In 2020 and 2021, two significant Supreme Court of Canada cases, Callow Inc. v. Zollinger  and Wastech Services Ltd. v Greater Vancouver Sewerage and Drainage District, clarified and confirmed the duty of good faith and honest contract performance. These cases have since been followed several times in Alberta and Canada to confirm, clarify, or extend the duty of good faith and honest performance. Understanding the evolution of the law following Callow  and Wastech is essential for all individuals and entities with contractual duties and rights. This article aims to provide an update on how appellate courts have applied the concepts of good faith and honest contractual performance, following Callow  and Wastech.

Extending the Duty of Honesty in Contractual Performance: C.M. Callow Inc. v. Zollinger, 2020 SCC 45

In Callow, the SCC extended the general duty of honesty in contractual performance to the exercise of discretionary decisions, even where the decision-maker has an absolute right by contract. 

Callow ran a property maintenance business. In 2010, his company concluded a contract with some condo corporations. The company made a new contract with the condo corporations in 2012, which was supposed to last for two more winters. If the condo corporations weren't happy, the contract said they could end it for any reason upon ten days' notice. In 2012, Callow attended a meeting to discuss some residents' issues about his services. The meeting went well, and he thought the problems were resolved. Callow's discussions with the condo corporations led him to believe that his contract would be renewed for the winter season. He continued to work throughout his summer contract, completing extra work free of charge to solidify the renewal of his winter contract. In September, the condo corporations terminated his contract, and Callow sued.

The majority of judges at the SCC said the condo corporations breached the contract. The condo corporations had a duty to act honestly toward Callow, but they they were dishonest in how they dealt with putting an end to the contract. They actively misled Callow to believe they were happy with his work and that the contract would not be ended early. 

The duty of honest performance does not mean one side has to sacrifice their interests for the other. It did not mean the condo corporations had to tell Callow that they were going to end the contract early, but they could not pretend the contract would be renewed once they knew it would be terminated.

The requirements of honesty in performance can go further than prohibiting outright lies. Whether or not a party has knowingly misled its counterparty is a fact-specific determination and can include lies, half-truths, omissions, and even silence, depending on the circumstances. One can mislead through action, by saying something directly to its counterparty, or through inaction, by failing to correct a misapprehension caused by one's misleading conduct.

The duty of honest performance attracts damages according to the ordinary contractual measure. Damages should put the injured party in the position it would have expected to be in had the duty been performed. Although reliance damages (the ordinary measure of damages in tort) and expectation damages will be the same in most cases, they are conceptually distinct. There is no basis for a breach of the duty of honest performance to be compensated through reliance damages.

Duty of Good Faith Contractual Discretion: Wastech Services Ltd. v. Greater Vancouver Sewerage and Drainage District, 2021 SCC 7

Wastech was a company that moved and disposed of waste. The Greater Vancouver Sewerage and Drainage District (Metro) was responsible for administrating waste disposal in the district. Wastech and Metro had a long-term contract that said that Metro could choose to send waste to any of three different disposal sites. Wastech would be paid a different rate depending on which site they chose. The rates were higher for sites that were farther away. The contract aimed to pay Wastech a "target operating ratio" of .89, meaning costs were 89% of revenue, and it did not guarantee a specific operating ratio in any given year. The contract also gave Metro discretion to send the waste to the site of its choice.

In 2011, Metro decided to send more waste to a closer location which meant that Wastech did not reach the target operating ratio. As a result, Wastech said Metro violated the contract.

In Wastech, the SCC said that good faith does not allow a contracting party to unreasonably use its discretion. The duty to exercise contractual discretion is only breached when the discretion is exercised in a manner unconnected to the purposes underlying the discretion. Where discretion is exercised in accordance with the purpose, that exercise may be considered reasonable according to the bargain the parties had chosen to put in place. But where the exercise stands outside the compass set by contractual purpose, the exercise is unreasonable in light of the agreement for which the parties bargained and may be thought of as unfair and contrary to the requirements of good faith.

What a Court considers unreasonable is highly context-specific and ultimately depends upon the parties' intention as disclosed by their contract:

  • For contracts that grant discretionary power, the matter to be decided is readily susceptible of objective measurement, the range of reasonable outcomes will be relatively smaller. 
  • For contracts that grant discretionary power in which the matter to be decided or approved is not readily susceptible to objective measurement, the range of reasonable outcomes will be relatively larger. 

In properly interpreting the contract for the purposes for which discretion was granted, the range of good faith behaviour comes into focus and breaches can be identified. Requiring substantial nullification — that is, the evisceration by one party of the better part of the benefit of the contract of the other — is not the appropriate standard for concluding a breach of the duty to exercise discretionary power in good faith.

The Supreme Court considers the use of discretion unreasonable when used in a way that is unconnected to the purpose for which the parties agreed to in the first place. In this case, the contract showed that the parties agreed to give Metro discretion. Wastech's case did not rely on allegations that Metro lied or exercised its discretion suddenly or arbitrarily. It also does not point to any identifiable wrong committed by Metro beyond seeking its own best interest within the bounds set for the exercise of discretion by the contract. The contract gave Metro discretion to determine how the waste was to be allocated. The purpose of the agreement was to allow Metro the flexibility necessary to maximize efficiency and minimize operating costs, it did not require Metro to ensure Wastech reached its target operating ratio in any given year. For this reason, the Court found that Metro exercised its discretion for the right purposes and did not violate the duty to act in good faith.

The Employment Law Context: Haack v. Secure Energy (Drilling Services) Inc., 2021 ABQB 82

In Haack, the Alberta Court of Queen's Bench confirmed that the duty of good faith and honest performance focuses on honesty and whether a contracting party has engaged in dishonest, deceptive or misleading behaviour. Haack's employment from Secure Energy (Secure) was terminated with cause, and his shares in the company were immediately bought for $1. He sued for wrongful dismissal, breach of the unanimous shareholder agreement (USA), and oppression. The Court found that Secure made false and misleading statements about his performance and then suggested they had precise knowledge and accurate information about deficiencies in Haack's performance without substantiating their claims against him. Secure used these statements to justify the termination and share buy-out. The Court further found that those misleading statements were made relating to the performance of their contractual obligations. Secure did not investigate the accuracy of the statements and acted carelessly, so the Court held that they did have the requisite knowledge that the statements were false and misleading. As a result, the Court found that Secure breached its duty of good faith and honest performance.

This case confirms that damages for breach of the duty of good faith and honest performance are often expectation damages (damages that would put the plaintiff back in the position they would have been in had the contract been performed). In this case, Haack did not identify any grounds for recovery, such as mental distress, and the test for punitive damages was not met.

Duty of Honest Performance + Good Faith Cannot Be Contracted Out Of: Canlanka Ventures Ltd. v Capital Direct Lending Corp.,  2021 ABCA 115; Berscheid v Government of Manitoba, 2022 MBCA 12

In Canlanka,  the parties entered into an agreement for mortgage services. The respondent (Canlanka) purchased two mortgages from the appellant broker (Capital), and Capital was hired to administer the mortgages. The contract contained the following clause:

"The Administrator [the appellant] agrees to act in good faith and to the best of its ability in the best interest of the Mortgage Holder [the respondent]."

The contract limited that clause by following it with:

"Due to the nature of the mortgage business and the surrounding environment of notices and information from a variety of sources, the Administrator [the appellant] will strive to attend to all aspects of the Mortgage Holder's [the respondent's] mortgage interests, but cannot therefore be held liable for any oversight, errors or omissions related to the mortgage interests included under this agreement [the "exclusion clause"]."

The Court found that Capital made two deliberate misrepresentations to Canlanka:

  1. Capital told Canlanka that one of its mortgages was in foreclosure. Yet, when Capital determined that the foreclosure was for a third-party property and not Canlanka's, it did nothing to correct the statement.
  2. Capital told Canlanka that another party intended to buy out a second mortgage, which was also incorrect. As a result, Canlanka could not make an informed decision about whether to foreclose on the mortgage or buy out another.

The Court held that the duty of good faith and honest performance in contractual performance does not require an express contractual provision - the duty is implied in every contract and cannot be contracted out of. Further, the Court held that the exclusion clause only excluded liability for negligence and that these misrepresentations went beyond that: they were intentional, active, and not innocent. The lack of evidence of personal gain by the defendant was irrelevant.

Canlanka  confirmed that the duty of good faith and honest performance exists separate and apart from any express contractual terms such as an exclusion clause and cannot be contracted out of.

The effect of exclusion clauses on the duty of good faith and honest performance was also canvassed by the Manitoba Court of Appeal in Berscheid. In this case, the trial judge found that an exclusion clause in the contract shielded the defendant from liability for breach of the duty of good faith and honest performance. The Court cited Callow in concluding this was an error of law:

"... I emphasize once again that it is unquestionable that the duty is imposed as a matter of contractual doctrine rather than by implication or interpretation, and, by virtue of its status as contractual doctrine, parties are "not free to exclude" the duty altogether."

Motives Are Important: Petrofrontier Corp. v Macquarie Capital Markets Canada Ltd., 2021 ABQB 54

Although personal gain is not necessary to find that the duty of good faith and honest performance was breached, the motive behind the breach is relevant. This was confirmed in Petrofrontier, a decision that looks at whether certain questions asked during a Questioning should be answered. The Court held that evidence as to the motive of the party alleged to be in breach could assist in proving whether or not a defendant deliberately created a state of affairs to justify the termination of a contract.

No Requirement to Subordinate Self-Interest: CWB Maximum Financial Inc. v. 2026998 Alberta Ltd., 2021 ABQB 137; Fram  Elgin Mills 90 Inc. v. Romandale Farms Limited,  2021 ONCA 201

In CWB,  the Court applied the duty of honest performance and good faith in the insolvency context. In CWB, the defendants owned a pharmacy and continued to operate it under a court-appointed interim receiver. The principal of the corporate defendant was actively trying to sell the pharmacy. The pharmacy alleged that the plaintiffs (CWB) had, through misrepresentation or omission, breached their duty of good faith. The pharmacy alleged that:

  1. CWB lulled them into a false sense of security and prevented them from taking steps that could have avoided the need for a receivership application. 
  2. CWB advised them that the first set of demands was just a formality not to be acted on, which was false. 
  3. A forbearance agreement was "sprung on them," and they had no opportunity to negotiate its terms.

Although it was ultimately found that there was no breach of the duty of good faith, the Court noted that the relationship between lender and debtor is contractual, and the duty applies. 

The conduct of the party alleged to have breached the duty of good faith should be assessed in light of the intent and policy objectives of the Bankruptcy and Insolvency Act. The remedy of receivership sought from the Court is a contractual component, and its initiation is subject to the lender's discretion, although the legal test is statutory. Therefore, the parties must act according to the duty of good faith and honest performance. Interested parties should not bring or conduct proceedings for an oblique motive or improper purpose.

In CWB, the duty of good faith required the parties not to lie to or mislead the other concerning the status of the loan or the state of the lender-borrower relationship. It did not impose a duty of loyalty or disclosure, or require the subordination of one's interests to the other. The fact that the duty does not require parties to subordinate or forgo their interests was confirmed by the Ontario Court of Appeal in Fram. In Fram, the Court stated that "courts should be very reluctant to interfere in the dealings of hard-headed business people pursuing their competitive goals. This pursuit is not forbidden in a market economy: it is expected".

Takeaways

Case law following Callow  and Wastech shows good faith and honest performance are now both broad and unescapable legal duties, across every contractual context. In the past  year, the case law has continued to develop these doctrines as powerful litigation tools, in many circumstances where strict contractual rights have been alleged to have been exercised capriciously or with morally questionable motives.  In coming years, we can expect the doctrine to become further entrenched.

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.