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Product Liability for Latent Defects and Proof of Loss of Profit in the Absence of Audited Financial Statements

Fasken
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Litigation and Dispute Resolution Bulletin

Executive Summary

In its decision handed down June 28, 2019 in the matter of Capmatic Ltd. v. American Brands,[1] the Quebec Court of Appeal rejected Capmatic Ltd. ("Capmatic ")'s appeal of the decision rendered October 24, 2016 by the Superior Court of Quebec.

In its decision, the Court of Appeal reiterated certain fundamental principles pertaining to product liability and provided guidance with regard to the possibility of proving financial losses without audited financial statements where other reliable evidence is available.

At trial, the Superior Court had granted the action of the plaintiff, American Brands S.A. ("American Brands"). American Brands was seeking reimbursement of the price paid for a bleach bottle filling and capping system ("Equipment") affected with latent defects and for damages incurred as a result of those defects.[2] The Superior Court ordered Capmatic to pay American Brands $464,599 plus interest and additional indemnity since May 14, 2012.

As evidence of American Brands' financial losses, the trial judge accepted unaudited financial statements, documents reproducing data drawn from its accounting systems, testimony given by the company's president, and an expert report, subject to the Court's evaluation of their probative value. Capmatic objected to this evidence citing the inadmissibility of hearsay and the best evidence rule. The trial judge overruled these objections because she considered the evidence submitted by American Brands necessary and sufficiently reliable, particularly since it would have been unreasonable to require American Brands' employees - who had entered the accounting data and lived in Costa Rica, - to testify at trial. After evaluating the probative value of the evidence provided and hearing both parties' arguments, the trial judge chose to reduce the amount of the claim.

The Court of Appeal held that the trial judge did not err by admitting evidence submitted by American Brands regarding its financial losses and that this decision respected the principle of proportionality as set out in article 18 of the Code of Civil Procedure.

Background

In 2007, Grupo Constenla, a Costa Rican company, tasked its subsidiary Grupo Polymer ("Polymer") to look into the acquisition of a bleach bottle filling and capping system for its American Brands division. Capmatic provided Polymer a detailed tender for the production of the Equipment.

In August 2008, American Brands issued a purchase order to Capmatic for the Equipment.

The Equipment was delivered in July 2009. In September 2009, a Capmatic technician, who had travelled to Costa Rica to activate the system, noticed flaws with the Equipment.

In September and October 2009, American Brands informed Capmatic that it had noticed problems with the Equipment, in particular signs of corrosion, premature breakage of components and inadequate production rates. Moreover, the automatic capping system didn't work, forcing American Brands' employees to cap the bottles by hand.

Capmatic denied any responsibility and suggested that the problems were largely due to the poor quality of American Brands' bottles, inadequate maintenance and the positioning of the labelling equipment provided by a third party.

Judgment at Trial

In her judgement, Justice Suzanne Courchesne concluded that a contractual relationship existed between American Brands and Capmatic, in spite of the latter's claim to the contrary. In addition, based on the evidence filed and the presumption of liability imposed on professional sellers pursuant to article 1729 of the Civil Code of Quebec, she ruled that the Equipment had several latent defects at the time of sale.

Indeed, a material defect in the Equipment led to the premature corrosion of several of its components. In this respect, the trial judge admitted the testimony of American Brands' expert to the effect that the choice of certain materials used in the design of the Equipment was unsuitable. Bleach repeatedly overflowed and the BPM rate (bottles per minute) anticipated in the contract was never attained.

Aside from the reimbursement of the sale price, American Brands also claimed US$ 434,013 in loss of profits on sales and US$ 100,904 for additional production and maintenance costs.

American Brands' evidence for these losses were based on tables that reproduced accounting data drawn from its ERP (Enteprise Ressource Planning) system, unaudited financial statements, internal balance sheets, a list of fees accrued with supporting documentation, the testimony of its president, and the report of an expert in accounting and quantification of damages.

Capmatic objected to the introduction as evidence of the financial documentation submitted by American Brands and to the expert report on the following grounds:

After hearing the testimony of the president of American Brands and its expert, Justice Courchesne admitted the financial documents and the unaudited financial statements because she considered the evidence necessary and reliable pursuant to article 2870 of the Civil Code of Quebec. Justice Courchesne took into consideration that these documents had been prepared using data from American Brands' ERP system, compiled daily by its employees in the normal course of business. Moreover, the expert contracted by American Brands had testified that the appropriate measures had been taken to ensure the integrity of the data from the accounting system and that, as such, the data could be relied upon to justify his opinion.

The trial judge, after reviewing the evidence and weighing the parties' arguments, including the expert report submitted by Capmatic, reduced American Brands' claim for losses on sales to US$ 203,287 and for additional production and maintenance costs to US$ 8,633.

The Court of Appeal Decision

The Court of Appeal, in a unanimous decision rendered by by judges Geneviève Marcotte, Marie-Josée Hogue and Geneviève Cotnam, rejected Capmatic's appeal, answering the following three questions in the process:

As for the first question, the Court of Appeal found that the trial judge was right to conclude that the contract had indeed been formed with American Brands since the latter issued the purchase order. Thus, the Court affirmed the decision of the Superior Court despite the fact that discussions had been initiated with Polymer and that the first payments had been made by the parent company Grupo Constenla before being reimbursed by American Brands. Taken as a whole, the behaviour of the parties showed that American Brands was indeed the co-contracting party.

As for the existence of the latent defects affecting the Equipment, the Court of Appeal emphasized that Capmatic had clearly attempted to retry the matter and had not succeeded in demonstrating that the trial judge had committed a palpable and overriding error in this respect.

The Court of Appeal reiterated that, pursuant to article 1729 of the Civil Code of Quebec, in the event of a sale between professionals, the buyer is the beneficiary of a triple presumption: (1) the presumption that a defect exists, (2) the presumption that the defect existed prior to the contract of sale, and (3) the presumption of causality between the defect and the deterioration or malfunction of the product. To enjoy the benefit of these presumptions, the buyer must only show that (1) the product was acquired from a professional seller, (2) that the product deteriorated prematurely compared to an identical product or product of the same type. When these criteria are met, the professional seller can reverse the presumption by showing either improper use of the product by the buyer, third party liability or force majeure.

In so doing, the Court of Appeal reaffirmed principles with it had already established in a previous decision : CNH Industrial Canada Ltd. v. Promutuel Verchères, société mutuelle d'assurances générales.[3] This decision, which noted that the buyer enjoys a "triple presumption," was also confirmed in Demilec inc. v. 2539-2903 Québec inc.[4] It is also important to note that the professional seller is presumed to have been aware that the defect existed in the first place.[5]

Capmatic argued that the Equipment formed part of a production line that included components provided by other manufacturers. It believed American Brands should have to prove which part of the Equipment was defective. The Court of Appeal disagreed noting, on the one hand, that the evidence did not support this theory and, on the other, that Capmatic was committed to delivering a fully-functional system that included labelling, bottling and cap bleaching according to the filling parameters and production rate set forth in the contract executed between the parties.

The Court of Appeal finally concluded that the trial judge had not erred in allowing American Brands to substantiate its financial losses in the manner it chose in spite of Capmatic's objections based on the inadmissibility of hearsay and the best evidence rule.

First, while the hearsay rules might have justified the testimony of employees responsible for the data entry into the accounting system, the Court of Appeal held that their presence in court would have been unreasonable because they reside in Costa Rica and their presence was unlikely to shed any further light on the matter. The Court of Appeal also held that the trial judge had not committed an error by deciding that the financial documents were admissible as evidence considering that their reliability was sufficiently guaranteed pursuant to article 2870 of the Civil Code of Quebec, which states the following:

2870. A statement made by a person who does not appear as a witness, concerning facts to which he could have legally testified, is admissible as testimony on application and after notice is given to the adverse party, provided the court authorizes it.

The court shall, however, ascertain that it is impossible for the declarant to appear as a witness, or that it is unreasonable to require him to do so, and that the reliability of the statement is sufficiently guaranteed by the circumstances in which it is made.

Reliability is presumed to be sufficiently guaranteed with respect in particular to documents drawn up in the ordinary course of business of an enterprise, to documents entered in a register required by law to be kept, and spontaneous statements that are contemporaneous to the occurrence of the facts. (Emphasis added.)

In the case at hand, the unaudited financial statements and other accounting documents prepared by American Brands were deemed reliable because the data was drawn from the accounting system used during American Brands' normal course of business. According to the Court, the trial judge did not err in this regard, particularly since the president of American Brands had testified as to the data entry procedures into the accounting system as well as the circumstances leading up to the implementation of this system. He also testified as to the tax and accounting norms implemented by the company. Finally, American Brands' expert confirmed having taken the necessary steps to ensure the reliability of the data.

The Court of Appeal also stressed that it was normal for small companies to have unaudited financial statements.

Normally, the rule of best evidence would have justified the production of all the supporting documents filed with the court. However, the Court of Appeal affirmed the judge's decision that the administration of this evidence would have been unreasonable in the circumstances and that this decision respected the principle of proportionality.

It is important to underscore the nuances raised by the Court of Appeal as regards its decision in the case CHLSD juif de Montréal v. Entreprises Francer inc.[6] sometimes cited to argue that a business cannot claim profit or losses if audited financial statements are unavailable. In that particular case, the Court of Appeal ruled that the appellant's objection as to the admissibility of the plaintiff's unaudited financial statements, which had been prepared by the brother of the company's directing mind and was not supported by any evidence as to their reliability, should have been sustained, and referred the matter back to the trial judge so that evidence may be completed as to damages.

The Court of Appeal took pains to draw attention to the particular circumstances of the aforementioned case by stressing that American Brands' unaudited financial statements were corroborated by the testimony of the company's president and a chartered public accountant. The latter also confirmed that the information that appeared in the financial statements had been drawn directly from the company's accounting system. In other words, and unlike the CHLSD case, the evidence adduced by American Brands provided a sufficiently reliable portrait of its financial situation to be admissible. In such a context, it falls to the trial judge to evaluate the probative value of the evidence. The Court of Appeal concluded that the trial judge had appreciated the probative value of the entirety of the financial documentation entered into evidence by American Brands and, after careful analysis, reduced the amount of the claim.

The main takeaway from the Court of Appeal's decision in this case is that a company without audited financial statements is not barred from claiming profit or losses so long as it provides sufficiently reliable evidence to corroborate the information presented. Whether garnered through an expert report prepared by an accountant, the testimony of representatives of the company, supporting documentation, or any other relevant means, the evaluation of the evidence's probative value is always left to the discretion of the court.


 

[1] 2019 QCCA 1150. For the appeal, American Brands was represented by the Honourable Martin F. Sheehan, Ad. E, now a judge of the Superior Court, Mr. Nikolas Blanchette, a partner at Fasken and leader of the real estate litigation group, and Mr. Nicolas-Karl Perrault, an attorney at Fasken specialising in civil and commercial litigation and product liability. In the first instance, Nikolas Blanchette was the lead attorney.

[2] 2016 QCCS 5092.

[3] 2017 QCCA 154.

[4] 2018 QCCA 1757

[5] ABB v. Domtar Inc., 2007 3 SCR 461.

[6] 2008 QCCA 2402.

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