Legal Blog

Economic Duress

Two men enter into a contract. The first does what was required under the contract; the second does not. He claims that he entered into the contract under economic duress. Can the first enforce that contract? As with many legal concepts, it all depends. The defence of economic duress certainly exists; the question, as in almost all actions, is whether the facts meet the criteria necessary to sustain the defence. These criteria and the defence were discussed in Elias v. Van Zanten, a 2019 decision of the Ontario Superior Court of Justice.

Pressure

The defendant was the operating mind of a corporation, which itself was a member of a joint venture that invested in a corporation trading in oil. He and his buddies had already sunk significant amounts of money into the venture; his investment alone was $750,000. Unfortunately, the investment was a bit of sinkhole and, by 2015, his corporation needed more funds to meet its obligations to the joint venture. None of these funds was forthcoming from the defendant or his buddies.

Along came the plaintiffs. They were willing to invest $300,000 USD in the corporation, which it would then use to meet its joint venture obligations, but only if the defendant personally guaranteed the debenture that the corporation was to issue to secure the investment.

After considerable pressure over a number of months, and realising that the corporation and its investors would lose all of their money if the additional funds were not received, the defendant capitulated and signed the personal guarantee.

The reasons for decision are not clear whether the money was advanced before or after the defendant signed the guarantee. If they were advanced before, we would have thought that the defendant might claim, as a defence, that there was no consideration for the guarantee – but this issue was never raised.

In November 2016, after the loan had matured, the plaintiffs’ lawyer demanded repayment of the $300,000. The defendant responded; he stated that the corporation was at a crucial stage of development leading up to the commencement of trading. Accordingly, the corporation was not in a position to make payments without financially crippling it and preventing further progress. More importantly, the defendant stated that he wanted to honour his guarantee, but had leveraged all of his personal assets to keep the corporation viable.

When the plaintiff sued, the defendant’s only defence was that he signed the guarantee under economic duress and was therefore not liable to pay the claim.

Elements

The Master, on the plaintiffs’ summary judgment motion, set out the law applicable to the defence of economic duress.

The law does not lightly set aside contracts reached by parties having contractual capacity. Duress can be a basis to render an otherwise valid contract unenforceable. To succeed in that defence, (the defendant) must show that (1) he faced a pressure which the law does not regard as legitimate and (2) the pressure was applied to such a degree as to amount to “a coercion of the will”.

The applicable factors to determine if (the defendant’s) will has been coerced are: (1) did he protest? (2) Was there an alternative course open to him? (3) Was he independently advised? and (4) After entering the contract did he take steps to avoid it?

Finally, even where all these elements are present, when a defendant subsequently affirms the agreement, the defence of duress is no longer available.

Legitimate

The Master stated that the applicability of the second criterion, coercion, was a genuine issue for trial. The real question was whether, as to the first criterion, the pressure exerted was not “legitimate.” The Master noted that the requirement for legitimacy was meant to differentiate between expected commercial pressure and illegitimate coercion. Pressure is illegitimate when one party threatens a crime (e.g. sign or I will break your spouse’s arm) or a tort (e.g. sign or I will ensure that your main supplier refuses to supply you with inventory) or when one party abuses its bargaining position to obtain disproportionately favourable terms (e.g. I will lend you $10,000, but you will give up 90% of your cash-poor corporation). This latter category and example correspond in great part to the concept of unconscionability.

The pressure on the defendant was legitimate because it was the normal sort of commercial pressure occurring in business. Although the defendant desperately needed funds, the plaintiffs did not create this situation and were under no obligation to remedy the problems that the defendant created. The Master noted that lenders commonly request personal guarantees and borrowers generally provide them only when they have no other option. The Master also noted that the terms of the loan and guarantee were not unconscionable. Indeed, the guarantee only covered the principal, not the interest, of the loan.

Accordingly, the Master held that the economic duress defence failed on the basis that the pressure was legitimate.

Confirmation

Even if the criteria were otherwise met, the defendant still would have had to demonstrate that he did not subsequently confirm the guarantee. However, when the defendant wrote to the plaintiffs’ lawyer noting that he wanted to honour the guarantee, he confirmed the guarantee and eliminated his defence of duress.

Interest

The guarantee only referenced the principal of the loan. Accordingly, the plaintiffs were not able to claim interest based on the interest rate that was set out in the loan. The plaintiffs therefore limited their claim to pre-judgment and post-judgment interest set under the Courts of Justice Act. Those rates are sufficiently low that, almost invariably, they are lower than any rate that may be set under contract. Regardless, the defendant argued that, because the guarantee only covered principal, and not interest, under the loan, the defendant was not liable even for pre-judgment and post-judgment interest under the Courts of Justice Act. In essence, he argued that if the guarantee did not include interest, then failure to honour the guarantee resulted in no interest at all.

The Master noted that sections of the Act contemplate pre-judgment interest and contractual interest and that, merely because contractual interest was not stipulated in the guarantee, interest was still available under the Act. The Master recognised that once the loan matured, the defendant was to have paid it and the plaintiffs would have had funds available to them for investment elsewhere. To accede to the defendant’s argument that the interest rate was zero, both before and after maturity, would have the perverse effect of rewarding default. No consequences would arise from that default.

The Master allowed both pre-judgment and post-judgment interest under the Act.

 

Image courtesy of AbsolutVision.

Written by Jonathan Speigel, the founding partner of Speigel Nichols Fox LLP, leads the litigation and construction practices.