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All commercial contracts in Canada are subject to a duty of good faith.
This includes an obligation to perform contractual obligations honestly and to exercise any discretion under the agreement in a reasonable manner, consistent with the purposes for which the discretion was granted.1
The principle of good faith, however, does not apply to non-contractual arrangements.
Nor does it permit Courts to impair the parties' freedom of contract by imposing a form of "judicial moralism", effectively re-writing the terms of the agreement.
A recent decision of the Ontario Superior Court, Dr. Michael Emon Dentistry Professional Corp. v. Alexander Sevo Dentistry Professional Corporation2 ("Emon"), illustrates that even if the duty of good faith applies to non-contractual arrangements, such as commercial letters of intent, Courts will not interfere with the broad discretion inherent in such business arrangements.
An Intention to Sell
The Emon decision involved a letter of intent involving the sale of an endodontics practice (the "LOI").
The LOI provided that it was "not contractual in nature or binding", except as otherwise provided. It included non-binding provisions, binding non-surviving provisions, and binding provisions that endured beyond the LOI's termination.
The LOI also included a number of conditions to be incorporated in the ultimate agreement of purchase and sale, including that there would be no material change in the contract, that the purchaser would enter into a lease agreement with the landlord where the endodontics practice was located, and that the purchaser, in his "sole and absolute discretion", would be satisfied with his due diligence investigations.
The purchaser also had the right under the LOI to terminate it by written notice if he was not "satisfied with [his] due diligence investigation for any reason".
Ultimately, after discussing the potential sale transaction for more than a year, retaining a consultant to conduct due diligence, and after failing to negotiate a new lease with the Landlord, the purchaser terminated the LOI.
The purchaser advised the seller that he was terminating the purchase transaction due to a number of alleged "red flags".
The seller commenced an action for breach of contract, alleging a number of violations of the duty of good faith by the purchaser.
The Court dismissed the action in its entirety.
In doing so, the Court effectively held that the purchaser had broad discretion under the contract and was well within his rights to terminate the LOI.
None of the purchaser's conduct amounted to a violation of the duty to act honestly under the LOI, nor did he exercise his discretion in an unreasonable manner.
A number of important lessons about good faith emerge from the Court's reasoning:
1. The LOI Appears to Have been Subject to a Duty of Good Faith
The LOI in Emon was clear that it was simply an agreement to agree.
The language of the LOI provided that it was "not contractual in nature or binding" and reflected only an "intention to proceed toward the negotiation of the Purchase Agreement".
Despite this, the Court in Emon conducted its analysis of the parties' conduct as though the duty of good faith applied to the LOI.
As stated above, good faith is a contractual doctrine, meaning it applies where the parties have a binding agreement.
In the absence of such agreement, or where the contract itself does not expressly require the parties to negotiate, for example, good faith principles have no application to non-contractual negotiations.
It is arguable the LOI fell into this latter category. This is especially so where the Court concluded that the LOI did not bind the purchaser "to completing the transaction unless the conditions precedent were met".
It may be that because the LOI included surviving provisions, the Court treated it as a binding contract to which a good faith analysis could apply.
2. Failure to Enter into Third Party Agreements Not a Breach of Good Faith
Assuming good faith applied, the seller argued that the purchaser's refusal to enter into a binding lease with the landlord for the endodontics practice was "inconsistent with the parties' expectations and a deliberate effort [by the purchaser] to delay and avoid his contractual obligations under the LOI".
The Court rejected this position. The LOI granted the purchaser the express right to enter into a lease on terms that was satisfactory to the purchaser. The purchaser had no duty to adopt the former lease entered into by the previous tenants.
Moreover, contrary to the seller's position, the Court held that the purchaser's retainer of a "leasing consultant" illustrated that the purchaser was acting in good faith and was pursuing leasing arrangements in earnest. The purchaser worked "diligently" with the leasing consultant to achieve a finalized lease.
There was "nothing unreasonable in [the purchaser's] attempts to negotiate and finalize a lease agreement".
3. No Breach of Good Faith in Expecting a "Turnkey" Practice
The Court further rejected the seller's argument that the purchaser acted in bad faith in the way he exercised his due diligence investigation of the endodontics practice.
In conducting his investigation, the purchaser learned that a key employee had resigned from the practice. In the Court's view, this constituted a "material disruption and adverse change in the Practice".
Where the LOI expressly contemplated that the purchaser would be acquiring a "turnkey" practice, the purchaser did not act in bad faith in exercising his discretion to terminate the LOI.
The purchaser had a legitimate expectation that the practice would continue after its acquisition: the resignation and retirement of key employees threatened that expectation to the core.
4. No Creation of Expectation that Transaction Would Close
The Court did not grant any legitimacy to the seller's position that the purchaser lied or acted dishonestly by creating the false impression that he would ultimately acquire the practice.
The LOI granted the purchaser the right to terminate if he was not "satisfied with [his] due diligence investigation for any reason".
Moreover, it was clear that once the purchaser learned of the resignation of a key employee in the practice, he had the requisite intention to exercise his discretion to terminate the LOI.
According to the Court, there was no evidence to suggest that termination was effected dishonestly by the purchaser.
Good Faith Cannot Re-Write the Parties' Bargain
Putting the issue of whether good faith could apply to the LOI at law, Emon establishes an important principle about the duty of good faith as applied to contractual relations: Courts will not employ the doctrine to rewrite the parties' bargain and impose a form of judicial moralism on the parties' conduct or agreement.
To the contrary, parties enjoy significant latitude in the way they devise their contractual terms, including any discretion exercised under the agreement.
Canadian Courts will not interfere with these contractual arrangements, unless the parties' conduct goes so far afield basic obligations of honesty and reasonableness.
Absent this high bar, the parties' contract remains binding, and enforcement should be interpreted in accordance with ordinary commercial realities.
Footnotes
1 Bhasin v. Hrynew, 2014 SCC 71; C.M. Callow v. Zollinger, 2020 SCC 45; Wastech Services Ltd. v. Greater Vancouver Sewerage and Drainage District, 2021 SCC 7.
2 Dr. Michael Emon Dentistry Professional Corp. v. Alexander Sevo Dentistry Professional Corp., 2025 ONSC 4961.
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.
