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When does “good faith” limit a company’s choices?

good faith

In 2014, the Supreme Court released its ground-breaking decision to recognize a common law duty of good faith in the performance of contracts in Bhasin v Hrynew. Five years later, the Court has granted leave to appeal in two cases that will give the Court the chance to revisit or reinforce the common law duty of good faith.

Confused law on the duty of good faith in performance of contracts

Until 2014, the role of good faith in the performance of contracts was not clear. For some agreements – like employment and insurance contracts – courts agreed that sometimes a limited implied duty of good faith existed. For example, courts said that employers should not act in bad faith when terminating employees; employers should not lie to or mislead the employee or be unduly insensitive. In another example, courts agreed that an insurer must act in good faith when considering claims, and the insured must act in good faith by disclosing facts material to the insurance policy.

Courts and academics suggested other situations where a duty of good faith performance of some kind might be appropriate. For example:

  1. where the parties must cooperate to achieve the objectives of the contract;
  2. where one party exercises a discretionary power under the contract; and
  3. where one party seeks to evade contractual duties.

Despite these moments of consensus, there was no clarity on what role good faith played in the performance of contracts. Some courts implied good faith into all contracts to establish a minimum standards of acceptable commercial behaviour. Other courts denied the existence of this duty, because such a duty of good faith would create commercial uncertainty and undermine freedom of contract.

The new general duty of good faith identified by the Supreme Court

In 2014, the Supreme Court of Canada cut through the confusion and held that there is a general common law duty of good faith, which applies to all contracts, to act honestly in the performance of contractual obligations. In Bhasin v Hrynew, Justice Cromwell explained:

This means simply that 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.

While the Supreme Court of Canada noted that the duty of honesty does not require a party disclose material information to other contracting parties, a party cannot “actively mislead” or deceive the other contracting party in relation to performance of the contract. Read more about this decision here.

What will the Supreme Court say about good faith after five years of experience?

After five years of experience with the general common law duty of good faith, the Supreme Court has now granted leave to appeal in two cases that debate the limits of that duty.

In CM Callow, a group of condominiums hired a contractor to perform maintenance services under two contracts, one for winter and one for summer. In spring 2013, the condos decided not to renew the winter contract, but they waited until fall 2013 to tell the contractor. The condos did not want to risk the contractor not completing the summer work if they told him earlier. During the summer, the contractor performed extra free landscaping work in the hopes that winter contract would renew. When the winter contract was not renewed, the contractor sued for breach of the duty of good faith.

The Ontario Court of Appeal ruled in favour of the condos, explaining that the duty of good faith espoused in Bhasin did not require parties to unilaterally disclose information. Further, the Court of Appeal held that the duty of good faith applied to matters directly linked to the performance of the contract; it did not limit parties’ freedom concerning future contracts not yet negotiated.

In Matthews, David Matthews worked for Ocean Nutrition from January 1997 to June 2011. He resigned and sued Ocean Nutrition for wrongful dismissal seeking damages for breach of his employment contract, including the loss of a Long Term Incentive Plan. Under the Plan, if the company was sold while Matthews was employed, he was entitled to receive a portion of the sale proceeds. The Court held that Matthews was entitled to a 15-month notice period. The company was sold during the 15-month period. The trial judge held that Matthews was entitled to share in the proceeds of the sale.

The Nova Scotia Court of Appeal ruled in favour of the company, holding that the plain wording of the Plan precluded any payment to Matthews. Justice Scanlan dissented: he explained that both the employment contract and the Plan contained implied duties of good faith. He held that Matthews’ dismissal had been engineered through the lies of another employee, and that the duty of good faith meant the company could not rely on the dismissal to avoid sharing the proceeds of sale with Matthews.

Both of these cases give the Supreme Court the chance to comment on the general common law duty of good faith it created five years ago. Given the facts in these cases, the Court will have the chance to confirm the distinction between good faith in the performance of the contract (in other words, not allowing a company to rely on a dismissal caused by the lies of another employee) and good faith outside the performance of the contract (in other words, not being obliged to advise the contractor that there would be no new winter contract). Such a distinction makes sense: during the term of the contract, the parties are bound to behave as they contracted to behave. Before there is a contract, parties are free to contract or not to contract as they choose.

By Mary Paterson, John M. Valley and Vinayak Mishra, Osler

Occasional Contributors

In addition to our regular guest bloggers, Inside Internal Controls blog published by First Reference, provides occasional guest post opportunities from various subject matter experts on the topics of risk management and best practices in finance and accounting, information technology, environmental issues, corporate governance, sales/marketing and operations, not-for-profits and business related issues in Canada. If you are a subject matter expert and would like to become an occasional blogger, please contact Yosie Saint-Cyr at editor@firstreference.com. If you liked this post and would like to subscribe to Inside Internal Controls blog click here.

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