Canada: A Comparative Look At Good Faith And Changed Circumstances, Hardship And More
The Canadian Supreme Court's decision in Churchill Falls (Labrador) Corporation

Introduction

This article focuses on the Supreme Court of Canada decision in Churchill Falls (Labrador) Corporation Limited v Hydro-Québec 2018 SCC 461¹. To most Canadians, the mere mention of Hydro-Québec and Churchill Falls in the same sentence spontaneously evokes the long-term contract at issue in this case. That contract has been a very public bone of contention between the Province of Québec and the Province of Newfoundland for more than 40 years. The Supreme Court's decision is used here as a launch pad for a broader discussion of good faith, changed circumstances and hardship, and the circumstances in which an arbitrator or judge may be called upon to alter the terms of a contract. These issues frequently arise in international arbitration.

The facts of the case

Background

The Churchill River is the longest river in Atlantic Canada. It flows toward the Atlantic in Labrador, in the easternmost province of Canada, Newfoundland-and-Labrador. The Churchill River basin has long been known as one of the areas with the greatest hydroelectric potential in the world. Among several locations with potential was Churchill Falls, in the Upper Churchill River. Until the 1960s, there were two obstacles to developing these water resources: the technical challenge of transporting electricity the great distance to the nearest markets in Southern Québec and the US without undue loss of power; and financing. To finance the project, its sponsors, Churchill Falls (Labrador) Corporation Limited (CF(L)Co) and its majority shareholder, had to find one or more creditworthy purchasers that would commit, on a take-or-pay basis, to purchase substantially all of the electricity generated by the plant. Hydro-Québec (H-Q) was one such potential purchaser. Moreover, in the 1960s, H-Q's engineers had developed high-voltage transmission lines that enabled electricity transportation over long distances without substantial loss of power. However, H-Q had alternatives: The Province of Québec also has huge hydroelectric potential, which in the 1960s remained largely untapped. At the time, H-Q had several major hydroelectric projects underway and so required convincing that it would make sense to support the construction of a plant owned by a third party and to purchase its electricity, rather than build its own additional hydroelectric facility.

The Contract

After nearly five years of negotiation, CF(L)Co convinced H-Q to defer its own hydroelectric projects and support Churchill Falls. In 1969, CF(L)Co and H-Q signed a contract providing the legal and financial framework for the Churchill Falls hydroelectric project (the Contract). It was a huge project, involving issuance of what was then the largest ever bond offering, construction of the largest hydroelectric plant in the world at the time, and transmission lines to transport electricity some 1,300km.

In addition to investing capital and providing an unlimited completion guarantee, H-Q undertook to purchase, over a 65-year period, virtually all of the electricity the plant would produce, whether it needed it or not. That take-or-pay commitment allowed CF(L)Co to use debt financing to cover construction costs. In exchange, H-Q obtained the right to purchase electricity at fixed prices for the 65-year Contract term. Those prices reflected the project's construction costs.

To assist CF(L)Co with servicing its massive debt in the early years of the Contract, revenues from the sale of electricity to H-Q were front-loaded, using a price schedule that declined over time, roughly tracking the reimbursement of the project debt. The last price reduction took effect in 2016, once the debt was retired, and the Contract provides for this price to remain fixed for the last 25 years of the Contract. This gave H-Q the kind of price stability and protection from inflation that it enjoys with its own projects, the key difference being that, at the end of the term, the Churchill Falls plant would remain the property of CF(L)Co.

The changed circumstances

Shortly after the Contract was signed, the oil price shocks of the 1970s brought major changes in the North American energy market. Then came the decline in public confidence in nuclear energy, following the Three Mile Island accident, in 1979. Beginning in the 1990s, there was a gradual deregulation of transmission systems in North America that liberalized access to the US market. These changes led to a substantial increase in the market price for electricity, which quickly far surpassed the Contract's pricing terms. This allowed, and continues to allow, H-Q to purchase electricity from Churchill Falls at a very low price while selling electricity to third parties at a substantially higher price.

In 2010, CF(L)Co commenced court proceedings seeking a declaration that H-Q has a duty to renegotiate the Contract pricing terms. CF(L)Co also asked that, as H-Q refused to renegotiate, the court itself modify the Contract by imposing a price formula designed to share the unanticipated profits flowing from the Contract.

CF(L)Co's case was that the fundamental changes in the energy market were unforeseeable and disrupted the equilibrium of the Contract. CF(L)Co argued that the benefits generated by the sale of Churchill Falls energy were so much greater than the parties could have foreseen when signing the Contract that H-Q's windfall profits had to be reallocated and shared more equitably. CF(L)Co based its claim on a general duty of good faith recognized in Québec civil law, and on what it described as an implied duty to renegotiate, based on equity.

H-Q's position was that CF(L)Co was seeking to introduce, through the back door of contractual good faith, the civil law doctrine of unforeseeability (la théorie de l'imprévision) which was never part of the law of Québec. H-Q maintained that CF(L)Co was receiving exactly what it bargained for, and that it was seeking to appropriate part of the benefits that rightfully belonged to H-Q under the Contract.

Before examining how the Supreme Court resolved the question, it is instructive to consider how other jurisdictions and soft law instruments deal with the issue of changed circumstances.

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