On March 18, 2016, the British Columbia Court of Appeal released reasons for judgment in Do v. Nichols, 2016 BCCA 128. This decision provides guidance on how to draft and enforce tough provisions in a contract that can withstand penal and unconscionability claims.
The Court of Appeal disagreed with the Supreme Court’s finding that the contractual provisions at issue were penal and unconscionable, and therefore unenforceable. In so doing, the Court of Appeal found Mr. Do’s petition for an order nisi of foreclosure on a mortgage to be valid, and declared the mortgage to be in default. It then referred the matter back to the trial court so that the appropriate foreclosure orders could be made.
At issue was the parties’ complex purchase and sale contract for a waterfront development property (the “Development Property”) owned by the Nichols on Pender Harbour. Pursuant to the agreement, Mr. Do would purchase the Development Property for $1,700,000 and the Nichols would take the necessary steps to have the Development Property subdivided. If and when subdivided, the Nichols had the option of purchasing one of the newly subdivided lots. At issue in this case were the additional terms that $500,000 would become due and owing by the Nichols to Mr. Do if the Nichols were “unable or unwilling to carry out the subdivision.” To secure this payment, the Nichols provided Mr. Do with a $500,000 mortgage on their home.
Mr. Do testified that the $500,000 mortgage was to act as a guarantee that the subdivision would take place. Mr. Nichols testified that he had no choice but to agree to the $500,000 mortgage on his home and other related terms as he had to strike a deal or lose the Development Property to a mortgagee who was in the midst of foreclosing on the Development Property.
The Court of Appeal referred to authorities confirming that the doctrine of penalty only arises in the context of a breach of contract, and is not designated to grant relief from a commercially imprudent bargain. The contract at issue contemplated that the Development Property might not be subdivided, in which case the Nichols would be obliged to pay Mr. Do the $500,000. A breach of contract was not required for the $500,000 to become owing. As such, the appellate court found that the provision requiring the payment of the $500,000 did not violate the doctrine of penalty.
The Court of Appeal also found that the contractual provisions at issue were not unconscionable. In order to set aside a bargain for unconscionability, a party must establish: (a.) inequality in the position of the parties arising from the ignorance, need or distress of the weaker, which left him in the power of the stronger; and (b.) substantial unfairness in the bargain. The Court of Appeal found that there was no substantial unfairness in the bargain since according to its reading of the purchase and sales agreement, the agreed value of the Development Property in a pre-subdivision state was not 1.7 million, but 1.2 million.
In this case, if the $500,000 becoming due and the foreclosure had resulted from a breach of contract, the court may have granted relief from the improvident bargain. That was not the case in this instance as the $500,000 becoming due was not triggered by a breach of contract. Where possible, deals should be negotiated so that harsh consequences do not depend upon a breach of contract to occur. The party enforcing the end of the bargain should also be prepared to demonstrate the fairness of the bargain.