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The obligation to act honestly in performing a contract

Darrell Gold | The Legal Corner | 2015-02-14

Darrell Gold

This article has been contributed by Darrell Gold LLB with Robins Appleby LLP.

In November 2014, the Supreme Court of Canada (Bhasin v. Hrynew, 2014 SCC 71 ) issued a unanimous decision which effectively expanded the common law approach to “good faith” in contracts by recognizing that there is a duty to act honestly in the performance of contractual obligations as part of that “good faith”.

In order to better understand what this means in terms of contracts and their performance going forward, we need to consider the facts in the Supreme Court case.

The Facts:

Company C marketed education savings plans to investors through retail dealers, known as enrollment directors (almost like a franchise relationship). A 1998 agreement governed the relationship between C and dealer B for a three-year term with automatic renewal unless either party gave six months’ written notice to the contrary.

H was another enrollment director and competitor of B.  H wanted B’s lucrative niche market and had approached B to propose a business merger. H actively encouraged Company C to force the merger. B refused a merger. 

Company C appointed H to review its enrollment directors for compliance with securities laws after the Alberta Securities Commission raised concerns about compliance issues among C’s enrollment directors. The role required H to audit Company C’s enrollment directors. B objected to its competitor reviewing its confidential business records. 

During Company C’s discussions with the Commission about compliance, it was clear Company C was considering a restructuring of its agencies in Alberta that involved B. In June 2000, Company C outlined its plans to the Commission and they included B working for H’s agency. None of this was known by B. 

B refused to allow H to audit his records and in May 2001, Company C gave notice of non‑renewal under the Agreement. 

At the expiry of the contract term, B lost the value in his business in his assembled workforce. The majority of his sales agents were successfully solicited by H’s agency. 

B sued Company C and H for damages. 

At trial the judge found Company C in breach of the implied term of good faith, H had intentionally induced breach of contract by Company C, and both Company C and H were liable for civil conspiracy.  The Court of Appeal allowed the appeal and dismissed B’s lawsuit.

B appealed.

The Decision:

The Supreme Court allowed B’s appeal against Company C and found Company C was liable for damages to B, but the Court dismissed B’s appeal against H.

It confirmed the trial judge’s decision that Company C “failed to act honestly in exercising the non‑renewal clause [and] acted dishonestly with B throughout the period leading up to its exercise of the non‑renewal clause, both with respect to its own intentions and with respect to H’s role as [auditor]”. Company C repeatedly misled B by telling him amongst other things, “that H was under an obligation to treat the audit information confidentially. 

The Reasons:

The decision of the Supreme Court involved a review and then expansion of the common law doctrine of “good faith”. The Court noted as follows:

1. The common law on good faith performance of contracts is “piecemeal, unsettled and unclear”.

2. 2 steps are needed to address that problem:

a. an acknowledgement “that good faith contractual performance is a general organizing principle of the common law of contract”; and

b. the need to “recognize ,…. that there is a common law duty which applies to all contracts to act honestly in the performance of contractual obligations ……[That principle] exemplifies the notion that, in carrying out his or her own performance of the contract, a contracting party should have appropriate regard to the legitimate contractual interests of the contracting party…..While “appropriate regard” for the other party’s interests will vary depending on the context of the contractual relationship it merely requires that a party not seek to undermine those interests in bad faith”.

3. The result is “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”.

4. However, “Unlike fiduciary duties, good faith performance does not engage duties of loyalty to the other contracting party or a duty to put the interests of the other contracting party first.”

5. Its application must be in a manner consistent with the “the freedom of contracting parties to pursue their individual self‑interest.  In commerce, a party may sometimes cause loss to another — even intentionally — in the legitimate pursuit of economic self‑interest. Doing so is not necessarily contrary to good faith”.

Based on the above, the Court found that:

a. Company C’s misleading conduct did not “fit within any of the existing situations or relationships in which duties of good faith have been found to exist”.  So the Court recognized “a new common law duty that applies to all contracts…: a duty of honest performance, which requires the parties to be honest with each other in relation to the performance of their contractual obligations”.<

b. Under this new duty, “parties must not lie or otherwise knowingly mislead each other about matters directly linked to the performance of the contract.  This does not impose a duty of loyalty or of disclosure or require a party to forego advantages flowing from the contract; it is a simple requirement not to lie or mislead the other party about one’s contractual performance.

c. The duty is “a minimum standard of honesty in contractual performance… irrespective of the intentions of the parties“.

d. It is not “a duty of disclosure or of fiduciary loyalty.  A party to a contract has no general duty to subordinate his or her interest to that of the other party. However, contracting parties must be able to rely on a minimum standard of honesty from their contracting partner in relation to performing the contract as a reassurance that if the contract does not work out, they will have a fair opportunity to protect their interests”.

The Lessons:  

1. The duty of honest performance includes having regard to the other party’s interest and is now a minimum contractual standard;

2. The duty cannot be contracted out of but can be modified using express terms – not a standard “entire agreement” clause.  

3. The duty should “promote, not detract from, certainty in commercial dealings”;

4. The duty will affect all contracts including leases, purchase and sale agreements, employment agreements, insurance agreements and claims etc.

5. It is not a fiduciary duty which carries with it a very high standard.

6. You do not have to subordinate your interest to that of the other party.

Disclaimer: This article is for general information purposes only and not intended as or to be relied upon for legal advice. Consult with a lawyer for your unique situation.

[*If there is a general real estate or leasing related question you would like to see addressed in a future article in “The Legal Corner”, please contact me directly by e-mail at dgold@robapp.com with your suggestion. Not all requests can be accommodated.]

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Darrell Gold

About the Author ()

Darrell is a partner at Robins Appleby LLP and is responsible for the leasing component of its Real Estate Group. He has extensive experience and expertise in all aspects of commercial, retail, office and industrial leasing, lease enforcement and dispute resolution on behalf of landlords, tenants and property and asset managers. As well, his practice includes acquisitions and dispositions of commercial real estate and general commercial contracts. Author’s website: https://www.robinsappleby.com

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