|By: I. Jamie Arabi, Litigation Associate|
In 2014, the Supreme Court of Canada released Bhasin v Hyrnew, which recognized a general principle of good faith in contractual performance. The decision highlighted one manifestation of that organizing principle: the duty not to actively deceive. Since Bhasin, there has been some confusion about how far the good faith principle extends. Two recent Supreme Court decisions have provided some clarity:
- CM Callow Inc v Zollinger (“Callow”) confirmed the expectation that parties will perform a contract without lies or deception. More importantly, it extended the duty of honest performance introduced in Bhasin, noting that inaction or silence can be “cousins in the catalogue of deceptive contractual practices”.
- Wastech Services Ltd v Greater Vancouver Sewerage and Drainage District (“Wastech”) explored the exercise of contractual discretionary powers in good faith. It accepts that parties must exercise contractual discretion reasonably within the context of the agreement reached.
In both decisions, the Supreme Court was careful not to erode freedom of contract. It accepted that contractual counterparties are not required to subvert their own interests to conform to either of the duties clarified in Callow and Wastech.
Callow and the Duty of Honest Performance
In the first decision, Callow had a two-year winter maintenance agreement with a group of condominium corporations (collectively “Baycrest”). The agreement allowed Baycrest to terminate if Callow failed to provide satisfactory services. Baycrest could also unilaterally terminate the agreement without cause, upon 10 days’ written notice.
In early 2013, Baycrest decided it would terminate the agreement. However, the parties continued to discuss the possibility of renewal during the spring and summer of 2013. During that time, Callow undertook work at no charge to Baycrest as an incentive for renewal. Baycrest accepted those “freebies”, which suggested to Callow that Baycrest would likely renew. After receiving the benefit of Callow’s “freebies”, however, Baycrest finally communicated to Callow its decision to terminate the agreement in September 2013.
Callow lost the opportunity to bid on other winter maintenance contracts because it expected that Baycrest was going to renew the agreement.
Making the connection: dishonesty and its relation to an existing agreement
To qualify as a breach of the duty, any dishonesty must be connected to the exercise of rights or the performance of obligations under the contract in place.
Notably, the Court of Appeal had found no breach because it focused on the dishonesty’s connection to the discussions surrounding a potential future contract. However, the Supreme Court decided differently on the grounds that Baycrest’s dishonest conduct concerned the exercise of the termination clause in the ongoing winter maintenance agreement.
Silence can constitute dishonesty
More significantly, the Supreme Court accepted that silence in some circumstances can constitute dishonesty. In circumstances where Baycrest knew that Callow expected a renewal, the Supreme Court commented:
One can mislead through action, for example, by saying something directly to its counterparty, or through inaction, by failing to correct a misapprehension caused by one’s own misleading conduct. To me these are close cousins in the catalogue of deceptive contractual practices.
Furthermore, the court found that Baycrest’s acceptance of “freebies”, including Callow’s improvement of two gardens, helped form the misleading impression that it would renew the agreement. As such, contracting parties should consider the potential effects of their omissions, silence, or inaction on their counterparties when performing a contract.
Wastech and the exercise of contractual discretionary powers in good faith
The Wastech decision addressed a related issue about the exercise of discretionary rights. The claimant, Wastech, was a waste transportation and disposal company with a long-standing contractual relationship with Metro, the statutory corporation responsible for the administration of Metro Vancouver’s waste disposal.
Under the contract, Metro enjoyed the flexibility necessary to maximize efficiency and minimize costs of the operation. In fact, the contract gave Wastech “absolute discretion” to allocate waste to various disposal streams. This had the potential to affect Wastech because Metro paid different rates based on the distance Wastech had to travel to the disposal facility.
In 2011, Metro used its discretion to direct more waste to a nearby disposal facility, which led to Wastech’s inability to reach its profit target. Wastetech referred the matter to arbitration, and argued that it would be unreasonable for a party to exercise its discretion in a manner that would “deny the other contractual party substantial benefits flowing to it which represent fundamental aspects of the parties’ legitimate contractual expectations.” As such, Wastech assumed that the law would protect against a “substantial nullification” or “evisceration” of contractual benefits under the guise of good faith.
Unreasonably exercising discretion
Ultimately, the Supreme Court disagreed. It found that a substantial nullification or evisceration of the contract’s benefit is not determinative of a breach of the duty to exercise discretionary powers in good faith. On the other hand, an exercise of discretion could constitute a breach if the party exercised its discretion in a manner unconnected to the relevant contractual purposes.
The relevant test is whether the exercise of the contractual discretion was unconnected to the purpose for which the contract granted discretion. Courts will not impose their own detached understandings of fairness. Instead, they will determine the measure of fairness by examining the parties’ own bargain. Courts will only intervene when the exercise of power is arbitrary or capricious in the context of the contract as agreed.
Ultimately, the Court stated that:
Good faith does not eliminate the discretion-exercising party’s power of choice. Rather, it simply limits the range of legitimate ways in which a discretionary power may be exercised in light of the relevant purposes.
The Supreme Court determined that Metro’s exercise of discretion was not unreasonable in context. The relevant considerations included that Wastech recognized that it could fail to meet its profit target but decided not to further negotiate the relevant clause. Furthermore, Wastech understood that the contract allowed Metro to take reasonable measures as it saw fit to maximize efficiency and minimize costs with regards to waste disposal allocation.
Key implications and takeaways from Callow and Wastech
Both of Wastech and Callow have important practical implications:
- The duties of honest performance and the reasonable exercise of contractual discretion are general principles of contract law. These duties apply to all contracts in Canada despite the intentions of the parties.
- If a party knowingly misleads another, the lack of an express contractual obligation of disclosure does not preclude an obligation to correct the false impression that is created. This means that a party that actively misleads should be mindful to correct any misapprehensions. Remaining silent can lead to a breach of contract.
- Honest performance and exercising discretionary powers in good faith do not require parties to subordinate their own rights or interests in favour of the other party. The principle of good faith does not rewrite the parties’ bargain.
- Parties should note that damages for a breach of the duty of honest performance will be assessed based on the expectation interest. The Supreme Court appears to accept that parties are best served by measuring the loss based on what would have been attained had the contract been performed.
- Contracting parties should take care in defining the bounds of contractual discretion. Whether or not discretionary power is used reasonably is considered in light of the bargain struck by the parties. As is generally the case, unambiguous language and clear discretionary clauses can prevent parties from enduring costly litigation.
Jamie Arabi is an associate at Theall Group LLP and maintains a broad commercial litigation practice. Jamie is passionate about advocacy and has represented clients at the Superior Court of Justice, the Ontario Court of Justice, and provincial tribunals. Jamie articled at a prominent, full-service firm, assisting on both commercial litigation and transactional matters. Additionally, Jamie worked for an international law firm in Dubai, where he assisted on securities and regulatory matters. During law school, Jamie joined the TradeLab International Economic Legal Clinic. He was also recognized for his contributions to the Lebanese community and served as a director of a not-for-profit cultural organization. Currently, Jamie volunteers for Pro Bono Ontario. Jamie is conversant in Arabic.
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