When negotiating a deal, it is common for parties to execute pre-contractual documents, such as a letter of intent, memorandum of understanding, or term sheet, reflecting the principal terms of the proposed transaction. Often, though not always, these pre-contractual documents provide that they are "non-binding" and that the deal is subject to, for example, due diligence and the execution of definitive agreements. It is also common for parties to provide in pre-contractual documents that they "agree to negotiate in good faith."
In the event of a dispute resulting from a breakdown in negotiations, parties should be aware of the fact that under Québec law (this is not the case in Ontario), while a properly drafted "nonbinding" pre-contractual document may preclude a court from finding that the terms of the precontract are enforceable, there is an independent duty for parties to negotiate in good faith even in the absence of an express clause to this effect in a pre-contractual document. As such, and notwithstanding the "non-binding" nature of a pre-contractual document, a party that breaches its duty to negotiate in good faith, or that unreasonably breaks off negotiations, can potentially be held liable, extra-contractually, for damages caused to the other party.
The Duty to Negotiate in Good Faith Under Québec Law
The duty to act in good faith is a well-recognized principle under Québec law. Indeed, this duty is expressly codified in the Civil Code of Québec which provides that "no rights may be exercised with the intent of injuring another or in an excessive and unreasonable manner which is contrary to the requirements of good faith" and "the parties shall conduct themselves in good faith both at the time the obligation is created and at the time it is performed or extinguished."
Though not expressly defined, the duty to act in good faith is understood, in broad terms, as the duty to act honestly and reasonably and to conduct oneself as would a "reasonable person" in the same circumstances (i.e., according to an objective standard). This duty encompasses the duty to act in good faith in the course of pre-contractual negotiations even where this has not been expressly provided for in pre-contractual documents. It should be noted that good faith is always presumed and, as a result, the party invoking a breach of this duty bears the burden of proof.
The duty to negotiate in good faith, and in particular the duty not to unjustifiably terminate negotiations, has been repeatedly acknowledged by all levels of courts in Québec. Québec's Superior Court has described the obligation to negotiate in good faith and the duty not to break off negotiations in an unreasonable manner as follows:
- "The obligation of good faith requires a spirit of active collaboration between the parties and concrete actions on both sides. To be in good faith, it is insufficient to simply not have a contrary intention, rather a party must act in good faith." [Unofficial translation]
- When one of the parties involved in the negotiation of a
contract decides to withdraw from the discussions, putting an end
to the possibility of concluding a contract, it may not do so
without a valid reason or in an abusive manner which causes damage
to the other party.
Nevertheless, the principle of the liberty to contract or not to contract remains. As long a as a party acts in good faith and reasonably, it may withdraw from ongoing negotiations if it comes to the conclusion that it is no longer in its interest to conclude the proposed agreement. In other words, the right to change one's mind still exists, and the party disappointed by the withdrawal from the negotiation can claim damages only if the withdrawal constitutes a civil fault."
Most recently, these principles were endorsed by the Québec Superior Court in Friedman v. Ruby, 2012 QCCS 1778 ("Ruby"). In Ruby, though concluding, after a careful consideration of the events in that case leading to the breakdown in negotiations, that the defendant had not breached its duty to negotiate in good faith, the Court reiterated that "the obligation to act in good faith must be respected by the parties even before a contract is concluded, as early as during the pre-contractual negotiations."
While the act of entering into negotiations does not, in and of itself, bind a party to execute a definitive agreement and while each case will ultimately be decided based on its own facts, the following general propositions dealing with the duty to negotiate in good faith can be gleaned from the case law and the views of the leading authors:
- Both the actions (e.g., words) or omissions of a party that unjustifiably terminates negotiations can give rise to liability and the injured party does not have the burden of proving fraudulent or intentional conduct by the wrongdoer. Simply put, the complainant only has to show that the wrongdoer, through its actions or omissions in the course of negotiations, failed to conduct itself in accordance with the requirements of good faith.
- A party may be liable for abruptly terminating negotiations without justification where it gave the other party reason to believe that an agreement would be executed.
- The stage of the negotiations is an important factor to take into account when evaluating whether a party complied with its good faith obligations. At an advanced stage of negotiations, a party will require serious reasons for not pursuing negotiations and may have the burden of proving these reasons.
Examples of a lack of good faith in negotiations can include:
- Failing to consider a serious offer by abruptly putting an end to negotiations
- Failing to disclose the existence of concurrent negotiations with another party even when exclusivity has not been expressly provided for
- Failing to disclose material information Misappropriating confidential information obtained in the course of negotiations (even in the absence of an express obligation of confidentiality)
Where a party fails to negotiate in good faith and unreasonably withdraws from negotiations, it may be liable for the damages caused to the injured party by its wrongful conduct. These damages may potentially include expenses incurred by the injured party in connection with the negotiations and the "value" of the time wasted.
No free-standing duty to bargain in good faith under Ontario law
In Ontario, there is no pre-contractual obligation to negotiate in good faith. This principle was recently confirmed in the 2011 decision of the Ontario Court of Appeal in Oz Optics Limited v. Timbercon, Inc., 2011 ONCA 714 ("Oz Optics"). In that case, the Ontario Court of Appeal stated that it is difficult to ascertain in what circumstances an obligation to act in good faith will be applied, but that "the common law has not recognized a free-standing duty of good faith based in tort" and that, to date, the Supreme Court of Canada has not extended the doctrine of good faith beyond the context of an existing contractual relationship. Having regard to the state of the law in this area, the Ontario Court of Appeal refused to impose a pre-contractual obligation of good faith.
The foregoing having been said, and while a party to negotiations is entitled to pursue its own interests, it should be noted that there are causes of action available under the laws of Ontario to sanction "wrongful" conduct in the context of negotiations that do not culminate in the execution of a definitive agreement, including, in appropriate circumstances, negligent misrepresentation, fraud, and the tort of deceit.
Under Québec law, when entering into negotiations, parties must be aware of the fact that even where they did not intend for pre-contractual documents to be "binding", and irrespective of whether definitive agreements are executed, a decision to unjustifiably terminate negotiations in a manner that is contrary to the requirements of good faith may expose that party to liability where its conduct causes damage to another person.
Under Ontario law, in Oz Optics, the Ontario Court of Appeal left open the possibility as to whether it could, in appropriate circumstances, find a pre-contractual good faith obligation. For the time being, however, such an obligation does not exist.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.