Canada: SCC Creates New Duty Of Good Faith In Contractual Performance

Last Updated: November 21 2014
Article by E. Craig Watson

Is there a general duty of good faith imposed on parties to a contract? Until recently, my answer to this question (assuming no unique statutory duties or fiduciary relationship or specialized relationship such as insurance contracts) would have been an unqualified "no."  This changed with the groundbreaking decision of the Supreme Court of Canada in Bhasin v. Hrynew, 2014 SCC 71. The SCC posed the following question: Does Canadian common law impose a duty on parties to perform their contractual obligations honestly?  The answer is "yes."

The facts of Bhasin are as follows. Canadian American Financial Corp. ("Can-Am") was in the business of marketing education savings plans.  Can-Am would enter into contracts with various retail agents, called enrollment directors, to sell the plans.  Beginning in 1989 Bhasin & Associates ("Bhasin") was an enrollment director for Can-Am.  In 1998 the parties negotiated a replacement contract that was styled as a commercial dealership agreement, as opposed to a franchise agreement.  The immediate effect of this was to remove the relationship from the requirements of the Alberta Franchises Act with its statutory duty of fair dealing.  Notwithstanding the structure of the 1998 agreement, it had many aspects similar to a franchise agreement: Bhasin could only sell Can-Am investment products; Bhasin owed Can-Am a fiduciary duty; Can-Am owned Bhasin's client list; Bhasin could not sell, transfer, or merge its operation without Can-Am's consent.  The agreement also provided for an automatic renewal after the three-year term unless one of the parties provided six months written notice to the contrary.

Mr. Hrynew owned one of the largest agencies in Alberta and was a direct competitor of Bhasin.  There was also considerable animosity between the two. When Hrynew became an enrollment director for Can-Am he was promised that he would be given consideration for mergers between enrollment directors.  Hrynew wanted Bhasin's market share.  He constantly proposed mergers with Bhasin.  He pressured Can-Am to force the merger.

In 1999 the Alberta Securities Commission, as a result of ongoing concerns with Can-Am's enrollment directors, required Can-Am to appoint a single provincial trading officer (PTO) to review compliance issues.  Can-Am appointed Hrynew notwithstanding that he lacked the necessary qualifications.  Bhasin refused to allow a competitor access to its confidential business records.

During 1999 and 2000 Can-Am had a number of discussions with the Securities Commission during which it confirmed that it was considering a restructuring of its business such that Bhasin would work for Hrynew.  This plan was finalized by June 2000.  Bhasin was never told.

Can-Am further misled Bhasin by telling it that Hrynew, as PTO, was under an obligation to keep all information confidential and that the Securities Commission had rejected its proposal to have an outside PTO – all of which was untrue.  When Bhasin demanded to know if a merger with Hrynew was a done deal, Can-Am responded equivocally even though from its perspective the merger was going to happen.  When Bhasin maintained his refusal to provide his records to Hrynew, Can-Am terminated the agreement in May 2001.

When the agreement was terminated Bhasin lost everything.

Bhasin sued both Can-Am and Hrynew.  At trial Bhasin was successful: Can-Am had breached an implied contractual duty of good faith by forcing Bhasin to submit to an audit by Hrynew and by exercising the non-renewal clause in a dishonest and misleading manner all for an improper purpose, Hrynew had intentionally induced a breach of contract, and both had engaged in a civil conspiracy.  The Alberta Court of Appeal allowed the appeal and dismissed the claim.

The Supreme Court of Canada allowed the claim as against Can-Am and awarded damages based upon what Bhasin's economic position would have been had Can-Am fulfilled its duty of honest performance: a duty which had, until this case, not been articulated by the court.

In concluding that such a duty exists at common law, the SCC first observed that while the notion of "good faith" has been imposed in specific instances of contract law, the common law has generally resisted any attempt to impose a free standing obligation on contracting parties of good faith performance.  The court concluded that the facts of this case required two incremental steps in the common law to make it "more coherent and more just."

The first step is to finally acknowledge and recognize that the common law already possesses an underlying organizing principle of good faith: simply put, "parties generally must perform their contractual duties honestly and reasonably and not capriciously or arbitrarily." (para 63) This organizing principle is not a freestanding rule.  It is a standard that informs the analysis of more specific contractual legal doctrines and the concept that parties to a contract should have appropriate regard for the legitimate interests of the other.  However:

"appropriate regard" for the other party's interests will vary depending on the context of the contractual relationship, it does not require acting to serve those interests in all cases.  It merely requires that a party not seek to undermine those interests in bad faith.  This general principle has strong conceptual differences from the much higher obligations of a fiduciary.  Unlike fiduciary duties, good faith performance does not engage duties of loyalty to the other contracting party or a duty to put the interests of the other contracting party first. (at para 65)

The application of this organizing principle to existing doctrines and its development in new situations will occur incrementally "in a way that is consistent with the structure of the common law of contract and gives due weight to the importance of private ordering and certainty in commercial affairs." (para 66)  In short, the court concluded that the existing connection of this organizing principle to doctrines such as unjust enrichment ensured that a general notion of "good faith" in contract law would not undermine certainty in commercial relationships.

The second step identified by the court is to "recognize, as a further manifestation of this organizing principle of good faith, that there is a common law duty which applies to all contracts to act honestly in the performance of contractual obligations." (para 33)

Can-Am's relationship with Bhasin did not fit into any of the existing contractual relationships that imposed a duty of good faith by operation of law.  Can-Am's conduct, however, was found to be objectionable.

To address Can-Am's objectionable conduct the court created a general duty of honesty in contractual performance.  The SCC described the duty as follows:

[73] ... I would hold that there is a general duty of honesty in contractual performance. 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.  Recognizing a duty of honest performance flowing directly from the common law organizing principle of good faith is a modest, incremental step. The requirement to act honestly is one of the most widely recognized aspects of the organizing principle of good faith ...

Further, the duty of honesty in contractual performance is not an implied contractual term but a general doctrine of contract law, operational regardless of the parties' intentions, which imposes minimum standard of honest performance.  Like the equitable doctrine of unconscionability, the parties to a contract cannot exclude this duty.

While the duty of honesty in contractual performance cannot be excluded, parties can minimize its operation provided a suitably worded clause is negotiated.  The clause must be specific to the duty and its relaxation intended by the parties.  An "entire agreement" clause will not suffice.

Honest performance does not require one to subordinate their interests to the other party.  All that is required is "a minimum standard of honesty from their contracting partner in relation to performing the contract as a reassurance that if the contract does not work out, they will have a fair opportunity to protect their interests." (para 86)  In the case at bar, the court acknowledged that the duty did not require a party to disclose information relevant to the decision to terminate the contract but did prohibit Can-Am from actively misleading or deceiving Bhasin in relation to the performance of the agreement. The analysis was summarized (at para 93) as follows:

(1) There is a general organizing principle of good faith that underlies many facets of contract law.

(2) In general, the particular implications of the broad principle for particular cases are determined by resorting to the body of doctrine that has developed which gives effect to aspects of that principle in particular types of situations and relationships.

(3) It is appropriate to recognize a new common law duty that applies to all contracts as a manifestation of the general organizing principle of good faith: a duty of honest performance, which requires the parties to be honest with each other in relation to the performance of their contractual obligations.

The SCC turned its attention to the effect of the termination clause in the agreement given the newfound duty of honesty in contractual performance and the trial judge's finding that Can-Am acted dishonestly.  Given the totality of Can-Am's actions, the court found that Can-Am breached the duty of honesty in contractual performance when it failed to act honestly in exercising the non-renewal provision.

The question for commercial people, then, is what is the practical effect of the duty of honesty in contractual performance?

The SCC did conclude that a duty of honesty in contractual performance would not cause uncertainty or pose a risk to contractual enforcement as reasonable commercial people undoubtedly already expect that parties to an agreement are not dishonest about their performance.  The common law's high regard towards allowing contracting parties the freedom to pursue their own self-interest would not be affected.

The scope of this new duty of honesty in contractual performance is unclear. At paragraph 73 of the decision the court stated: "parties must not lie or otherwise knowingly mislead each other about matters directly linked to the performance of the contract."  The law must develop to define what a "lie" is in a contractual setting.  Is it solely a statement as opposed to actions?  Must it be by commission as opposed to omission?  While instinctively we all know, or think we know, what a lie is, this is not any assurance that the law will define it as such.

The SCC found that there is no duty of disclosure. Presumably then, the failure to alert a contracting party to, for example, a decision to terminate an agreement as permitted could not be considered a lie.  Would this conclusion be applicable though if asked outright?  Is it dishonest to negotiate with a competitor during the term of an agreement so as to maximize one's self-interest before deciding to terminate an agreement?

If, as stated by the SCC, the duty simply requires a fair opportunity to protect one's interests, how can strict compliance with the written terms of an agreement be improper?  If a six-month notice provision is negotiated by the parties, presumably to protect their self-interest, is this not a "fair opportunity"?  Presumably Can-Am and Bhasin thought so.

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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