After the Supreme Court of Canada's decision in Bhasin v Hrynew, 2014 SCC 71, the concept of good faith has played a critical role in shaping contractual obligations. In recent years, a number of decisions have further illustrated the scope of good faith and the key takeaways that parties should take into account when entering agreements. One of the key issues that practitioners have noted with the evolving line of cases on the matter is that what is and is not permissible according to the existing judgments is often defined in binary terms. The questions we most commonly receive are versions of "where do you think the line is when things are grey?" Realistically, this is not something anyone can answer definitively until courts make rulings on it, but rather than just summarize the commonly cited cases, we wanted to explore where we think the limits of the rulings may lie based on the language used in them. Our summaries here provide not just an overview of the cases and decisions, but use our best judgment to assess where we think courts may go next and what that means for commercial relationships.
C.M. Callow v. Zollinger, 2020 SCC 45
The appellant, C.M. Callow Inc. (Callow), a corporation providing winter services, entered into a maintenance contract with a group of condominium corporations. The contract contained a clause allowing the condominium corporations to terminate the contract on 10 days' notice if Callow's services were no longer required. The respondent, Zollinger, later became the property manager of one of the condominium corporations and advised the condominium corporations to terminate the contract. The condominium corporations decided it would do so at the end of the season, but did not inform Callow immediately and instead led him to believe that the contract would be renewed. Before the contract was terminated, Callow performed work above and beyond the scope of the contract in hopes of incentivizing the condominium corporations to renew the contract. The evidence showed that the condominium corporations were aware of the Callow's motive as well as his belief that the contract would be renewed.
When the condominium corporations finally terminated the contract, Callow sued for breach of contract, alleging that the corporations had acted in bad faith by accepting free services while knowing Callow was offering them in order to maintain their future contractual relationship. Callow further alleged that the corporations knew or ought to have known that he was relying on the representations that he was providing satisfactory service. The Supreme Court of Canada upheld the Court of Appeal's decision, finding that the corporations breached the duty of honest performance by acting dishonestly and failing to disclose their intention to terminate the contract.
Takeaway: Parties must not mislead or deceive each other in relation to contractual matters.
This case is significant in clarifying the duty of honest performance and its relationship to the principle of good faith. The Supreme Court of Canada held that the duty of honest performance requires parties to act honestly and not mislead or deceive the other party in relation to contractual matters. While the duty to act honesty does not impose a duty of loyalty or of disclosure, condominium corporations and Zollinger had to refrain from false representations. Parties cannot rely on the strict terms of a contract to justify dishonest conduct - the duty of honest performance imposes an obligation to act honestly and in good faith when performing contractual obligations, even if the terms of the contract allow for termination or other actions.
What it leaves open, however, is how much a party is permitted to not say or to be non-committal. But for the encouragement of Zollinger and the corporations to Callow to have him continue performing extra tasks, the courts may not have found a breach of good faith. This suggests that silence is distinguished from active encouragement. Moreover, if Zollinger or the corporations had not reached a final decision but were merely leaning toward termination, especially if the communication demonstrated that nothing had been decided on the renewal aspect, perhaps the court would have ruled differently.
Wastech Services Ltd. v. Greater Vancouver Sewerage and Drainage District, 2021 SCC 7
The appellant, Wastech Services Ltd (Wastech), a waste removal contractor, and respondent statutory corporation, Greater Vancouver Sewerage and Drainage District (Metro), entered into a contract for waste disposal services. There were three disposal facilities, with one being relatively further than the other two. Wastech was to be paid at a reduced rate, subject to a number of variables, for the transportation of waste to closer facilities.
The compensation structure for Wastech was based on a "Target Operating Ratio" (Target OR), which reflects a scenario where Wastech's operating profit was 11%, but the contract did not guarantee that Wastech would achieve the Target OR in any given year. If the Target OR deviated from the actual operating ratio (Actual OR), the parties would share the financial consequences of the deviation equally. If the Actual OR exceeded the Target OR, Metro would pay Wastech an additional amount equal to 50% of the difference between the two operating ratios. On the other hand, if the Actual OR was less than the Target OR, Wastech would do the same for Metro.
In 2010, Metro reallocated the waste transportation for Wastech, leading to lessened profit for Wastech. Wastech then claimed Metro had breached the contract by allocating waste among the facilities in a manner that deprived Wastech of the possibility of achieving certain metrics, thus resulting in lower profits.
Takeaway: Parties may pursue their own interests as long as they exercise reasonable contractual discretion.
The case reinforces that the duty of good faith requires reasonable exercise of contractual discretion, in a manner connected to the purposes underlying the discretion. As long as this is met, parties have the freedom to pursue their own interests - they are not required to subordinate their interest to those of other parties. Where it does not do so, the exercise of discretion may be considered arbitrary or capricious, and may amount to a breach of the duty of good faith. In this case, while Wastech may condemn the self-interested conduct of Metro that made it impossible to achieve the fundamental benefit for which it had bargained, Metro is not considered to have committed any actionable wrong in exercising the discretion provided for under the contract.
Another key consideration in the decision is that the contract here was characterized as long-term and relational, dependent upon an element of trust and confidence between the parties, thus requiring Metro to have "appropriate regard for the legitimate contractual interests of Wastech when exercising its discretionary contractual power." Further, because of their trust in each other, the parties may have found the situation giving rise to this dispute unlikely to occur. However, it was still a risk that the parties had specifically considered in their agreement, so whatever trust and cooperation the parties might owe each other from their relationship cannot resolve this case in favour of Wastech by requiring Metro to act as a fiduciary. The court supplements this by stating that this is not an example of an unforeseen or unregulated matter that was left to the trust and cooperation between the parties. Here, the parties foresaw this risk and chose to allow for discretion. If, for example, Metro was using its discretion in waste allocation to gain leverage over Wastech with respect to another dispute or if the contract had not provided for Metro's discretionary allocation, the judge may be more likely to find that there had been a breach of the duty of good faith.
2161907 Alberta Ltd. v. 11180673 Canada Inc., 2021 ONCA 590
2161907 Alberta Ltd. (216) held the rights to the "Tokyo Smoke" cannabis brand in Ontario, which it licensed to various retail operators. 11180673 Canada Inc. (111) entered into a commercial lease agreement with 216 that included 216 offering funding for start-up costs, rent and a "branding fee." Two days before the store was supposed to open, there was a dispute regarding 216's obligation to pay the rent for the month of the opening, and 111 advised 216 that it would not be opening the store as planned. 216 claimed this was a threat to cease carrying on business and thus breached the agreement. 111 alleged that 216 acted in bad faith by terminating the agreement after misleading it about the funds available to it and by leading it to believe that the "branding fee" would be paid and the rent deferred.
The trial judge found that while 216 did not lie to 111, it "pounced on" a single statement made by the 111 as a basis to trigger default, and thereby achieved its goal of ending the relationship with 111 and attempted to discharge its obligation to pay the "branding fee." However, the Ontario Court of Appeal found that 216 did not knowingly mislead 111 - it simply changed positions in light of new information, after it perceived that there was a threat to cease to carry on business. The act of triggering the default was not unreasonable, malicious, or so inconsiderate of 111's legitimate contractual interests as to constitute bad faith. Further, the court concluded that there was no basis to suggest that the termination was an excuse to avoid paying the "branding fee." 216 had a legitimate interest in protecting its brand in circumstances that the parties expressly stipulated would give rise to a right of termination, even if 216 erroneously believed those circumstances were present. While the court ruled in favour of 111 on the grounds that they did not threaten to cease to carry on business in a way that would entitle 216 to terminate the agreement, the trial judge's finding of bad faith was set aside.
Takeaway: Parties are not required to act against their own commercial self-interest.
This case highlights that while the duty of good faith requires parties to act honestly and in a commercially reasonable manner, it does not impose an obligation on a party to act against its own self-interest. By considering the circumstances of each case, courts may find that parties are permitted to take actions in their own interest, such as terminating agreements, provided that their intentions support a legitimate concern and were not malicious. For example, in this case, the licensor, 216, had a legitimate interest in terminating contracts that posed a risk to its upstream licence if it became known that its licensees were troublesome. Had the licensor merely wished to punish the licensee, however, or "make an example of" the licensee, the court may have taken a dimmer view.
Canlanka Ventures Ltd. v. Capital Direct Lending Corp., 2021 ABCA 115
The respondent/cross-appellant, Canlanka Ventures Ltd (Canlanka) bought several second mortgages from the appellant/cross-respondent, Capital Direct Lending Corp. (Capital Direct). The trial judge found that Capital Direct made two intentional misrepresentations with respect to one particular mortgage, the Bastien mortgage, after Canlanka stopped receiving payments from this mortgage. Capital Direct told Canlanka that the Bastien mortgage had been placed into foreclosure and that another party intended to buy out the mortgage when neither were the case.
Canlanka alleged that this precluded it from making informed decisions and that Capital Direct breached the duty of good faith. The trial judge found that Capital Direct deliberately made misrepresentations and did nothing to protect Canlanka's interest, thus breaching the duty of good faith. The Alberta Court of Appeal upheld the decision, stating that this was not simply a failure to advise of general or third-party information, but active misrepresentation that deprived Canlanka of the right to make its own decisions in relation to taking action to protect its investment.
Takeaway: Parties must not intentionally mislead each other.
This case demonstrates that parties are considered to have breached the duty of good faith when they make misrepresentations that are active, intentional, and go well beyond innocent non-disclosure. This is particularly the case when the other party has no reason to infer other meanings from the representations that are made and when the party making the representation does nothing to clear up the misleading statements. The court makes it clear that parties cannot rely on ambiguous wording, such as the aforementioned "mortgage," in their communications to argue that the other "should have known" certain information, when they have been deliberately leading the other party to believe otherwise.
Bhatnagar v. Cresco Labs Inc., 2023 ONCA 401
One of the appellants, Bhatnagar, founded a corporation, 180 Smoke, with the other appellants in 2013. Through a share purchase agreement (the SPA), the appellants sold the corporation to another corporation, CannaRoyalty Corp. (operating as Origin House). The SPA provided the appellants an opportunity to earn amounts in addition to the price paid on closing if 180 Smoke met certain milestones during the "earn-out period." Before the SPA was executed, 180 Smoke became aware of a potential acquisition of Origin House and negotiated with Origin House that, if there were a change of control of Origin House during the earn-out period, 180 Smoke would be paid an "Unearned Milestone Payment Commitment" totalling the amount of all future entitlements to unearned milestone payments.
Origin House entered into an agreement to be purchased by Cresco Labs (Cresco), the respondent, in 2019 (during the earn-out period) but there was a delay in the closing. When asked what would happen to the milestone payments if the transaction did not close, Origin House did not agree to make the payment automatically but said there was "no reason to believe [the Cresco Transaction] will not close." When the transaction closed later than expected in 2020, 180 Smoke was paid the Unearned Milestone Payment Commitment, but not as much as they would have received if the transaction had closed earlier in 2019. 180 Smoke did not meet the revenue targets in 2019 and was thus unable to claim the milestone payments. They consequently brought an application seeking, among other things, an order directing Cresco to pay the 2019 milestone payment, arguing that they were entitled to it pursuant to the SPA or that any failure to meet the targets was a result of breaches of contract by Origin House and breaches of the duty of good faith in contractual dealings.
Among the alleged breaches of good faith by Origin House, the application judge rejected 180 Smoke's claims that Origin House had hindered 180 Smoke's efforts to implement its expansion plan and achieve their revenue targets in 2019 in a manner that constituted a breach of the duty of good faith. However, the judge found that Origin House had breached its duty of honest performance of the SPA "by having advised the [Appellants] repeatedly until October 2019 that the [Cresco Transaction] would close in 2019 and not correcting or updating that advice when Origin House was informed by Cresco that the closing date would be pushed out to January of 2020."
The application judge's finding of the breach of the duty of honest performance stemmed from two elements: 1) the active and repetitive representation that the transaction would close in 2019 and 2) the failure to update the closing date. However, on appeal, the judge found that 180 Smoke was aware that the Cresco transaction could close in 2020, later than expected. Thus, the application's judge finding was set aside - Origin House did not breach its duty of honest performance.
Takeaway: Parties cannot take advantage of each other by claiming the other was dishonest by means of non-disclosure of information of which they were already aware.
It can be concluded that a party must not actively nor passively mislead the other with respect to critical information, or else this will likely constitute a breach of good faith. But if it is proved that a party was aware of this information, they cannot later claim that they did not know or that they were deceived by the other party as a basis for alleging a breach of good faith.
Conclusion
Since Bhasin, the principle of good faith has been a guiding element in all contractual relationships. The above cases demonstrate that parties have various implied obligations of honesty and reasonableness in exercising contractual discretion, even when balancing their own commercial interests.
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