When Performing A Contract: Say What You Mean and Mean What You Say

The Duty of Honest Contractual Performance is Expanded by the Supreme Court of Canada

Until recently, we would have been fairly confident that a client could safely terminate a contract if it did so in accordance with the termination clause of the agreement, provided that it was not done dishonestly for an improper purpose. Not so anymore. If a terminating party leads the other party to believe that the contract will not be terminated, or fails to correct a misapprehension of the other party caused by its misleading conduct, the terminating party may be liable for damages for breach of the duty of honest contractual performance.

The Ontario Court of Appeal in 2018 considered the case of CM Callow Inc. v. Zollinger, where both parties agreed that a termination clause was properly exercised. However, the terminating party had delayed informing the other party that they were terminating the contract in order to avoid jeopardizing ongoing work being performed. The Court of Appeal unanimously wrote in a short and clear decision that while the terminating party may not have acted honourably, its actions did not rise to the high level required to establish a breach of the duty of honest contractual performance. To find otherwise would have the effect of substantially modifying the clear termination provision, a key component of the contract. The Court of Appeal’s decision should have been the end of the story.

However, the Supreme Court of Canada in a split decision recently overturned the Court of Appeal, causing consternation among corporate law practitioners. The majority of the Court stated that the duty to act honestly in the performance of a contract was breached in this case because of misleading statements that had been made about the intention to terminate. We highlight some of the key points of this decision and important take-aways below.

It is increasingly important for our clients to be sure that each of its contracts is clearly written to reflect the intention of the parties and also to be sure that any subsequent correspondence about the performance of the contract is clear and not misleading. Say what you mean, and mean what you say.

The Duty of Honest Contractual Performance

Parties to a contract owe each other a duty not to lie or knowingly mislead each other about matters directly linked to contractual performance. This duty of honest contractual performance was recognized in the watershed Supreme Court of Canada case in 2014, Bhasin v Hyrnew, written for a unanimous Court by former Justice Thomas Cromwell (and who, incidentally, was Kevin’s civil procedure professor at Dalhousie Law School, and whom Kevin credits for helping him at that time navigate the interview process to secure a clerkship at the Supreme Court of Canada).

The Court in Bhasin recognized that good faith contractual performance is a general organizing principle of Canadian common law and that contractual parties are under a duty to act honestly in performing their obligations. Importantly, this duty does not arise as a result of any implied contractual term, but rather, is a general doctrine of contract law. It precludes contracting parties from lying or knowingly misleading each other about matters directly linked to contractual performance. The Court in Bhasin clarified though that the duty of honest performance does not impose a duty of loyalty or of disclosure or require a party to forego advantages flowing from the contract. Justice Cromwell expressly stated that there is no unilateral duty to disclose information relevant to termination.

The Court in Callow however seems to have taken this one step further by finding that a failure to correct another party’s mistaken belief about the intended exercise of a termination right may be a breach of the duty of honest performance and so constitute a breach of contract.

Facts in Callow

In 2012, a group of condominium corporations (“Baycrest”) entered into two different contracts with C.M. Callow Inc. (“Callow”): a two-year winter maintenance contract, and a separate summer maintenance contract. Pursuant to clause 9 of the winter maintenance contract, Baycrest was entitled to terminate the winter maintenance contract with Callow upon giving 10 days’ written notice.

Baycrest had decided in early 2013 that it would terminate Callow’s winter contract. This was not communicated to Callow. During the summer of 2013, Callow performed “freebie” work beyond what the summer maintenance contract required which it hoped would incentivize Baycrest to renew the winter maintenance agreement. Callow incorrectly believed that, after having discussions with Baycrest board members, Baycrest was likely to renew the winter contract. Baycrest did not inform Callow of its decision to terminate the winter maintenance agreement, was aware of Callow’s mistaken belief and did not take steps to correct this belief. In September of 2013 Baycrest provided Callow with the contractually required 10 days’ notice that it would be terminating the winter maintenance contract.

The ability of the appellants to exercise the termination clause was not in dispute at trial. Moreover, in its factum, the respondent acknowledged that the appellants were not contractually required to disclose that they had decided to terminate the contract prior to the 10-day formal notice period specified in the winter contract, and that the failure to provide notice on a more timely basis was not in and of itself evidence of bad faith.

The trial judge was satisfied that Baycrest actively deceived Callow from the time the termination decision was made to September 2013. She found that Baycrest acted in bad faith by withholding the information to ensure Callow performed the summer maintenance services contract and by continuing to represent that the contract was not in danger despite its knowledge that Callow was taking on extra tasks to bolster the chances of renewing the winter maintenance contract.

As noted above, the Ontario Court of Appeal did not find a breach of the duty of honest contractual performance and reversed this decision, holding that Callow had only bargained for 10 days’ notice of early termination and Baycrest had provided such notice. The Court of Appeal quoted Justice Cromwell in Bhasin as follows in support of its conclusion that the actions of Baycrest did not rise to the high level required to establish a breach of the duty of honest performance:

The principle of good faith must be applied in a manner that is consistent with the fundamental commitments of the common law of contract which generally places great weight on the freedom of contracting parties to pursue their individual self-interest. In commerce, a party may sometimes cause loss to another — even intentionally — in the legitimate pursuit of economic self-interest: A.I. Enterprises Ltd. v. Bram Enterprises Ltd., 2014 SCC 12, [2014] 1 S.C.R. 177, at para. 31. Doing so is not necessarily contrary to good faith and in some cases has actually been encouraged by the courts on the basis of economic efficiency: Bank of America Canada v. Mutual Trust Co., 2002 SCC 43, [2002] 2 S.C.R. 601, at para. 31. The development of the principle of good faith must be clear not to veer into a form of ad hoc judicial moralism or “palm tree” justice. In particular, the organizing principle of good faith should not be used as a pretext for scrutinizing the motives of contracting parties.

The Majority Decision in Callow

Callow dealt with similar issues as Bhasin; however, based on the specific facts of Callow, Justice Kaisirer, writing for the majority, found a breach of the duty of honest performance and ordered that damages be paid by Baycrest ($64,306.96, representing the profit Callow would have received if it had had the winter contract). There was also a concurring opinion delivered by Justice Brown and a dissenting opinion delivered by Justice Côté.

The narrow question addressed by the Court was whether Baycrest failed to satisfy its duty not to lie or knowingly mislead Callow about matters directly linked to the performance of the winter maintenance agreement. The majority found that even though Baycrest had what was, on its face, an unfettered right to terminate the winter maintenance agreement on 10 days’ notice, the right had to be exercised in keeping with the duty to act honestly. The Court held that Baycrest had actively misled Callow and that “[i]n 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.”

The Court found that Baycrest knowingly misled Callow into believing the winter maintenance agreement would not be terminated. By exercising the termination clause dishonestly, Baycrest breached the duty of honesty on a matter directly linked to the performance of the contract, even if the 10-day notice period was satisfied and irrespective of its motive for termination.

Dissent and Commercial Uncertainty

Justice Côté dissented on the basis that the duty of honest performance ought to remain clear and easy to apply. The obligations related to honest performance should remain negative because extending honest performance beyond negative obligations would hinder commercial certainty. Thus, under Bhasin, silence cannot be considered dishonest without a positive disclosure obligation. A positive disclosure obligation should not arise because one party realizes its counterparty is operating under a mistaken belief unless the non-mistaken party’s conduct has materially contributed to this mistaken belief. In her analysis, Justice Côté drew attention to the danger of distinguishing between different types of silence:

Are we to draw sophisticated distinctions between “mere silence” and other types of silence as Brown J. suggests? If that be so, I wonder how a contracting party – on whom, I note, the law imposes neither “a duty of loyalty or of disclosure” nor requirements “to forego advantages flowing from the contract” (Bhasin, para 73) – is supposed to know at what point a permissible silence turns into a non-permissible silence that may constitute a breach of contract.

Justice Côté would have dismissed the appeal on the basis that Baycrest had not made any representations that had misled Callow into thinking that Baycrest would not terminate the winter agreement for any reason other than unsatisfactory services and because, she found, that the trial judge had extended the ambit of the duty of honest performance in a way that was not consistent with the other principles set out in Bhasin.

While Justice Côté firmly rejected the majority decision and found that there was no breach of the duty of honest performance, she noted that her decision would not leave Callow without recourse under other established grounds, such as a claim for unjust enrichment for the freebie work, although such claims were not advanced in this case.

Key Take-Aways

In fulfilling their obligations, contractual parties should keep the following in mind based on the principles set out in Callow:

  • The duty of honesty in contractual performance applies to all contracts.
  • Honest performance does not impose disclosure obligations beyond what is in the contract, but there may now be an obligation to correct a false impression about the performance of the contract if the impression was created by the party’s own actions.
  • Whether or not a party has knowingly or actively misled its counterparty is a highly fact-specific determination and can include lies, half-truths, omissions, and even silence, depending on the circumstances.

Contracting parties should consider taking practical steps to protect themselves:

  • Review your contracts to make sure they are up-to-date and you can comply with the terms.
  • Have one point of contact responsible for communications about each contract to avoid potentially conflicting statements and seek appropriate internal approvals before making any statements about the contract.
  • Keep a written record of all communications and assume that everything you say or put in writing will be disclosed in litigation, even internal communications and text messages.

A court strives first and foremost to enforce the bargain that the parties entered into. This makes it incumbent on the parties to a contract to clearly set out that bargain. Callow agreed in the contract that Baycrest could give 10 days’ notice of termination for any reason, which, according to both parties and all levels of court, they properly did. Callow’s claim for damages rested primarily on its inability to secure other customers for the winter season, which it says they could have done if it had been told earlier about the termination (i.e., when Baycrest made its decision to terminate). This highlights an important option which was open to Callow: it could have avoided these damages by striking a bargain that actually met its needs, for example it would not be unusual to require 30 or 60 days’ notice to terminate a service contract, or it could have required that notice be given in advance of a particular date in the calendar year sufficiently before the winter season in order to have time to seek new clients. To make matters worse, Justice Côté noted that at trial Mr. Callow didn’t actually understand the termination provision. He was under the impression that the termination provision was unenforceable because the duration of the contract was for two years. The whole dispute could have been avoided by Callow if it had entered into a contract that reflected its actual needs. Say what you mean.

The Callow decision seems to change the rules of the game between contracting parties and it may lead to the commercial uncertainty that Justice Cromwell warned against and that Justice Côté believes may occur as a result of this decision extending the duty of honest performance beyond “negative” obligations. Future contract litigation may focus even more on matters extraneous to the contract including statements and omissions that occur after the contract is signed. If you are concerned about the performance of a counter-party to a contract, ask them in writing to confirm their intentions and document their actions. They might give you the foundation for a future claim if you feel after the fact that they may have misled you. If on the other hand you receive a request like this or you perceive there may be some uncertainty about your intentions, proceed with caution and be careful not to actively mislead. Mean what you say.

There will be more to come on this topic as the Supreme Court of Canada is due to release its reasons in a companion case shortly. Stay tuned.

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