The Supreme Court of Canada’s 2014 decision in Bhasin v Hrynew shook up contract law with the clarification that good faith contractual performance is a “general organizing principle” of the common law of contract. The precise boundaries of this duty of good faith have thus far been difficult to discern and define. Luckily, the Ontario Court of Appeal recently provided some helpful guidance on the matter in 2161907 Alberta Ltd. v 11180673 Canada Inc.[1]
The case arose from a series of agreements with respect to the opening of a cannabis store in Toronto. The Applicant, 2161907 Alberta Ltd. (“216”), held the rights to a cannabis brand, which it licensed to retail operators. The Respondent, 11180673 Canada Inc. (“111”), entered into licensing and leasing agreements with 216 with a view to opening a branded retail cannabis store.
Two days before the store was intended to open, a dispute arose with respect to whether 216 was obligated to fund the payment of 111’s rent for the month of the store opening. 216 mistakenly advised that it could not provide additional funds to 111. Concerned it would not be able to fund that month’s rent and other operational expenses, 111 advised that the store would not be opening. That evening, 216’s president was able to resolve the dispute, including by referencing a “Branding Fee” that would soon be paid to 111. However, on reviewing the parties’ License Agreement the following morning and seeking legal advice, 216 took the position that 111’s threat not to open the store constituted a “threat to cease to carry on business” contrary to the agreement, and purported to terminate the agreement on that basis. 111 nevertheless carried on with the store opening. 216 did not pay the Branding Fee, and commenced an application seeking a declaration that the License Agreement had been validly terminated.
The application judge held that 111’s threat not to open the retail store did not constitute an event of default under the License Agreement, such that 216’s termination of the agreement was invalid. The Ontario Court of Appeal agreed. In its view, the agreement’s reference to circumstances where 111 “threatens to cease to carry on business” required that such a threat be objectively credible. In the circumstances, 111’s threat not to open the cannabis store was not objectively credible: it was a manifestation of objectively reasonable frustration regarding a potential inability to cover expenses, not a true intent not to open the store.
However, the Court of Appeal disagreed with the application judge’s finding that 216 had acted in bad faith. After reviewing the principles surrounding good faith contractual performance, as sourced in the Supreme Court of Canada’s decision in Bhasin v Hrynew[2] (and supplemented more recently by its decisions in C.M. Callow Inc. v Zollinger[3] and Wastech Services Ltd. v Greater Vancouver Sewerage and Drainage District[4]), the Court addressed four potential sources of bad faith conduct in this case, and found that none of them met the requisite threshold:
- 216 misled 111 with respect to payments 216 was required to make, or would make, under the parties’ agreements. However, it did not knowingly or intentionally mislead: it did not lie or otherwise act dishonestly. 216 merely expressed its honest beliefs and intentions at the time, which turned out to be mistaken. In the absence of active misleading, this conduct did not constitute bad faith.
- 216’s “pouncing” on a single statement by 111 as a basis to trigger default did not constitute bad faith. 216’s position on terminating the agreement was “not unreasonable, malicious, or so inconsiderate of 111’s legitimate contractual interests as to constitute bad faith”, and was not manufactured or concocted. 216 perceived 111’s comments as a genuine threat, and had an interest in ending such threats. 216’s interpretation of the License Agreement may have proven to be wrong, but “absent a finding that it was a position manufactured to achieve 216’s objective of ending the relationship, an unreasonable position, or a position taken capriciously or arbitrarily, it constitutes an error and no more.”[5]
- By terminating its agreement with 111, 216 was able to avoid paying the Branding Fee. This did not amount to bad faith conduct. A contracting party has a duty not to evade its contractual obligations in bad faith; however, the fact that termination releases a party from making a payment does not alone amount to bad faith, even where that termination is later found to have been invalid.
- 216 was not evading its contractual obligation to pay the Branding Fee by invoking a breach of its own making. While 111’s threatening statement was triggered by 216’s own misinterpretation of an agreement, there was no deliberate attempt to create the conditions supporting termination.
In short, 216 had breached its contract with 111, but had not done so in bad faith.
The key takeaway is that parties generally cannot fall backwards into a breach of the duty of good faith contractual performance, based on an honest and reasonable mistake. Some element of knowledge, intent, malice, arbitrariness or unreasonableness must underlie a mistake or misrepresentation in order for it to amount to bad faith conduct. Contracting parties should be diligent before acting under or making representations with respect to obligations under a contract – but they can breathe easier knowing that a reasonable mistake is unlikely to lead to a finding that they acted in bad faith.
[1] 2021 ONCA 590.
[2] 2014 SCC 71.
[3] 2020 SCC 45.
[4] 2021 SCC 7.
[5] 2161907 Alberta Ltd. v 11180673 Canada Inc., 2021 ONCA 590 at para 63.
