Canada: The Duty Of Good Faith Performance: An Unfettered Right To Terminate Is Not Unfettered

Last Updated: June 6 2018
Article by Cynthia Spry

The Ontario Court of Appeal recently found that a termination clause in a contract that appeared, on its face, to provide an unfettered right of termination is subject to the duty of good faith contractual performance set out by the Supreme Court of Canada in Bhasin v. Hrynew, 2014 SCC 71.

Background: In Mohamed v. Information Systems Architects Inc., the Plaintiff (Respondent), Mitchum Mohamed ("Mohamed"), entered into an Independent Consulting Agreement with the Defendant (Appellant), Information Systems Architects Inc. ("ISA") for a six-month project. The project was with Canadian Tire, whose agreement with ISA required that ISA not utilize any consultant who had a criminal record.

Prior to signing the agreement with ISA, Mohamed told ISA that he had a dated criminal record from high school. He consented to a criminal record check, and also disclosed his criminal record in a declaration of criminal record form. He began work on ISA's Canadian Tire project, but when the criminal record check came back, one month later, Canadian Tire received a copy and asked ISA to replace Mohamed.

ISA terminated Mohamed's engagement, relying on a provision in the contract that permitted it to terminate immediately if "ISA determines that it is ISA's best interest to replace the Consultant for any reason". Mohamed sued, claiming damages in the full amount that would have been paid, had the contract been completed. Both sides moved for summary judgment.

Judicial History: At first instance, Justice Perell found that, read literally, the termination provision gave ISA an unfettered right to terminate Mohamed's contract. However, by adding the contra proferentem rule to the contractual interpretation analysis (which requires any ambiguity to resolved against the draftsperson), and by considering the doctrine of good faith performance of contracts from Bhasin v. Hrynew, it was unclear whether ISA did in fact have an unfettered right of termination.

His Honour ultimately held, among other things, that ISA had breached its duty of good faith performance by failing to exercise the termination clause in good faith, and, in the alternative, the termination clause was void for uncertainty.

On Appeal: ISA argued that Justice Perell had erred in law by referring to the contra proferentem rule and the good faith performance obligation in interpreting the termination clause, after finding that its meaning was clear when read literally. The court agreed that this would have been an extricable error of law had his Honour done so; however, rather than interpreting the termination clause to change its literal meaning, Justice Perell was assessing the main issue – whether the appellant exercised its right to terminate in good faith.

The Court of Appeal did find that Justice Perell had made two extricable legal errors: (1) having found that the meaning of the termination provision was clear when read literally, there was no basis to apply the contra proferentem rule (this rule is used to resolve ambiguity, not create it); and (2) having found the meaning of the termination clause to be clear, his Honour could not conclude that the clause was void for vagueness/uncertainty.

Nothing turned on these errors, however, as his Honour correctly found that ISA was obliged to exercise its termination right in good faith, and it breached the agreement by failing to do so. ISA's reliance on the criminal record to terminate the contract, despite the disclosure by Mohamed one month earlier, was not a good faith exercise of its rights, particularly where it had not tried to secure Canadian Tire's agreement to Mohamed's continued work on the project, and had not offered Mohamed another consulting project.

The Court held that although Mohamed was willing to accept that his engagement could be terminated with no payment when the appellant deemed it to be in its best interests to do so, he expected, as he was entitled to do, that ISA would only exercise its rights under the termination clause in good faith. When that did not occur, the respondent was entitled to damages.

The Takeaway: In Bhasin v. Hrynew, the Supreme Court of Canada held that the new duty of honest performance should not be thought of as an implied term, but a general doctrine of contract law that imposes as a contractual duty a minimum standard of honest performance. It operates irrespective of the intentions of the parties, and is to this extent analogous to equitable doctrines which impose limits on the freedom of contract, such as the doctrine of unconscionability.

Despite this, the Court of Appeal approached the contract at issue in Mohamed's case from the perspective of the reasonable expectations of the parties. This case highlights the continuing uncertainty about the exact nature and effect of the duty of good faith contractual performance, and how courts will approach its application.

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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