Blog Series – Update on the Organizing Principle of Good Faith
Part 2 – Self-Interested Exercise of Contractual Discretion: SCC Issues New Decision on the Duty to Exercise Discretion in Good Faith
On February 5, 2021, the SCC issued its decision in Wastech on the duty to exercise contractual discretion in good faith. This is the second decision out of the SCC on good faith since the SCC first confirmed, and then clarified, the existence of the organizing principle of good faith and duty of honest performance in Bhasin and C.M. Callow, respectively.
In Wastech, the SCC clarified that discretionary decision-making under a contract will not constitute bad faith, even if the decision is made out self-interest, unless the discretion is exercised unreasonably, such as when decisions are made arbitrarily, capriciously or in a manner unconnected to the purposes underlying the discretion. In other words, parties are free to exercise their discretion to make decisions that ensure their own best interests are met, as long as the decision is made within the bounds set for the exercise of discretion by the agreement. Ultimately, whether a discretionary decision had been made in bad faith will be a highly contextual analysis requiring careful examination of the circumstances and contract at issue.
Greater Vancouver Sewerage and Drainage District (“Metro”) is a statutory corporation responsible for waste disposal for the Metro Vancouver Regional District. To carry out this duty, Metro entered into a contract with Wastech Services Ltd. (“Wastech”) whereby Wastech would remove and transport waste from the area to three disposal facilities. Under the contract, Metro had absolute discretion to decide which facility the waste would be moved to, but Wastech would be paid a higher rate for waste transported to the facilities that required the furthest travel. Wastech was not guaranteed a minimum amount that it would earn each year for services provided under the contract.
Problems arose between the parties when Metro decided to send waste to a closer facility rather than those located further away. This discretionary decision saved Metro unnecessary additional costs associated with waste transportation while depriving Wastech of the higher revenue it could have earned from transporting waste to the more distant facility. Wastech claimed that Metro’s allocation decision caused Wastech to fail to reach its target profit for the year and amounted to a breach of the duty of good faith. The matter was brought before an arbitrator who decided that Metro had breached its duty of good faith and awarded damages to Wastech.
Lower Court Decisions
Subsequent decisions by the BC Supreme Court (“BCSC”) and the Court of Appeal struck down the arbitrator’s award.
The BCSC did not agree with the arbitrator that Metro failed to have the “appropriate regard” for Wastech’s interests, thereby breaching its duty of good faith. In his reasons for judgment, the trial judge pointed out that having an “appropriate regard” simply requires parties to not undermine each other’s interests in bad faith and did not “require Metro to serve Wastech’s interest or disregard its own self-interest.” The trial judge explained that the duty to exercise contractual discretion in good faith had to be considered in light of the negotiated terms of the contract, and identified that Metro and Wastech had deliberately chosen not to constrain Metro’s discretion. As such, Metro’s exercise of discretion in allocating waste to the closer facility did not breach the duty of good faith.
Following suit, the Court of Appeal dismissed Wastech’s appeal, upholding the BCSC’s decision and emphasizing that to find a breach of a duty of good faith, a measure of “dishonesty, untruthfulness, improper motive, or ‘bad faith’” must be present.
On February 5, 2021, the SCC dismissed Wastech’s appeal, upholding the decision of both the BCSC and the Court of Appeal to set aside the arbitrator’s award.
The SCC firmly stated that there is a well-established duty to exercise contractual discretionary powers in good faith. Therefore, the question before the SCC was: what constraints does the duty of good faith place on a party exercising contractual discretion? In response, the Court put it simply:
“… the duty to exercise contractual discretion in good faith requires the parties to exercise their discretion in a manner consistent with the purposes for which it was granted in the contract, or, in the terminology of the organizing principle in Bhasin, to exercise their discretion reasonably.”
Although one party’s exercise of discretion may result in the loss of an expected benefit for the other, this alone is not enough to establish a breach of contract. To establish a breach in the duty to exercise discretion in good faith, the alleging party must show that the exercise was disconnected from the purpose for which it was granted and as a result was unreasonable.
When applying these principles to Metro’s waste allocation decision, the SCC found that Metro had not breached its duty to exercise its discretion in good faith. The SCC stated that Metro acted reasonably and was given “absolute discretion”, which was meant to allow Metro to administer waste disposal in the most efficient and cost-effective manner. Although the parties agreed to try and reach a target level of profitability, the contract did not guarantee that the target would be reached, and the parties were aware of the risks associated with the exercise of discretion and the potential variance in annual revenues. Ultimately, the SCC held that Wastech failed to bargain for the advantage it was seeking and since Metro was not in a fiduciary relationship with Wastech, Metro’s exercise of discretion only had to show “loyalty to the bargain, not loyalty to Wastech.”
Practical Implications for Contracting Parties
Wastech demonstrates that contractual exercises of discretion may negatively impact one party’s anticipated benefits under a contract without constituting bad faith as long as the discretion was exercised within the confines of the contractual arrangement. Accordingly, Wastech should be a warning to contracting parties that when negotiating a contract with rights to discretionary decision-making, the contract must clearly outline what discretionary powers will be given to which party and whether there are any restrictions on such.
During contractual negotiations, parties should consider all the ways in which discretionary decision-making under a contemplated contract could impact their respective interests. If your counterparty is given absolute discretion to make a decision under a contract, you must be aware that the duty of good faith will not require your counterparty to subordinate its interests to yours when making discretionary decisions. The best approach is to negotiate carefully and draft your contracts with precision as to the benefit that you expect to receive thereunder.
If you missed Part 1 of this blog series, you can read it here. And 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.