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Supreme Court Commentary on Contractual Duties of Good Faith and Honest Performance: Zollinger and Wastech

03-Mar-21

By Lydia Roseman

In 2014, the Supreme Court of Canada (“SCC”) released its seminal decision, Bhasin v. Hrynew.[1] In this decision, the Supreme Court officially recognized an organizing principle of good faith in all contracts and a duty to act honestly in all contract performance.

This decision spurred a copious amount of litigation and academic commentary.[2] It seems like almost every contractual dispute since Bhasin’s publication has referred in some way to the principle of good faith or the duty of honest performance.

The SCC recently had the opportunity to once again comment on the principle of good faith and the duty of honest performance as well as clarify some of the confusion that has existed in Bhasin. In particular, the Court issued two decisions in the last few months addressing these principles: Wastech Services Ltd v Greater Vancouver Sewerage and Drainage District[3] and CM Callow Inc v Zollinger.[4]

As these duties will apply to every contract and cannot be removed, it is important that contracting parties understand exactly what these cases mean for them; what conduct is permitted and what conduct will find them upon breach of these duties.

Zollinger – the Duty of Honest Contractual Performance

Facts and Procedural History

The appellant (“Callow”) was a company operating a snow removal service; the respondents (collectively “Baycrest”) included 10 condominium corporations and a designated property manager. The parties had signed a two-year commercial winter maintenance agreement which permitted Baycrest to terminate the contract unilaterally on 10 days’ notice. The lawsuit centered around the manner in which the respondents exercised this termination clause.

While Baycrest gave the requisite 10 days’ notice, Callow argued that they exercised the termination clause in a dishonest or misleading way. Baycrest had decided in March or April to terminate the contract but did not inform Callow of this decision until September. During the intervening period, Baycrest through its conduct led Callow to believe that the contract would be renewed, leading to lost business opportunities for Callow.

The trial judge found in favour of Callow, holding that Baycrest’s actions were dishonest. The Court of Appeal disagreed and overturned the decision. The SCC ultimately allowed the appeal, finding that Baycrest engaged in “active deception” which breached the duty of honest performance.

Important Principles

This case helped clarify exactly what will constitute a breach of the duty of honest performance. Bhasin recognized that there is no duty of disclosure but that dishonest conduct would breach the duty. This left a lot of grey area in what type of “dishonest” conduct would be sufficient to constitute a breach.

Zollinger clarified that “active deception” is sufficient to breach the duty of honest performance, even absent an outright lie. The SCC also helped clarify the difference between simple non-disclosure and active deception:

Baycrest may not have had a free-standing obligation to disclose its intention to terminate the contract before the mandated 10 days' notice, but it nonetheless had an obligation to refrain from misleading Callow in the exercise of that clause. In circumstances where a party lies to or knowingly misleads another, a lack of a positive obligation of disclosure does not preclude an obligation to correct the false impression created through its own actions.[5]

In essence, while there is generally no duty of disclosure, the decision says that there may be a positive duty to correct a false impression that a party has itself created. The Court also said that parties cannot “tell half-truths in a manner that knowingly misleads a counterparty.”[6]

Therefore, active deception may include “lies, half-truths, omissions, and even silence, depending on the circumstances”.[7]

The Court explained the duty another way, saying that the duty of honesty really creates a “negative” duty, i.e. the duty not to act dishonestly. In other words, “the duty of honesty recognized in Bhasin is a negative obligation — not to lie — rather than a positive obligation — to act in good faith”.[8]

The SCC noted the following factors which constrain the breadth of the duty of honesty: first, a party need not subvert its own interests to those of the other party by acting as a fiduciary or otherwise in a selfless manner that confers a benefit on the other side. Second, “[i]t is not enough to say that, temporally speaking, dishonesty occurred while both parties were performing their obligations under the contract; rather, the dishonest or misleading conduct must be directly linked to performance”.[9]

Much of the decision then elaborated on how to determine if the dishonest conduct is sufficiently connected to the performance of, or exercise of rights under, the contract. The Court noted that there must be a “nexus” to the contractual relationship. “By focusing attention on the exercise of a particular right under a particular contract, a direct link to the performance of that contract is helpfully drawn.”[10]

There is no requirement that the contracting party intend that the other party rely on their representation or false statement for the duty of honesty to apply.

As for the result of a breach of the duty, the Court notes that the duty of honesty does not constrain the exercise of a termination clause, but instead attracts damages where the right to terminate is exercised dishonestly.

Wastech – the Duty to Exercise Contractual Discretion in Good Faith

Facts and Procedural History

Wastech (a waste transportation and disposal company) contracted with Metro (a statutory corporation) to administer waste disposal services for a region of Vancouver. The parties had a longstanding contractual relationship. Under the contract, there were three disposal facilities that waste could be transported to. Which facility that was used impacted Wastech’s profit. Metro had absolute discretion to allocate waste between the facilities under the contract and there was no guarantee of profit to Wastech. 

In 2011, Metro reallocated waste to a lower profit disposal facility with the result that Wastech earned less profit than expected. Wastech argued that this breached the contract, in particular the duty to exercise contractual discretion in good faith. The arbitrator agreed and awarded compensation to Wastech. The Supreme Court of British Columbia allowed the appeal and the Court of Appeal agreed. The SCC, in concurring reasons, unanimously dismissed the appeal.

Important Principles

This decision affirmed that there is a duty to exercise contractual discretion in good faith in all contracts. Like the duty of honest performance, this duty is “obligatory in all contracts” and the parties are not able to contract out of it.[11]

The primary issue in this case was the scope of the duty and what will constitute a breach. The Court summarized the key principles of the decision as follows:

In sum, then, the duty to exercise discretion in good faith will be breached where the exercise of discretion is unreasonable, in the sense that it is unconnected to the purposes for which the discretion was granted. This will notably be the case where the exercise of discretion is capricious or arbitrary in light of those purposes because that exercise has fallen outside the range of behaviour contemplated by the parties. The fact that the exercise substantially nullifies or eviscerates the fundamental contractual benefit may be relevant but is not a necessary pre-requisite to establishing a breach.[12]

Therefore, the proper test for a breach of this duty asks whether the party exercised a discretionary contractual power for a purpose unconnected to the reasons for which that discretion was granted.

Determining the intended purpose (or purposes) of the discretionary power is a matter of contractual interpretation. Where the discretionary power is not used for one of those intended purposes, the power is exercised unreasonably and there is a breach of the duty. In this way, the “negotiated bargain [remains] the primary source of justice between the parties.”[13]

The Court additionally affirmed that the duty of honesty will apply to contractual discretionary powers meaning that the power “cannot, at a minimum, be exercised dishonestly.”[14]

Where the discretionary power is exercised honestly and in line with a proper purpose, it “may be thought of as undertaken fairly and in good faith on the parties’ own terms. As such, barring issues such as unconscionability not raised in this appeal, that exercise is … insulated from judicial review as a matter of fairness.”[15]

This means the Court should not consider what is “fair according to its view of what is the proper exercise of the discretion”[16] or “ask whether the discretion was exercised in a morally opportune or wise fashion from a business perspective.”[17] Instead, the sole focus is on the purpose for which the power was granted.

The duty should not be used to “eliminate the discretion-exercising party’s power of choice.”[18] It also does not require that one party subordinate its own interests to the other contracting party’s interests. Instead, “it simply limits the range of legitimate ways in which a discretionary power may be exercised in light of the relevant purposes”.[19]

Some jurisprudence had previously held that a breach of the duty of good faith necessarily occurs where “a party is deprived of substantially the whole benefit of a contract”. The SCC disagreed. The Court noted that “the fact that an exercise of discretion substantially nullifies or eviscerates the benefit of the contract could well be relevant” [20] to showing an improper purpose; however, “absent some infringement of the non-exercising party’s rights, there is no actionable wrong for the law to correct.”[21]

That being said, the Court noted in applying the duty to the facts of the case that there will likely be limits to a discretionary power based on the reasonable expectations of the parties. For example, the Courts will generally assume that the parties did not intend to give one contracting party “untrammelled power” that would leave the other at its “uninhibited whim”.[22]

Conclusion

These SCC decisions clarify a number of contractual principles that remained unclear following Bhasin. The most important takeaways from these decisions for contracting parties are as follows:

  • parties must not lie, tell half-truths, or otherwise deceive each other regarding matters that relate to the contract;
  • if a party, through its conduct, creates a false impression relating to the contract, it has a positive duty to correct that impression;
  • the duty of honesty applies only to matters relating to the contract and contractual performance;
  • a party exercising a discretionary contractual power must do so for a purpose connected to the reasons for which that discretion was granted; and
  • so long as the exercise of discretion relates to a purpose for which it was granted, the party’s conduct should be insulated from judicial oversight (barring unconscionability).

As the SCC noted, most parties entering into a contract would expect that they, and their contracting party, will act in good faith. Therefore, these principles should codify those reasonable expectations and not create new duties not contemplated by the parties.

That being said, following the Zollinger and Wastech decisions, parties may want to consider altering their conduct in two ways.

First, it may be appropriate now to specifically identify the intended purpose or purposes of any discretionary powers in contracts. By doing so, the parties will clarify what will be a proper (and by implication an improper) justification for exercising a discretionary power.

Second, contracting parties will need to be more cautious than ever of any false impression that they, or their employees, may be leaving. Any false impressions will need to be corrected or the party risks being held in breach of its contractual obligations.


[1] 2014 SCC 71 [Bhasin].

[2] For example, the popular case database WestlawNext Canada shows 1,076 citing references to Bhasin with 664 being other court decisions.

[3] 2021 SCC 7 [Wastech].

[4] 2020 SCC 45 [Zollinger].

[5] Zollinger, ibid at para 38.

[6] Ibid at para 77.

[7] Ibid at para 91.

[8] Ibid at para 86.

[9] Ibid at para 49.

[10] Ibid at para 68.

[11] Wastech, supra note 3 at para 94.

[12] Ibid at para 88 (emphasis added).

[13] Ibid at para 5.

[14] Ibid at para 54.

[15] Ibid at para 70.

[16] Ibid at para 71.

[17] Ibid at para 73.

[18] Ibid at para 75.

[19] Ibid at para 75.

[20] Ibid at para 84.

[21] Ibid at para 83.

[22] Ibid at para 92.

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