Blog Series – Update on the Organizing Principle of Good Faith

Part 1 – Unfettered (but Honest) Termination of Contracts: SCC Issues New Decision on the Duty of Honesty in Contractual Performance

Series Overview

In recent months, the Supreme Court of Canada (“SCC”) has released two decisions which have provided guidance on the organizing principle of good faith performance of contracts.  Back in 2014, we provided you with an overview of the OG case that started it all by confirming the existence of the organizing principle of good faith: Bhasin v. Hrynew (“Bhasin”).  In this two-part series, we’re breaking down the SCC’s new decisions and giving you an update (and some much-needed clarification) on this organizing principle.

In this Part 1 of the series, we’ve provided an overview of C.M. Callow Inc. v. Zollinger, 2020 SCC 45 (“C.M. Callow”) – a case which confirmed that honesty really is the best policy when exercising contractual rights – and in Part 2, an overview of Wastech Services Ltd. v. Greater Vancouver Sewerage and Drainage District, 2021 SCC 7, which focuses on the duty of good faith in respect of a contracting party’s exercise of contractual discretion.

In Bhasin, the SCC confirmed that an organizing principle of good faith in contracts exists and requires parties to perform their contractual rights and obligations honestly and in good faith.  However, depending on the nature of those rights and obligations, acting in good faith can mean different things.  As we will explain in this series, specific duties arise under the broad umbrella of the organizing principle of good faith, including the duty of honest performance of contractual rights and obligations and the duty to exercise contractual discretion in good faith.

C.M. Callow Overview

On December 18, 2020, the Supreme Court of Canada issued a new decision in C.M. Callow on the organizing principle of good faith and duty of honest performance of contracts.  This is the first decision out of the SCC on good faith and honest performance since the SCC confirmed the existence of the organizing principle of good faith and duty of honest performance in its landmark decision in Bhasin.  According to the SCC in Bhasin, the duty of honest performance is a contract law doctrine that “requires the parties to be honest with each other in relation to the performance of their contractual obligations” [93].  Parties mustn’t subvert their own interests to those of their counterparty, however they must have “appropriate regard” for the legitimate contractual interests of their counterparty.  This duty applies equally to the performance of contractual obligations and the exercise of contractual rights.

In C.M. Callow, the SCC restored the trial judge’s decision that a contracting party breached the duty of honest performance when it exercised its right to terminate a contract several months after having made the decision to terminate and after leading its counterparty on to believe that the contract would not be terminated.  The SCC held that this was intentionally misleading and rose to the level of breaching the duty of honest performance.  Further, the SCC clarified that, depending on the circumstances, parties can mislead one another, in bad faith, via “lies, half-truths, omissions, and even silence”: [91].

Facts

In 2012, a group of condominium corporations (collectively, “Baycrest”) entered into a two-year winter maintenance contract with C.M. Callow Inc. (“Callow”) whereby Callow agreed to provide certain maintenance services, including snow removal.  Under the contract, Baycrest was entitled to terminate for any reason upon giving 10 days’ written notice to Callow.   In March or April of 2013, Baycrest decided to terminate the contract but chose to withhold that information from Callow until September 2013.

In the interim, in the summer of 2013, Callow raised the possibility of renewing the contract for a subsequent two-year term with Baycrest and, based on those discussions, Callow thought it was likely that the contract would be renewed and that Baycrest was satisfied with its services.  Accordingly, Callow chose to forego opportunities to bid on other winter maintenance contracts.  Further, to better its chances of receiving a contract renewal, Callow provided additional services to Baycrest during the summer of 2013 without charge.

In September 2013, Baycrest provided 10 days’ notice to Callow of its intention to terminate the contract, and Callow filed a statement of claim for breach of contract, claiming that Baycrest terminated in bad faith.

Lower Court Decisions

The trial judge held that Baycrest had acted in bad faith by “actively deceiving” Callow from the time that the decision to terminate was made until September 2013 and also by accepting the additional services knowing that Callow was providing them in an effort to ensure the contract would be renewed.

The Court of Appeal overturned the trial judge’s decision, holding that the trial judge had improperly expanded the duty of honest performance and that Baycrest’s deception related to the renewal of the contract, which technically pertained to the negotiation of a contract not yet in existence and therefore did not trigger the duty of honest performance.

SCC’s Decision

The SCC allowed Callow’s appeal and reinstated the trial judge’s decision.  A majority of the Court found that the duty of honest performance of the contract precluded the active deception by Baycrest by which it knowingly misled Callow into believing that the winter maintenance contract would not be terminated.  Even though Baycrest:

(i) was entitled to terminate for convenience (i.e. for any reason);

(ii) satisfied its contractual obligation to provide 10 days’ notice of termination to Callow; and

(iii) made no express representations as to its intention to continue the contract,

the Court held that Baycrest’s exercise of its termination right was dishonest because Baycrest was deliberately silent and misleading as to its intention to terminate.  Further, Baycrest knew that Callow was under the false impression that the contract would continue and may even be renewed, and therefore Baycrest had an obligation to correct Callow’s false impression in order to avoid a finding of breach of the duty of honest performance.

The SCC was careful to note that the duty of honest performance does not mean that parties have a positive obligation of disclosure.  However, lying or knowingly misleading another party through express statements, omissions or even silence, will constitute a breach of the duty of honest performance. The court also noted that this duty does not constrain a party’s right to terminate.  Rather, it will attract an award of damages if the manner in which the right is exercised is dishonest.  In other words, a dishonest termination will remain legally valid, but damages will follow.

Ultimately, the SCC ordered that Baycrest pay Callow “expectation damages” (not “reliance damages”), meaning Callow was awarded damages that would put it back in the position it would have been had Baycrest not breached its obligation to behave honestly in the exercise of the termination right.  The SCC determined that, had Baycrest corrected the misrepresentations it made to Callow once it recognized that Callow had drawn a false inference as to the longevity of the contract, Callow would have had the opportunity to secure a replacement winter maintenance contract, and therefore awarded Callow an amount equal to the profit that Callow would have made over the remainder of the term of the winter maintenance contract.

Practical Implications for Contracting Parties

Following C.M. Callow, parties should exercise diligence and caution when terminating agreements, even when terminating pursuant to a unilateral and seemingly unfettered right to terminate for convenience.  If a party decides that it is going to terminate an agreement sometime in the future, that party does not have to notify its counterparty of its intention to terminate earlier than the contract stipulates (i.e. the party must only provide notice in accordance with the notice provision in the contract); however, the terminating party cannot knowingly mislead its counterparty as to its intentions between the time the decision to terminate is made and the notice of termination is issued.

Depending on the circumstances, deception (and therefore bad faith) can extend to deliberately remaining silent in the face of questions or attempted discussions about the contractual arrangement.  At a minimum, a party terminating a contract must refrain from making false representations (express or implied) in anticipation of the notice period and may have a positive obligation to correct any misapprehensions that arise.

Want More?

Check out Part 2 of this series on the SCC’s recent decision in Wastech, which will provide guidance on the duty to exercise contractual discretion in good faith. If you have any questions or comments relating to what we discussed above, feel free to reach out to Erin Reimer from our Litigation Team.