Atlantic Lottery Corp v Babstock: Waiver of Tort Steps Out of the 17th Century, but Uncertainty Persists

In Atlantic Lottery Corp v Babstock (“Babstock”), the Supreme Court of Canada recently rendered a decision that settles a significant issue in the area of remedies in tort, contract, and unjust enrichment, but the decision raises a host of other questions for how Canadian tort law, contract law and the law of damages will develop in the coming years.

We note that this article does not consider the class action aspect of the decision, which was a notable component of the court’s analysis in and context of this case.

Background

The Atlantic Lottery Corporation Inc. (“Atlantic Lottery”) licensed the operation of video lottery terminal games (“VLTs”). Douglas Babstock and Fred Small (the “plaintiffs”) applied for certification of a class action against Atlantic Lottery on the basis that VLTs are inherently dangerous and deceptive. In particular, the plaintiffs pleaded three causes of action in support of a gains-based remedy, quantified by the profit Atlantic Lottery earned by licensing VLTs: “waiver of tort”, breach of contract, and unjust enrichment.

With respect to the issue of waiver of tort, the plaintiffs alleged that Atlantic Lottery breached a duty to warn of the inherent dangers associated with VLTs. More significantly, they argued that waiver of tort is an independent cause of action that allows for a gains-based remedy without having to prove the existence of an underlying tort upon which the application of waiver of tort must be based.

As the court observed, the confusion surrounding “waiver of tort” related in large part to the anachronistic nature of the term. At the time of its inception in the 17^th century, waiver of tort was so named because a plaintiff was procedurally required to waive its ability to claim in tort (hence the term “waiver of tort”) and ratify the defendant’s conduct in order to recover the defendant’s profits from wrongdoing on the basis of an implied contract. In other words, it represented an election between different forms of action. Over time, the doctrine evolved such that a plaintiff would prove the occurrence of a tort, but then waive the ability to seek tort damages in favour of seeking to recover the defendant’s profits from its wrongdoing. In other words, waiver of tort represented an election between different remedies.

With respect to breach of contract, the plaintiffs alleged that a contract arose from Atlantic Lottery’s offer of the VLTs to the public and the plaintiffs’ acceptance by playing the VLTs. They further argued that Atlantic Lottery was required under implied terms to provide VLTs that were fit for use and of merchantable quality, to use reasonable skill and care in providing VLTs, and to act in good faith. The plaintiffs alleged that Atlantic Lottery breached all of these terms.

Finally, the plaintiffs alleged that Atlantic Lottery was unjustly enriched at the plaintiffs’ expense.

For its part, Atlantic Lottery applied to strike the plaintiffs’ claim on the basis that it disclosed no reasonable cause of action.

Decisions of the Courts Below

The plaintiffs succeeded in obtaining certification at first instance, while Atlantic Lottery’s application was dismissed. The certification judge found that because the plaintiffs intended to pursue a collective remedy (i.e. Atlantic Lottery’s profits) without proving individual damage, there were common issues among the class that would be better addressed through a class action.

On appeal, a majority of the Newfoundland and Labrador Court of Appeal affirmed the certification judge’s conclusions and allowed the plaintiffs’ claims in waiver of tort, breach of contract and unjust enrichment to proceed to trial.

Regarding waiver of tort, the majority concluded that the doctrine could operate as an independent cause of action for disgorgement of Atlantic Lottery’s profits, where the doctrine would serve the purpose of deterring wrongful conduct. In addition, the majority concluded that plaintiffs alleging negligence need not prove damage in order to establish an entitlement to disgorgement. Accordingly, the majority concluded that the plaintiffs’ claim for waiver of tort disclosed a reasonable cause of action. Furthermore, the majority held that the pleaded facts could support a claim for disgorgement as a remedy for breach of contract, but declined to address the issue of unjust enrichment.

Atlantic Lottery was granted leave to appeal to the Supreme Court of Canada.

The Supreme Court’s Decision

A five-judge majority allowed the appeal on the basis that the plaintiffs had failed to disclose a reasonable cause of action. The central focus of the majority’s analysis rested on addressing whether a gains-based remedy could be available to the plaintiffs on the basis of waiver of tort, breach of contract, or unjust enrichment.

Waiver of Tort/Disgorgement

With respect to waiver of tort, the majority clarified that the term should be abandoned, given the confusion associated with it; instead, the plaintiffs’ claim was better understood as seeking disgorgement of Atlantic Lottery’s profits. The majority also clarified the distinction between disgorgement and restitution, noting that the latter requires that a defendant’s gain correspond to the plaintiff’s loss, whereas the former is focused exclusively on the defendant’s gain. In this case, the plaintiffs were seeking disgorgement because they were seeking to obtain Atlantic Lottery’s profits without having to demonstrate any damage.

Most importantly, the majority concluded that waiver of tort is not an independent cause of action. This fact was critical in this case, as the plaintiffs attempted to rely on waiver of tort to effectively create a new cause of action similar to negligence but lacking the requirement that the plaintiffs prove they had suffered harm or damage. Instead, the majority held, waiver of tort is an election between different remedies, and requires an underlying cause of action to be proven. In addition, the majority clarified that the mere creation of risk without actual harm is not wrongful conduct. Beyond the conceptual incoherence that a new cause of action would create, it would also produce practical difficulties in the form of any one plaintiff being able recoup the entirety of the defendant’s gain without having to explain why that one plaintiff is entitled to recover the entire gain.

Interestingly, the majority declined to consider whether disgorgement would be available where negligence has been established, as the plaintiffs in this case failed to properly plead that Atlantic Lottery caused any harm or damages – indeed, the plaintiffs expressly disclaimed any intention of doing so. Accordingly, the majority left unanswered a significant point of debate on this issue.

Finally, the majority rejected the plaintiffs’ contention that the Criminal Code prohibits VLTs, and that Atlantic Lottery was therefore in breach of the Code. In particular, the plaintiffs argued that criminal conduct warrants exceptional relief for breach of contract in the form of disgorgement or punitive damages, and would effectively void any potential defence to the plaintiffs’ claim of unjust enrichment. The majority rejected this argument on the basis that the Criminal Code does not prohibit VLTs. However, it left unaddressed the plaintiff’s arguments as to how criminal conduct would affect the availability of remedies in respect of breach of contract and unjust enrichment.

Breach of Contract

With respect to breach of contract, the majority addressed a number of different remedies sought by the plaintiffs: disgorgement, punitive damages, and nominal damages. Overall, the majority concluded that the plaintiffs’ decision to seek exclusively non-compensatory damages doomed their claim to failure.

Regarding disgorgement, the majority observed that disgorgement for breach of contract will only be available where other remedies, such as compensatory damages, an injunction, or specific performance are inadequate, and only where the plaintiff has a “legitimate” interest in preventing the defendant’s profit-making. As to what circumstances will create a “legitimate” interest, the majority observed that this would best be left to lower courts to develop on a case-by-case basis. However, the majority observed that the key to “developing principles for gain-based recovery in breach of contract is to consider what legitimate interest a gain-based award serves to vindicate”. Here, the plaintiffs had no legitimate interest in Atlantic Lottery’s profit-making.

Regarding punitive damages, the majority noted that such damages require an independent actionable wrong that exists separately from the breach of contract. In this case, the plaintiffs’ only claim that could fulfill this criteria would be for breach of an obligation of good faith. However, the majority concluded that “not every contract imposes actionable good faith obligations on contracting parties”, and in the present case, the alleged contract between the plaintiffs and Atlantic Lottery did not give rise to any recognized duties of good faith. Notably, the majority did not consider the duty of honest performance, which applies to all contracts.

Finally, with respect to nominal damages (i.e. damages, typically in the order of $1 or $2, awarded where a legal wrong has occurred but the plaintiff has not suffered any tangible loss), the majority concluded that the claim should not survive because a reasonable claim is one that has a reasonable chance of achieving the outcome that the plaintiff seeks. In this case, the plaintiffs expressly rejected remedies quantified on the basis of loss, in favour of seeking purely non-compensatory damages.

Unjust Enrichment

With respect to unjust enrichment, the majority summarily disposed of the plaintiffs’ claim on the basis that their own pleading argued that a contract existed between the parties, and that because there was no criminal conduct, the contract provided a juridical reason for Atlantic Lottery’s enrichment.

The Partial Dissent

A four-judge minority dissented in part from the majority’s reasons, finding that the plaintiffs’ claim for breach of contract disclosed a reasonable cause of action and that there should be remedies potentially available for that breach (if proven).

With respect to breach of contract, the minority observed that certain of the plaintiffs’ claims relied upon allegations of implied terms in fact, the existence of which should properly be determined at trial. With respect to potential remedies, the minority observed that nominal damages are always available for causes of action that do not require proof of loss, even if they are not pleaded.

In addition, the minority disagreed with the majority on the issue of disgorgement of profits. In a detailed analysis of this point, the minority found that because there is an unsettled point as to whether quasi-fiduciary duties exist in Canadian law, the plaintiffs should be entitled to argue that a quasi-fiduciary relationship existed in this case which might constitute the exceptional circumstance necessary to justify disgorgement. In addition, the minority concluded that disgorgement need not be understood as a compensatory award, but can be justified on the basis of deterring misconduct.

Finally, on the issue of punitive damages, the minority observed (correctly, in our view) that after the pleadings of this case were filed in 2012, the court in Bhasin recognized the duty of honest performance. As the plaintiffs had plead that Atlantic Lottery had behaved dishonestly, this was sufficient to bring the duty of honest performance into issue (and was therefore sufficient to render punitive damages a plausible remedy). Accordingly, the minority concluded that it would have certified the plaintiffs’ class action on the basis of their breach of contract claims.

Analysis

While the court’s analysis of waiver of tort will likely feature most prominently in commentary as a result of the clarity that the court has brought to this controversial and confusing doctrine, Atlantic Lottery Corp v Babstock is equally interesting for the questions it leaves unanswered.

Regarding waiver of tort, had the court decided differently, the risk of indeterminate liability would have increased greatly given that parties unaffected by a breach of a duty of care could claim a defendant’s financial gains. As the majority rightly observed, in our opinion, this would have promoted a race to the courthouse steps for parties seeking a financial windfall.

More disappointingly, however, the court’s decision not to address whether disgorgement would be available in cases of negligence leaves a significant question unanswered. Given that negligence is pleaded far more readily than other torts to which disgorgement does apply (e.g. conversion, deceit, and trespass), this represents a missed opportunity to address a point of law that is likely to make its way back to the Supreme Court in due course.

The majority and minority’s differing approaches as to the availability of disgorgement for breach of contract also leaves uncertainty as to how the law on that topic will and should develop. First, the majority declined to consider whether criminal conduct could ground a “legitimate interest” in disgorgement, although it would seem that such circumstance could not do so on the basis of breach of contract, since the illegality would void the contract. In other words, there would be no contract to breach, and therefore no underlying cause of action.

Second, the question of whether quasi-fiduciary duties exist in Canadian law appears to remain open for debate, insofar as the majority’s comments on this topic are arguably obiter. This in itself is a significant legal issue, as the recognition of these duties would greatly expand potential liability in contractual relationships based on trust, confidence, and the protection of vulnerability arising from the relationship.

Third, the majority and minority’s disagreement as to the proper criteria for recognizing grounds for a “legitimate” interest in disgorgement as a remedy for breach of contract risks generating confusion for lower courts and the bar. The majority’s analysis suggests, without expressly stating so, that future instances of a “legitimate” interest will presumably serve a compensatory purpose. However, the minority’s analysis takes a different approach, emphasizing that non-compensatory remedies have already been recognized in Canadian law (e.g. punitive damages), such that future instances of a “legitimate” interest could serve a non-compensatory purpose. While this disagreement may seem somewhat academic, it nevertheless represents two diametrically opposed views of how to develop this important point of law and may therefore complicate how the law develops.

Fourth and finally, the majority’s analysis of the good faith issue raises questions as to how to reconcile Babstock with the court’s earlier decision in Bhasin v Hrynew. In Bhasin, the court established that the duty of honest performance applies to all contracts, and is not a duty out of which the parties can contract. On this point, we are of the view, with respect, that the majority decision in Babstock is inconsistent with Bhasin.

In view of the foregoing, it is clear that Babstock is equally significant for what issues it does not decide just as much as it is for what issues it does decide. It remains to be seen how many issues raised in this decision will be addressed over the coming years, many of which we would not be surprised to see re-emerge at the Supreme Court in the years to come.

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