Supreme Court Introduces Duty of Honest Contractual Performance Authors

Litigation - Canada

Supreme Court introduces duty of honest contractual performance Authors

Contributed by Dentons Barbara L Grossman

November 25 2014

Introduction Facts Lower court decisions Supreme Court decision Comment

Introduction Jason Chin

The Supreme Court's recent decision in Bhasin v Hrynew(1) recognised a new common law duty of honest performance applicable to all contracts, which requires the contracting parties to be honest with each other in relation to the performance of their contractual obligations. This duty is a manifestation of an organising principle of good-faith contractual performance that underpins and informs various contract doctrines and requires "that parties generally must perform their contractual duties honestly and reasonably and not capriciously or arbitrarily". Bhasin is an important decision, as the existence of a general duty to perform contractual obligations in good faith has long been an unsettled area within the Canadian law of contract. In Bhasin the Supreme Court sought to introduce clarity and coherence into this area of the law, which it described as "piecemeal, unsettled and unclear".

Before Bhasin, it was unclear whether there was a general common law duty of good faith with respect to the performance of all contractual obligations, or if such a duty existed only in certain contractual contexts such as employment, franchise and insurance contracts, contracts in the tendering context and the requirement of good faith in exercising a contractual discretion. This uncertainty was underscored by the fact that two provincial appellate courts had recently come to contradictory decisions. The Ontario Court of Appeal in Barclays Bank PLC v Devonshire Trust(2) implied a generalised duty not to defeat or eviscerate the object of a contract. By contrast, in its decision in Bhasin(3) the Alberta Court of Appeal held that there was no generalised duty of good-faith performance of contracts.

Ultimately the Supreme Court drew a distinction between good-faith contractual performance as an organising principle of the common law of contract (thus explaining the existence of a duty of good- faith contractual performance in certain specific contractual contexts noted above), and a general duty applicable to all contracts to act honestly in the performance of contractual obligations. The general duty of honest performance that the Supreme Court recognised represents an important, albeit modest, incremental development in the law of contract intended to make the Canadian common law more coherent and more just.

Facts

The parties in Bhasin were Canadian American Financial Corp ('Can-Am'), which markets registered education savings plans (ESPs), and two dealers of these plans. The dealers, Mr Bhasin and Mr Hrynew, were competitors with an acrimonious relationship. Hrynew made several attempts to take over Bhasin's business and eventually urged Can-Am to force such a merger. Can-Am subsequently began considering a restructuring plan that involved Hrynew subsuming Bhasin's business.

The agreement at the heart of the dispute was a commercial dealership contract between Can-Am and Bhasin. The agreement's term was three years and it provided for automatic renewal unless one of the parties gave six months' written notice of non-renewal. The contract included an entire agreement clause.

The relationship between the parties deteriorated further when the regulator – the Alberta Securities Commission – required Can-Am to appoint a single person to monitor compliance across the province. Can-Am chose Hrynew, a move Bhasin resisted. In particular, he refused to allow Hrynew access to his confidential business records. Can-Am eventually issued a non-renewal notice to Bhasin under the agreement and the agreement expired soon thereafter. Bhasin lost his ESP dealership business and Hrynew eventually hired much of Bhasin's former salesforce. Bhasin sued Can-Am for breach of contract, Hrynew for inducing breach of contract and both for civil conspiracy. Lower court decisions

The trial judge found in favour of Bhasin. In particular, the trial judge implied a term of good faith in making renewal decisions under the agreement based on the notion that the agreement was analogous to employment and franchise agreements. Courts typically imply a duty of good faith in these two types of contract as a matter of law. Can-Am was found to have breached this implied good-faith term of the agreement that restricted Can-Am's exercise of its right to issue the non- renewal notice. Further, the trial judge found that Hrynew had intentionally induced the breach of contract and that both Hrynew and Can-Am were liable for unlawful means civil conspiracy.

The Alberta Court of Appeal overturned the trial judge's decision, finding that she had erred in implying a term of good faith in the agreement in light of the absence of any restriction in the non- renewal right and the existence of the entire agreement clause. The basis for the claims in civil conspiracy and inducing breach of contract fell away as a result of the Alberta Court of Appeal's holding that there had been no breach of contract.

Supreme Court decision

The primary issue before the Supreme Court was whether, at common law, there is a general duty to perform contractual obligations in good faith.

The Supreme Court held that there is a general duty of honest contractual performance in every contract and that parties cannot contract out of this duty. It is a doctrine of contract law that is a manifestation of an overarching "organizing principle of good faith". The Supreme Court explained the duty of honesty in contractual performance as follows:

"This 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."

Good faith as general organising principle The Supreme Court explained that an organising principle states in general terms a requirement of justice from which more specific legal doctrines may be derived. It is not a free-standing rule, but rather a standard that underpins and is manifested in more specific legal doctrines and may be given different weight in different situations.

The organising principle of good faith, according to the Supreme Court, is "that parties generally must perform their contractual duties honestly and reasonably and not capriciously or arbitrarily". This organising principle exemplifies the notion that a contracting party should have "appropriate regard to the legitimate contractual interests of the contracting partner", with "appropriate regard" varying depending on the context of the contractual relationship, but at a minimum requiring that a party not seek to undermine the other party's interests in bad faith.

The Supreme Court noted that recognising this organising principle would help to bring coherence to a disjointed body of case law. In other words, good faith underlies and manifests itself in various more specific judicial doctrines within the law of contract, such as: l unconscionability; l implied terms in franchise and employment contracts; and l the requirement of good faith in exercising contractual discretion.

Looking forward, the Supreme Court stated that the existing case law would act as "the primary guide to future development" of good faith. Importantly, it stated that good-faith claims would generally not succeed if not tethered to the existing "body of doctrine that has developed which gives effect to aspects of the [good faith organizing] principle in particular types of situations and relationships". Still, the Supreme Court left some room for growth, stating that "the list is not closed".

The Supreme Court was careful to note that the organising principle of good faith is sensitive to the context of the contractual relationship. For instance, the duty would have different implications in the context of long-term relational contracts as opposed to one-off transactional contracts. It cautioned that the organising principle of good faith should not be used as a pretext for scrutinising the motives of contracting parties.

Duty of honest contractual performance The Supreme Court held that the recognition of a general duty of honest contractual performance is an appropriate incremental step in the development of the common law of contract, recognising that the implications of the broader, organising principle of good faith must be allowed to evolve according to the same incremental judicial approach.

As noted above, the duty of honest performance is limited. The Supreme Court stated that it is a duty not to lie or otherwise knowingly mislead each other about matters directly linked to the performance of the contract; it is not a duty of loyalty to the other contracting party or of disclosure, or a requirement to forego advantages flowing from the contract.

This new duty, according to the Supreme Court, should not be considered an implied term, but a general doctrine of contract law that imposes a minimum standard. Therefore, parties are not free to contract out of the duty of honest performance, although they can modify and 'relax' it by express terms in their contract to contextualise it.

Applying new duty of honest performance to facts Applying the duty of honest performance, the Supreme Court found that Can-Am had acted dishonestly with Bhasin. Can-Am misled Bhasin, telling him that Hrynew was obligated to treat Bhasin's information as confidential. Further, Can-Am falsely indicated that the Alberta Securities Commission had rejected a proposal to name a third-party compliance officer. The Supreme Court held that Can-Am failed to act honestly with Bhasin in exercising the non-renewal clause by its failure to be honest with Bhasin with respect to its settled intentions regarding renewal. The entire agreement clause was of no avail to Can-Am because, as stated above, parties cannot contract out of the duty of honest performance.

With respect to Hrynew's conduct, the Supreme Court held that there had been neither a conspiracy nor inducement to breach on the part of Hrynew – he did not encourage Can-Am to be dishonest and its dishonesty could not be attributed to him. Accordingly, he was not liable.

Damages were assessed by the Supreme Court according to the contract measure of damages at the value of Bhasin's business around the time of non-renewal, C$87,000, on the basis that but for Can-Am's dishonesty, Bhasin could have acted so as to retain the value in his agency by selling his business rather than see it, in effect, expropriated and turned over to Hrynew.

Comment

The issues raised by Bhasin are central to the common law of contracts, and are therefore important to businesses and lawyers practising in any area in which contracts play a prominent role. As a whole, the decision can be classified as a cautious approach to good faith, and one sensitive to several competing interests.

First, it appears that the duty of honest performance is narrow. As described above, the duty appears to be limited to refraining from active deception. Indeed, on the facts of Bhasin the plaintiff had been explicitly lied to and misled regarding Can-Am's conduct and intentions. It remains to be seen how the duty will be applied where the misleading statement is misleading not because it is an outright lie (as was the case in Bhasin), but because it is a half-truth that omits some important information (ie, making a statement that is the truth but not the whole truth, and thereby misleading by omission rather than by commission). The absence of a duty of disclosure would be relevant in such a scenario.

The Supreme Court also considered the issue of commercial certainty when crafting its decision. For instance, it noted that by tying the organising principle of good faith to existing doctrine, predictability in commercial contracts would not be undermined. Further, it suggested that a narrow duty of honesty already accords with the reasonable expectations of parties to commercial contracts, as parties do not expect dishonesty among their trading partners. Moreover, two of common law Canada's most significant trading partners – Quebec and the United States – already recognise a duty of good faith in contractual performance.

However, the precise effects of Bhasin remain to be seen. The Supreme Court decision does not provide a specific test for dishonesty and notes that the list of doctrines falling under the organising principle of good faith is not closed. This opening will undoubtedly give rise to future litigation as parties test the boundaries of the new duty of honest performance and the newly recognised organising principle of good faith.

Finally, with respect to freedom of contract, the court made important statements regarding how parties may seek to limit the new duty's impact on their agreements. While parties may not contract out of the duty, the Supreme Court suggested that its requirements could be relaxed by agreement in certain contexts "so long as they respect its minimum core requirements". The Supreme Court then quoted, with approval, the Uniform Commercial Code: "The parties, by agreement, may determine the standards by which the performance of those obligations [eg, of good faith] is to be measured if those standards are not manifestly unreasonable." However, the court was clear that a generic entire agreement clause will not limit the duty of honest performance.

The following takeaways from the decision are relevant to both litigation lawyers and commercial lawyers: l While lying or knowingly misleading the other party about one's contractual performance infringes the new common law duty of honest contractual performance, the duty is not a duty of fiduciary loyalty, a duty of disclosure or a duty to forgo the advantages of a contract. l While parties cannot contract out of the duty and therefore a generically worded entire agreement clause will be of no relevance, contract drafters may wish to consider language to relax the requirements of the new duty by establishing their own standards of honest performance, perhaps using US law as a guide. l The existing jurisprudence that recognises a broader duty of good-faith performance in certain specific contractual contexts has not been upset and the Supreme Court held that the list is not closed. l While the Supreme Court did not recognise a general standalone duty of good-faith performance applicable to all contracts, it did recognise an overarching organising principle of good faith (ie, that parties generally must perform their contractual duties honestly and reasonably and not capriciously or arbitrarily) that underlies and manifests itself in various more specific judicial doctrines governing contract performance, including the new duty of honest performance. The Supreme Court held that the implications of the organising principle of good faith must be allowed to evolve according to an incremental judicial approach using the existing jurisprudence as the primary guide to future development. l The Supreme Court's decision was limited to the performance of contracts and did not address the negotiation of contracts. It remains to be seen whether the duty of honest performance will develop into an analogous honesty constraint applicable in the contract formation phase. It may be expected to do so in situations where an existing contract between the parties specifically contemplates or provides for the negotiation of a further contract.

For further information on this topic please contact Barbara L Grossman or Jason Chin at Dentons by telephone (+1 416 863 4511), fax (+1 416 863 4592) or email ( [email protected] or [email protected]).

Endnotes

(1) 2014 SCC 71.

(2) 2013 ONCA 494.

(3) 2013 ABCA 98.

The materials contained on this website are for general information purposes only and are subject to the disclaimer.

ILO is a premium online legal update service for major companies and law firms worldwide. In-house corporate counsel and other users of legal services, as well as law firm partners, qualify for a free subscription. Register at www.iloinfo.com.