Canada: Honesty Is Now More Than Just The Best Policy: Supreme Court Of Canada Recognizes A "General Organizing Principle" Of Good Faith And A Duty Of Honesty In Performing Contractual Obligations

On Nov. 13, 2014, the Supreme Court of Canada released its unanimous decision in Bhasin v Hrynew, 2014 SCC 71. In this landmark case, the Supreme Court has for the first time recognized a "general organizing principle" of good faith and a duty of honesty in contractual relations.

Facts

The decision involved the relationship between the plaintiff/appellant Mr. Bhasin and Canadian American Financial Corp ("Can-Am"). Can-Am markets educational savings plans to investors through retail dealers, known as enrollment directors, and Mr. Bhasin was one such enrollment director. The agreement governing the relationship between Can-Am and Mr. Bhasin took effect in 1998 for a three year term and provided that it would automatically renew unless either party gave written notice to the contrary.

Mr. Hrynew, another defendant, was also an enrollment director for Can-Am and a competitor of Mr. Bhasin. Mr. Hrynew wanted to take over Mr. Bhasin's market and had previously approached Mr. Bhasin about a possible merger and encouraged Can-Am to pressure Mr. Bhasin into the merger. Mr. Bhasin refused.

Can-Am began considering a restructuring that involved Mr. Bhasin working for Mr. Hrynew's agency and in June 2000 outlined these plans to the Alberta Securities Commission. Mr. Bhasin was unaware that any of this was happening and Can-Am repeatedly misled him. Can-Am appointed Mr. Hrynew to monitor its enrollment directors for compliance with the securities laws of Alberta. This new role required Mr. Hrynew to audit the other enrollment directors, including Mr. Bhasin. Mr. Bhasin refused to allow Mr. Hrynew access to his business records.

Can-Am threatened to terminate the 1998 agreement and in May 2001 gave notice of non-renewal of the agreement. The trial judge found that at the end of the contract term Mr. Bhasin lost the value in his business as the majority of his sales agents were solicited to work for Mr. Hrynew's agency.

Mr. Bhasin sued Can-Am and Mr. Hrynew. The trial judge held that Can-Am had breached an implied term of good faith in the contract, and that Mr. Hrynew had intentionally induced a breach of contract.

The Court of Appeal for Alberta allowed the appeal and dismissed Mr. Bhasin's lawsuit.

The SCC Decision

While several points were raised before the Supreme Court, one question was squarely at issue: Does the common law of Canada impose a duty on contracting parties to perform their obligations honestly?

The unanimous reasons of the Court, delivered by Justice Cromwell,  begin by observing that the common law's traditional resistance to acknowledging a general and independent doctrine of good faith performance of contractual obligations had resulted in an "unsettled and incoherent body of law." To remedy this perceived problem, the Court sought to "take two incremental steps in order to make the common law less unsettled and piecemeal, more coherent and more just":

  • Acknowledging good faith in contractual performance as a general organizing principle that underpins and informs rules in which the common law, in various situations and types of relationships, recognizes obligations of good faith performance of a contract; and
  • Recognizing, as a manifestation of this organizing principle of good faith, that there is a common law duty applying to all contracts to act honestly in the performance of contractual obligations.

The Court held that these steps were desirable for three reasons:

  • The common law was uncertain;
  • The approach to the issue of good faith performance lacked coherence; and
  • The law was out of step with the reasonable expectations of commercial parties, particularly with respect to two major trading partners of common law Canada: Quebec and the US.

In charting the way forward the Court observed that commercial parties expect a "basic level of honesty and good faith in contractual dealings", and that "[w]hile they remain at arm's length and are not subject to the duties of fiduciaries, a basic level of honest conduct is necessary for the proper functioning of commerce." The Court concluded that by recognizing a general duty to perform contracts honestly, contractual relations would be more certain and coherent, consistent with reasonable commercial expectations.

A General Organizing Principle

The general organizing principle is, in the words of the Court, simply that "parties generally must perform their contractual duties honestly and reasonably and not capriciously or arbitrary." As the Court explains, this organizing principle is "not a free-standing rule, but rather a standard that underpins and is manifested in more specific legal doctrine and may be given different weight in different situations."

In practice, the Court held, the organizing principle will be manifested by parties through an appropriate regard for the contractual interests of the contracting partner in carrying out the contract.

The Court explains that the organizing principle of good faith should use existing law as the primary guide to future development of the doctrine, through existing doctrines governing the situations and relationships in which the law requires "honest, candid, forthright or reasonable contractual performance." The Court notes that the list of these situations and relationships, which includes those of insurance and employment, is not closed and further development may occur incrementally. The Court further explains that the context-specific nature of the application of the doctrine "would likely have different implications in the context of a long-term contract of mutual cooperation than it would in a more transactional exchange."

The Right to Pursue Individual Self-Interest Remains (to some degree)

The Court states:

The principle of good faith must be applied in a manner that is consistent with the fundamental commitments of the common law of contract which generally places great weight on the freedom of contracting parties to pursue their individual self-interest. In commerce, a party may sometimes cause loss to another – even intentionally – in the legitimate pursuit of economic self-interest...Doing so is not necessarily contrary to good faith and in some cases has actually been encouraged by the courts on the basis of economic efficiency. 

How this intended application is possible is not explained, as it would seem that the motives of a party would be a relevant consideration in determining whether that party performed a contract "honestly and reasonably and not capriciously or arbitrarily".

A New Common Law Duty of Honesty

Having elucidated the general organizing principle of good faith performance, the Court introduced a new "general duty of honesty in contractual performance" as a manifestation of that principle. The Court explained the nature of the new duty:

...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.

This duty of honesty will apply even in the face of entire agreement clauses as it is an implied term of all contracts and, like unconscionability, cannot be displaced by such a clause. The Court did, however, allow for the possibility of modifying the duty of honest performance through express terms to that effect.

The Court concludes its analysis with a summary of principles:

(1) There is a general organizing principle of good faith that underlies many facets of common law;
(2) In general, the particular implications of the broad principle for particular cases are determined by resorting to the body of existing doctrine that has developed and gives effect to aspects of that principle as it applies in particular types of situations and relationships; and
(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 Path Forward

The implications of this decision are unclear and potentially wide-ranging. The scope of the duty of honest performance in practice is difficult to predict. The Court recognizes that "the precise content of honest performance will vary with context and the parties should be free in some contexts to relax the requirements of the doctrine so long as they respect its minimum core requirements", although these "minimum requirements" are not identified and it is hard to say in what contexts the Court foresees parties relaxing the doctrine.

For the foreseeable future the requirements of the "general organizing principle" and the scope of the duty of honesty will be the subject of strenuous debate in legal proceedings involving all kinds of contractual arrangements. Contracting parties should be very cautious in assessing their performance obligations and behaviour in light of this ground-breaking decision.  

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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