Apr 23, 2020
The Duty of Commercial Parties to Act in Good Faith: How Far Does it Go?
Since 2014, Canadian contract law has recognized that commercial parties owe one another a duty of “honest contractual performance”, as an element of the principle of good faith. According to the Supreme Court of Canada in its leading decision, Bhasin v. Hrynew, 2014 SCC 71, parties should not lie or knowingly mislead each other about matters related to the performance of the contract.
But how far does this duty extend?
A 2019 decision of the British Columbia Court of Appeal, Greater Vancouver Sewerage and Drainage District v. Wastech Services Ltd., 2019 BCCA 66, tries to answer this question. The Court affirms that the duty of good faith, as applied to contracts, is narrow and limited. It does not create a discrete obligation on one party to have due regard to the other’s contractual interests.
The Wastech decision was appealed to the Supreme Court of Canada in December, 2019. It now remains to be seen just how far the principle of good faith extends.
Of Waste and Contractual Re-Allocation
Wastech involved a complicated commercial agreement in which Wastech agreed to remove and haul solid waste on behalf of Greater Vancouver Sewerage and Drainage District (“Metro”).
Wastech was bound to accept all municipal solid waste provided to it by Metro and transport it to the Cash Creek Landfall, known as a “long-haul” or to the Burnaby Incinerator or Vancouver Landfill, known as a “short-haul”.
In 2011, Metro re-allocated waste between short-haul and long-haul destinations (the “Re-Allocation”).
This had the effect of increasing Wastech’s costs in such a way that it was unable to fulfill its “targeting operating ratio” (the “Ratio”) under the agreement.
As a result of the Re-Allocation, Metro paid Wastech $2.8 million as an adjustment pursuant to the adjustment mechanisms under the agreement.
Wastech then pursued the matter further at arbitration, arguing that it was entitled to an additional $2.8 million.
The arbitrator held, amongst other things, that Metro made a “conscious decision” to redirect the waste.
Relying on a passage from Bhasin, the arbitrator noted that the Re-Allocation, which had significant financial implications beyond those addressed by the agreement’s adjustment mechanisms, failed to show “appropriate regard” for Wastech’s interests under the contract.
Although the arbitrator expressly found that Metro’s conduct had been “both honest and reasonable”, he also noted that Wastech had a “legitimate contractual expectation” that Metro would not exercise its discretion with respect to the Re-Allocation in such a way that would deprive Wastech of the chance to achieve its Ratio.
Thus, Metro breached its duty good faith duty to Wastech. It was required to compensate Wastech in the amount of $2,888,162.
The matter was ultimately appealed to the British Columbia Court of Appeal.
The Court of Appeal held that the arbitrator erred in law on four grounds and upheld a lower Court decision allowing the appeal from the arbitrator’s decision.
No Standalone Civil Wrong of “Disregard of Contractual Interests”
The first significant ruling made by the B.C. Court of Appeal was that the duty of good faith is breached where a party fails to have “appropriate regard” for the other, in circumstances where an agreement has not been found to be “nullified” or “eviscerated”.
The Court noted that in no way did Bhasin intend to suggest that the duty of good faith “would as a matter of law be breached whenever a party exercising a contractual discretion fails to have ‘appropriate regard’ for the other party’s (contractual) interests”.
In the Court’s view, the arbitrator’s ruling misread Bhasin. The arbitrator effectively pushed the concept of good faith beyond its conceptual boundaries.
While the Supreme Court of Canada in Bhasin noted that “a contracting party should have appropriate regard to the legitimate contractual interests of the contracting partner”, this did not create an independent civil wrong of “disregard of contractual interests”. To do so would stifle freedom of contract. Parties can act in their own economic self-interest—the concept of good faith does not discourage or sanction that conduct.
The Court noted that the arbitrator took the passage in Bhasin out of context. In the same paragraph in which the Supreme Court of Canada noted that a contracting party should have “appropriate regard” to the other party’s interests, the Court also held that the organizing principle of good faith “merely requires that a party not seek to undermine those [contractual] interest in bad faith”. According to the Court in Wastech, to hold otherwise would “constitute a radical extension of the law”.
Thus, unless the failure by Metro to show “appropriate regard” for Wastech’s interests had the effect of nullifying or eviscerating the agreement “in the sense that it immediately deprived Wastech of all or substantially all of the benefit for which it bargained”, Metro’s disregard of Wastech’s contractual interests did not amount to a breach of the principle of good faith.
“Bad Faith” Requires a Finding of Bad Faith
The second key error made by the arbitrator was that he found a breach of good faith on Metro’s part, without a parallel finding of improper motive or bad faith. To the contrary, the arbitrator held that the Re-Allocation was “honest and reasonable” from Metro’s perspective.
The Court in Wastech observed that it is not a breach of good faith for a party to exercise its contractual discretion in a way that is at odds with the legitimate contractual expectations of the other party. An additional, subjective element of dishonesty is required.
The Court cited other common law examples of what amounts to “bad faith”. This includes:
- conduct contrary to community standards of honesty, reasonableness or fairness;
- conduct characterized by malice, untruthfulness, ulterior motive or the intentional equivalent of fraud; and
- conduct that is so reckless that the absence of good faith can be deduced and bad faith presumed.
In this case, Metro’s Re-Allocation was not intended to undermine Wastech’s interests in bad faith. From a subjective perspective, Metro acted honestly. The Court in Bhasin did not intend to extend good faith to “attribute dishonesty (which, it will be remembered, carries a ‘stench’) to a party in the circumstances of Metro in this case”.
Where Do We Go From Here?
The Supreme Court of Canada heard an appeal of the B.C. Court of Appeal’s decision in Wastech in December, 2019. It now has to decide how limited in scope the duty of good faith will be. This will engage the concept of how much Courts can interfere with freedom of contract.
Civil liability for a breach of contractual good faith can be viewed along a spectrum.
On the one hand, liability could theoretically be imposed where a contractual party fails to show “appropriate regard” for the other party’s interests. This form of liability is likely too broad. It would result in a finding of bad faith where each contracting party put its own economic self-interest ahead of the other. This is not the type of “wrong” contract law needs or desires to sanction.
On the other hand, liability for bad faith could be restricted only to those situations where there is a subjective element of dishonesty or conduct akin to fraud. This narrows the scope of good faith considerably. Under this scenario, the duty only applies where the plaintiff can show that the defendant intentionally acted in a bad faith manner, possibly with a view to harm.
The key to the Wastech
decision is how the Supreme Court of Canada will define contractual good faith along this spectrum.