Honesty isn’t just the best policy, it’s (now) the law, Canada’s Supreme Court rules with respect to contract performance

November 18, 2014

In its unanimous decision in Bhasin v. Hrynew, 2014 SCC 71, released on November 13, 2014, the Supreme Court of Canada ruled that there is a common law duty to act honestly in the performance of contractual obligations. The Supreme Court did state that the good faith was an organizing principle of the common law of contract from which other more specific contract rules could follow (including this newly recognized duty to act honestly). But it is important to note that, in this appeal from an Alberta ruling, the Court did not go as far as to affirm the existence of a general stand-alone obligation to perform contractual obligations in good faith or reasonably. Nevertheless, recognition of good faith as an organizing principle allows courts to develop such rules incrementally in appropriate situations. The Court very clearly stated that a duty of honesty or good faith did not include positive duties of disclosure or fiduciary duties. Note that this ruling does not affect contracts governed by Quebec’s civil code, which already recognizes a duty of good faith in performance.

Facts

The appellant, Mr. Bhasin, through his business Bhasin & Associates, was an enrollment director for Canadian American Financial Corp. (Can-Am) beginning in 1989. Can-Am marketed education savings plans (ESPs) to investors through enrollment directors such as Mr. Bhasin. In 1998, Mr. Bhasin and Can-Am entered into an agreement to govern their relationship which replaced a 1989 agreement which had an indefinite duration. The term of the 1998 agreement was three years, with automatic renewal unless one of the parties gave sufficient notice to the contrary.In 1999, the Alberta Securities Commission began to take a closer look at ESP marketers. One step it took was to require Can-Am to appoint a “provincial trading officer” (PTO) to examine the securities law compliance records of its enrollment directors. Can-Am’s choice of PTO was Mr. Hrynew, who was himself an enrollment director and who, significantly, had been making overtures to Mr. Bhasin with respect to a possible merger of their two businesses. Mr. Hrynew had also been aggressively lobbying Can-Am with respect to such a merger. Mr. Bhasin, who had strongly opposed Mr. Hrynew’s approaches, was disturbed to learn that a competitor had been appointed to examine the private records of his company. His complaints to Can-Am were met with assurances that the ASC had refused to allow an outside PTO and that Mr. Hrynew was bound by a confidentiality agreement. Neither of these assurances was true. The company also led Mr. Bhasin to believe that it was not working behind the scenes to effect Mr. Hrynew’s merger plan – which was also apparently untrue.

In the end, Mr. Bhasin refused to give Mr. Hrynew access to his records. Can-Am responded by exercising its termination right. Having essentially lost his business as a result, Mr. Bhasin sued both Can-Am and Mr. Hrynew, arguing that Can-Am had not exercised the non-renewal right in good faith and that Can-Am and Mr. Hrynew had engaged in a civil conspiracy to induce the breach of his contract.

Decisions of the courts below

Mr. Bhasin won his case at trial. The Alberta Court of Queen’s Bench agreed that a good faith performance requirement should be implied into the contract and that it had been breached. It also agreed that Mr. Hrynew and Can-Am had unlawfully conspired to induce the breach of contract. The Court of Appeal reversed, largely on the basis that Canadian common law does not imply a good faith duty with respect to contractual performance.

Decision of the Supreme Court of Canada

The Supreme Court stated that the key issues on the appeal were the “straightforward” questions of whether Canadian common law imposes a duty on the parties to perform their contractual obligations honestly, and if so, whether Can-Am had breached that duty. The Court answered both questions in the affirmative (although it agreed that Mr. Hrynew was not responsible for inducing breach of contract or conspiracy and dismissed that portion of the appeal.)

Analysis of the ruling

Good faith in contractual performance: inadequacy of the existing “piecemeal” approach

The Supreme Court began its analysis with a review of the state of the duty of good faith in contract law noting that Anglo-Canadian law has resisted acknowledging any generalized and independent doctrine of good faith performance of contracts. The result, the Court stated, is an “unsettled and incoherent body of law” that has developed “piecemeal” and which is “difficult to analyze”.

In reviewing the existing jurisprudence, the Court noted that some Canadian courts have held that there is a broad role for good faith as an implied term of all contracts, while others have found a more limited role for good faith only in certain contexts. The Court also noted that existing case law is not clear about the source of good faith obligations – sometimes good faith has been implied as a matter of law, sometimes as a matter of intention of the parties and sometimes as a matter of contractual interpretation. Canadian courts have tended to rely on the ad hoc and arbitrary identification of situations and relationships in which good faith duties are engaged.

Good faith as a “general organizing principle”

The Court saw its mission as that of bringing “certainty and coherence to this area of the law in a way that is consistent with reasonable commercial expectations”. In order to achieve this, it took the philosophically complex approach of adopting good faith in contractual performance as a “general organizing principle” while recognizing as a legal requirement only part of what might arguably be said to follow from that principle, i.e. “the duty to perform contracts honestly.”

If you find this slightly confusing, you are likely not alone. To take a step back, the Court’s key idea here is that the common law, by its nature, develops incrementally. Thus, in affirming that good faith in contractual performance is a “general organizing principle”, the Court is not recognizing a freestanding duty of good faith that applies across the board to all aspects of contractual performance. That would be too drastic and non-incremental a change to make all at once. Instead, what the Court appears to be doing is setting some ground rules for the future evolution of the common law in this area. In other words, whatever incremental change may occur in the future will be influenced by the “general organizing principle” that good faith duties should apply to the performance of contracts. However, the court is also saying that, in order not to “undermine certainty in commercial contracts”, this should be achieved only incrementally.

The Court described the general organizing principle of good faith in the following broad terms:

The organizing principle of good faith 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 partner.

Presumably, as we move forward, Canadian courts may revisit what constitutes “appropriate regard” within the context of various types of fact situation, and it will be as the result of such reconsiderations that the common law in this area may continue on the path of incremental development. The Court was of the view that such an approach strikes “the correct balance between predictability and flexibility” by “[t]ying the organizing principle to the existing law [and thereby mitigating] the concern that any general notion of good faith in contract law will undermine certainty in commercial contract.”

Duty of honesty derived from the good faith “principle”

Having introduced the concept of a “general organizing principle”, the Court proceeded to establish its immediate implications, in terms of legal rights and obligations that should be recognized as part of the contemporary common law of Canada. This is where the duty of honesty comes in. After considering the state of the common law in England, Australia and other jurisdictions, as well as in Canada, the Court determined that, at the current stage in the development of our common law, the main legal obligation that flows from the general organizing principle of good faith is the “general duty of honest contractual performance”.

The precise application of this duty to specific fact situations is obviously something that remains to be fleshed out by Canadian courts, but the Supreme Court did offer some general observations. On the positive side, the duty of honesty:

…means simply that parties must not lie or otherwise knowingly mislead each other about matters directly linked to the performance of the contract.

What the duty of honesty does not entail is equally worth noting, however:

[It] 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.

The Court stated that the duty of honest performance should not be confused with a duty of disclosure or of fiduciary loyalty, noting that a party to a contract has no general duty to subordinate his or her interest to that of the other party. The Court framed the duty as “a minimum standard of honesty” that contracting parties have a right to expect from one another in relation to the performance of the contract (“as a reassurance that if the contract does not work out, they will have a fair opportunity to protect their interests”).

The Court also considered that the duty has similarities to the tort of civil fraud but exists as a stand-alone duty. The Court noted that unlike a claim for fraud, breach of the duty of honest contractual performance does not require the defendant to intend that the false statement be relied on. Moreover, a breach of the duty of honest performance supports a claim for damages according to the contractual rather than the tortious measure.

Does the Court suggest any limits to the possible future development of good faith duties?

The Court did not opine on how good faith duties might be incrementally expanded in future. This case was only about one specific situation, which in the Court’s view was effectively remedied through the recognition of a “minimum standard of honesty”. However, the Court noted that good faith may be invoked in widely varying contexts, which will call for a “highly context-specific understanding of what honesty and reasonableness in performance require so as to give appropriate consideration to the legitimate interests of the contracting parties.”

However, even as it suggested the possibility of future incremental growth, the Court was careful to state that the organizing principle of good faith “must be applied in a manner that is consistent with the fundamental commitments of the common law of contract”, which include placing “great weight on the freedom of contracting parties to pursue their individual self-interest”. Even the intentional infliction of a loss on another party to a contract “is not necessarily contrary to good faith” and may even legitimately be encouraged by the courts (e.g. on “economic efficiency” grounds). Statements such as these appear designed to place some general constraints on future applications of the principle of good faith, so as to preclude what the court variously calls “palm tree justice” or “ad hoc judicial moralism”. Furthermore, in what might be seen as an attempt to discourage some potential litigants, the Court warned that “the organizing principle of good faith should not be used as a pretext for scrutinizing the motives of contracting parties.”

Can the duty of honesty be excluded by agreement?

The ruling is not entirely clear on the scope of any such limitation. Initially, the Court stated that because the duty of honesty is a general doctrine of contract law, the parties are not free to exclude it, for example, through an entire agreement clause. The duty of honesty is said to be “to this extent analogous to equitable doctrines [such as] unconscionability” that operate “irrespective of the intentions of the parties”.

Having said that, the Court qualified its position to a certain extent, stating that the scope of honest performance may be “influenced” by the parties in a particular context if they do so expressly: “The precise content of honest performance will vary with context and the parties should be free in some contexts to relax the requirements of the doctrine so long as they respect its minimum core requirements.” The Court strongly suggested, however, that a “generically worded entire agreement clause” would not be sufficient to indicate the intention of the parties to depart from the basic tenets of honest performance.

Application to the facts of the case

The Court found that the problems with Can-Am’s treatment of Mr. Bhasin did not fit within any of what were described above as the situations and relationships that Canadian courts have, under the existing “piecemeal” approach, identified as creating duties of good faith. Thus, for example, the relationship between Can-Am and Mr. Bhasin was not an employment or franchise relationship. Nor could Can-Am’s decision not to renew the contract be classified as an exercise of contractual discretion such as would engage a “situational” duty of good faith. In addition, a duty of good faith could not be implied on the basis of the intentions of the parties given the clear terms of the entire agreement clause in the agreement.

That led the Court to consider the imposition of the new common law duty described above, under the broad umbrella of the organizing principle of good faith performance of contracts. As one would expect given the discussion above, the Court rejected Mr. Bhasin’s argument that a general duty of good faith applied to the situation, but accepted the more limited proposition that a duty of honesty had existed. The Court found that Can-Am had breached its duty to perform its agreement with Mr. Bhasin honestly as it had not been truthful with Mr. Bhasin about its intentions regarding the proposed merger and misled him about Mr. Hrynew’s role in the securities law compliance review. Although it might be said that this dishonesty only set in motion a chain of events that led to Can-Am’s decision not to renew the agreement, the Court held that the dishonesty and the non-renewal were “intimately connected”. The Court held that Mr. Bhasin should be awarded damages on the basis of what his economic position would have been had Can-Am fulfilled that duty, i.e. he would have been able to retain the value of his business at the time of renewal, which the evidence showed was $87,000. Mr. Bhasin was thus awarded damages in this amount.

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