commercial experience with respect to the good, which makes it impossible for them to personally verify the quality of the good: Pourcelet, at p. 158; Rousseau‑Houle, at pp. 139‑52; F. Langelier, Cours de droit civil de la province de Québec, vol. V, 1909, at p. 77; Mignault, at p. 118.

[60] It should be noted, however, that since the enactment of art. 1733 C.C.Q., the presumption of knowledge has applied to all professional sellers without distinction. Only non‑professional sellers are now exempt from the presumption.

3.6.2.3 Rebuttable Nature of the Presumption of Knowledge

[61] The nature of the presumption must now be examined to determine its effect, that is, whether it can ultimately be rebutted and, if so, under what conditions. This Court has considered this question in a number of judgments. Samson & Filion v. Davie Shipbuilding & Repairing Co., 1924 57 (SCC), [1925] S.C.R. 202, was one of the first leading decisions in which the presumption of knowledge on the seller’s part was addressed. That case concerned the sale of used pipes. The contract of sale did not contain a limitation of liability clause. This Court held that the presumption of knowledge does not apply to a non‑professional seller with no expertise. Such a seller is not liable for damage caused by the good unless he or she had actual knowledge of the defect. Manufacturers and professional sellers ([translation] “who [sell] works of [their] craft, or of the trade that is [their] profession”), on the other hand, are subject to a presumption of knowledge, which is rebuttable.

[62] A few years later, this Court rendered its decision in Touchette v. Pizzagalli, 1938 39 (SCC), [1938] S.C.R. 433, which concerned the sale of a new car by a professional seller to a non‑professional buyer without the manufacturer’s involvement. Under the contract, the warranty was limited to the one provided by the manufacturer. The Court noted that professional sellers are presumed to know about any defects in the goods they sell, although it implicitly acknowledged that a manufacturer or a specialized professional seller can rebut the presumption of knowledge:

It is now settled that the seller is responsible in respect of all damages sustained by the purchaser by reason of latent defect where the seller is either a manufacturer or a person who deals in, as merchant, articles of the same kind as that which was the subject of the sale. Unless he can establish that the defect was such that it could not have been discovered by the most competent and diligent person in his position, his ignorance is no excuse, because it is conclusively presumed (in the absence of such proof) to be the result of negligence or of incompetence in the calling which he publicly practises and in respect of which he thereby professes himself to be competent. The principle is spondet peritiam artis. [Emphasis added; p. 439 (per Duff C.J.).]

[63] As mentioned above, this Court noted in Kravitz that, in the context of the warranty against latent defects, the manufacturer and professional seller of a defective good are presumed to be in bad faith (p. 798). In that case, the Court went even further, however, refusing to allow the manufacturer to transfer its liability to the dealer despite the dealer’s professional knowledge (at p. 798):

What is the situation when, as in the case at bar, the manufacturer has sold a new thing to a dealer who is himself a professional seller? If the latter is presumed to be aware of the defects when he resells the thing, does it not follow that he is also presumed to be aware of them when he buys it from the manufacturer? While this reasoning could have some appeal in certain circumstances, it cannot serve to exempt the manufacturer from his liability for latent defects in the thing he has manufactured when he sells it to a dealer who is responsible for reselling it. The manufacturer of a defective thing must assume the ultimate responsibility for his incompetence, actual or presumed. The bad faith of the professional seller toward the non‑professional buyer does not convert the “dol” of the manufacturer toward his dealer into an act of good faith. [Emphasis added.]

[64] The Court then analysed the sub‑purchaser’s action against the dealer and noted that in France, limitation of liability clauses do not relieve manufacturers of liability since the presumption of knowledge applicable to them is not rebuttable (pp. 799‑801). The Court did not rule on the nature of the presumption of knowledge applicable to manufacturers (p. 802). It simply concluded that neither the limitation of liability clause included by the dealer in the contract of sale nor the manufacturer’s limited warranty could be a bar to the sub‑purchaser’s extra‑contractual remedy against the manufacturer based on the warranty against latent defects.

[65] Some authors have cited the principles enunciated by Pothier or the reference in Kravitz to French law as a basis for stating that the presumption of knowledge is irrebuttable, where manufacturers and specialized professional sellers are concerned, because of their duty to be masters of their craft. But these authors concede that the presumption remains rebuttable for non‑specialized professional sellers who have no control over the manufacture of the product and no specific knowledge of the product: Edwards, at pp. 289‑94; Pourcelet, at pp. 158‑59; Mignault, at p. 113.

[66] However, the majority view in Quebec law is that the presumption of knowledge provided for in art. 1527 C.C.L.C. is rebuttable, even for manufacturers: Manac inc./Nortex v. Boiler Inspection and Insurance Co. of Canada, 2006 QCCA 1395, [2006] R.R.A. 879 (C.A.); also Oakwood Construction Inc. v. Ratthé, [1993] R.D.I. 181 (C.A.), at p. 183; Blandino v. Colagiacomo, 1988 1193 (QC CA), [1989] R.D.I. 148 (C.A.), at pp. 151 and 153; Oppenheim v. Forestiers R.P.G.M. inc., J.E. 2002‑1197 (C.A.), SOQUIJ AZ‑50133145, at para. 24. Several authors have observed that it is very difficult for a manufacturer to rebut this presumption by showing the court that it was impossible to know about the defect: D.‑C. Lamontagne, Droit de la vente (1995), at pp. 103‑4; Jobin, at p. 62; Deslauriers, at p. 82; Faribault, at pp. 295‑96. Indeed, it has been pointed out that there are no known cases in which a manufacturer has in fact succeeded in rebutting the presumption: Rousseau‑Houle, at pp. 138‑52; Langelier, at p. 77.

[67] The new wording of the C.C.Q.’s provisions, which codify the case law under the C.C.L.C., confirms the majority view. In art. 1729 C.C.Q., the legislature kept the word “presumed” rather than using “deemed” (réputé). A presumption “concerning presumed facts is simple and may be rebutted by proof to the contrary” (art. 2847, para. 2 C.C.Q.). When the first and second paragraphs of art. 1733 C.C.Q. are read together, it is apparent that the legislature has provided that a professional seller who “was aware or could not have been unaware” of a defect cannot exclude his or her liability. In our opinion, if the legislature took care to mention two situations in which professional sellers cannot exclude their liability, this was because it realized that situations arise in which they might raise as a defence that they were not or could not have been aware of the defect in the thing. Otherwise, the legislature would simply have stated that professional sellers may not exclude their liability by contract.

3.6.2.4 Means of Rebutting the Presumption of Knowledge on the Manufacturer’s Part

[68] It can be seen from the case law and the academic commentaries that a single standard governs the defences available to all sellers to rebut the presumption of knowledge applicable to them. As this Court held in Samson & Filion, it must be determined whether a reasonable seller in the same circumstances would have been able to detect the defect at the time of the sale.

[69] Contrary to C.E.’s position, it is never open to a manufacturer to rely on its ignorance of the defect as its sole defence: Samson & Filion, Touchette and Kravitz. The manufacturer may rebut the presumption only by showing that it did not know about the defect and that its lack of knowledge was justified, that is, that it could not have discovered the defect even if it had taken every precaution that the buyer would be entitled to expect a reasonable seller to take in the same circumstances.

[70] The principle underlying this rule is that to absolve a manufacturer from liability will be justified if the manufacturer shows that it had full knowledge of the technology in its field at the time the good was designed and that the defect in question cannot be attributed to it. This principle is consistent with the idea that gave rise to the presumption of knowledge, as set out by Pothier, according to which manufacturers must be masters of their craft.

[71] Although the standard for a rebuttal of the presumption of knowledge will always be an objective one, the strength of the presumption will vary depending on the seller’s expertise. A non‑specialized professional seller will be able to rebut the presumption more easily than a specialized professional seller. Manufacturers will have difficulty rebutting it because they have special knowledge and because they are responsible for manufacturing the goods.

[72] Even though the possibility of manufacturers rebutting the presumption is accepted, the high standard of diligence they are required to meet means that the range of defences available to them remains very narrow. Only two defences have been recognized so far, and C.E. has invoked neither of them. Under the first of these defences, a manufacturer can rebut the presumption by proving causal fault on the part of the buyer or a third person, or superior force: Manac inc./Nortex, at para. 138; Commentaires du ministre de la Justice, vol. 1, at p. 902. The second defence is that of development risk, but it is still subject to debate in contract matters. This defence enables the manufacturer to avoid liability if it would have been impossible to detect the defect given the state of scientific and technical knowledge at the time the good was put on the market. In such a case, only scientific or technological discoveries made after the good was put on the market will have permitted the defect to be detected. This defence originated in London & Lancashire Guarantee & Accident Co. of Canada v. Cie F.X. Drolet, 1944 46 (SCC), [1944] S.C.R. 82, and is now partially codified in respect of extra‑contractual matters in art. 1473 C.C.Q.

3.6.2.5 Application of the Limitation of Liability Clause

[73] The rules discussed above mean that a professional seller who was aware of a defect or who has not rebutted the presumption of knowledge cannot avoid liability. Such a seller cannot rely on a limitation of liability clause, but is obliged to reimburse the buyer for the sale price and provide compensation for any damage resulting from the latent defect (art. 1527 C.C.L.C.).

3.6.3 Comparative Aspects

[74] Following this survey of the rules relating to latent defects in Quebec civil law, it may be of interest to consider the extent to which these rules resemble the rules of French law or those that are applied in the rest of Canada. In fact, every provision of the C.C.L.C. respecting the warranty against latent defects is a restatement of the rules of the French Civil Code (“F.C.C.”). It will therefore be interesting to see how the issues before the Court have been analysed in French law. Moreover, a brief review of the common law rules will show that they differ significantly from the applicable rules of Quebec law and French law.

3.6.3.1 French Law

[75] In French law, the conditions for enforcing the warranty against latent defects are essentially the same as in Quebec law: the defect must be serious, must have existed before ownership was transferred, and must be latent (arts. 1641 and 1642 F.C.C.).

[76] For the determination as to whether a defect is latent, the professional buyer is subject to a rebuttable presumption of knowledge of the defect: A. Bénabent, Droit civil: Les contrats spéciaux civils et commerciaux (5th ed. 2001), No. 226; see also O. Barret, “Vente”, in Répertoire de droit civil (2nd ed. (loose‑leaf)), vol. X, Nos. 563 and 565, and J. Huet, Les principaux contrats spéciaux (2nd ed. 2001), at pp. 329‑30. This presumption is stronger where the buyer is from the same field of expertise as the seller. However, professional buyers can rebut the presumption at any time by showing that it would have been impossible for them to detect the defect: Barret, Nos. 569 and 571, and Bénabent, No. 226.

[77] When the conditions for enforcing the warranty are met, the buyer has a redhibitory or an estimatory action against the seller (art. 1644 F.C.C.). It is also open to the buyer to seek damages if the seller knew about the defect (art. 1645 F.C.C.) or is presumed to have known about it. However, these actions may be subject to the application of limitation of liability clauses (art. 1643 F.C.C.).

[78] A professional seller is subject to a presumption of knowledge of latent defects in the good sold (Civ. 1^re, November 24, 1954, J.C.P. 1955.II.8565, obs. H.B.; also Civ. 1^re, January 19, 1965, D. 1965.389, and obs. G. Cornu, Rev. trim. dr. civ. 1965.665). This presumption is almost irrebuttable; the only exception is where it would have been impossible to detect the defect, and the parties are a professional seller and a professional buyer [translation] “from the same field of expertise”. This exception has rarely been applied by the courts, which have interpreted it narrowly: Com., November 6, 1978, J.C.P. 1979.II.19178, obs. J. Ghestin, and obs. G. Cornu, Rev. trim. dr. civ. 1979.392; also Huet, at pp. 348‑49, and P. le Tourneau, La responsabilité civile (3rd ed. 1982), at p. 375, No. 1183.

[79] Developments in French law relating to the presumption of knowledge on the part of professional sellers have incorporated the rules governing the presumption into the legal framework applicable to limitation of liability clauses and have confirmed that the presumption is almost irrebuttable. As a result, the analysis of the presumption of knowledge on the part of professional sellers also applies to the review of limitation of liability clauses. This means that such clauses are valid in principle (art. 1645 F.C.C.), but that they are inapplicable in cases involving professional sellers. On an exceptional basis, a professional seller will be able to invoke a limitation of liability clause if the buyer is a professional from the same area of expertise and if it would not have been impossible to detect the defect: Com., October 8, 1973, J.C.P. 1975.II.17927, obs. J. Ghestin; Civ. 3^e, October 30, 1978, J.C.P. 1979.II.19178, obs. J. Ghestin, and obs. G. Cornu, Rev. trim. dr. civ. 1979.392; Com., November 6, 1978, J.C.P. 1979.II.19178, obs. J. Ghestin, and obs. G. Cornu, Rev. trim. dr. civ. 1979.392. Thus, a professional seller will always be liable where it would have been impossible for the buyer to detect the defect, regardless of the buyer’s status.

3.6.3.2 Common Law

[80] In Canada, the common law rule is that a latent defect must affect an essential characteristic of the good and make that good unfit for its intended use: Tony’s Broadloom & Floor Covering Ltd. v. NMC Canada Inc. (1995), 1995 7153 (ON SC), 22 O.R. (3d) 244 (Gen. Div.), aff’d (1996), 1996 680 (ON CA), 31 O.R. (3d) 481 (C.A.); Jenkins v. Foley (2002), 215 Nfld. & P.E.I.R. 257, 2002 NFCA 46. The onus is on the buyer to prove that the latent defect was known to the seller or that the seller showed reckless disregard for what he or she should have known. However, where it has been established that the seller could have obtained information about an essential characteristic of the good, the seller cannot simply allege an honest belief: Parlby Construction Ltd. v. Stewart Equipment Co., 1971 1426 (BC SC), [1972] 1 W.W.R. 503 (B.C.S.C.), at pp. 507 and 509‑10.

[81] With some exceptions, provincial and territorial statutes generally allow sellers to limit the warranty against latent defects by contract. Contrary to French and Quebec law, the common law has no specific rule for the special case of professional sellers and buyers of identical expertise. In principle, a limitation of liability clause in a contract between two merchants will be valid unless it is declared to be unenforceable either for unconscionability or because failure to discharge the obligation to which it applies would amount to a fundamental breach of contract.

[82] Under the doctrine of unconscionability, a limitation of liability clause will be unenforceable where one party to the contract has abused its negotiating power to take undue advantage of the other. This doctrine is generally applied in the context of a consumer contract or contract of adhesion.

[83] Under the doctrine of fundamental breach, parties with equal bargaining power can, in certain cases, apply to have an unreasonable clause declared unenforceable on the basis that it does not reflect the intent of the parties. For this purpose, the breaching party’s failure to perform its obligations under the contract must be such that it “deprives the non‑breaching party of substantially the whole benefit of the agreement”: Guarantee Co. of North America v. Gordon Capital Corp., 1999 664 (SCC), [1999] 3 S.C.R. 423, at para. 50. Thus, the existence of a latent defect does not automatically amount to a fundamental breach of contract: G. H. L. Fridman, The Law of Contract in Canada (5th ed. 2006), at p. 592; the latent defect must be “irreparable”, or the good must be unusable: Hunter Engineering Co. v. Syncrude Canada Ltd., 1989 129 (SCC), [1989] 1 S.C.R. 426, at pp. 501‑2; Guarantee Co. of North America; R. G. McLean Ltd. v. Canadian Vickers Ltd., 1970 386 (ON CA), [1971] 1 O.R. 207 (C.A.), at pp. 211‑12.

[84] Once the existence of a fundamental breach has been established, the court must still analyse the limitation of liability clause in light of the general rules of contract interpretation. If the words can reasonably be interpreted in only one way, it will not be open to the court, even on grounds of equity or reasonableness, to declare the clause to be unenforceable since this would amount to rewriting the contract negotiated by the parties.

3.6.3.3 Conclusion on Comparative Law

[85] In short, owing to certain of its characteristics, the common law, to an even greater extent than French law, cannot easily be grafted on to Quebec civil law. Nor, despite the connections between Quebec civil law and French law, does it appear any more desirable to import the rules of the French system into Quebec law. What now remains to be considered is how to apply the Quebec rules to the facts of the instant case.

3.7 Analysis of C.E.’s Liability

[86] The trial judge made findings of fact. The Court of Appeal saw no palpable errors in them, and the parties have not asked us to review them. Only the conclusions of law drawn from those facts are in issue. As mentioned above, the trial judge concluded that the cracking of the tubes was a design feature rather than a design defect. Domtar contests this conclusion and argues that the cracking constitutes a latent defect. It must therefore be determined whether there was in fact a latent defect in C.E.’s recovery boiler and, if so, whether C.E. knew or is presumed to have known that there was such a defect.

3.7.1 Existence of a Latent Defect

3.7.1.1 Seriousness of the Loss of Use

[87] In the case at bar, the trial judge’s conclusion that the superheater did not have a latent defect was based on two errors he made in interpreting this first criterion. The first was to limit the definition of a defect to a problem preventing the good from being used at all, while the second was to confuse the sale of a lower‑performance version of a good with the sale of a defective one.

[88] A defect will be considered to be serious if it renders the good unfit for its intended use or so diminishes its usefulness that the buyer would not have bought it at the price paid (arts. 1522 C.C.L.C. and 1726 C.C.Q.). An example frequently cited by the authors is where a house is at risk of water damage owing to a crack in its foundation. The crack does not actually have to cause such damage for a latent defect to exist; it is enough that the crack exists and that it is likely to lead to serious damage.

[89] C.E. considers only the first aspect of the seriousness of the defect. According to its interpretation, the boiler could not be considered to be defective unless there were absolutely no possibility of it working. The trial judge, too, failed to ask whether the usefulness of the good had been diminished, as he stressed that the recovery boiler could continue to operate despite the cracks.

[90] In the instant case, the superheater was a new product at the time of delivery. After 18 months of use, 6 leaks had to be repaired, 789 H‑style tie welds had to be replaced, and 764 cracks were detected in the superheater’s various compartments. The cost of these repairs reached $445,483.57, and the boiler was out of service for 13 days. Six months later, a full inspection revealed 3 new leaks and 859 new cracks, including some that C.E.’s expert described as being severe and likely to cause new leaks. Domtar replaced the superheater two years after it was put into service. However, the trial judge himself stated that this type of machine is designed for continuous use, apart from scheduled shutdowns, and generally has a lifespan, free of major problems, of at least 15 years. The fact that Domtar noticed leaks by chance does not make the defect less serious, especially since so little time had elapsed since the equipment was put into service. This clearly suggests abnormal wear and tear of the machine. Furthermore, an engineer who testified for C.E. acknowledged that it should normally take 15 to 20 years for cracks to occur in the superheater tubes.

[91] For the defect to be considered serious, it was enough for there to be a problem with the boiler so serious that the buyer would not have purchased the boiler had it known about the problem. The trial judge himself concluded that Domtar would undoubtedly have elected to use hinge‑pin attachments, just as any other paper manufacturer provided with the relevant information about the two types of attachments would have done. He added that if Domtar had elected to use hinge‑pin attachments, it is probable that no leaks would have been discovered in the ITSH and that fewer cracks would have been found in the ITSH and HTSH. In our opinion, these findings of fact support the Court of Appeal’s conclusion that Domtar would not have bought a boiler with H‑style tie welds if it had been informed of the risks associated with this type of attachment.

[92] There is another problem with the trial judge’s characterization of the facts: the confusion between performance and defectiveness of a product. In the case at bar, C.E. submitted that the hinge‑pin attachments were simply of higher quality than the H‑style tie welds. While it is true that a manufacturer may design goods of varying quality, each version of a good must be fit for its intended purpose for as long as a buyer might reasonably be entitled to expect. Yet the technology of hinge‑pin attachments existed at the time the boiler was manufactured. What are in issue here are not two types of attachments of different quality or different brands, but rather two types of attachments, one of which tends to weaken the tubes, and is as a result likely to cause unscheduled shutdowns of the boiler, even after only a short time in operation.

[93] C.E. knew about the problems associated with the rigidity of both A‑style and H‑style tie welds. Furthermore, it was the rigidity of H‑style tie welds that prompted C.E.’s parent company to decide to offer hinge‑pin attachments as the standard in superheater design. Nevertheless, C.E. used A‑style and H‑style tie welds without having independent analyses conducted to determine whether they could withstand the stress placed on the tubes by the circulation of steam at high temperatures. According to the trial judge, C.E. chose instead to rely on its customers’ experience in this respect to assess the real efficacy of its new product. Moreover, it can be seen from a memorandum filed at trial that C.E. had delayed the adoption of hinge‑pin attachments in order to maintain its competitive position in the marketplace, and that the decision to adopt them as the standard had been imposed on the manufacturer gradually by market forces:

. . . it is apparent that it was reluctantly responding to market forces that were to the effect that “the pulp and paper industry no longer considers the use of tie welds to be an acceptable superheater attachment . . . .”

(2003 52306 (QC CS), [2003] R.J.Q. 2194, at para. 41)

[94] Where there is a serious problem that affects the use of a good and the manufacturer is aware of the problem, the manufacturer must address the problem to avoid being held liable for it. The manufacturer cannot simply put the product on the market and wait for reactions from users.

[95] This being said, C.E. still uses H‑style tie welds in the design of some of its products, sometimes in combination with hinge‑pin attachments. The present reasons for judgment should not be understood to imply that H‑style tie welds must never be used in the design of superheaters. However, as a boiler manufacturer, C.E. is required to take its customers’ needs and objectives into account in designing its boilers. This is the standard that Domtar was entitled to expect C.E. to meet.

3.7.1.2 Existence of the Defect at the Time of the Sale

[96] In the case at bar, the cracking caused by the use of H‑style tie welds was not the result of abnormal use of the recovery boiler, as C.E. originally claimed. Moreover, the trial judge found that the cause of the cracking was related to the rigidity of the attachments used. C.E. decided, with good reason, not to pursue its original argument in this Court. In all probability, the defect existed at the time of the sale.

3.7.1.3 Domtar Was Unaware of the Defect at the Time of the Sale

[97] This criterion requires the application of a subjective standard. The trial judge found that Domtar did not have actual knowledge of what he described as a design feature. According to the evidence, C.E. did not share the information it possessed on this subject with Domtar.

3.7.1.4 Latency of the Defect Despite Domtar’s Expertise

[98] The latency of a defect is analysed in relation to the buyer’s level of expertise. In other words, should Domtar have known it was running a risk of excessive cracking because of the use of H‑style tie welds?

[99] The trial judge found that Domtar’s “principal interlocutor” was aware of the two different opinions on the attachments since he had been a member of the Black Liquor Recovery Boiler Advisory Committee which met to discuss recent cases in which problems with recovery boilers had led to unscheduled shutdowns. The trial judge also mentioned the expertise of Domtar’s engineering department and of Simons‑Sandwell as regards the operation of pulp and paper mills. Although Domtar was characterized as a sophisticated operator of the equipment used in operating a pulp and paper mill, the issue here is the design of a custom‑made piece of industrial equipment. C.E. is a company that specializes in the design of recovery boilers. According to the trial judge, approximately 50 to 60 percent of C.E.’s revenue came from the design and sale of boilers. The company enjoyed an 80 percent share of the Canadian market for these machines. Expertise in operating such equipment does not automatically entail expertise in the actual design of the product. The manufacturer inevitably has more complete knowledge of the product it has designed since it controls the materials and labour.

[100] In discussing the professional qualifications of Domtar’s representatives, the trial judge stated that Simons‑Sandwell was knowledgeable to a certain extent about boilers and was aware of, among other things, the existence and potential advantages of hinge‑pin attachments. However, neither Simons‑Sandwell nor Domtar knew that the tie welds were in all probability the cause of the numerous cracks that had appeared.

[101] C.E. submits that the trial judge did not attach sufficient importance to Simons‑Sandwell’s knowledge. This argument must fail. The defect is not apparent simply because Domtar was assisted by an expert. Since the cause of the excessive cracking was unknown to both Domtar and Simons‑Sandwell, the defect in this case was indeed latent.

3.7.2 Applicability of the Limitation of Liability Clause

[102] As mentioned above, the limitation of liability clause may be relied on only if C.E., as a manufacturer, can rebut the presumption of knowledge applicable to it. C.E. had to prove that another manufacturer in the same circumstances would not have known of the defect: Samson & Filion. Its argument in this Court is based not on fault on the part of Domtar or a third party, or on superior force or development risk, but on its own good faith throughout its business relations with Domtar. Although good faith has not yet been recognized as a means of rebutting the presumption, it will be helpful to review the facts as alleged by C.E. and found by the trial judge.

[103] The trial judge reviewed in detail the evolution of the types of attachments used in recovery boilers. In 1977, C.E. had decided to replace A‑style tie welds with H‑style tie welds because A‑style tie welds had been causing serious leakage problems over the previous five years. C.E. decided that H‑style tie welds would be preferable, even though they had not been tested.

[104] Manufacturers started using hinge‑pin attachments in the early 1980s. It can be seen from internal C.E. memoranda that a number of customers in the United States had complained about problems with cracks and leaks linked to tie welds. As a result, C.E.’s parent company adopted hinge‑pin attachments as its standard in the United States in 1984. But a similar problem was occurring in Canada: C.E. had received complaints about A‑style tie welds from Canadian customers in January 1983, May 1983 and December 1984. In June 1985, C.E. recommended to one of its customers that it use hinge‑pin attachments to avoid cracks and leaks. In 1988, C.E. decided to limit its use of hinge‑pin attachments in order to maintain its competitive position in the marketplace:

An internal memorandum insisted on the use of tie welds because of the additional cost to manufacture hinge pins, and that in order to maintain the competitive position of C.E. in the marketplace, hinge pins should only be used when there was a “known failure, deterioration, misalignment, etc. of our present standard tangent tube flex ties”, or, “if specifically requested by the customer or when ‘latest state‑of‑the‑art’ design is noted.”

(2003 52306 (QC CS), [2003] R.J.Q. 2194, at para. 39)

C.E. did not finally adopt hinge‑pin attachments as its Canadian standard until the following year. However, C.E. had known about the problems associated with tie welds since the early 1980s, that is, before Domtar submitted its purchase order in September 1985.

[105] It can be seen from the evidence that the technical knowledge of the time had led some of C.E.’s competitors, and even its parent company, to change their standards. To successfully rebut the presumption of knowledge, it matters little that C.E. believed in good faith that it had solved the problem. Simply having an honest belief in the adequacy of its product is not enough to relieve a manufacturer of liability. It must be concluded that, since C.E. has failed to raise a valid defence, it has not rebutted the presumption of knowledge applicable to it in accordance with the standard established in Samson & Filion.

[106] It is therefore our view that the Court of Appeal correctly found that there was a latent defect in the superheater that C.E. knew or should have known about. Since C.E. has failed to rebut the presumption of knowledge applicable to it, it cannot rely on the limitation of liability clause in its defence.

3.8 Duty to Inform

[107] The trial judge found that C.E. had breached its duty to inform, whereas in the Court of Appeal’s view, the issue related to the warranty against latent defects. The two concepts overlap, but it is important to distinguish them in order to identify the circumstances in which each rule will be applied.

[108] Whereas the warranty against latent defects is expressly provided for in the C.C.L.C. and the C.C.Q., the duty to inform derives instead from the general principle of good faith (Bank of Montreal v. Bail Ltée, 1992 71 (SCC), [1992] 2 S.C.R. 554, at p. 586; arts. 6, 7 and 1375 C.C.Q.) and the principle of free and informed consent. Furthermore, the scope of the general duty to inform is much broader than that of the disclosure of a latent defect. This duty encompasses any information that is of decisive importance for a party to a contract, as Gonthier J. stated in Bail (see pp. 586‑87). It is therefore easy to imagine a situation in which a seller would be in breach of the duty even though no latent defect exists.

[109] Where a seller fails to discharge the duty to disclose a defect, on the other hand, it can probably be said at the same time that he or she has also breached the general duty to inform the buyer of a factor of decisive importance in respect of the good sold, namely the existence of a latent defect. The instant case is one example of this. If a party invokes the seller’s warranty against latent defects, the duty to inform is in a sense subsumed in the analysis of the seller’s liability for latent defects, and there is no need for the court to conduct a separate analysis on the seller’s duty to inform. As a result, our analysis and conclusion regarding C.E.’s liability under the warranty against latent defects are sufficient to dispose of the case before the Court.

[110] What now remains is to consider C.E.’s argument concerning the reduction of the quantum awarded to Domtar in light of Domtar’s failure to mitigate its damages and of the payment it received from its insurer, Lloyd’s, as well as the actions against Chubb, based on the performance bond, and Arkwright, based on the all risk insurance policy.

3.9 Reduction of the Quantum of the Damages

[111] In this Court, C.E. has submitted two arguments for reducing the quantum of the damages awarded to Domtar by the Court of Appeal. First, C.E. contends that by replacing a superheater that was fully operational, Domtar failed to mitigate its damages and that Domtar is accordingly entitled to be reimbursed only for the repairs effected in the spring of 1989. Second, C.E. submits that the determination a posteriori by a court that the damage was not covered by the insurance policy does not alter the compensatory nature of the payment that has already been made. According to C.E., the payment made to Domtar by Lloyd’s was intended to settle certain claims, including the one related to the purchase of the boiler from C.E., and once that payment was made, Lloyd’s was subrogated to Domtar’s rights and Domtar’s claim for damages against C.E. had to be reduced accordingly.

[112] The trial judge rejected C.E.’s suggestion that Domtar could have repaired the superheater instead of replacing it. He noted that Domtar had had to make a decision in light of the available information and that its inability to adequately assess the alternatives was due to C.E.’s breach of the duty to inform. Regarding the subrogation argument, the trial judge agreed with C.E. and held that the damages claimed by Domtar should be reduced by the amount it had received from Lloyd’s.

[113] The Court of Appeal also rejected the repair scenarios proposed by C.E., citing Domtar’s need for reliable equipment. However, it reversed the trial judge’s holding on the subrogation issue. According to the Court of Appeal, for a payment to result in subrogation of an insurer to the rights of the insured, it must be made to the insured on account of an obligation arising from the insurance contract or by operation of law. In the instant case, because a clause in the insurance contract between Lloyd’s and Domtar expressly excluded damage resulting from a breakdown of or defect in the recovery boiler, the payment made by Lloyd’s could not have been related to the damages being claimed by Domtar. Lloyd’s was not, therefore, subrogated to Domtar’s rights. The Court of Appeal’s reasons are sound, and there is no need to intervene.

3.10 Chubb’s Appeal

[114] This Court granted leave to appeal in this incidental case because its outcome depended directly on the outcome of the main case. In this case, Domtar relies on a contract establishing a performance bond in its favour. Under the contract, Chubb agreed to guarantee the performance of C.E.’s obligations under the contract of sale for the recovery boiler. Since there was a latent defect in the superheater, Chubb is solidarily liable for the amount of its guarantee as surety in favour of Domtar, as the Court of Appeal held.

3.11 Domtar’s Appeal Against Arkwright

[115] This incidental case concerns an “all risk” insurance policy issued by Arkwright that covered Domtar’s property, including the recovery boiler, at the time of the events in question. Domtar has already been indemnified under this policy for the damage it sustained as a result of the repairs effected in the spring of 1989. However, the policy contained a clause excluding damage resulting from latent defects in the boiler.

[116] In its appeal, Domtar seeks to demonstrate that the losses were nonetheless covered by the insurance policy. More specifically, it submits that the lost profits it suffered in the fall of 1989 when C.E.’s superheater was replaced with one from B. & W. resulted from the faulty design of the H‑style tie welds. In other words, the latent defect affected not the entire boiler or superheater, but strictly the H‑style tie welds, and the damage was accordingly covered by the policy.

[117] The trial judge agreed with Arkwright. In his view, replacing the superheater was not the only possible solution for Domtar, since at the time the machine was replaced, it could have continued operating indefinitely. Domtar could not, therefore, rely on its all risk insurance policy to recover disbursements made to prevent a hypothetical future loss.

[118] Domtar appealed that judgment. The Court of Appeal considered the replacement of the superheater to have been necessary. In its view, however, the tie welds could not be dissociated from the superheater itself and the insurer could rely on the exclusion clause because the design defect affected the entire superheater and not just the tie welds. According to the Court of Appeal, the narrow interpretation Domtar seeks to give the exclusion clause would deprive the clause of any effect, and the loss to which Domtar’s claim applied was clearly not covered by the insurance policy with Arkwright.

[119] In the main case, we held that the superheater’s design was defective because of the excessive cracking of the tubes caused by the use of H‑style tie welds, and that C.E., as the manufacturer, was liable for, inter alia, the cost of replacing the superheater. To accept Domtar’s contention that the welds can be dissociated from the superheater would render the exclusion clause meaningless, since it would in almost every case be possible to isolate one component as the cause of the defect.

[120] To sum up, Domtar’s submissions in this appeal against Arkwright are unfounded in law. For the reasons given by the Court of Appeal, we are therefore of the opinion that the cost of replacing the defective superheater was excluded under the insurance policy.

4. Disposition

[121] For these reasons, we would dismiss the three appeals and affirm the judgments of the Court of Appeal, with costs throughout.

APPENDIX

Civil Code of Lower Canada

1522. The seller is obliged by law to warrant the buyer against such latent defects in the thing sold, and its accessories, as render it unfit for the use for which it was intended, or so diminish its usefulness that the buyer would not have bought it, or would not have given so large a price, if he had known them.

1523. The seller is not bound for defects which are apparent and which the buyer might have known of himself.

1524. The seller is bound for latent defects even when they were not known to him, unless it is stipulated that he shall not be obliged to any warranty.

1525. If the seller knew the defect of the thing, he is obliged not only to restore the price of it, but to pay all damages suffered by the buyer.

He is obliged in like manner in all cases in which he is legally presumed to know the defects.

1528. If the seller did not know the defects, or is not legally presumed to have known them, he is obliged only to restore the price and to reimburse to the buyer the expenses caused by the sale.

Civil Code of Québec

1726. The seller is bound to warrant the buyer that the property and its accessories are, at the time of the sale, free of latent defects which render it unfit for the use for which it was intended or which so diminish its usefulness that the buyer would not have bought it or paid so high a price if he had been aware of them.

The seller is not bound, however, to warrant against any latent defect known to the buyer or any apparent defect; an apparent defect is a defect that can be perceived by a prudent and diligent buyer without any need of expert assistance.

1728. If the seller was aware or could not have been unaware of the latent defect, he is bound not only to restore the price, but to pay all damages suffered by the buyer.

1729. A seller may not exclude or limit his liability unless he has disclosed the defects of which he was aware or could not have been unaware and which affect the right of ownership or the quality of the property.

An exception may be made to this rule where a buyer buys property at his own risk from a seller who is not a professional seller.

Appeals dismissed with costs.

Solicitors for the appellants ABB Inc., Alstom Canada Inc. and Chubb Insurance Company of Canada: Stikeman Elliott, Montréal.

Solicitors for the appellant/respondent Domtar Inc.: Ogilvy, Renault, Montréal.

Solicitors for the respondent Arkwright Mutual Insurance Company: Kugler, Kandestin, Montréal.