In a recent game-changing decision, the Supreme Court of Canada set out the scope and limits on the duty to act in good faith when performing a contract.

The highest court in the land ruled that when a contract gives a certain party some degree of choice, that choice must be exercised in a reasonable manner, or the party will be deemed to have breached the contract by acting in bad faith.

This particular case is not based on a real estate dispute, but the implications of the judgment should be considered if you are in a similar position in a real estate-related contract.

The case before the court

In Wastech Services Ltd. v. Greater Vancouver Sewerage and Drainage District (“Wastech”), a waste disposal company (the “Company”) entered in a long-term contract with Greater Vancouver Sewerage and Drainage District (the “District”) for hauling and removal of solid waste at three different disposal sites. The Company was compensated at different rates, depending on which site was chosen, with the most profitable site being the farthest away.

The contract gave the District “absolute discretion” to choose which disposal site to use. There was a cost/revenue target for the Company’s compensation identified in the contact. However, the contract itself provided no guarantee the target would be met.

In 2011, the District re-allocated the waste disposal sites and opted to send much more waste to a closer site. This substantially decreased the Company’s profits and increased its costs and the Company consequently failed to meet its target.

The Company commenced an arbitration proceeding against the District and sought compensatory damages.

It was alleged the District breached the Contract and failed to act in good faith by deliberately allocating the waste to sites which made it impossible for the Company to meet its target. The arbitrator ruled in the Company’s favour and agreed the District acted in bad faith by using its discretion in a manner that did not allow the Company to meet its target.

The Supreme Court’s decision

After a series of appeals, the matter eventually reached the Supreme Court, where the arbitrator’s decision was overturned.

The Supreme Court ruled that because the contract gave the District “absolute discretion” to choose which disposal sites to use, the District was not obligated to use its discretion to guarantee the Company would meet its target. It was also noted the Company had full knowledge of this discretion and the risks it posed when it entered the Contract.

As such, although the District had a duty to exercise its discretion in good faith, the duty was not breached in that case.

The importance of the Wastech decision cannot be overstated. Although the District was held not to have acted in bad faith in that particular case, the Supreme Court clearly set out the requirement to act in good faith when discretion exists under a contact and when this duty will be breached.

How this might affect you

So what does this mean exactly?

The answer is that, essentially, when a party is given some choice under a contract, they must exercise it in a way connected to the purpose for which it was given. If the party exercises its discretion in a manner not connected to its purpose, the party will have breached its duty to make the decision in good faith.

Although Wastech dealt specifically with a waste removal agreement, the Supreme Court stated the duty of good faith “operates in every contract irrespective of the intentions of the parties” and it applies to any contract that has some amount of choice involved. It is therefore applicable to any number of agreements, including commercial leases, development agreements and construction contracts.

For instance, a few weeks after Wastech was decided, it was considered in a recent Ontario Superior Court decision involving a commercial lease dispute between the Ottawa Hospital and an adjacent medical centre. A dispute arose concerning the number of parking spaces allocated to the medical centre and the hospital, citing Wastech, successfully argued that, pursuant to the lease, it exercised its discretion to allocate the appropriate number of parking spaces in good faith.

We would be wise to keep Wastech in mind when exercising a right to make a discretionary decision under a contract. Before the decision is made, it is important to be mindful of the reason the discretion was given in the first place. If the discretion is exercised for an arbitrary reason or for a reason not connected to its purpose, the decision will be deemed to have been made in bad faith, which could result in a damages claim.