Words and Intentions

Landmark cases have recently broadened the courts’ ability to interpret contractual intent. Does this represent a more nuanced approach, or does it open the door to ambiguity in contract law?
IN RECENT YEARS, COURTS HAVE layered some common sense on to the way in which Canadian courts decide contractual disputes between parties. In a series of rulings at the Supreme Court of Canada and provincial appeal court levels — rulings that the legal community called “groundbreaking” or “blockbuster” — high court judges tried to clarify contract law and the “good faith” obligations owed by contracting parties. The courts also broadened the principles and factors judges could use to determine guilt and liability, when a party allegedly fails in their good faith obligations. In rulings that modernize common law, the courts decided that, when it came to contractual interpretation, judges could go beyond the literal words within a contract to infer broader intent.

For the Canadian business world, rulings such as Bhasin v. Hrynew, 2014 SCC 71, and Sattva Capital v. Creston Molly, 2014 SCC 53, have implications for how companies should negotiate and perform their obligations in a contract. The rulings also re-emphasized the need for crystal clear language in the terms parties put into their contracts. Yet, some lawyers argue, the Supreme Court has also added more uncertainty and risk for businesses that think they’ve just signed an airtight agreement.

In Bhasin the SCC noted that a notion of “good faith” underlies many elements of modern contractual law, but added Anglo-Canadian common law has “resisted” any general doctrine of good faith performance of contracts. As a result, Canadian jurisprudence on the matter is, as they put it, “piecemeal, unsettled and unclear.”

Bhasin goes some way to resolving this state of affairs because, at its essence, it means that parties have a duty of honest performance when fulfilling contractual obligations. The SCC, in a unanimous decision, wrote for the first time that there is a general organizing principle of good faith in the “honest” performance of contracts throughout Canada. The ruling in Bhasin, the court added, puts “in place a duty that is just, that accords with the reasonable expectations of commercial parties and that is sufficiently precise that it will enhance rather than detract from commercial certainty.”

While Québec addressed the concept of honest contractual performance in its Civil Code decades earlier, until 2014 the rest of Canada had been forced to rely on English common law mired in jurisprudence from centuries ago.

The change in the demeanour of Canadian common law surrounding contractual interpretation “is significant” for both courts and corporations, says Sarah Woods, a partner with Woods LLP in Montréal. “It is certainly a big improvement in my view to the common law in that you now have, under the general organizing principle of good faith, a positive duty to not mislead and be dishonest with your co-contractor in the execution of your contract.” Still, she adds, “It is surprising that it took the common law that long, considering the positive obligations that have existed in the Civil Code in Québec since 1991.”

Eli Lederman, a Toronto litigator at Lenczner Slaght Royce Smith Griffin LLP, has a practice that focuses on contract disputes and acted for the defendant in Bhasin v. Hrynew. The plaintiff, Harish Bhasin, was a top Alberta enrolment director for Canadian American Financial Co. (Can-Am), which sold Education Savings Plans through people like Bhasin. Bhasin had a three-year contract with Can-Am that would automatically renew unless it was terminated by either side with six months’ written notice. Larry Hrynew was also an enrolment director and a competitor of Bhasin’s. Wanting a chunk of Bhasin’s lucrative market, Hrynew repeatedly, and to no avail, tried to force Bhasin to merge with him.

The real dispute between Bhasin and Hrynew started when the Alberta Securities Commission became concerned about Can-Am’s operation. It appointed Hrynew a Provincial Trading Officer and, despite the apparent conflict of interest, ordered an audit of the company’s enrolment directors. As a PTO, Hrynew used his position to attempt to gain access to Bhasin’s confidential business records. Bhasin refused to provide them.

Can-Am, for its own reasons, aided Hrynew in his merger objective. According to court documents, the company applied repeated pressure tactics to try to get Bhasin to turn his records over to Hrynew. Bhasin continued to refuse, and eventually, Can-Am terminated their contract, giving Bhasin the required six-month non-renewal notice contained in the terms of their contract. Once Bhasin was out, Hrynew acquired much of his business.

Bhasin sued Hrynew and Can-Am in the Alberta Court of Queen’s Bench. The trial judge found that, though it was not overtly stated in Bhasin’s contract with Can-Am, it was implied in the terms that any decisions to terminate a renewal would be made in good faith. The court found Hrynew and Can-Am liable of a civil conspiracy because they breached that good faith owed to Bhasin in their contract.

However, Lederman, who has represented clients in some of the most significant contract-liability cases in Canada, convinced the Alberta Court of Appeal to overturn the lower-court ruling in favour of Hrynew and Can-Am. The appeal court decided there was no basis in law for the Queen’s Bench judge to evaluate the tactics Can-Am and Hrynew used against Bhasin in deciding not to continue Can-Am’s contract with him. The lower court should only have considered the express provisions of the contract that, in fact, did allow Can-Am to cancel its contract with Bhasin after giving six months’ notice.

“The Alberta Court of Appeal,” says Lederman, “I think understood that the terms of the contract in the Bhasin contract were unambiguous.” The appeal court, adhering to long-held jurisprudence, said no analysis of intent or bad faith is warranted when terms of a contract are perfectly clear. But when the case moved up to the Supreme Court, continues Lederman, it reversed the Alberta Court of Appeal’s decision. The highest court said the original trial judge was right to examine the facts behind Can-Am’s decision to terminate the renewal of Bhasin’s contract. The SCC, Lederman recounts, “went on to say, ‘No, even in a contract where the terms were unambiguous, every party to a contract has now a duty of honest performance. And they have to perform every obligation under their contract honestly.’ That duty of honest performance emanates from this general organizing principle that the [SCC] recognized duly exists in the common law.”

But Lederman suggests the SCC, despite good intentions, has made the business of entering into contracts even more risky than before 2014. “Even though the [SCC] takes the view that the broadening of this duty of honest performance to apply to all contracts will ensure commercial certainty, I’m not sure that’s the case.” Lederman says that, with courts now able to go beyond the plain meaning of the words in a contract in determining whether a party has failed to perform them honestly and in good faith, certainty about a contract is more doubtful and exposure to liability higher.

The Bhasin case wasn’t the only SCC decision in 2014 that shifted the landscape of contractual interpretation. In Sattva Capital v. Creston Moly, the SCC changed the standard of review that appellate courts can use when deciding whether they should hear appeals emanating from lower courts or arbitration tribunals regarding contract law.

The long-standing rule for appellate courts was that they could review the judgments of lower courts regarding contract law only on narrow questions of law, using what is known as a “standard of correctness,” explains Matthew Milne-Smith, a partner with Davies Ward Phillips & Vineberg LLP in Toronto. Questions of fact could also be reviewed, but only on the much higher standard of “palpable and overriding error.” In essence, that meant that the appeal court would only grant leave if a trial judge actually misinterpreted the meaning or intention of a law.

For the most part, though, the facts of a contractual intepretation case carried little if any weight when an appellate court was reviewing the decision of a lower court. “Traditionally, says Milne-Smith, “the approach [for appellate review] was, you read the contract, you interpret the contract, end of story.” But over the centuries, a few logical exceptions to that approach did slowly creep into the common law. By the late 20th century, a judge could consider other factors when reviewing a contractual dispute, but only in cases where there was contractual ambiguity.

“For example, you could look at the communications between the parties before the contract,” says Milne-Smith. But for an appellate court to look at questions of mixed fact and law, there had to be what’s known in law as a palpable and overriding error. “Which means, even if I think the position of the trial judge might be wrong, I still have to, as an appellate judge, allow it to stand if I don’t think it’s so badly wrong as to rise to the level of a palpable and overriding error.”

But the Sattva case changed that. In rendering judgment, the SCC wrote that the historical approach of using only questions of law in determining the rights of parties bound in a contract “should be abandoned. Contractual interpretation involves issues of mixed fact and law as it is an exercise in which the principles of contractual interpretation are applied to the words of the written contract, considered in light of the factual matrix of the contract.”

In other words, says Milne-Smith, the SCC was saying, “No, no, no. You don’t have to wait for cases with ambiguity. A judge should always look at the factual matrix in order to understand how to interpret a contract.” Now, more than ever, says Milne-Smith, there’s “a desire for certainty and un-ambiguity in contractual drafting. And you need to have good counsel to make sure you can accomplish that.”

The SCC rulings mean that judges can now examine a wider array of evidence in determining whether a party failed to perform its good faith obligations outlined in a contract. So parties involved in a contract, Milne-Smith continues, must “be aware of the fact that your communications at the pre-contractual stage could become the subject of litigation. So don’t say anything that could be taken out of context.”

Since 2014, says Sarah Woods, Bhasin has been cited in around 300 Canadian cases. The message from the case law, she says, is that those entering into contracts “have to make sure they are on side and they are transparent in the execution of their obligations.” And that’s not just a job for lawyers. “[This] will be a preoccupation at the operations level, the people on the ground. The people who are interacting with the other party.”