Last week, we wrote about the Supreme Court of Canada’s recent decision in which it clarified the scope of the duty of honesty in contractual performance.
The Supreme Court of Canada then released another decision in which it clarified the nature and scope of the duty to exercise contractual discretion in good faith.
Contract Provided for Absolute Discretion
Awaste transportation and disposal company (the “disposal company”) and a statutory corporation (the “statutory corporation”) responsible for the administration of waste disposal for the Metro Vancouver Regional District had a long‑standing contractual relationship which contemplated the removal and transportation of waste by the disposal company to three disposal facilities. The disposal company was to be paid at a differing rate depending on which disposal facility the waste was directed to and how far away the facility was located. The contract did not guarantee that the disposal company would achieve a certain profit in any given year and it gave the statutory corporation absolute discretion to allocate waste as it so chose.
In 2011, the statutory corporation reallocated waste from a disposal facility further away to one that was closer, resulting in the disposal company recording an operating profit well shy of its target.
As a result, the disposal company alleged that the statutory corporation breached the contract by allocating waste among the facilities in a manner that deprived it of the possibility of achieving the target profit for 2011. It claimed that the statutory corporation exercised its contractual power to decide where the waste would be allocated in the region contrary to the requirements of good faith.
The disposal company referred the dispute to arbitration and sought compensatory damages.
Lower Courts Reject Duty of Good Faith Finding
The arbitrator found that a duty of good faith applied, that the statutory corporation had breached that duty, and that the disposal company was therefore entitled to compensation.
The Supreme Court of British Columbia allowed the statutory corporation’s appeal, and set aside the arbitrator’s award on the basis that the imposition of a contractual duty to have appropriate regard for the interests of another contracting party must be based on the terms of the contract itself, and that the parties had deliberately rejected a term constraining the exercise of discretionary power to allocate waste.
The Court of Appeal dismissed the disposal company’s appeal.
The disposal company then appealed to the Supreme Court of Canada and argued that the courts below had failed to understand the notion at the core of the Supreme Court of Canada’s decision Bhasin v. Hrynew, according to which a contracting party should have “appropriate regard to the legitimate contractual interests of [their] contracting partner”. It stated that the statutory corporation’s exercise of discretion made it impossible to earn the level of profit it had bargained for under a long-term relational contract, which was predicated on trust between the parties. The disposal company claimed that the statutory corporation exercised its discretionary power in a way that failed to meet the standard of honesty and reasonableness required by Bhasin.
At issue was the nature and scope of the duty to exercise contractual discretion in good faith.
Supreme Court of Canada Dismisses Appeal
The Supreme Court of Canada explained that the disposal company was correct in stating that the organizing principle of good faith recognized in Bhasin exemplifies the idea that a contracting party should have appropriate regard to the legitimate contractual interests of their contracting partners. Therefore, the issue was not whether the duty to exercise contractual discretion in good faith exists, but on what basis it exists and according to what standard its breach can be made out.
However, the court found that the disposal company had misrepresented Bhasin’s organizing principle and had overstated one of the specific duties of good faith contained in that decision by claiming compensation for its lost opportunity based on a dishonest or unreasonable exercise of the discretion to reallocate waste under the contract. The court explained:
“The duty to exercise contractual discretion is breached only where the discretion is exercised unreasonably, which here means in a manner unconnected to the purposes underlying the discretion. This will be made out, for example, where the exercise of discretion is arbitrary or capricious, as Cromwell J. suggested in Bhasin in his formulation of the organizing principle of good faith performance. According to Bhasin, this duty is derived from the same requirement of corrective justice as the duty of honest performance, which requirement demands that parties exercise or perform their rights and obligations under the contract having appropriate regard for the legitimate contractual interests of the contracting partner. […]
Carefully considered, the [disposal company]’s case does not rest on allegations that it fell prey to lies or deception. There is no claim that the [statutory corporation] exercised its discretion capriciously or arbitrarily. The [disposal company] does not point to, under the guise of allegedly unreasonable conduct, any identifiable wrong committed by the [statutory corporation] beyond seeking its own best interest within the bounds set for the exercise of discretion by the agreement. The duty of good faith at issue here constrains the permissible exercise of discretionary powers in contract but, in so doing, it does not displace the detailed, negotiated bargain as the primary source of justice between the parties.”
The court then clarified that this good faith duty did not require the statutory corporation to subordinate its interests to those of the disposal company, nor did it require that a benefit be conferred on the disposal company that was not contemplated under the contract or one which stood beyond the purposes for which the discretion was agreed.
Ultimately, the court found that the statutory corporation did not exercise its discretionary power to reallocate waste in breach of a good faith duty. The court stated that by seeking damages on the basis of the contractual duty of good faith, the disposal company was asking the court to award it an advantage not provided for in the agreement between the parties in the absence of any appreciable breach of contract or identifiable wrong. The court held:
“This seems to me to confuse the requirements of good faith performance with an injunction to act selflessly in a way that stands outside the ordinary compass of social ordering by contract, in service of a notional solidarity between the parties based on a different theory of justice. […]
Like the distinct duty of honest performance, the duty to exercise contractual discretionary powers in good faith is not a fiduciary duty. In exercising a contractual discretionary power, “a party may sometimes cause loss to another — even intentionally — in the legitimate pursuit of economic self-interest” […]. Doing so is not necessarily exercising discretion wrongfully or in “bad faith”.”
As a result, the court dismissed the disposal company’s appeal.
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