You Gotta Have (Good) Faith: Supreme Court releases decisions in Callow and Wastech

When performing a contract, say what you mean, mean what you say, and exercise your discretion reasonably.

Recently, the Supreme Court of Canada released two companion case decisions dealing with the duty of good faith in contractual performance. The first decision, C.M. Callow Inc. v. Zollinger (“Callow”) came out in December and the second, Wastech Services Ltd. v. Greater Vancouver Sewerage and Drainage District (“Wastech”), more recently in early February.

Good faith was at the heart of the issues in both cases.

Parties to a contract owe each other a duty not to lie or knowingly mislead each other about matters directly linked to contractual performance and to exercise contractual discretionary rights in good faith. These duties were recognized in the watershed case of 2014, Bhasin v Hyrnew (“Bhasin”) 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).

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.

It is increasingly important for our clients to be sure that each of their 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.

Key Take-Aways

The cases discussed below provide some important considerations whether you’re negotiating a contract or already party to a finalized one:

• The duty of honesty in contractual performance applies to all contracts.
• Take care that your contracts reflect your intentions. Consider, for example, what kind of notice of termination you really need, and any key timing considerations involved. Review contracts that are already in place to make sure they are up to date and that they still accurately reflect your bargain.
• Make good use of recitals and ensure they set out the purpose of the contract, and the purpose of any discretionary powers. Recitals were key to the Wastech decision, and helped to evidence the purposes for which the successful party’s discretion could be exercised.
• Ensure that your communications with contractual counterparties reflect the internal direction you plan to take with that contract.
• Consider having 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.
• Be alert for indications that the counterparty is under a mistaken impression about the contract or its performance.
• If you are exercising a contractual discretionary right, ensure your exercise is not arbitrary or capricious, and consider providing written reasons when you exercise it, particularly if the situation is contentious. Written reasons may help you prove the purpose for which you exercised your discretion more readily to a court or other decision-maker later on.
• 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.

Bhasin: Honesty and Discretion in Contractual Performance

The Court in Bhasin recognized that good faith contractual performance is a general organizing principle of Canadian common law.

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. The Court in Callow took 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.

Justice Cromwell in Bhasin also recognized that courts have required that discretionary powers not be exercised in a manner that is “capricious” or “arbitrary”. The Supreme Court in Wastech provided further clarity on good faith and discretionary powers in articulating that the duty of good faith requires a party to exercise contractual discretion reasonably.

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

In Callow, both parties agreed that a termination clause in a services contract was properly exercised. However, the terminating party had delayed informing the other party that it was terminating the contract in order to avoid jeopardizing ongoing work being performed, and had made representations that led the service provider to believe that the contract would be renewed.

In 2018, the Ontario Court of Appeal unanimously found 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.

However, the Supreme Court of Canada in a split decision overturned the Court of Appeal. The majority of the Supreme Court stated that the duty to act honestly in the performance of a contract was breached in this case because of misleading statements that the respondents made to the appellant about their intention to terminate the contract.

Callow Facts

In 2012, a group of condominium corporations (“Baycrest”) entered into two different contracts with C.M. Callow Inc.: 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. After having discussions with Baycrest board members, Callow incorrectly believed that Baycrest was likely to renew the winter contract.

Baycrest did not inform Callow of its decision to terminate the winter maintenance agreement, and was aware of Callow’s mistaken belief but did not take steps to correct it. 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 Baycrest to exercise the termination clause was not in dispute at trial. Moreover, in its factum, Callow acknowledged that Baycrest was not contractually required to disclose that it 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.  …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.  …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 Kasirer, 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:

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.  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.

What the Agreement Says is Crucial

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 perhaps 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 counterparty to a contract, consider asking 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.

Wastech: Exercising Discretionary Rights Reasonably

Wastech, a Supreme Court companion case to Callow, clarifies some of the duties recognized in Bhasin by confirming how a discretionary contractual right may be exercised.

Wastech Facts

Wastech, a waste transportation and disposal company, and Greater Vancouver Sewerage and Drainage District (“Metro”), a statutory corporation responsible for the administration of waste disposal in Vancouver, had a long-standing contract in place for the removal and transportation of waste by Wastech to three local disposal facilities.

Wastech was to be paid at differing rates depending on which disposal facility the waste was directed to and how far away the facility was located. Wastech was paid more if the site was farther away. The contract gave Metro absolute discretion to allocate waste as it chose, and did not guarantee any particular level of profit for Wastech.

In 2011, Metro reallocated waste from a disposal facility further away to one that was closer. Ultimately, this reallocation resulted in a lower profit margin for Wastech so that its operating profit was well below its target for that year. Wastech alleged that by exercising its discretion to reallocate waste to the closer facility, Metro had breached its duty to exercise its discretion in good faith.  The dispute was initially referred to an arbitrator.

In the arbitrator’s opinion, if viewed only from Metro’s perspective, Metro’s conduct was both honest and reasonable. However, because its conduct “showed a lack of appropriate regard for Wastech’s legitimate expectations,” Metro had breached its duty of good faith. Therefore, Wastech was entitled to compensation.

The Supreme Court of British Columbia allowed Metro’s appeal, and set aside the arbitrator’s award on the basis that the imposition of any contractual duty to have appropriate regard for the interests of another contracting party must be based on the terms of the contract itself. In this case the parties had deliberately rejected a term constraining the exercise of Metro’s discretionary power to allocate waste.

The Court of Appeal dismissed Wastech’s appeal. The Supreme Court of Canada also upheld the decision of the Supreme Court of British Columbia.

Supreme Court Decision in Wastech

The Supreme Court based its decision on the finding that Metro’s exercise of discretion under the contract was not unreasonable and was therefore not a breach of the duty to exercise contractual discretionary powers in good faith. The Court considered discretion to be used unreasonably when exercised in a way that is unconnected to the purposes for which the discretionary right was provided in the first place.

In this case, the recitals of the contract described the parties’ intentions to encourage each other to maximize efficiency and minimize cost. The purpose of allowing Metro the discretion to allocate waste in this context was to allow it adequate flexibility to achieve these purposes. The Court found that Metro’s exercise of discretion to select one waste site over another “was guided by the objectives of maximizing efficiency, preserving remaining site capacity, and operating the system in the most cost-effective manner, and was made in furtherance of its own business objectives.”

The majority found that Metro exercised its discretion in a manner that was connected to the purpose for which that discretion was granted. Therefore, Metro did not violate the duty of good faith.

What a court considers unreasonable is highly context-specific, and ultimately depends upon the intention of the parties as evidenced by their agreement.  A capricious or arbitrary exercise of discretion, for example, may constitute a breach of the duty of good faith, and therefore a breach of the contract.