IT Contracting: Focus on Quebec, Part I – Seller Liability for Software Integrators?

In light of Quebec’s unique legal environment in North America (i.e. Quebec is a civil law jurisdiction with French as its official language), I thought I would use my first three contributions to Slaw to address certain issues peculiar to Quebec in relation to sophisticated IT contracts such as systems integration and outsourcing agreements. I have chosen not to discuss language related issues at any length for, except in Government related procurement scenarios, the contracting and negotiation process can be conducted in English in Quebec based on forms of agreements consistent with industry standards. I will rather focus on a number of substantive legal issues fairly unique to Quebec in the North American context.

As the second largest provincial economy in Canada – Quebec’s GDP is roughly half that of the province of Ontario, and is comparable to those of jurisdictions such as the State of Washington, Norway or Hong Kong – Quebec remains a significant market for large international integrators and outsourcers. Yet, certain specificities of the province’s legal system will typically require vendors to pause to review their typical legal risk tolerance analysis and adapt their practices slightly to appropriately address these in the Quebec context. 

For starters, I have selected a legal issue unique to Quebec that has yet to be appropriately discussed or analyzed at any length in the province. Needless to say, this legal issue hasn’t yet had any echo in case law. In fact, it hasn’t even hit the radar screen of most legal practitioners in Quebec. And from my discussions with a few who are familiar with the issue – experienced IT practitioners, essentially – it isn’t clear what the outcome will be if and when it is ever brought before a Court here.

This issue is specific to systems integrators and outsourcers providing software as part of their service relationship with customers. Simply stated, there is currently a risk in Quebec that systems integrators and outsourcers that provide software as part of a service engagement may be held liable, as sellers under the sales contract regime, for any latent defects in such software … with uncapped liability. 

To fully appreciate the issue – and its origins – let’s first back track and review a few general provisions of the Civil Code of Quebec (the “Civil Code” or “C.c.Q.”).

The Sales Contract Latent Defects Regime in the Civil Code

Under the Civil Code’s sales contract regime, the statutory “quality” warranty imposed on sellers essentially takes the form of a warranty against “latent” defects (Articles 1726 and ff. C.c.Q.). Simply stated, to qualify as “latent” under the Civil Code, a defect must: (i) be latent, (ii) be sufficiently serious, (iii) have existed at the time of the sale, and (iv) have been unknown to the buyer at the time of the sale. Pursuant to Article 1730 C.c.Q. as interpreted by case law, suppliers, resellers, distributors (and other similar intermediaries) of goods/property are also bound to warrant the buyer against latent defects in the same manner as a seller – this rule was originally introduced to improve buyers’ direct recourses against the original seller and manufacturers (i.e. in the past, buyers were often unable to sue these due to the lack of privity of contract). 

While sellers can normally have buyers contractually waive (in whole or in part) the latent defects regime, it is against public policy in Quebec to do so in certain specific circumstances.

Pursuant to Article 1733 C.c.Q., a seller may not exclude or limit its liability “unless [it] has disclosed the defects of which [it] was aware or could not have been unaware”. Article 1728 C.c.Q. complements Article 1733 C.c.Q. by stating that “if the seller was aware or could not have been unaware of the latent defect, [it] is bound not only to restore the price, but to pay all damages suffered by the buyer”.

Case law decided under Article 1728 C.c.Q. has held that all professional sellers (i.e. essentially all sellers, suppliers, resellers, distributors and other intermediaries except for individuals making a sale privately not for business purposes) are presumed to have had knowledge of the latent defect (i.e. they “could not have been unaware” of the latent defect, to use the exact words of Article 1728 C.c.Q.). As a result, professional sellers in Quebec are exposed to being liable for all damages recoverable at law and suffered by buyer as a result of a latent defect – which could include, to the extent there is sufficient causal nexus, lost-profit like damages. It is worth noting that this liability exposure can not be waived, excluded or curtailed in advance by contract vis-à-vis a buyer, whether through a limitation of liability, a disclaimer of warranties or any other like contractual technique. For in the prism of Articles 1728 and 1733 C.c.Q., the seller’s behaviour is then assimilated to fraud or to an intentional fault, the liability for either of which can never be limited in advance contractually anyway in Quebec.

Once the existence of a latent defect has been established against a professional seller, the only way out of liability is for the seller to rebut the “presumption of knowledge”. This is typically not easy to do, in particular for specialized professional, and it requires a showing of (i) fault on the part of the buyer or a third person, (ii) force majeure, (iii) development risks, or that (iv) the professional seller’s selection of goods was reasonable and well informed and there was no way for it to verify the existence of such latent defect. But this is not an easy task as demonstrated by the latest Quebec Court of Appeal decision on this point in Les Entreprises d’Électricité Rial Inc. v. Lumen (500-09-018781-088)(April 7, 2010)(C.A.) 2010 QCCA 655 (CanLII), which ultimately held that a professional reseller of Sylvana light bulbs was responsible for latent defects therein on the above stated ground. See also the leading Supreme Court Case on this issue: ABB Inc. v. Domtar Inc., [2007] 3 S.C.R. 461.

Software Integrators and Outsourcers Liable for Software as Sellers?

I can hear you say: “This is all very interesting, but what do sales contract-related issues have anything to do with software?” Fair point, I agree. And in fact, it has been the law in Quebec since the 90s that (software) licenses are not sales contacts, nor are they leases, but are rather sui generis contracts governed by the legal regime applicable to all contracts generally – as opposed to the “sales” or “lease” contractual regimes in the Civil Code.

So, “What is the problem”, I hear you say again? Well, the problem comes for the complete overhaul of the Civil Code that was implemented sixteen years ago. In 1994, after having worked on various drafts for decades, the Quebec Government finally adopted and put into effect the Civil Code in replacement of its prior version. As part of this sweeping reform, the Civil Code implemented a new set of rules governing services contracts and contracts of enterprise (most of the time in the latter case, construction contracts) (See Articles 2098 and ff. C.c.Q.). One of those rules targeted the scenario where a (non-IT) service provider or contactor delivered third party goods or materials to its customer as part of a construction project or service contract. Because the contractor service provider were the only ones with privity of contract with the third party seller from which they had purchased the goods or materials delivered to the customer, this rule was intended to provide the customer with the same “sales contract” recourses against its contractor or service provider as it would otherwise have had directly against the third party seller had the customer – and not the contractor or service provider –purchased such goods or materials itself directly from the third party seller.

The rule is found at Article 2103 C.c.Q. and reads as follows:

2103. The contractor or the provider of services furnishes the property necessary for the performance of the contract, unless the parties have stipulated that only his work is required.

He shall furnish only property of good quality; he is bound by the same warranties in respect of the property as a seller. (…)

In other words, where a service provider or a contractor provides goods or materials as part of its contract with a customer, the law will deem it be a “seller” in respect thereof.

This all works fine in the brick and mortar world. But how should Article 2103 C.c.Q. be applied in the modern IT reality?

Obviously, when Article 2103 C.c.Q. was drafted in the decades leading to 1994, the IT industry was in its infancy. So we can arguably presume that the drafters of Article 2103 C.c.Q. did not have software or other intangible assets in mind when they drafted the provision. Most probably, I argue, when they used the word “property” in Article 2103 C.c.Q., the drafters were thinking about plywood, lumber, machinery, and other tangible goods which were to be purchased by the service provider or contractor, and then resold to the customer as part of the larger service or construction contract. In other words, it is my view that Article 2103 C.c.Q. was meant to apply to property “purchased” by service providers and contractors and then “resold” to customers. Nothing more, nothing less.

But the rule at Article 2103 C.c.Q. could have devastating effects if also applied in the systems integration and outsourcing contexts, where COTS software platforms and products are customarily obtained, procured, installed and/or managed by service providers. In other words, is COTS software procured and then installed by a service provider equivalent, within the meaning of Article 2103 C.c.Q., to property “furnished” by the service provider? I argue that it is not. But if it were to be, we could end up in a nonsensical situation whereby systems integrators and outsourcers could be liable as “sellers” for software that they obtained from third party licensors, while such third party licensors would at the same time continue not to be liable as “sellers”, but only as licensors in accordance with their license agreement with the service provider or the customer. Stated otherwise, if licensors are not liable for latent defects in their software products pursuant to Quebec law, why should systems integrators and outsourcer be so liable solely as a result of having performed procurement and/or integration services in respect thereto? Would it make any sense that systems integrators and outsourcers be faced with potential uncapped liability for latent defects in third party COTS software, when at the same time the relevant third party licensors could not? I believe not.

In the Meantime, Managing The Risk …

Until and unless a consensus develops in Quebec – and especially in Quebec case law –as to the non applicability of the second paragraph of Article 2103 C.c.Q. to the software/licensing environment, systems integrators and outsourcers doing business in Quebec must keep this risk in mind when negotiating IT service transactions with Quebec-based customers.

A number of risk-mitigating mechanism may be envisaged to manage this exposure, such as obtaining an indemnity from third party licensors or having foreign law govern the contract with the customer. But none of these have yet been generally used in relation to this specific risk, and they would each pose various challenges both from an enforceability perspective and from an “adoption” standpoint, whether with the software industry generally or with Quebec governmental customers. But that is a story for another day …