Contracts and the doctrine of good faith – A New Era

In Bhasin v Hrynew, the Supreme Court of Canada made a significant ruling regarding the duty of good faith in contract relationships. This will provide guidance to an area of Canadian law described as “piecemeal, unsettled and unclear.”. In this article, Cole Vegso provides a brief explanation of the decision and considers some of the implications for Canadians.

Introduction

In Bhasin v Hrynew,¹ the Supreme Court of Canada made a significant ruling regarding the duty of good faith in contract relationships. This will provide guidance to an area of Canadian law described as “piecemeal, unsettled and unclear.”²

The Supreme Court of Canada had previously commented on the duty of good faith only for specific types of contracts, such as employment, construction tendering and insurance contracts.³ It had abstained from establishing any underlying general principles that apply to all types of contracts.

Facts

Through a written contract, B was a dealer who sold financial products to investors on behalf of C. H, a competitor of B, also sold financial products for C. H approached B about a merger of their businesses but this was rejected. Determined to realize its goal, H then made overtures to C relating to its merger aspirations with B’s business. C then made statements to B that were dishonest. C did not renew its contract with B. This allowed H to obtain much of B’s business in a roundabout manner by soliciting B’s former clients. B’s business was negatively affected.

B commenced a lawsuit against C and H for the non-renewal of the contract and B’s lost business, among other things. The claims against H were dismissed but C was held liable for the damages suffered by B.

Reasons

Compared to other jurisdictions, the law in Canada (absent Quebec) relating to duty of good faith is antiquated and has developed slowly. In Quebec and the United States this duty has been recognized through statute law. It has recently been viewed with increased importance in England and Australia as well.⁴

Justice Cromwell, who authored the decision on behalf of a unanimous Court, provided these reasons for advancing the duty of good faith:⁵

• the current common law in Canada is uncertain on this issue;
• the current approach to good faith performance lacks coherence; and
• the common law is currently out of step with the reasonable expectations of commercial parties, especially those based in Quebec and the United States.

In doing so, good faith contractual performance was recognized as a general organizing principle of contract law in Canada. A specific manifestation of this principle that was recognized is the duty of honest performance.⁶

From a legal-economic perspective, the duty of good faith and honest performance are both logical and practical, as most parties that enter into an agreement likely expect the other party to adhere to a minimum standard of conduct.⁷ Where there is an ongoing relationship between two parties, trust and cooperation require a basic level of honest performance. Without this, it would be difficult to maintain the contractual relationship. Even one-off transaction contracts require this duty, as misleading or deceitful conduct of a party is not an expected part of the bargain.⁸

Justice Cromwell stated the duty of good faith and honest performance would enhance commercial certainty as it aligns with the reasonable expectations of the commercial parties at the time they enter into the agreement.

Justice Cromwell did not set out a specific legal test to determine when a breach of the doctrine of good faith occurs. Instead, the analysis is to be done on a contextual basis. In the case before the Supreme Court of Canada, it was clear that based on the facts, C owed B a duty of good faith and that it failed to honestly fulfill its obligations. As the majority of litigation involves facts that are neither black nor white, this decision provides limited guidance on how the doctrine of good faith will apply in future instances. In this respect, further guidance by the Supreme Court of Canada would have been beneficial in better understanding what the standard will be.

Fundamental Contract Principles Still Prevail

Justice Cromwell was clear that the duty of honest performance was neither a reformulated duty of disclosure nor a fiduciary duty. There is no general rule that a party must subordinate its interests to that of the other party. Further, a distinction can be made between a party who fails to disclose a material fact and a party who is actively dishonest. Despite a similar result, Justice Cromwell suggests it is only the latter that has breached its duty of honest performance.⁹

Equally important, the good faith doctrine “must be applied in a manner that is consistent with the fundamental commitments of the common law which generally places great weight on the freedom of contracting parties to pursue their individual self-interest.”¹⁰ This will partially calm those who fear that the doctrine of good faith could develop into a form of ad hoc judicial moralism, colloquially referred to as palm tree justice.

One major concern contracting commercial parties will have is determining whether their anticipated or actual conduct is sharp business practice or bad faith and/or dishonest performance. In other words, what is the standard the contracting party will be judged by. This uncertainty may result in commercial parties being less forthcoming and more secretive when they correspond with the other contracting party for fear that frank disclosure could be used as the basis for a future lawsuit.

Justice Cromwell reasoned that adding the duty of honest performance was an important incremental step. Yet, he also found that the good faith doctrine “must be allowed to evolve according to the same incremental judicial approach.”¹¹ This suggests that further change under this doctrine will be pragmatic and slow.

Concluding Remarks

When fearing the practical implications of the doctrine of good faith on the Canadian marketplace, it is important to recognize that the Civil Code of Quebec already recognizes a broad duty of good faith relating to contract formation, performance and termination.¹² Further, in the United States, the Uniform Commercial Code and the Restatement (Second) of Contracts (1981) provide for a general duty of good faith in all contracts. Together, these statutes have been enacted in the vast majority of U.S. states.¹³ This suggests that the impact of this recent decision will not be as transformative as some commentators eagerly anticipate (or fear).

Time will tell how the doctrine of good faith will be interpreted, whether the doctrine will evolve at a rapid or incremental rate and the impact it will have on commercial contracting parties and the Canadian marketplace.

If you have questions or would like further information on this topic, please contact Cole Vegso at [email protected] or call 519-660-7755.

¹ 2014 SCC 71.

²Ibid at 59.

³Honda Canada Inc. v. Keays, 2008 SCC 39; Martel Building Ltd v Canada, 2000 SCC 60; Fidler v Sun Life Assurance Co of Canada, 2006 SCC 30. Note that it is beyond the scope of this article to examine the interplay between this decision and the aforementioned decisions that already have addressed the duty of good faith.

⁴Bhasin, supra note 1 at 57-58.

⁵Ibid at 41.

⁶Ibid at 63, 73. Importantly, the Court stated that an exclusion clause does not bar the duty of good faith or honest performance as it is an organizing principle.

⁷Ibid at 45.

⁸Ibid at 60.

⁹Ibid at 86.

¹⁰Ibid at 70.

¹¹Ibid at 92.

¹²Cite civil code, art 6, 7, 1375.

¹³Bhasin, supra note 1 at 84.