The Supreme Court of Canada Releases a Pair of Decisions on The Duty of Honest Contractual Performance, Good Faith and the Proper Exercise of Contractual Discretion
In 2014, the Supreme Court of Canada (“SCC”) in Bhasin v. Hrynew, 2014 SCC 71 affirmed the existence of a duty of honest contractual performance. In the headnotes of Bhasin v. Hrynew it was stated that the SCC affirmed two incremental steps the law was taking to make the common law more coherent and just. Those steps were described as follows:
The first step is to acknowledge that good faith contractual performance is a general organizing principle of the common law of contract which underpins and informs the various rules in which the common law, in various situations and types of relationships, recognizes obligations of good faith contractual performance. The second step is to recognize, as a further manifestation of this organizing principle of good faith, that there is a common law duty which applies to all contracts to act honestly in the performance of contractual obligations.
The exact nature, limits and rights attaching to the duties affirmed and described in Bhasin continue to be detailed and molded by subsequent decisions. Two recent decisions of the SCC provide further details on such duties: C.M. Callow Inc. v. Zollinger, 2020 SCC 45 and Wastech Services Ltd. v. Greater Vancouver Sewerage and Drainage District, 2021 SCC 7.
C.M. Callow Inc. v. Zollinger concerned a winter maintenance contract and a separate summer maintenance contract. Throughout the spring and summer before the winter contract was set to expire the defendants lead C.M. Callow to believe that the winter contract would be renewed. C.M. Callow, enticed by the defendants’ conduct and to encourage the renewal of the winter contract, offered services above and beyond the requirements of its summer contract throughout the performance of same. While C.M. Callow was led to believe the winter contract would be renewed, the defendants had already determined to cancel the winter contract on its terms and said nothing.
The SCC held that the defendants’ conduct was dishonest in that they knowingly misled C.M. Callow into believing the winter maintenance contact would be renewed. While the defendants enjoyed the contractual right to not renew the winter agreement per its termination provisions, the SCC found that the exercise of that contractual right was not exercised honestly.
The SCC held that the defendants were required to have “…appropriate regard to the legitimate contractual interests of their counterparty…”, although the defendants were not required to subvert their own interests or act selflessly. The SCC went on to find that contractual obligations and rights must be pursued “…honestly and reasonably and not capriciously or arbitrarily where recognized by law.” Further, conduct that is misleading or dishonest must be directly linked to contractual performance to trigger the duty of good faith in contract. Fairness, bargaining power, contractual terms and other contextual qualifiers inform the application of the duty of good faith.
The SCC clarified that the duty of good faith does not prevent the exercise of a contractual right but may attract damages when such a right is exercised in breach of the duty of good faith. The SCC found that, although the defendants had exercised a contractual right of termination in accordance with the terms of the contract, they exercised that duty dishonestly by leading C.M. Callow by their words and conduct to believe that the contract would be renewed to the advantage of the defendants and disadvantage of C.M. Callow. The SCC summarized as follows:
When [the defendants] deliberately remained silent, while knowing that Mr. Callow had drawn the mistaken inference the contract was in good standing because it was likely to be renewed, it breached the duty to act honestly. In my view, the trial judge did not create a new duty of disclosure in correcting that wrong but rather sought to denounce the [the defendants’] conduct. Remedying that with an order for damages to repair [the defendants’] failure to exercise clause 9 in accordance with the requirements of the duty of honest performance did not confer a benefit on [C.M.] Callow; it merely set matters right on the usual measure of corrective justice following this breach of contract.
It appears that the pith of C.M. Callow Inc. v. Zollinger was that the SCC was not prepared to tolerate exercise of an otherwise unfettered contractual rights if such exercise also “…transgresses the core expectations of honesty required by good faith in the performance of contracts.” The SCC found that dishonesty can be established through the obvious, being outright lies, but also through concealment and misleading.
The SCC found that appropriate damages were at least the amount of profit C.M. Callow expected to net on the winter contract it expected to be renewed, which was $64,306.96. The SCC also found that C.M. Callow was entitled to #14,835.14, being the amount it spent leasing equipment specifically for the winter maintenance contract.
Wastech Services Ltd. v. Greater Vancouver Sewerage and Drainage District involved a waste transportation company working for the defendant municipal contractor. The contract involved Wastech transporting waste to three different facilities, each of which had differing rates for such transportation depending on several factors. Eventually the defendant reallocated the transportation to a closer facility, resulting in a substantial reduction in Wastech’s profits that it otherwise expected to earn. Wastech complained that the change in the way the contract was to be performed, among other things, amounted to a breach of the duty of good faith.
The SCC summarized the heart of the dispute as follows: “The problem in this case is not so much whether the duty to exercise contractual discretion in good faith exists, but on what basis it exists and according to what standard its breach can be made out.” The SCC went on to describe the following principles:
The duty to exercise contractual discretion is breached only where the discretion is exercised unreasonably, which here means in a manner unconnected to the purposes underlying the discretion. This will be made out, for example, where the exercise of discretion is arbitrary or capricious, as Cromwell J. suggested in Bhasin in his formulation of the organizing principle of good faith performance. According to Bhasin, this duty is derived from the same requirement of corrective justice as the duty of honest performance, which requirement demands that parties exercise or perform their rights and obligations under the contract having appropriate regard for the legitimate contractual interests of the contracting partner. Like the duty of honest performance observed in C.M. Callow Inc. v. Zollinger, 2020 SCC 45, the duty recognized here is one that applies in a manner Cromwell J. referred to as doctrine in Bhasin, i.e., the duty applies regardless of the intentions of the parties (Bhasin, at para. 74).
The duty of good faith at issue here constrains the permissible exercise of discretionary powers in contract but, in so doing, it does not displace the detailed, negotiated bargain as the primary source of justice between the parties.
Importantly, the good faith duty at issue does not require the respondent to subordinate its interests to those of the appellant, nor does it require that a benefit be conferred on the appellant that was not contemplated under the contract or one which stands beyond the purposes for which the discretion was agreed.
The SCC went on in its analysis to note that the duty of good faith remains an evolving one, the duty of good faith is highly fact specific and relates to appropriate consideration and legitimate interests triggered by the circumstances. The SCC noted that honest contractual performance is a manifestation of the more general duty of good faith and constrains the exercise of contractual discretionary powers. To exercise such contractual discretionary powers dishonestly is to breach the contract.
The SCC posited that “… beyond the requirement of honest performance, to determine whether a party failed in its duty to exercise discretionary power in good faith, one must ask the following question: was the exercise of contractual discretion unconnected to the purpose for which the contract granted discretion? If so, the party has not exercised the contractual power in good faith.” Reasonableness can relate to whether discretion was exercised in good faith and relates back to the context of the bargain struck by the parties.
The SCC was careful to point out that the duty of good faith does not call upon the court to ignore that parties can be self-interested in their economic relations or to exercise ad hoc judicial moralism or “palm tree” justice. What the SCC appeared to get at was not that a party could not exercise contractual discretion in any manner intended by the parties, but it could be restrained from capricious exercise of discretion allowed by the four corners of the contract but which was otherwise not intended by the contract.
The SCC ultimately found that the context of the contract made it quite clear that its terms were drafted to reserve discretion to pursue the most cost-effective means to accomplish the waste removal. There was no guarantee of specific targets payable to Wastech. There was explicit risk that discretion could be exercised which would affect profitability baked into the heart of the contract. The discretion exercised by the City was within its contractual discretion and within the risks accepted by Wastech when it entered the contract.
The lessons to be learned from C.M. Callow Inc. v. Zollinger, 2020 SCC 45 and Wastech Services Ltd. v. Greater Vancouver Sewerage and Drainage District, 2021 SCC 7 are, at once, both simple and nuanced. Because a contract gives a party to exercise contractual discretion does not mean that the exercise of such discretion may be restrained only by the words of the contract. Such discretion may call into question whether such discretion was exercised in a manner consistent with good faith and the duty of honest contractual performance which questions engage a highly-fact specific analysis that applied legal principles which continue to evolved and be better understood.
Perhaps the simplest lesson to be learned from a pre-litigation perspective is for parties entering a bargain to spell out within their contract very clearly what contractual discretion exists, why it exists and any understanding or agreement as to how such discretion can or should be exercised that is shared between the contracting parties. The simplest lesson to be learned in the context of performance of contracts is that exercise of contractual discretion should be scrutinized in the context of whether it may breach duties of good faith and that both the party exercising such discretion and the counterparty should engage in this analysis.