The Supreme Court of Canada (SCC) established a duty of good faith in contractual performance in its precedent-setting 2014 decision of Bhasin v. Hrynew. In this decision, the court recognized an organizing principle of good faith which contractual parties must observe in order to perform their contractual duties honestly and reasonably and not capriciously.

Since then, the law has continued to develop as the duty is applied in the lower courts. The SCC has recently decided two cases involving the measure of the duty of good faith in contractual dealings. The two decisions are C.M Callow Inc. v. Zollinger and Wastech Services Ltd. V. The Greater Vancouver Sewerage and Drainage District (Metro).

Callow v. Zollinger

We previously discussed this case in an earlier post entitled “The Contractual Duties of Good Faith & Honest Performance”. To summarize, a consortium of condominium corporations knowingly led a contractor to believe a services contract would be renewed, in order to ensure performance under the existing contract. In its decision, the SCC found that the consortium had breached its duty of honesty to the contractor by failing to address performance concerns when they became a problem, and by implying the contract would be renewed when the consortium knew it wouldn’t be.

When Does the Use of Discretionary Power Breach the Duty of Good Faith?

In the second case mentioned above, Wastech was a waste disposal provider. It operated three locations for garbage disposal. Wastech benefited from a long-term contract with Metro for waste removal. Metro was the publicly funded agency responsible for waste and sewage disposal in greater Vancouver. The contract included a term mandating that Wastech would operate at a margin of 11%. It was not a guarantee in any given year but simply a target to guide the parties. Wastech wanted to operate profitably, and Metro wanted to control costs.

Metro had the contractual right to decide to which of the Wastech sites the waste would be sent to. The rate of compensation was different for each of the three sites. The closer they were, the lower the rate.

In 2011, Metro decided to use the closest site more often. This meant a lower pay rate for Wastech such that it could not operate at an 11% margin. Wastech’s position was that Metro had exercised its contractual discretionary right in bad faith and therefore had breached their contract. This had been done by Metro choosing the closer location too often and thereby ignoring the target operating margin clause.

Arbitrator Finds Metro Breached Duty of Good Faith; Lower Courts Disagree

The contract called for arbitration of such disputes. There the arbitrator decided that the parties had specifically intended to not add a clause to prevent Metro from making choices that would prohibit Wastech from operating at 11%. The arbitrator also found that Metro had the right to exercise its discretion even where it had a negative financial impact on Wastech. However, the arbitrator further determined that there was an obligation of good faith when exercising this discretionary power. Metro had breached this obligation by exercising its discretion so severely that Wastech could not possibly operate at an 11% margin. Wastech was to be compensated as a result.

The matter made it to the courts in British Columbia. Metro was successful in appealing the arbitrator’s decision both at the trial level and at the Court of Appeal. The motions judge felt the arbitrator’s decision contradicted the terms chosen by the parties in their contract and the Court of Appeal felt the duty to act in good faith had been overextended by the arbitrator.

SCC: Contractual Discretionary Power Must be Exercised in Good Faith, but Metro Had Not Breached its Obligation

The results in the lower courts were upheld and Wastech’s appeal was dismissed.

The SCC agreed that there is a duty of good faith when exercising a contractual discretionary power. It cannot be used unreasonably. The Court said that the use of discretion is unreasonable when such use is in no way connected to the purposes for which the parties agreed that there should be a discretionary power. In the case at hand, the purpose of the discretionary power was to allow Metro to operate efficiently, which included controlling expenses. That is exactly what Metro did in exercising its discretion, so it was a reasonable use and within its duty of good faith.

At Milosevic & Associates, our team of Toronto corporate commercial lawyers regularly represent clients in complex commercial litigation matters including contract disputes like the one described above. Over the years, our team of exceptional litigators has seen it all and has successfully fought for our clients’ rights. Our impressive track record speaks for itself.  Call us at 416-916-1387 or contact us online to schedule a consultation.