Canada: The Second Opinion: Good Faith In The Shadow Of Contractual Rights

A Commentary on Recent Legal Developments by the Opinions Group of McCarthy Tétrault LLP

Are parties under a duty of good faith in deciding whether to exercise a right of non-renewal when the term of an evergreen contract comes to an end?  In Bhasin v. Hrynew, 2013 ABCA 98, the Alberta Court of Appeal said no, at least where the evergreen clause does not contain an express provision to this effect.  The ruling in Bhasin contains an extensive review of the law in this area, and may well prove to be the most important Alberta case on the duty of contractual good faith since Mesa Operating Ltd. v. Amoco Canada Resources Ltd. (1994), 149 A.R. 187 (C.A.).  It is also an important cautionary tale for those who would seek to use the duty of good faith to limit discretionary contractual rights.

Background

Bhasin involved a claim against a company ("CAFC") which marketed RESPs to parent-investors through various retail dealers.  The plaintiff, Mr. Bhasin, was one such retail dealer, and had been in a contractual relationship with CAFC for some time.  CAFC proposed a change to its dealership contracts, and a council of dealers that included Bhasin obtained a legal opinion about the new wording, which Bhasin reviewed.  Among the changes introduced by CAFC was an evergreen clause in s. 3.3 to which Bhasin agreed after express negotiations.  The clause stated that the term of the contract would last for three years, and be automatically renewed for successive three year periods, unless either party notified the other that they desired expiry of the agreement at least six months prior to the end of the relevant term.

The litigation arose when CAFC selected Mr. Hrynew, a competitor of Bhasin, to audit its dealers in order to monitor their compliance with Alberta securities law.  Bhasin objected to being audited by Hrynew given the potential for misuse of his confidential information.  As well, Hrynew wished to merge his own business with Bhasin's, and although this was encouraged by CAFC, Bhasin refused.  When CAFC exercised its s. 3.3 right to not renew the contract, Bhasin sued both CAFC and Hrynew, and the action was allowed at first instance.  Moen J. found, inter alia, that CAFC breached an implied duty of good faith by exercising the non-renewal right for improper reasons, i.e., to retaliate against Bhasin for refusing to submit to Hrynew's audit and to coerce Bhasin into merging with him.

The Bhasin Appeal

The Court of Appeal, consisting of Justices Côté, Paperny and Belzil, unanimously overturned the trial judgment.  After observing that many of Moen J.'s findings were based on arguments that Bhasin never pleaded, it proceeded to reject her fundamental conclusion that the non-renewal right was subject to implied preconditions.  In doing so, the Court produced the following list of legal principles to the delight of defendants everywhere:

1. There is no duty to perform most contracts in good faith. ...

2. The only duty of good faith in employment contracts is relatively narrow: not to announce or implement their termination in a harsh or demeaning way. That duty does not extend to the reasons for termination, but to the manner of termination. Even if we accepted the contract here to be an employment contract, or a melded contract including an employment contract, that would not help the plaintiff. The two governing cases say that employment contracts are not generally contracts of good faith in all respects. ...

3. a.  Courts can imply terms in contracts which are not explicit only when  the new term is

i. so obvious that it was not even thought necessary to mention, or

ii. truly necessary to make the contract work at all, not merely reasonable or fair.

b.  Mere foresight of a possible happening is not enough; both parties must have intended the term.

c.  The law's presumption is against implying terms.

4. . Notwithstanding #3, a term cannot be implied in a contract which would contradict an express term of that contract. ...

5. Though Mr. Bhasin's case at trial emphasized mental suffering, it is not compensated in contracts law (partly subject to #2 above on harsh modes of termination).

6. Some degree of inequality in bargaining power, need, or knowledge, is not enough to upset or amend the terms of a contract, short of actual unconscionability. (Or a request for equitable remedies to enforce, or statutory duties or rights to rescind.) ...

7. Parol evidence is not to be used directly to interpret a contract

a. if its words are unambiguous,

b. or to look at the actual subjective intent of one or both parties.

8.  A contract can validly exclude or nullify parol evidence, previous negotiations, representations, terms, promises or conditions, not found in the written document (absent actual fraud). ...

9. Courts should be especially wary of altering or interpreting creatively formal contracts carefully negotiated and written, with legal advice. ...

10. Courts should not attempt after the fact to rewrite a contract to accord with what the court now thinks, or one party now believes, is more just or more businesslike, especially in the full light of hindsight. ... (para. 27, citations omitted)

Applying these principles, the Court made four interesting findings.

First, it held that Moen J. erred in relying upon parol evidence of contractual negotiations, oral promises and the expectations of the parties given the existence of an entire agreement clause in the contract.  This clause excluded any "terms.. expressed, implied or statutory, other than expressly set out in this Agreement".  As a result, the Court distinguished the Ontario Court of Appeal's ruling in Civiclife.com Inc. v. Canada (A.G.) (2006), 215 O.A.C. 43, where an entire agreement clause that did not expressly exclude implied terms was found insufficient to preclude the application of the duty of good faith.  The Court also noted that, even apart from the entire agreement clause, it was inappropriate to consider this parol evidence since the contract was not ambiguous and the evidence went beyond mere background knowledge.

Second, the Court rejected the submission that the contract was an "employment" agreement, such that CAFC was subject to a duty of good faith by operation of law.  It noted that the agreement was "clearly not an employment contract in form or substance", and that even if it were, employment contracts are not as a general matter contracts of good faith, particularly in "a case of non-renewal (expiry), not of termination".

Third, the Court also rejected the argument that a duty of good faith arose by implication from the intentions of the parties.  It observed that nothing in the contract suggested the parties intended it to be of perpetual duration.  Instead, 3.3 plainly stated that the agreement would expire if one party chose to exercise its non-renewal right.  To suggest that "the contract will keep renewing itself automatically every three years, if the motive for giving the notice does not meet certain standards... flatly contradicts the clause's words".

Finally, the Court held that Moen J. erred in focusing upon inequality in bargaining power or sophistication between the parties.   In fact, given Bhasin's receipt of the legal opinion and the "expressly negotiated" nature of the evergreen clause, the Court found that the existence of such inequality was not "even arguable".

Significance

The significance of Bhasin lies in the Court's refusal to impose a duty of good faith upon the exercise of non-renewal rights, even though – as Moen J. emphasized below - they involve the use of a discretionary power.  As the Ontario Court of Appeal observed in Civiclife.com, discretionary contractual powers are one of the classic situations in which courts will imply duties of good faith.  Indeed, the Alberta Court of Appeal's own prior judgment in Mesa was such a case; Lord Sumption made the same point more recently in Hayes v Willoughby [2013] UKSC 17  at para. 14.

By declining to imply such a duty in Bhasin, the Court has signalled that the mere fact a contractual right is discretionary is not itself a sufficient reason for placing good faith constraints upon it.  Rather, judges must still ask whether those constraints are consistent with the text, context and purposes of the relevant provision and the contract as a whole. There may be some cases in which an unfettered discretionary right is precisely what a reasonable observer would conclude the parties intended.  The non-renewal provision in Bhasin is an example of this phenomenon.

As a practical matter, Bhasin also suggests that parties negotiating evergreen clauses should insist upon express limits to any non-renewal power if they are concerned that it may be exercised for improper purposes.  Absent such express terms, the strategy of sheltering in the common law duty of good faith at trial may prove difficult, especially where the evergreen clause was negotiated between parties of roughly equal bargaining power with the benefit of legal advice, and is located in a contract containing an entire agreement clause.  In the end, as Bhasin confirms, "the thoughts or impressions of the parties cannot be used to vary the express terms of a contract".

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