Conduct Matters in Contracts

This article reviews the minimum standards of conduct expected of contracting parties in Canada

Unpacking the Bhasin Decision

by Lise Patry, BA SC (CHEM ENG), LLB, ICD.D, Patry Law | Originally Published on October 19, 2016

Courts in common-law jurisdictions in Canada have historically been reluctant to impose certain minimum standards of conduct on commercial contracting parties, out of a concern that doing so will “[inject] uncertainty and risk of arbitrary outcomes into the world of commercial agreements whose objective is the pursuit of predictability and certainty.” (Addison Chevrolet Buick GMC Limited et al. v. General Motors of Canada Limited et al., 2015 ONSC 3404; the decision was reversed on appeal, but not on this point).

While there’s a general recognition that parties must act reasonably in the exercise of their contractual rights, determining whether there was a general obligation to act in good faith has not always been clear. Only recently has the Supreme Court of Canada issued a decision that seeks to provide greater coherence and clarity on the duty of good faith in commercial contracts.

In Bhasin v. Hrynew, 2014 SCC 71, the Supreme Court of Canada recognized an “organizing principle of good faith in contract law,” foreclosing arguments that parties to a commercial contract need not be concerned about how well or how poorly they treat counterparties when exercising their contractual rights. (Geoffrey Hall, in his book Canadian Contractual Interpretation Law, Third Edition comments that, “The next few years will likely involve significant developments in this area … Provincial appellate courts – which heretofore have been hostile to the concept of a duty of good faith in contractual performance – have to work out how far the principle extends.”)

This article will look at minimum standards of conduct expected of contracting parties in Canadian common-law jurisdictions, and the impact Bhasin has had on this area of the law.

Duty to be Honest

In Bhasin, the SCC established a new common-law duty of honesty in contractual performance. Justice Cromwell, who wrote the decision for the court, said: “This [new duty] means simply that parties must not lie or otherwise knowingly mislead each other about matters directly linked to the performance of the contract. This does not impose a duty of loyalty or of disclosure or require a party to forego advantages flowing from the contract; it is a simple requirement not to lie or mislead the other party about one’s contractual performance …”

As predicted by Geoffrey Hall in his book, since the Bhasin decision, litigants have often raised the organizing principle and the duty of honesty. Since Bhasin was released, more than 50 reported decisions have considered allegations that defendants breached the duty of honesty, but there are no cases that involve a thorough consideration of the duty of honesty in the context of a commercial contracting relationship.

In another context, the Saskatchewan Court of Queen’s Bench in The Real Canadian Superstore v. United Food and Commercial Workers Local 1400, 1998 had the following to say about dishonest conduct:

  • Dishonest conduct refers to conduct that ordinary decent people would feel is discreditable because it is at variance with straightforward or honourable dealings.
  • In deciding whether the conduct is dishonest conduct, you must apply an objective test.
  • Dishonesty includes acting with a clear intent to defraud.• Dishonesty requires an intention to be dishonest (citing Fisher v. Guardian Insurance Court of Canada, (1995) 28 CCLI (2d) BCCA).
  • Dishonesty requires proof that the dishonest party used deceit, falsehood and that, on a balance of probabilities, there was an intention to defraud the other party.

Honest conduct is a minimum expectation of contracting parties. In considering this duty of honesty, parties should avoid acts they know or ought to know are contrary to straightforward and honourable dealings, particularly if they are likely to mislead the other party. This includes:

  • being deceitful and creating falsehoods, and could go so far as to include knowingly omitting key information in conversations with the intent to mislead,
  • failing to answer pertinent questions asked by the other party, or
  • avoiding a difficult conversation that the dishonest party knows, or ought to know, will result in the other party making mistaken assumptions about contractual performance.

The Duty to Operate in Good Faith

The SCC in Bhasin said that “the principle of good faith exemplifies the notion that in carrying out his or her own performance of the contract, a contracting party should have appropriate regard to the legitimate interests of the contracting partner” and this requires that “a party not seek to undermine those interests in bad faith.”

The SCC acknowledged the existence of specific classes of contracts in which the duty of good faith is implied, and other doctrines in which good faith is relevant. The SCC also acknowledged that the list of doctrines where a duty was recognized is not closed, thereby implicitly inviting lower courts to develop new doctrines as appropriate.

Since Bhasin, close to 100 reported decisions have considered the duty of good faith between contracting parties. Here are excerpts from some key decisions on the duty of good faith, both before and after Bhasin:

  • Bhasin did not extend the duty of good faith beyond that in the existing authorities (Greater Vancouver Sewerage and Drainage District v. Wastech Services Ltd., 2016 BCSC 68).
  • The duty of good faith is not a stand-alone duty. It will be implied when circumstances justify it (Wilson Fuel Co. Ltd. v. Power Plus Technology Inc. 2015 NSSC 304. See also Kangas v. Souster 2009 SKPC 46 and MHR Board Game Design Inc. v. CBC 2013 ONCA 728).
  • Duty of good faith applies to specific classes of contracts, such as employment, joint ventures and partnership agreements, and in competitive tenders (Bhasin. See also G. Hall, and A. Swan, Canadian Contract Law, Third Edition).
  • Authorities tend to agree that good faith will be implied in most long-term commercial contracts, because a long-term relationship is certain to be based on an assumption that each party will behave in good faith (A. Swan. See also Wilson Fuel Co. Ltd.).
  • Good faith is not fiduciary duty. A party that acts in good faith does not have to subordinate its interest to that of any other party; it simply cannot use the power that the agreement gives it in ways that are abusive, unfair or dishonest (Bhasin. See also A. Swan).
  • If duty of good faith exists, it means that, in exercising your contractual rights, you must have appropriate regard for the legitimate business interests of the other party. Having “appropriate regard” does not require acting to serve those interests in all cases (Bhasin).
  • A discretionary power must, at minimum, always be exercised honestly and in good faith, which means one must not act capriciously or arbitrarily (Greenberg v. Meffert et al., 1985 (ONCA) and Partec Lavalin Inc. v. Meyer, 2001 ABCA 145 and 0856464 B.C. Ltd. v. TimberWest Forest Corp. 2014 BCSC 2433).
  • There is a possible implied duty of good faith when negotiating within the confines of an existing contract, as a matter of contract interpretation (Empress Towers v. Bank of Nova Scotia 1990 (BCCA). See also G. Hall).
  • The duty of good faith is breached when a party acts in bad faith (Arton Holdings Ltd. et al. v. Gateway Realty Ltd. 1991 (NSSC). See also A. Swan: “The only workable definition of good faith is that it denotes the absence of bad faith”).

What is Bad Faith?

  • In Canada, the test for bad faith does not include the need to show that a defendant intentionally acted in bad faith (Mesa Operating Limited Partnership v. Amoco Canada Resources Ltd. 1994 ABCA).
  • Bad faith is when a party acts in a manner that substantially nullifies the contractual objectives or causes significant harm to the other, contrary to the original purposes or expectations of the parties (Mesa. See also: Crawford v. New Brunswick 1997 (NBCA)).
  • Conduct that is contrary to community standards of honesty, reasonableness or fairness has been described as bad faith (Gateway Realty. See also: TSP-INTL Ltd. v. Mills 2005 (ONSC), overturned on appeal on different grounds).
  • The arbitrary exercise of discretion has been associated with bad faith in a number of cases – arbitrariness alone may ground a decision that a party acted in bad faith (London Humane Society (Re), 2010 ONSC 5775, although this case deals with a decision made by a Board of Directors under its bylaws and may not fully transfer over to an exercise of a contractual right by a commercial party).

In considering the content of the duty of good faith and bad faith, it’s easy to get lost in the nuanced judicial considerations of what each duty means. And not only are they nuanced: they can seem contradictory at times.

While there is certainly value in understanding the nuances when considering a specific fact situation, to avoid running into legal problems, parties should give appropriate consideration to their partner’s business interests when exercising a right or discretion, such as a right to terminate a contract.

Failure to consider the impact on the other party’s business interests when exercising one’s contractual rights and privileges could give rise to legal claims.

The Duty to Be Reasonable

Long before Bhasin, there was a general recognition that parties must exercise their contractual rights and discretions reasonably, and not do so arbitrarily or capriciously. The seminal decision on this duty is the 1958 Supreme Court of Canada decision in Mason v. Freedman. In Mason, the SCC held that “a vendor who seeks to take advantage of [a] clause must exercise his right reasonably and in good faith and not in a capricious or arbitrary manner.”

Writings and key cases that have considered this duty to exercise one’s contractual rights reasonably have this to say:

  • Courts will apply an objective standard or a subjective standard when evaluating the reasonableness of a party’s exercise of a contractual discretion. Where a court uses a subjective standard, the freedom of the party possessing the discretionary power is significant and only good faith and honesty is required. The court will not consider whether the conduct was objectively reasonable (G. Hall).
  • Whether reasonableness is measured against a subjective or objective standard will depend on the words of the contract (Partec, and G. Hall).
  • When an objective standard of reasonableness is applied, acting reasonably entails some subordination of a party’s interests in the sense that its rights or its conduct will be tested with reference to an external objective standard (Partec, and A. Swan).
  • The use of “sole discretion” has been subject to an objective standard of reasonableness (Greenberg).
  • The exercise of a discretion in one’s “sole opinion” imposes upon the party exercising the discretion a duty of honesty and good faith in the exercise of the discretion (McKenna’s Express Ltd v. Air Canada, 1992 2849 (PE SCTD), citing Gateway Realty).
  • Where a party reserves the right to exercise a discretion “unreasonably,” it merely excludes the obligation of the party exercising the power to give reasons for its action. It does not allow a party to exercise its right unreasonably (Marshall v. Bernard Place Corp, 2002 (ONCA)).
  • Even where the expression “in its sole and absolute discretion” is used, a party’s exercise of discretion must be reasonable. No contractual discretion is absolute (Marshall).

Parties who wish to reserve greater freedom of decision-making when exercising their contractual rights and discretions must use language that clearly demonstrates that intention.

But regardless of the language, parties exercising a contractual right or discretion should always be prepared to justify their actions, in the event of a challenge, as they will be called upon to show that the right was exercised in good faith, and not capriciously or arbitrarily. Parties who are unable to justify their actions may be held to have breached their contractual obligations.

When exercising a contractual right, think before you act, especially if acting could negatively affect your business counterparty. And try to avoid acting arbitrarily when exercising your contractual rights. Understand your business rationale for taking a specific action and, if possible, do what you can to minimize the impact on your contracting party.

Beyond the Words of the Contract

The SCC’s decision in Bhasin shows that actions outside of the contract matter in the interpretation of the contract.

The cases teach us that Canadian courts have little patience for parties who improperly exercise their contractual rights and discretions. Contracting parties who lie, mislead or bully their contracting counterparts, or act with complete disregard for the impact their actions have on those with whom they have contracted could end up in court. This is especially true where there is a power imbalance and a long-term business relationship. This was emphasized by the SCC in Bhasin.

Anything short of acceptable conduct and the predictability of the written words in your contract fly out the window, with trouble likely to follow. Bhasin will be used against you, your business reputation will suffer, and your staff may be distracted by the grueling process of litigation. Once in court, not only may the court find that you’ve breached an implied duty of honesty, good faith or reasonableness, you also run the risk of having a limitation of liability provision ignored by the court, which opens up the possibility of significant damages awarded against you (see Tercon Contractors Ltd. v. British Columbia (Transportation and Highways), 2010 SCC 4). Courts are generally hostile toward defendants who try to hide behind an exclusion clause to avoid the effect of fraudulent or grossly negligent conduct that causes injury to the plaintiffs (see Roy v. 1216393 Ontario Inc., 2011 BCCA 500 and Solway v. Davis Moving & Storage Inc. 2002 (ONCA)).

And all of this because you weren’t decent toward the other contracting party.

Readers are cautioned not to rely upon this article as legal advice nor as an exhaustive discussion of the topic or case. For any particular legal problem, seek advice directly from your lawyer or in-house counsel. All dates, contact information and website addresses were current at the time of original publication.