Litigation – Corporate Commercial

For the first time in common law Canada, the Supreme Court of Canada has recognized a legal duty to perform contractual obligations honestly and with regard to the legitimate expectations of other parties. The origin of that duty, the Court stated in its 2015 decision in Bhasin v. Hryniew, could be found in a general “organizing principle” of good faith performance.

The Bhasin court described its ruling as an attempt to make Canadian contract law more settled, fairer and more closely aligned with the reasonable expectations of the parties. But the disparate and sometimes tortuous commentary that followed on the decision’s release suggests that the judgment falls short of its goals.

Bhasin was about a renewal clause in a contract between an Alberta company that marketed education savings plans to investors and one of its agents, who sold the company’s product through his own business. The company had an absolute right to terminate its agreement with the agent after three years. In doing so, however, the company acted dishonestly, misleading the plaintiff about plans to merge his business with a competing business and about its efforts to have the plaintiff’s agency audited by the competing agency. In the end, the plaintiff’s objections to the merger and attempt to audit his records led to the non-renewal. Consequently, the plaintiff lost his business, with most of his own sales force moving to the competing company. When he sued, the central issue was whether the defendant owed him a duty of good faith.

In its unanimous decision, the Court recognized that Canada’s common law courts had refrained from enunciating an underlying principle of good faith and a duty to act honestly in the performance of contracts for fear of creating commercial uncertainty and interfering with freedom of contract. But as the Court saw it, it was the haphazard development of the law that had created the uncertainty. The failure to recognize the duty also failed to accord with reality, given that commercial parties would never accept contracts that allowed dishonesty in their performance. Finally, the modern trend, manifested in the US and Québec, was to recognize the obligation of basic honesty.

The “organizing principle,” not itself a duty, required parties to refrain from undermining other parties’ interests by acting in bad faith. The duties of good faith that existed in areas like franchise, employment, insurance and real estate law were examples of duties that arose from this principle. Bhasin’s twist was to leave open the possibility that new duties would emerge, the first one being the duty of honest contractual performance enunciated in the decision. The upshot is that the decision is open-ended: think, perhaps, Donoghue v. Stevenson, the seminal decision in the common law of negligence that engendered a continuing evolution of new duties of care and duties of care in new contexts.

So while Bhasin may provide certainty in the sense of putting an end once and for all to the debate about whether a principle of good faith exists, it creates uncertainty by failing to clearly establish the limits of that principle. Even with respect to the enunciated duty of honesty that falls under the principle, the court provides little guidance on what constitutes the “honesty” that good faith demands.

In attempting to limit its ruling, the SCC was careful to say that the duty of honesty is not a fiduciary duty, a duty of disclosure, or a duty of loyalty, and does not imply subordination of a party’s own interests: rather, it imposes only “a minimum standard of honest contractual performance,” meaning that “parties must not lie or otherwise knowingly mislead each other about matters directly linked to the performance of the contract.”

Absent a bright line, lawyers are advising their clients to be more cautious in general and more careful in the answers they give to specific questions that are asked of them by parties to their contracts. No one is suggesting, however, that the good faith principle vitiates absolute discretion clauses in contracts as a matter of course. So financial institutions and other lenders, for example, can breathe a bit easier: Bhasin, after all does not imply that lenders must give or have reasons for calling demand loans, but if they do give reasons, the reasons must be truthful.

What is clear is that parties may not contract out of duties stemming from the organizing principle: they can, however, define or delimit them in a particular context so long as they maintain the minimum standard that a particular duty implies. For example, lawyers might expand on absolute discretion by expressly stating that a right can be exercised for any reason at all or that no reason need be given for the exercise of a right.

While the SCC was at pains to point out that the sky had decidedly not fallen in jurisdictions where good faith was entrenched, Québec’s experience may be instructive. The duty in Québec, however, is much broader than the one articulated in Bhasin: it goes beyond performance of the contract to its formation and throughout its term, and the standard for good faith is an objective one that goes beyond honesty to what a reasonable person would do. That may explain why the three relevant provisions in the current Quebec Civil Code have engaged more than 5,100 cases in 20 years, amounting to some 250 annually.