In Stratton Electric Limited v. Guarantee Company of North America et al., Mr. Justice G. Dennis Lane of the Ontario Superior Court was required to fix costs of the successful defendant, Guarantee Company of North America, in an action that had proceeded to a summary trial under simplified procedure. In the course of so doing, he made some interesting comments about costs awards. In particular, he found that the principle of “reasonableness” applies to costs awarded on a substantial indemnity basis, just as it does to costs on a partial indemnity scale. After finding that Guarantee was entitled to costs on a substantial indemnity basis, he awarded only $20,000 for legal fees instead of the $52,152 that had been claimed.
The plaintiff was an electrical subcontractor who had not been paid for work done. The subcontractor sued the contractor and Guarantee, which had issued a surety bond. Guarantee settled with the plaintiff and proceeded to trial against the contractor and its principals (“the Indemnitors”), seeking to be indemnified for the payment to the unpaid subcontractor. Guarantee relied on an Indemnity Agreement that it had with the Indemnitors. The indemnity payment was only $16,262. What was really in issue in this case was legal costs.
Following a three-day summary trial under Rule 76, Justice Lane gave judgment against the Indemnitors in favour of Guarantee, in the amount of $44,014.55. He was then required to fix costs.
Guarantee sought costs on a substantial indemnity basis, relying on a provision in the Indemnity Agreement with the Indemnitors, whereby they had agreed “[t]o indemnify and save GCNA harmless from and against every claim, demand, liability, expense, loss, cost, charge, adjusters’ and consultants’ fees, fees of attorneys retained by GCNA on a solicitor and own client basis, bills of costs for claimants’ attorneys, judgments and any and all liability therefor, sustained or incurred by GCNA by reason of having executed or procured the execution of Bonds on behalf of Carosi [the Indemnitor]”. The Indemnitors argued that the court should exercise its discretion to award costs on the lower scale of “partial indemnity” rather than on the “substantial indemnity” scale. However, after reviewing the jurisprudence, Justice Lane said that “it appears to me that a contractual provision for the recovery of costs on a specified scale ought to be enforced unless there are special circumstances, such as improper conduct by the claiming party, which persuade the court to order otherwise. Where there are no such circumstances, the court nevertheless has the obligation to police the amount claimed, to ensure that it is no more than is appropriate and properly recoverable.”
An issue that was not canvassed in the decision, evidently because it was not raised, was whether “substantial indemnity costs” is indeed the contemporary equivalent of costs “on a solicitor and own client basis”, which was the scale referred to in the Indemnity Agreement. A number of cases have equated “costs as between a solicitor and his/her own client” with the current phraseology, costs on a “full indemnity” basis: see Antorisa Investments Ltd. v. 172965 Canada Limited, for example. In the present case though, counsel for Guarantee claimed only costs on a substantial indemnity basis, a scale that has been held by at least some judges (see Power J.’s decision in Rodriguez Holding Corp. v. Vaughan (City)) to be something less than full indemnity. Thus, Lane J. was not required to decide whether, because the Indemnity Agreement had provided, in effect, for costs on a “full indemnity” basis, there was any obligation on him to consider the reasonableness of the costs claimed. Instead, he dealt with costs payable on a “substantial indemnity” scale. However, he did advert to the distinction at one point in his decision and suggested that even the “full indemnity” scale would have been subject to review and adjustment by the court:
While the Agreement might be construed as authorizing a claim for full indemnity, that would make little practical difference since the court in either case is bound to review the amount to ensure “that the solicitor, as an officer of the court, is remunerated properly and no more, for the work he does as a solicitor.” [quoting from Orkin: The Law of Costs 2nd ed. paragraph 301 and cases cited, esp. footnote 10.]
His Honour then turned to a consideration of the amount properly payable in this case as “substantial indemnity” costs. He noted that Guarantee “seeks costs of $59,915, based on preparation of some 140 hours ($46,152); counsel fee for three days ($6,000); GST ($3,650) and disbursements ($4,112), all on a substantial indemnity costs basis”. Counsel for Guarantee was called to the bar in 1992. Justice Lane calculated that the hourly rates being charged were “at the high end of the rates recommended by the Costs Subcommittee for partial indemnity costs”. There is no prescribed scale for costs on a substantial indemnity scale, but Justice Lane observed that the partial indemnity rates would have to be increased by 50% to derive the corresponding rates on a substantial indemnity basis.
His Honour referred to an observation that has repeatedly been made in the caselaw, dealing with the grid of maximum hourly rates for partial indemnity costs: that “the recommended rates were the maximum rates for partial indemnity costs and would be expected to ‘apply only to the more complicated matters and to the more experienced counsel within each category’.”
His Honour ruled that “this warning applies to substantial indemnity costs as well as to partial indemnity costs”.
Because the case was not, in the opinion of Lane J., a particularly complicated one and counsel for Guarantee was not “among the most experienced practitioners in her rate group”, he held that the both the rates charged and the hours claimed needed to be reduced significantly.
In arriving at his conclusion, Justice Lane emphasized the importance of the “proportionality” principle in cases under Simplified Procedure: costs awards for such cases will be lower than those conducted under the “ordinary procedure”, to reflect the smaller sums in issue. His Honour expressed the principle using rather colourful language:
Counsel simply cannot expect the costs regime for Simplified Rules cases to produce costs awards like the regular cases. Small cases cannot carry big fees any more than you can make a winter coat out of a small scrap of cloth.
Turning to the amount that was properly recoverable by Guarantee in this case, without speciifically referring to it, His Honour based his analysis on the “reasonable expectations” provision of subrule 57.01(1)(0.b):
In exercising its discretion under section 131 of the Courts of Justice Act to award costs, the court may consider, in addition to the result in the proceeding and any offer to settle or to contribute made in writing,
(0.b) the amount of costs that an unsuccessful party could reasonably expect to pay in relation to the step in the proceeding for which costs are being fixed.
In strong language, Lane J. held that the amount being claimed as costs by Guarantee was far too high in the circumstances:
 In my view, the award of costs in the case before me in the amount proposed by GCNA would be subversive of the basis on which the Simplified Rules are intended to operate. The amount claimed is so disproportionate to the amount in issue as to create a justifiable sense of injustice in those called upon to pay. If these costs were awarded as claimed, there would be a chilling effect on persons contemplating litigation over modest claims.
 GCNA has the right to engage whatever law firm it pleases to collect the $16,000 plus the $28,000 in costs, and that firm can assign whatever lawyer it chooses to do the case at whatever rate the client is willing to pay. However, they both should be aware that for cases under $50,000, they cannot expect the opposite party to bear whatever fees they and their lawyers choose to incur. The costs must be proportionate to what is at stake to enable persons of modest means to have access to justice. The reasonableness of costs awards has a profound impact upon access to justice for persons of modest means.
 No reasonable person sued for $44,000 would expect to have to face legal costs of his opponent of $60,000 for a three day Simplified Rules summary trial. When the transaction costs exceed what is at stake by nearly 50%, the bounds of reason have been far exceeded.
Accordingly, His Honour allowed substantial indemnity costs of $20,000 plus GST and disbursements. If Guarantee receives a bill for the amount that had been sought as costs, after payment of the costs awarded, Guarantee would still owe $32,152 plus GST to its lawyers.
At a recent CLE presentation in Ottawa, we were told that a startling 40% of cases in the system locally are under Rule 76’s simplified procedure. This means that, for the most part, the amounts in issue in those cases are less than $50,000.
We suspect that, in many instances, those cases remain unresolved because of the “sunk costs” of legal fees and disbursements already incurred. Parties continue to litigate, gambling that they will be successful at trial and will recover most of those sunk costs (along with the amount in dispute).
Decisions such as Stratton Electric require a sober reconsideration of this approach. Justice Lane’s costs award of $20,000 was made on a substantial indemnity scale and still represented only 38.35% of the actual fees incurred by Guarantee. If the award had been made on the more usual partial indemnity scale (usually 66% of substantial indemnity) and the same proportionate reduction had been made, the allowed fees would have been only $13,333, leaving Guarantee with a shortfall of $38,818. Once parties come to realize that even if they are completely successful (as Guarantee was here), they will not be reimbursed for a large portion of their legal fees, it will cease to make sense for them to proceed to trial (at least not with senior lawyers charging rates appropriate to much more significant cases).
We have seen similar outcomes in actions conducted under ordinary procedure, where the amount in issue has been much greater. The Antorisa Investments case is a recent example. There, the claim faced by the successful defendant was $500,000 and the legal fees incurred by that defendant were $1.1 million. Justice Lax awarded costs (on a partial indemnity scale) of $650,000.
Justice Lane’s decision in Stratton Electric makes it clear that even parties armed with a contractual entitlement to substantial indemnity (or arguably, even full indemnity) costs are not insulated from the “reasonable expectations” levelling of subrule 57.01(1)(0.b). This is the first case that we have seen in which the court has explicitly said that “reasonable expectations” applies to substantial indemnity costs, just as it does to costs on a partial indemnity basis (although some other decisions have implicitly recognized this). There seems to be no reason to conclude that this dictum will not be equally true of actions under the ordinary procedure as it is of Rule 76 litigation.
We have, in the past, expressed the view that Rule 57’s twin factors of “the principle of indemnity” and “reasonable expectations” are irreconcilable and that the latter should trump the former. That is the approach that the courts seem to have taken. However, the current state of the law of costs has produced great uncertainty for both plaintiffs and defendants. Legal fees and disbursements have come to represent, in many cases, a significant component of what is in issue between the parties. Counsel on both sides need to be able to estimate for their clients what exposure to legal fees and disbursement they risk in going to trial. At the moment, counsel for either a plaintiff or a defendant has to wrestle with questions like these:
does “reasonable expectations” trump “the principle of indemnity” when fixing costs? If so, on what basis will a court determine what is “reasonable” in a given case?
if “reasonable expectations” applies to costs on a substantial indemnity scale, what effect will this have on plaintiffs’ offers to settle (since plaintiffs are normally entitled to costs on a substantial indemnity basis if the judgment at trial is as favourable as the offer)?
where a court awards costs on a “fuil indemnity” basis, must it nevertheless apply the standard of “reasonable expectations”? Justice Lane in Stratton Electric would seem to be saying “No”, but Justice Hackland in Schouten v. Rideau said that “only in those rare cases where a complete indemnity for costs is ordered will [very high hourly rates] be awarded”, suggesting that such an award might not be limited by reasonable expectations.
while the principle of “proportionality” now seems to be applied in both simplified and ordinary procedure cases, it is difficult to predict how it will be applied. In a case in which the sum in issue is, say, $300,000, what would be an acceptably proportionate amount of legal fees?
We will continue to watch (and report) as the courts struggle with these perplexing costs issues.