Executive Summary: Key Legal and Evidentiary Issues

• CPC breached two contracts for natural health products by failing to follow a specified dual extraction process for Chaga Capsules and delivering mould-contaminated Beauty Secret Powder.

• Real Organics could not establish that following the prescribed extraction method would have yielded the desired polysaccharide concentration close to 50%, defeating its lost profits claim for the Chaga Capsules.

• Reconstructed production records were presented to Real Organics without disclosure of their inauthentic nature, giving rise to a breach of the duty of honest performance finding at trial.

• Civil fraud claims against CPC and Dr. Cai were dismissed due to insufficient pleading, lack of reliance on alleged misrepresentations, and absence of evidence of Dr. Cai's personal knowledge of the falsehoods.

• The $10,000 award for breach of the duty of honest performance was set aside on cross appeal because the claim was neither properly pleaded nor argued at trial.

• Real Organics' refusal to accept CPC's offer to reprocess chaga at no charge was found not to constitute an unreasonable failure to mitigate, given CPC's prior conduct and the mould issues with the Beauty Secret Powder.

The business relationship and the chaga products venture

In 2015, Ivy Liou, who controlled Real Organics & Naturals House Ltd. ("Real Organics"), identified Canadian chaga — a fungus found on birch trees containing polysaccharides said to have health benefits — as the foundation for a new health and beauty products business. She planned to purchase chaga from a Québec supplier and use a dual extraction method common in Chinese natural product manufacturing to extract the polysaccharides. On April 15, 2016, Ms. Liou met with Dr. Yuan Ma, the founder of Canadian Phytopharmaceuticals Corporation ("CPC"), a Richmond, BC-based contract manufacturer and private labeler of natural health products, to discuss having CPC manufacture the chaga products Real Organics intended to develop. The individual respondents — Dr. Carina Cai, Kok-Sing Lim, and Daniel Wang — were either directors or employees of CPC who dealt with Ms. Liou. Dr. Ma suggested that they begin by extracting the polysaccharides from a test batch of chaga, and if Ms. Liou was satisfied with the results, they could then move forward with full commercial production.

The test batch and the processing specifications

Two days after the initial meeting, Ms. Liou emailed Dr. Ma asking CPC to apply to Health Canada for a natural product number ("NPN") for Chaga Capsules, one of the products Real Organics intended to develop, and directing him to use a small amount of chaga supplied by Real Organics to process a test batch. Her email specified a three-step manufacturing process: hot water extraction performed under high pressure (480 psi / 4.0 MPa) at 80–90 degrees Celsius, alcohol (ethanol) precipitation for water-insoluble components, and a final process combining and powdering the two extracts plus the residue fibre into capsules. The test batch was processed in late May 2016. Ms. Liou sent a bottle of the resulting powder to Silliker JR Laboratories, ULC ("Silliker") for testing. The certificate of analysis ("COA") showed a polysaccharide content per weight of 50.2% — a level Ms. Liou considered key to ensuring the marketability of the Chaga Capsules as Real Organics' flagship product. Encouraged by these results, the parties turned to processing commercial-sized batches. Ms. Liou sent CPC slightly modified processing specifications, reflecting what she understood to be the process followed by CPC in the production of the successful test batch. These specifications were found to constitute a central term of the parties' agreement governing the production of Chaga Capsules (the "Second Batch Contract"). CPC received two 500 kg batches of chaga from Real Organics' Québec supplier on August 10 and 23, respectively. The parties also entered into a separate contract for the manufacture of Beauty Secret Slimming and Nourishing Powder ("Beauty Secret Powder"), to be made from the chaga residue left after the processing of raw chaga into Chaga Capsules (the "Beauty Secret Powder Contract").

Internal disruption at CPC and the failed second batch

Just as production of the Chaga Capsules ramped up in mid-September 2016, a shareholders' dispute within CPC led to the ouster of Dr. Ma and the departure of his daughter, Jie Ma, who had been CPC's Production Manager. CPC was without a Production Manager until mid-November 2016, when Dr. Cai was appointed as the Manager for Quality Control, and Alice Chen was appointed as Production Manager. Dr. Wang joined CPC in October 2016, assuming the role of Chief Scientist and, shortly thereafter, the additional role of VP of Production. After the commercial-sized batch (the "Second Batch") was processed, CPC provided Ms. Liou with a bottle of the extracted powder, which she again took to Silliker for testing. The COA revealed a polysaccharide concentration of only 6% — a level Ms. Liou considered far too low to be marketable. CPC agreed to do further testing and to conduct an investigation into the result. During the investigation phase, CPC learned that the production records for the Second Batch were missing, and that it could not even access electronic copies of the documents given to the production staff. The technicians involved in the processing were interviewed and replacement production sheets were created that did not align entirely with the technicians' conflicting recollections. The trial judge found that CPC recreated the production records to make it appear that the process roughly complied with the extraction process outlined in the Second Batch Contract.

The Beauty Secret Powder contamination and the breakdown of negotiations

CPC processed the Beauty Secret Powder from the chaga residue in June 2017. At this time, the technicians discovered that the chaga residue, which had been stored in plastic bags, was wet. CPC conducted an analysis of the resulting product, which showed there were no unacceptable levels of mould. CPC then encapsulated and delivered 991 bottles of the Beauty Secret Powder to Ms. Liou on July 19, 2017, samples of which Ms. Liou sent to Silliker for testing. By early July 2017, Ms. Liou's frustration with CPC's lack of answers on the status of the Second Batch had increased. It had been approximately six months since her initial discussion with Dr. Cai about the disappointing test result. At some point in July, she told Dr. Cai she wanted to look at CPC's production records. When Ms. Liou and three Real Organics employees went to CPC to inspect the production records on July 26, 2017, CPC did not disclose that the documents it provided were reconstructions, not the original records. Ms. Liou found it suspicious that the production records were in such pristine condition — something one would not expect if the pages had been filled out on the factory floor as the work progressed. On July 28, 2017, Mr. Lim, one of CPC's directors, offered Ms. Liou two options: first, CPC would stop any further production and provide Real Organics with the same grade and same amount of chaga to replace the product provided to CPC; or second, CPC would process 1,000 kg of replacement chaga for Real Organics at a higher price, with CPC to supply the chaga. Ms. Liou did not accept either option — the first because she did not trust CPC to buy the raw material; the second because it involved a significant increase in price. Meanwhile, on July 31, Silliker's analysis of the bottled Beauty Secret Powder revealed a mould content far beyond acceptable levels. Mr. Lim presented a third option on August 3, 2017: CPC would perform the processing of raw materials provided by Real Organics without charge. Ms. Liou did not accept that offer, apparently because she wanted CPC to also cover the cost of the raw materials. On August 8, after Mr. Lim learned that Ms. Liou had filed a complaint about CPC to Health Canada, triggering a "compliance verification", he emailed Ms. Liou to inform her that CPC was no longer willing to engage in negotiations and was prepared to address the issue through the courts.

The contractual terms at issue

The case centered on two contracts. The Second Batch Contract incorporated the processing specifications Ms. Liou had sent to CPC specifying the dual extraction method, including hot water extraction under high pressure, ethanol precipitation for water-insoluble components, concentration ratios, and a final process combining and powdering the extracts into capsules. The Beauty Secret Powder Contract was governed by separate Contract Manufacturing Terms and Conditions that included a limitation of liability clause (section 8.3), which provided that the remedies under that section represented all remedies available to the client for any defective products, and that under no circumstances would the manufacturer be liable for anything more than the costs of the client-supplied raw materials.

The trial proceedings and the initial damages award

The parties attempted to resolve their dispute through a summary trial in February 2019, but the matter was found to be unsuitable for that form of proceeding. The action proceeded to a full trial over 22 days between November 21, 2022, and September 1, 2023. Ms. Liou and Real Organics were self-represented at trial. Real Organics pleaded breach of contract in relation to both the Second Batch Contract and the Beauty Secret Powder Contract, as well as breach of fiduciary duty, conspiracy, and fraud. Before trial, it abandoned its claim for specific performance, seeking instead damages of over $1.7 million for lost profits, as well as punitive, exemplary and aggravated damages. The trial judge found CPC breached the Second Batch Contract because it did not follow the specified dual extraction process, breached the Beauty Secret Powder Contract when it produced powder which contained unacceptably high levels of mould, and breached its duty of honest performance when it provided Ms. Liou with recreated production records without advising her of the significant uncertainty about their accuracy. The judge dismissed the civil fraud and conspiracy claims, all claims brought by Ms. Liou personally, and all claims against the individual defendants. At trial, Real Organics also withdrew its claim for breach of fiduciary duty. Regarding causation and damages, the judge held that he could not say with certainty what would have happened if CPC had properly performed the contract for the production of the Second Batch by following the specified dual extraction process. However, he found that Real Organics would have at least had an opportunity to perform further development with the benefit of what had been learned from the Second Batch. Accordingly, instead of awarding lost profits in relation to the Second Batch, the judge compensated Real Organics for the wasted raw material. Real Organics was ultimately awarded $84,420, comprised of: $30,000 for loss of anticipated profit from the Beauty Secret Powder; $950 for the cost of testing the Beauty Secret Powder for mould; $39,600 (the cost of acquiring the raw chaga) for breach of the Second Batch Contract; $3,870 as a refund of deposits paid; and $10,000 in "nominal damages" for breach of the duty of honest performance. The judge ordered each party to bear their own trial costs, finding that Real Organics should have accepted formal settlement offers from CPC in November 2022, which included a $150,000 payment in exchange for the waiver of all claims against CPC, and consent dismissal of the claims against the individual defendants.

The appeal and the expert evidence on causation

On appeal, Real Organics raised four grounds, claiming the judge misapprehended or ignored evidence, which led him to: dismiss the lost profits claim for the Chaga Capsules; award only nominal damages for breach of the duty of honest performance; fail to find CPC and Dr. Cai liable for civil fraud; and deny Real Organics full costs of the trial proceedings. On the lost profits claim, the Court of Appeal found the trial judge's conclusions were amply supported by the evidence he accepted. CPC's expert, Dr. Fatehi, a chemical engineer specializing in biomass extraction and testing, tested four batches of chaga using the appellant's prescribed method and obtained polysaccharide concentrations of only 18.85% — far below the approximately 50% required by Real Organics. Dr. Fatehi opined that the concentration of polysaccharides in raw chaga depends on the quality of the chaga itself, as well as the method and duration of storage. The quality of the chaga in turn depends on the environment in which it grows, including the nutrition in the soil, the amount of sun and water, the growing temperatures and other environmental factors. Ms. Liou's own research, as reflected in the various patent applications she made, demonstrated that the extraction process she instructed CPC to use might not have been an ideal one, as the applications varied as to the ratios and sequencing they identified for alcohol and water extraction. The appellants raised four specific challenges: the alleged stability of polysaccharide concentrations in raw chaga; a dual extraction process completed by Real Organics in 2020 that allegedly achieved a polysaccharide concentration above 65%; the significance of a high solvent-to-raw-material ratio; and Dr. Fatehi's alleged failure to use a condenser in his testing. All four were rejected. The judge was entitled to put no weight on Ms. Liou's lay evidence about polysaccharide stability. Her assertions about the 2020 result were not supported by documentary evidence and the judge had identified issues with her credibility. The judge accepted that variations in solvent-to-raw-material ratios could affect the composition but found insufficient evidence to conclude the specified process would have yielded the desired concentration. Dr. Fatehi explained that the vapour produced during extraction does not contain polysaccharides, and therefore the use of a condenser would not have affected the polysaccharide content in the extracted powder.

The civil fraud claims

The Court of Appeal upheld the dismissal of the civil fraud claims. Real Organics did not plead that CPC was liable for misrepresenting information pertaining to the test batch COA. Nor did Real Organics plead that CPC made fraudulent representations in relation to the Second Batch beyond the alleged forging of production records presented to Ms. Liou in July 2017. The Court emphasized that lawsuits are to be decided within the boundaries of the pleadings, and that an allegation of fraud must be clearly pleaded and supported by material facts. As for Dr. Cai, the judge found "nothing that would support any assertion that Dr. Cai had knowledge that the information [in the Beauty Secret Powder COA] was false" and made an express finding that "Dr. Cai had no role in the production records." The appellants also had not proved the requisite element of reliance on the alleged misrepresentation, given the short time between the sharing of the production records and Ms. Liou's conclusion that the documents were inaccurate.

The cross appeal and the duty of honest performance

On CPC's cross appeal, the Court of Appeal agreed that the $10,000 award for breach of the duty of honest performance must be set aside. The amended notice of civil claim contained only a general plea for breach of contract. When the respondents demanded particulars of the breach of contract claim, the appellants' particularized allegations focused on CPC's failure to adhere to the processing procedures and to meet the concentration expectation — not on dishonesty in contractual performance. The appellants acknowledged that their amended notice of civil claim did not use the words "duty of honest performance." Neither the judge nor the parties addressed the duty of honest performance in oral submissions at trial, and the judge did not alert the parties to his intention to consider it or invite submissions on that point. The Court held that a party wishing to advance such a claim must clearly plead the material terms of the contract as well as the nature of the breach due to the defendant's alleged dishonesty, citing Ocean Pacific Hotels Ltd. v. Lee, 2025 BCCA 57 and Bhasin v. Hrynew, 2014 SCC 71.

The ruling and the overall outcome

The Court of Appeal, in a unanimous decision written by Madam Justice Fenlon and concurred in by Justice Dickson and Justice Iyer, dismissed Real Organics' appeal on all four grounds and allowed CPC's cross appeal in part. The $10,000 award for breach of the duty of honest performance was set aside, reducing Real Organics' total damages from $84,420 to $74,420. On the issue of mitigation, the Court found that Real Organics' failure to accept CPC's offer was not unreasonable, noting that a plaintiff is not held to a high standard of conduct in mitigation, that Real Organics had lost confidence in CPC given CPC's delay in responding to concerns about the Second Batch and its obfuscation of the production records, and that immediately prior to receiving the offer, Real Organics had learned that the Beauty Secret Powder contained mould and could not be marketed. The $30,000 award for loss of anticipated profits on the Beauty Secret Powder was upheld; the judge's conservative assessment was not found to be in error, and the limitation of liability clause did not preclude the award given the existence of two distinct contracts. CPC was entitled to costs of the appeal. Each party was ordered to bear their own costs of the cross appeal given that success had been divided. The trial judge's order on trial costs was not disturbed.