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Conduct carrying a “stench”: Bhasin and bad faith contractual performance

12 minute read

The Bhasin principles: the duty of good faith

One of the most significant Supreme Court of Canada cases in recent years for those litigating business disputes is Bhasin v Hrynew, 2014 SCC 71.

In this case, the Court found that “good faith contractual performance is a general organizing principle” of contract law and imposed a new “duty… to act honestly in the performance of contractual obligations” [paras. 33 and 93]. The general duty of honest contractual performance means that the parties must not lie or otherwise knowingly mislead each other about matters directly linked to the performance of the contract [para. 73]. This development was intended to, “bring a measure of coherence and predictability to the law and… bring [it] closer to what reasonable commercial parties would expect it to be” [para. 41].

Does breach of the duty require dishonesty?

The outcome in Bhasin turned on a consideration of the respondents’ honesty, however, elsewhere in the decision the Court also described this new duty more broadly: as requiring parties to generally perform their contractual duties, “honestly and reasonably and not capriciously or arbitrarily” [para. 63].

Courts since Bhasin have grappled with how to deal with conduct that falls short of dishonesty but constitutes acting “unreasonably” or “capriciously or arbitrarily”. What conduct fails the good faith test? This determination is challenging, in part, because of the limits that the Court placed on the new duty:

  • In carrying out performance of a contract, a contracting party should have appropriate regard to the legitimate contractual interests of the contracting partner. While this will vary depending on the context of the contractual relationship, it does not require acting to serve those interests in all cases. It merely requires that a party not seek to undermine those interests in bad faith. This general principle has strong conceptual differences from the much higher obligations of a fiduciary. In other words, there is no duty of loyalty or duty to put the interests of the other contracting party first [para. 64];
  • The principle of good faith must be applied in a manner that is consistent with the fundamental commitments of the law of contract, which values 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 and in some cases has actually been encouraged by the courts on the basis of economic efficiency. The organizing principle of good faith should not be used as a pretext for scrutinizing the motives of contracting parties [para. 70]; and
  • Where the contract is not one of utmost good faith (uberrimea fidei) which may require disclosure, a clear distinction can be drawn between a failure to disclose a material fact, even a firm intention to end the contractual arrangement, and active dishonesty [para. 86].

The need for a unifying principle

In Bhasin, the Court noted that the organizing principle of good faith had already manifested itself through existing doctrines in which the law required “honest, candid, forthright or reasonable contractual performance”. These separate doctrines applied with respect to certain types of situations (contracts requiring the cooperation of the parties to achieve the objectives of the contract, contracts that allow for the exercise by a party of contractual discretion, and where a contractual power is used to evade a contractual duty) and relationships (employment, insurance, franchise, and tendering contracts, for example) [para. 66].

In some cases, good faith required more than honesty on the part of the contracting party, or that a party’s discretionary power not be exercised in a manner that is “capricious” or “arbitrary”.

In other contexts, Courts previously had been reluctant to extend the requirements of good faith beyond honesty for fear of causing undue judicial interference in contracts [para. 89].

The Court found that this former analytical approach created complexity and uncertainty; hence the need for a unifying principle. However, the application of Bhasin by the Courts in the decisions below has not led to the predictability which had been hoped. It is still not clear whether or when dishonesty is required for a breach of the duty of good faith and outcomes may still depend upon how the Court characterizes the type of contract.

The latest word in Ontario: “unreasonableness” is enough

In Ju v Tahmasebi, 2020 ONCA 383, the applicant/appellant sellers (Ju and Cai) and respondent buyer (Tahamasebi) entered into two agreements of purchase and sale for a property that the appellants were responsible to have severed into two lots. The buyer provided a first deposit at the time into which the agreements were entered, to be held in trust, and agreed to provide a second deposit, “after the seller provides City or OMB severance approval to the buyer’s lawyer”.

Instead, two years later and after failing to respond to the buyer’s requests for information on the status of the severance application which had been granted six months earlier, the sellers told the buyer that the lots had been severed and imposed a 60-day closing date in accordance with the agreements.

The buyer asked for an extension due to the two-year delay and the fact that she was away. The sellers refused the request and demanded payment of the second deposit “ASAP”. When the buyer did not comply with the sellers’ unilateral demand, the sellers terminated the agreements and relisted the properties for sale. When the specified closing date arrived, neither party tendered to close.

The sellers brought an application for two declarations:

  • 1) That the buyer had repudiated the agreements by not paying the second deposit on demand; and
  • 2) That the first deposit be paid to them.

The application judge found that, having received the buyer’s extension request, and knowing that she was out of the country, the sellers, “set a deadline that they could reasonably have expected would be impossible for the [buyer] to meet”. She dismissed the application on the basis that the sellers’ conduct was not “consistent with the organizing principle of good faith that underlies Canadian contract law”. The Ontario Court of Appeal dismissed the sellers’ appeal. The Court, “defer[rred] to the application judge’s conclusion that it was a violation of the principle of good faith”.

It found that this was “just another way of saying that the sellers had acted unreasonably”, relying upon Bhasin at para. 66: the “organizing principle of good faith manifests itself through the existing doctrines about the types of situations and relationships in which the law requires, in certain respects, honest, candid, forthright or reasonable contractual performance”.

This analysis of the standard of good faith conduct required seems more consistent with that in the Mohamed decision than in the Callow decision, both discussed below.

But….Bhasin to be re-visited by the SCC

The Supreme Court of Canada will be re-considering the Bhasin principles in two cases: CM Callow Inc. v Zollinger, 2018 ONCA 896; and Greater Vancouver Sewerage and Drainage District v Wastech Services Ltd., 2019 BCCA 66, which will be heard together.

In CM Callow Inc. v Zollinger, the plaintiff/respondent (Callow) provided maintenance services to the defendants/appellants (Zollinger), which were ten condominium corporations and a designated property manager, pursuant to two two-year contracts. One contract covered summer maintenance and the other covered winter maintenance. The contracts provided for early termination on 10 days’ notice. The appellants decided to terminate the winter contract about six months before it provided Callow with notice of termination to avoid jeopardizing Callow’s work on the summer contract. During this six-month period, Callow provided “freebie” landscaping work in the hope that it would provide an incentive for the appellants to renew the contracts.

The trial judge decided that the appellants had breached their contractual duty of honest performance to Callow by acting in bad faith by:

  • 1) Withholding the fact that they intended to terminate the winter contract to ensure that Callow performed the summer contract; and
  • 2) Continuing to represent to Callow that the winter contract would be renewed.

The Ontario Court of Appeal allowed the appeal, and held that the trial judge had “improperly expanded the duty of honest performance” in a manner that went beyond the terms of the winter contract and, in effect, modified the termination provision in the contract.

It held that while the facts may well suggest a failure by the appellants to act honourably, it did not rise to the “high level” required to establish a breach of honest performance. The duty of honest performance required the parties only to be honest with respect to matters directly linked to the performance of the winter contract, then in effect, not future potential contracts. According to Bhasin, there was no unilateral duty to disclose information relevant to termination.

The Ontario Court of Appeal which decided Callow distinguished it from its earlier decision in Mohamed v Information Systems Architects Inc., 2018 ONCA 428. It concerned the defendant’s/respondent’s (Information Systems Architects Inc.) decision to terminate a consulting contract for technological services pursuant to which it placed Mohamed with Canadian Tire on the ground that Mohamed had a criminal record, even though he had disclosed it before the contract was entered into. The respondent made no attempt to redress the problem or offer Mohamed any other consulting project with another client when Canadian Tire learned of the criminal record and asked that Mohamed be replaced.

The Court of Appeal in Mohamed agreed with the motion judge’s finding that the contract had been breached because the termination provision had not been exercised in good faith. The Court of Appeal in Callow asserted without further explanation that, “the circumstances of the present case are very different”; in Mohamed, the Court found that although the appellant had a “facially unfettered right” to terminate the contract, it had an obligation to exercise its right to termination in good faith, which it failed to do.

These decisions by the Ontario Court of Appeal only months apart are seemingly inconsistent on the standard of conduct which constitutes a breach of the new duty of good faith contractual performance.

In Callow the respondents’ conduct in actively misleading Callow was called a “failure to act honourably, but did not rise to the ‘high level’ required to establish a breach of honest performance”. In Mohammed the respondent’s conduct in terminating the consulting contract based upon information it had pre-contract constituted a failure to act in good faith.

The outcomes in the two decisions can perhaps be reconciled on the basis that Bhasin requires good faith performance of the contract. In other words, in Mohamed, there was a finding that the respondent had failed its duty of good faith performance of the contract in effect at the time of the termination. By way of contrast, the facts in Callow did not attract the Bhasin principle because the respondents’ impugned conduct was not in furtherance of the performance of an existing contract. With respect, it is hard to see how the outcome in Callow comports with Bhasin’s objective to “bring the law closer to what reasonable commercial parties would expect it to be”.

The basic facts of Greater Vancouver Sewerage and Drainage District v Wastech Services Ltd., also on appeal to the Supreme Court of Canada, are as follows. Wastech had a long-term agreement with Greater Vancouver Sewerage which provided for the removal and hauling of the City’s solid wastes. The profitability of that contract to Wastech depended upon the allocation by the City of such waste between short-haul and long-haul destinations.

Wastech complained when the City exercised its discretion to change this allocation, which reduced the profitability of the contract. In an arbitration initiated by Wastech, it claimed damages for its loss. The arbitrator found that the City’s conduct had been honest and reasonable from its point of view (including its legitimate desire to reduce the volume of waste going to the long-haul landfill to increase its lifespan), but that it had failed to give “appropriate regard” to Wastech’s interests and expectations and this constituted “dishonesty” for the purposes of the Bhasin duty of good faith.

The City appealed the arbitrator’s decision to the British Columbia Supreme Court, which allowed the appeal. The British Columbia Court of Appeal dismissed Wastech’s appeal to that Court. At para. 71, it found that Bhasin was concerned with conduct that has “at least a subjective element of improper motive or dishonesty” and considered the meaning of “bad faith”. It refers to “conduct that is contrary to community standards of honesty, reasonableness or fairness”, connoting “malice, untruthfulness, ulterior motive or…other intentional conduct equivalent to fraud”, or conduct that “is so reckless that absence of good faith can be deduced and bad faith presumed”.

Because the arbitrator had made no finding that the City had sought to undermine Wastech’s interests or to do so in bad faith and found that the decision to reallocate waste was both honest and reasonable from the City’s perspective, it concluded: “I doubt the Court in Bhasin  intended that the principle of good faith would be extended so far as to attribute ‘dishonesty’ (which, it will be remembered, carries a ‘stench’) to a party in the circumstances of [the City] in this case”.

Because this decision arises from an appeal of an award of an arbitrator, one wonders whether the Supreme Court of Canada will also take the opportunity to clarify the impact (if any) of Vavilov on appeals of arbitral awards. See my earlier blog on this subject

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Lisa C. Munro, Q.Arb

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