Canada: Update On The Duty Of Good Faith In The Negotiation And Performance Of Commercial Contracts

Last Updated: October 8 2013
Article by Christine Renaud
  1. Express covenants to negotiate in good faith

Absent a special relationship between parties to a negotiation, Canadian law does not recognize an overarching duty to negotiate in good faith. The Courts have consistently refused to imply an obligation to negotiate in good faith on the basis that each party is entitled to pursue its own interest to the fullest extent possible in the course of the negotiation. However, it is not uncommon for parties to include a contractual commitment to negotiate in good faith. When such an express term is present, under what circumstances will the obligation be enforceable?

The Ontario Superior Court will grapple with this issue in a trial set to begin in December between two behemoths in the beer industry, Molson Canada and Miller Brewing Company (Court file CV-13-10053-CL).

Molson has been Miller's exclusive Canadian licensed distributor of Miller brand beer since 1982. As is typical in exclusive distributorships, Molson was contractually required to meet certain minimum sales volume targets. Miller had the right to terminate the agreement if the minimum targets were not met.

As a result of competitive forces, the parties entered into negotiations to amend the agreement, including modification of the sales targets. A letter of intent was signed, the preamble of which expressly stated that the parties would "negotiate in good faith towards the execution of an amendment". An amendment was later executed in which Miller waived Molson's minimum sale requirements for two years provided a certain other pre-condition (a revision to industry standards to permit the sale of Miller beer in clear bottles) was met. The amendment also provided that if that other pre-condition was not met, and the amendment thereby ceased to be effective, the parties would nonetheless "negotiate in good faith to ...reset the minimum volume targets".

Eventually, the pre-condition was not met, and Miller's express waiver of Molson's sales targets was no longer applicable. In respect to the express covenant to negotiate in good faith to reset volume targets in the event the amendment became ineffective, Miller's position was that the covenant was not a legally enforceable obligation. Miller delivered a notice of termination for Molson's failure to meet the minimum sales targets prescribed by the licence.

Molson launched an action in the Superior Court, claiming that Miller had failed to negotiate the alteration of sales targets in good faith and was thus prevented from exercising its right of termination. Molson sought, and was granted, an interlocutory injunction restraining Miller from terminating the licence until the Court could consider the merits of the action in a full trial. The motions judge was satisfied that there was a "serious issue to be tried" (the relatively low threshold for granting pre-trial injunctions), that Miller had breached its contractual obligation to negotiate in good faith and that the equities otherwise favoured the maintenance of the status quo (i.e. the continuance of the licence) until trial.

The motions judge found that there was nothing in the jurisprudence which suggested that a covenant to negotiate in good faith was always an uncertain obligation, and therefore always unenforceable. Rather, parties who agree to such a covenant are presumed to intend that a breach of the obligation will attract legal consequences. Relying on recent U.S. jurisprudence, the motions judge found that when all the material terms of an agreement have been agreed to in principle, such as in a letter of intent or deal term sheet, an agreement to negotiate a contract in good faith may be enforced, even, it appears, if the deal terms are expressed to be "non-binding". The motions judge considered such jurisprudence to better reflect current commercial realities and was preferable to older jurisprudence that tended to exclude the possibility of an enforceable obligation to negotiate under all circumstances.

It is important to emphasize that the motions judge's findings were made in the context of a motion for an interlocutory injunction. Therefore, his findings are certainly not the last word on the matter. However, his reasons may reflect a new judicial willingness to uphold and enforce express covenants to negotiate in good faith in those circumstances where the certainty and scope of the obligation can be determined. In making that determination, whether or not the parties have agreed in principle to all material terms of the contract, such as in a letter of intent or term sheet, will be key. In those circumstances, a party's later proposal of terms that differ dramatically from the terms earlier agreed to in principle may constitute a breach of its express covenant to negotiate in good faith.

  1. Implying a duty of good faith in contractual performance

On August 22, 2013, the Supreme Court of Canada granted leave in Harish Bhasin v. Larry Hrynew (Docket No. 35380). The Court will consider, among other legal issues, whether, and the circumstances under which, the Court will imply and impose an obligation of good faith upon a party's performance of its contractual obligations. In particular, can a court imply such an obligation in the context of an unambiguous contract containing an "entire agreement" clause? A trial judge in Alberta, after a month long trial, answered "yes" but was overruled by the Alberta Court of Appeal.

The core facts of the case are as follows. The plaintiff, Bhasin, sold Education Savings Plans, a financial instrument marketed by Canadian American Financial Corp. (Canada) Limited ( "CAFC"). He signed a contract of indefinite duration with CAFC, one of the terms of which was a prohibition from selling non- CAFC products. Bhasin succeeded to build a small agency selling CAFC's products. Nine years into the relationship, CAFC proposed to amend the contract. One of the proposed amendments was to fix the term of the contract at three years, automatically renewable for successive three year periods, unless one of the parties wished to terminate the contract. The proposed contract also contained an "entire agreement" clause expressly disavowing any terms or obligations not expressly contained in the agreement. After receiving legal advice, Bhasin signed the amended contract.

Approximately three years later, CAFC exercised its right of non-renewal and purported to terminate the agreement. No reason was given for the non-renewal.

Bhasin sued CAFC claiming that there was an implied term of the contract that CAFC would not terminate the contract without a valid reason. In the absence of such a reason, the non-renewal of the contract breached an implied duty of good faith.

After considering all the evidence, including facts that transpired before and after the execution of the amended agreement, the trial judge, in a 529 paragraph decision, found an implied a duty of good faith as claimed by Bhasin and found CAFC liable to him for significant damages. The trial judge was satisfied that it was reasonable to imply a term to the agreement that Bhasin would not be terminated without cause, despite the unambiguous non-renewal term and the express entire agreement clause.

First, the trial judge found that Bhasin was inherently vulnerable to CAFC at the time of signing the amended contract and that this imbalance in negotiating power justified the imposition of implied good faith terms by operation of law.

Second, the trial judge found that the parties intended to perform their obligations in good faith and the entire agreement clause did not oust this intended good faith term. The trial judge accepted evidence that CAFC had represented to Bhasin that the non-renewal clause would not be invoked without a good reason.

Third, the trial judge negated the effect of the "entire agreement" clause, finding that such a clause was only effective when both parties to the contract possessed a high level of sophistication and relatively even bargaining positions. In the circumstances of the case, that clause did not avoid the duty of good faith implied by operation of law and the parties' intentions, so found, when the second contract was signed.

Once the trial judge imposed the duty of good faith performance and negated the effect of the exclusionary "entire agreement" clause, she recited several discrete examples of CAFC' s bad faith in its dealings with Bhasin, more than sufficient to constitute a breach of the implied good faith obligations.

A unanimous Alberta Court of Appeal, in a relatively short 43 paragraph decision, overturned the trial judge's decision and dismissed Bhasin's case. The appellate court recited several legal principles that negated the imposition of any implied duty of good faith.

The Court of Appeal held that the agreement was clear and unambiguous. The degree of bargaining inequality did not attain the level of unconscionability which is required at law in order for duties of good faith to be implied. There were no pre-conditions to CAFC's exercise of the right of non-renewal. It was incorrect for the trial judge to rely on the thoughts or impressions of the parties to vary the express terms of their contract. The "entire agreement" clause must be given legal effect.

The Supreme Court of Canada's grant of leave signals the importance that Court attaches to the legal issues at stake in the proceedings. We expect the appeal to be argued in 2014 with a decision no later than the first quarter of 2015. Whatever the outcome, the decision will undoubtedly discuss when, and under what circumstances, a Court will imply duties of good faith in the performance of a party's otherwise unambiguous contractual obligations and when an "entire agreement" clause will be given full effect to negate such implied terms.

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.

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