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Risk Allocation Clauses: Who Pays for Increased Costs? – You be the Judge

Original Publication Date: December 21, 2016

Contract managers always have to deal with risk. But how confident are you about the wording of your “risk allocation clauses”? What happens if costs have unexpectedly skyrocketed, and your contract doesn’t mention certain expenses? Decide who pays for the “risk of increased costs” in the following contract:

Snarpen Contracting Ltd. agreed to buy 123 deer from Arbutus Bay Estates Ltd. Both parties understood that Arbutus Bay would purchase the deer in the United States at auctions, and then transport them to quarantine stations. Agriculture Canada required testing for diseases prior to import into Canada. If one animal tested positive, all other animals in a group would be held in quarantine for a minimum of 90 days. So both parties knew that positive results during quarantine would lead to extra costs for feeding and housing, as well as for locating and transporting replacement deer. The signed contract allocated the risk between the parties as follows:

“Snarpen Contracting Ltd. agrees to purchase 123 Fallow does in the amount of $800 Cdn each from Arbutus Bay Ltd. … Arbutus Bay does not take the risk of testing according to the federal requirements for import into Canada nor the risk of injury in transport. The price includes transport to Mayne Island.”

Such a poorly worded risk clause led to considerable difficulties between the parties. Arbutus Bay originally purchased a total of 132 deer in the United States. Twenty-four deer died in transport or in testing. Fifty-two deer tested positive for disease, and could not be imported into Canada. Some animals were returned to suppliers, and others were eventually resold. Eventually, Arbutus bought another 51 deer as replacement animals. As healthy animals cleared quarantine, Arbutus made delivery to Snarpen. Eventually, 64 deer were delivered.

Arbutus Bay interpreted the contract as meaning that Snarpen would pay for the extra costs due to disease, testing and injury. When Snarpen refused to pay the extra expenses ($500 per animal), Arbutus stopped delivery of the remaining healthy animals.

Snarpen’s view was that the risk clause was silent about costs. Snarpen said that such costs were logically part of Arbutus’ business risks as a deer supplier. Instead, Snarpen interpreted the risk clause as meaning that Snarpen accepted risks such as missing a breeding season due to delays in quarantine.

Who pays for the additional costs?

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Our case is based on Snarpen Contracting Ltd. v. Arbutus Bay Estates Ltd. [1996], B.C.J. No. 830, a judgment by the British Columbia Court of Appeal.

Initially, the trial judge held that Arbutus Bay had breached the contract by refusing to deliver the remaining healthy deer. The trial judge said that the “no-risk” clause meant that Arbutus Bay would not be liable for breach of contract if failure to deliver was caused by quarantine testing. But the trial judge rejected any interpretation that the risk clause imposed a variable price on the plaintiffs (i.e., to pay for any extra costs that might be incurred).

Subsequently, the B.C. Court of Appeal applied the “business efficacy” test for implied terms, and overruled the trial judge. According to the Court, the no-risk clause clearly said that the risks in the transportation and testing of the deer were not with Arbutus Bay. Therefore, the risks, by necessary implication, were with Snarpen Contracting – the only other party to the contract.

As a result, Snarpen Contracting was liable for any extra costs incurred by Arbutus Bay for testing and transportation. When Snarpen refused to pay, it had breached its obligations under the contract. Arbutus was legally correct in refusing to deliver any more healthy animals while those costs remained unpaid. The Court of Appeal ordered judgment in favour of Arbutus Bay Estates, minus any credits owing to Snarpen Contracting.

The Supreme Court of Canada has also applied the “business efficacy” test to implied terms in a contract. In M.J.B. Enterprises Ltd. v. Defence Construction (1951) Ltd. [1999], S.C.J. No. 17 (see The Legal Edge, Issue 25) the Court said that implied terms should only be enforced as “ … necessary to give business efficacy to a contract.” These are the terms “ … which the parties, would say, if questioned that they had obviously assumed” would be part of the contract.

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Readers are cautioned not to rely upon this article as legal advice nor as an exhaustive discussion of the topic or case.  For any particular legal problem, seek advice directly from your lawyer or in-house counsel.  All dates, contact information and website addresses were current at the time of original publication.