Gotta have (good) faith: The Supreme Court clarifies the duty of good faith in contracts
Pursuant to recent decisions of the Supreme Court of Canada there are two separate but related aspects of the duty of good faith, both of which arise in every contract: (1) honest performance and (2) good faith exercise of discretionary power.
Honest performance – C.M. Callow Inc. v. Zollinger (“Callow”)
The Callow case involved the duty of honest performance. Baycrest entered into a 2-year contract with Callow, under which Callow agreed to carry out winter maintenance work. The contract contained a termination clause allowing Baycrest to terminate the agreement upon 10 days’ written notice.
Baycrest decided to terminate the contract but did not disclose their intention to Callow. Meanwhile, Callow carried out extra “freebie” work, at no charge, hoping that Baycrest would renew the contract. After receiving the benefit of the extra work, Baycrest delivered a notice of termination. Callow sued Baycrest for breach of contract and bad faith.
The trial judge found that Baycrest breached the duty of good faith by keeping Callow in the dark about its intention to terminate. Damages were awarded to Callow. On appeal, the Court of Appeal overturned the trial judge’s decision, finding that the duty of honesty does not include a positive duty to disclose an intention to terminate a contract, absent a clause to the contrary.
The Supreme Court restored the trial judge’s decision. Although the majority agreed that the duty of honest performance does not create a general duty to disclose or subordinate a party’s own interests to a counterparty, the duty of honesty goes beyond barring outright lies. For example, parties can breach the duty by “knowingly misleading” through “lies, half-truths, omissions, and even silence” or a failure to “correct a misapprehension caused by one’s own misleading conduct”.
In this case, the majority agreed with the trial judge that Baycrest’s communications and actions, particularly in accepting Callow’s “freebie” work, led Callow to believe that the contract would be renewed. Thus, Baycrest’s conduct amounted to dishonest performance.
Good faith exercise of discretion – Wastech v. Greater Vancouver Sewerage (“Wastech”)
Wastech involves the duty of good faith exercise of discretionary power. Wastech and Metro had a long-standing waste management contract, under which Wastech removed and transported waste to three facilities. Under the contract, Wastech’s rates depended on where it transported the waste, but Metro had absolute discretion to allocate waste as it saw fit.
Metro reallocated the waste to a facility which caused Wastech to suffer a financial loss. Wastech claimed that Metro breached the duty of good faith by reallocating the waste in a manner that caused lost profits. At arbitration, the arbitrator agreed with Wastech and awarded it damages.
The issue at the Supreme Court was whether the arbitrator erred by finding that Wastech’s decision to reallocate the waste amounted to bad faith. The majority stated the following:
Where a party to a contract exercises its discretion unreasonably, […] in a manner not connected to the underlying purposes of the discretion granted by the contract, its conduct amounts to a breach of the duty to exercise contractual discretionary powers in good faith [emphasis added].
Like the duty of honest performance, this duty does not require a party to “confer a benefit” or “subordinate its interests” to the counterparty. In every case, the court must interpret the clause in the context of the contract as a whole.
In this case, the majority held that Metro acted reasonably based on the words of the contract. The recitals described the parties’ intention to “maximize efficiency and minimize costs”. The contract also contained detailed clauses that managed the risks and rewards of the operation. In this context, the purpose of Wastech’s discretion to re-allocate risk was to allow flexibility to maximize efficiency and minimize cost.
The scope and content of the duty of good faith is highly case-specific and depends on the contract at issue. Given the evolving case law, commercial parties should carefully draft their agreements to maximize certainty and mitigate risk. Our professionals are always available to assist commercial parties with drafting and reviewing contracts to ensure they meet their specific needs.