Canada: The Right Of First Refusal And Good Faith In Your Business Contract: What You Need To Know

A right of first refusal clause ("ROFR") can be a critical component to any commercial agreement.

In the context of an asset or share purchase, ROFRs allow the holder of the right to enter into a transaction after a valid offer to purchase is made by a third party and before others can exercise the purchase option.

ROFRs are typical in joint venture situations, where the parties to the joint venture have the ability to buy out the interests of the other(s) who choose to leave and sell their interests.

Like all aspects of Canadian contracts, ROFRs are subject to the duty of good faith established by the Supreme Court of Canada in Bhasin v. Hyrnew, 2014 SCC 71; C.M. Callow Inc. v. Zollinger, 2020 SCC 45; and Wastech Services Ltd. v. Greater Vancouver Sewerage and Drainage District, 2021 SCC 7.

But does the duty of good faith require that all parties bound by a ROFR must look out for the opposing parties' commercial well-being?

A recent decision of the Ontario Court of Appeal, Greta Energy Inc. v. Pembina Pipeline Corp., 2022 ONCA 783, answers this question in the negative.

Greta Energy holds that the duty of good faith allows parties exercising their contractual rights under a ROFR to act in their economic self-interest.

The Answer is Blowin' in the Wind

Greta Energy concerned the sale of three wind farms, two of which were subject to ROFRs under their respective agreements.

The appellants held two respective ROFRs on two of the assets that the respondent sought to purchase.

In 2016, Veresen, which indirectly owned majority interests in the two wind farms, decided to sell its assets. The respondent submitted a bid to purchase. The bid was successful and the respondent was invited to negotiate an agreement of purchase and sale.

After the respondent provided a breakdown of the purchase price for each of the wind farms, ROFR notices were sent to the appellants so they could exercise their respective rights.

One of the appellants, Greta, which had an interest in one of the wind farms and also held a ROFR, advised the seller Veresen that it intended to exercise its ROFR on one of the wind farms, but not the other.

However, Greta effectively refused to consent to the sale of the other wind farm to the respondent, on the basis that the price of the wind facility was being wrongly manipulated by the respondent. The appellants alleged that Veresen and the respondent conspired to manipulate the price of the assets being sold in bad faith by Veresen to prevent the appellants from exercising their ROFRs.

The appellants started an action against the respondent for breach of contract (including breach of the duty of good faith), conspiracy, breach of fiduciary duty, and inducing breach of contract.

On a motion for summary judgment, the appellants' action against the respondents was dismissed. The motion judge found that Veresen established a valid process for selling its assets and the respondents properly engaged that process. It was not commercially unreasonable for the respondent to pay a price for assets that would pressure the appellant ROFR holders not to exercise their rights.

On appeal to the Court of Appeal, at issue was whether the respondents worked together to manipulate the asset price in bad faith to prevent the appellants from exercising their ROFRs.

The Court of Appeal dismissed the appeal and upheld the dismissal of the appellants' action.

In doing so, the Court elucidated a number of important principles about the nature of good faith in contractual relations, particularly with respect to ROFRs:

1. Fair Market Value is Not Conclusive on Whether Parties Act in Good Faith.

One of the arguments advanced by the appellants was that the respondents deliberately allowed and encouraged the price of the wind farm to be artificially inflated in bad faith. The motion judge rejected that argument, however, finding that the competitive bidding process involved an escalating pressure on prices.

The Court of Appeal upheld this finding, noting that the fair market value of the assets was not conclusive in determining whether the respondents acted in good faith under their contract:

The motion judge accepted that there was no correct price for a ROFR; there was only what the vendor offered and the purchaser was willing to accept. Thus, fair market value was not determinative of whether the respondent Veresen acted in good faith. In any event, no expert evidence on the fair market value of the assets was tendered by [the appellants].

2. Good Faith Does Not Impose a Duty of Disclosure.

The Court of Appeal further rejected the argument that the contractual duty of good faith imposed an obligation on the respondent Veresen to disclose the process it engaged in with the buyer respondent to determine the price among the assets.

Citing the Supreme Court of Canada's decision in C.M. Callow Inc. v. Zollinger, supra, the Court of Appeal found that good faith does not require disclosure by commercial parties, unless the lack of disclosure involves a form of dishonesty or an attempt to mislead:

As for disclosing information to the appellants, as the motion judge noted, C.M. Callow Inc. v. Zollinger . does not impose a duty of disclosure so long as a party does not knowingly mislead the other party. However, the motion judge found that [the respondent] Veresen provided all documents requested in the five separate requests for information made by the appellants, and the appellants' evidence was that they had sufficient information to determine whether or not to waive the ROFR.

3. Attempts to Discourage the Exercise of a ROFR May Be Commercially Reasonable.

In assessing whether the respondents were liable for inducing a breach of contract, the Court found that, at worst, one of the respondents may have intended to discourage the appellants from exercising their ROFRs.

However, the Court suggested that such conduct does rise to the level of inducing a breach of contract. The exercise of a ROFR is a competitive process. Discouraging the exercise of a ROFR may very well fall within the ambit of commercially responsible conduct:

. the dynamic between the ROFR holder and the third party is a competitive one: the respondents were entitled to discourage the exercise of the ROFR and did not "eviscerate" the appellants rights .

Good Faith is Subject to Commercial Reasonableness

Greta Energy represents an important qualification to the principle that all Canadian commercial contracts are bound by a duty of good faith: that duty is necessarily circumscribed by notions of commercial reasonableness and competition.

In the context of a ROFR, Courts hesitate to sanction conduct that hinders the exercise of the ROFR right, so long as such conduct is honest, not misleading, and commercially sensible. Competitive commercial activity is permissible where the underlying basis for the ROFR is not "eviscerated".

There are limits, then, to the duty of good faith. The business context in which parties exercise their rights under the contract will inform the Courts' analysis of the parties' behaviour.

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.