Legal Blog

Nasty

 Can an otherwise valid contract be set aside and, if so, for what reasons? There are always nuances, but, in general, the law does not countenance unconscionable agreements, agreements without consideration, or agreements procured by economic duress. Economic duress was the subject matter of Process Automation Inc. v. Norstream Interac Inc., a 2010 decision of the Ontario Superior Court of Justice.

Background

The defendant (call it the “general”) had a contract to supply a propane mixing station to the government of Iraq (the “owner”) for about $300,000. The general contracted with the plaintiff (the “sub”) to provide part of the work for $194,000. They agreed that if there were any backcharges from the owner, for delay or any other reason, they would equally share them.

 The general had an irrevocable letter of credit to ensure that the owner would ultimately pay the contract price. The general and sub completed their work by May 2006, about six weeks late; because of the delay, the owner deducted $20,000 from the contract price.

 Between completion and February 2007, the sub and general had a multitude of phone calls and emails regarding payment. As time progressed, the sub became increasingly desperate for its money.

 Without doubt, the owner was delaying payment for no apparent reason. However, by February 1, 2007, the bank collecting on the LOC informed the general that the general was soon going to be paid – and so it was on February 12.

 One day later, the representatives of the sub and general met at a donut shop, at which time the general presented the sub with an agreement that, in essence, stated that the general needed to pay only $100,000 of the $194,000 owed. The sub signed the agreement; the general immediately handed over, and the sub accepted, a $100,000 cheque. The cheque was drawn on a special account that the general’s representative had opened in his own name.

 Two months later, the sub sued the general for the $94,000 due on their original agreement.

 Duress

 A contract signed under physical duress is voidable. In effect, it is extortion and the law will not allow the guilty party to benefit from it.

 A contract signed under economic duress can also be set aside, but there are a number of factors to consider.

 1. Did the victim protest at the time?

 2. Were alternate courses available to the victim?

 3. Was the victim independently advised?

4. Did the victim take steps to avoid the contract in a timely manner?

 5. If the above factors indicate that the victim was coerced, was the coercion legitimate?

 Holdings

 The judge dealt with the four factors and the 5^th condition as follows:

 1. The sub’s representative protested immediately; he told the general’s representative that the general was leaving the sub no choice. The general knew from the flurry of emails that the sub’s economic condition was precarious.

 2. The sub had no other alternatives available. Its owner was tapped out personally and its subsub, after giving numerous extensions, had given the sub a 3-day ultimatum: pay or be sued.

 3. The sub signed at the meeting without receiving any advice. The general informed him that his choice was to sign then or get nothing.

 4. The sub sued within 2 months of signing the agreement and that was soon enough.

 5. The nature of the pressure was direct and immediate. The nature of the demand was to reduce the monies due for no real reason. Further, the judge emphasised the following circumstances:

 a) The sub did not know that the owner had paid the general.

b) The general knew that the sub did not know.

The sub was initially under the impression that the purpose of the meeting was to discuss whether the general could advance 30% of the money due pending the receipt of the contract price from the owner or to discuss plans to assist the sub to finance the account receivable.

 The judge concluded that the sub was forced to sign the agreement with “a gun to his head” and voided the agreement due to economic duress. The judge also had some harsh words for the general’s representative: “There was a deliberate course of conduct by Arroyave to exploit the precarious financial position of Fenske and PAI in February 2007 to unjustly enrich himself and/or Norstream. The evidence is compelling that this was a well orchestrated plan to deny a small businessman money that was rightfully his.”

 Consideration

 Under common law, if one party gives no consideration to the other, that party cannot enforce the contract. However, section 16 of the Mercantile Law Amendment Act of Ontario states that part performance when expressly accepted by a creditor pursuant to an agreement will extinguish an obligation even without new consideration (i.e. a creditor can agree to accept less than is owed in exchange for an immediate payment).

 This would seem to negate the ability of the sub to claim that the agreement with the general should be set aside. However, the judge interpreted this section to mean that, although there was no need for consideration to accept less than what was due, the section was still subject to the common law principles of undue influence, unconscionability, and economic duress.

 Accordingly, since the judge found that that the agreement was entered into under economic duress, the fact that section 16 did not require additional consideration was meaningless. The agreement was still void.

 Personal

 The judge also took the unusual step of finding that the general’s representative was personally liable for the debt. Although the general rule is that a corporation is liable for its debts and the people who run and own it (i.e. shareholders, directors, officers, and employees) are not, the general rule is subject to the condition that the people who run and own the corporation are not guilty of fraud, deceit, or want of authority. The judge noted that “Arroyave’s conduct … was a model of duplicity; he made a conscious decision to use his far greater bargaining power and knowledge of the situation to take advantage of a small business and its owner who were facing financial ruin. His actions were deliberate, calculating and thoroughly reprehensible …”

 Amount

 The judge held that the general and its representative were liable for $84,000, after giving credit for the $10,000 that was the sub’s 50% share of the owner’s delay setoff, plus interest from 2006. There is no decision regarding costs so the parties must have agreed upon them. We expect that the costs agreed upon were significant, particularly given the judge’s view of the general’s conduct.