The Supreme Court of Canada recognises a new duty of honesty in contractual performance
April 2015 | SPECIAL REPORT: MANAGING RISK
Financier Worldwide Magazine
Canada’s highest court has considered, for the first time, whether the law imposes a duty of good faith in contractual performance.
In its recent landmark decision, Bhasin v Hrynew, the Supreme Court of Canada (the Court) unanimously held that good faith contractual performance is a “general organising principle” of Canadian law. Flowing from this general organising principle is the duty of contracting parties to act honestly and reasonably in the performance of their contractual obligations.
The recognition of this new duty – and the wave of litigation likely to flow from it – raise significant risk management implications for companies carrying on business in Canada.
Harish Bhasin sold investment products for Can-Am. Their relationship was governed by a commercial dealership agreement that would automatically renew at the end of each three-year term unless one of the parties gave six months’ written notice to the contrary.
Bhasin’s key competitor was Larry Hrynew, another Can-Am dealer with whom Bhasin had a long history of animosity. Hrynew repeatedly pressured Can-Am to force a merger of his business with Bhasin’s business, which Bhasin strongly opposed. Can-Am eventually designed a restructuring plan that would force the merger. Can-Am also appointed Hrynew as an auditor, which gave Hrynew access to Bhasin’s confidential business information.
Can-Am misled Bhasin about how and why Hrynew was selected as an auditor. Can-Am also assured Bhasin that Hrynew was bound by a duty of confidentiality in his new role, when in fact Hrynew was not subject to any such duty. When Bhasin asked Can-Am about the likelihood of merging his business with Hrynew’s business, Can-Am equivocated – however, the merger was actually a done deal as far as Can-Am was concerned. In the meantime, Bhasin’s contract with Can-Am had come up for renewal.
When Bhasin refused to allow Hrynew to audit his records, Can-Am gave Bhasin notice that it would not renew their dealership agreement. Bhasin commenced this litigation in response.
The Court found that Can-Am’s dishonesty was directly and intimately connected with Can-Am’s performance of the dealership agreement and its decision not to renew Bhasin’s contract. Accordingly, Can-Am breached a newly recognised duty of honest contractual performance when it failed to act honestly with Bhasin in its exercise of the non-renewal clause. The Supreme Court awarded Bhasin the value of his business at the time of non-renewal.
The Court observed that the current state of the law of good faith in Canada is uncertain, lacks coherence and is out of step with the expectations of contracting parties.
The general concept of good faith is nothing new to Canadian law, as Canadian courts have previously recognised duties of good faith in a variety of contractual and statutory contexts. However, Canadian courts have long been reluctant to impose a standalone duty of good faith for fear that it would disrupt commercial certainty, undermine freedom of contract and invite courts to interfere with the express terms of a contract. As a result, courts have previously applied the concept of good faith in a piecemeal fashion, without any degree of consistency.
To bring Canadian law in line with American, British and Australian authorities, and to remedy the perceived lack of consistency, the Court took what it called two “incremental steps”. First, it acknowledged that good faith contractual performance is a general organising principle of Canadian contract law. Second, as a further manifestation of this organising principle of good faith, the Court concluded that there is a duty to act honestly in the performance of contractual obligations.
The duty of honest performance means that a party may not lie, actively mislead or deceive the other contracting party about matters directly linked to the performance of the contract. The genesis of this duty is commercial parties’ reasonable expectations of honesty and good faith in their contractual dealings. While parties doing business together remain at arm’s length, may pursue their individual self-interest and are not subject to the duties of a fiduciary, the Court observed that a basic level of honest conduct is necessary to the proper functioning of commerce.
By contrast to the duty of honest performance, the organising principle of good faith is not a free-standing rule, the breach of which is enforceable in and of itself. Instead, it forms a standard that manifests through existing doctrines that require honest, candid, forthright or reasonable contractual performance.
In short, the organising principle of good faith exemplifies the notion that contracting parties must have “appropriate regard for the legitimate contractual interests” of their counterparties. What exactly constitutes “appropriate regard” for another’s interests will vary from case to case, but as a general rule, parties may not seek to undermine another party’s interests in bad faith.
Neither the general organising principle of good faith performance nor the duty of honest performance go so far as to engage duties of loyalty to the other contracting party, or create a duty to put the interests of the other contracting party first. Causing loss to another party in the pursuit of business objectives is not necessarily contrary to good faith. There is also no duty of disclosure, even in the context of providing advance notice of a decision to terminate a contract.
Businesses are encouraged to be on their best behaviour while lower courts interpret the Court’s findings in subsequent decisions.
Implications for risk management
While the Court attempted to clarify the state of the law of good faith contractual performance in Canada, what remains less clear is the scope of the new liability that has been created for parties to Canadian commercial contracts.
Parties must now, more than ever, ensure that they are always acting with honesty, candour and transparency. In most cases, parties already operate in good faith and conduct themselves in an honest manner. However, the Bhasin decision underscores the importance of careful communication between contracting parties during all stages of the lifecycle of the contract, from negotiation to execution to termination. Parties must be cautious and ensure that they are always communicating candidly and honestly. Comments or conduct that could be construed as deceptive will increase a party’s litigation risk, and should be avoided.
Those wishing to benefit from the new duty may generously ask questions of their contracting counterparties, since a dishonest or even an equivocal answer could now give rise to a cause of action.
Businesses should review and consider revising precedent or standard form contracts in light of the newly articulated duty of honesty, as the duty will operate irrespective of the parties’ intentions. The duty of honesty cannot be eliminated by contract, and so clauses that purport to exclude terms not expressly included in the agreement will not shield parties from their obligation to tell the truth.
The Court left some room for parties to influence the scope of the duty of honesty by contract, “so long as they respect its minimum core requirements”. These “minimum requirements” were not identified by the Court, and it remains to be seen in what contexts the courts will allow the doctrine to be relaxed or modified by mutual agreement. Nevertheless, parties may wish to discuss and contractually define the standards by which the performance of the duty of honesty will be measured. Contracting parties may also consider expressly setting out if and when there will be a duty to disclose certain information, or incorporate contractual language that expressly identifies decisions that may be made arbitrarily. In the same vein, identifying exactly what will be considered when making a discretionary decision under the contract – and therefore what constitutes “appropriate regard” for the interests of the other party – may prevent litigation down the road.
Furthermore, businesses facing litigation can expect to see allegations of a breach of the duty of honest contractual performance and violations of the organising principle of good faith emerging as standard claims in breach of contract actions. Since these allegations focus on conduct, internal decision-making and intentions, the scope of pre-trial discovery will likely be broadened. As a result, longer hearings – and an overall increase in legal costs – will be sure to follow.
Much remains to be decided in the wake of the Bhasin decision. Both the scope of the organising principle of good faith and the specifics of the duty of honesty will need to be interpreted by lower courts. In the meantime, and as always, honesty is the best policy.
Brett Harrison is a partner and co-chair of the Insolvency Litigation Group, Calie Adamson is an associate and Kristen Pennington is an articling student at McMillan LLP. Mr Harrison can be contacted on +1 (416) 865 7932 or by email: firstname.lastname@example.org. Ms Adamson can be contacted on +1 (416) 865 7240 or by email: email@example.com.
© Financier Worldwide
Brett Harrison, Calie Adamson and Kristen Pennington