The Supreme Court of Canada (the “SCC” or the “Court”) released its reasons for judgment last week in the case of Wastech v. G.V. Sewerage and Drainage (“Wastech”), a companion case to the Callow judgment we previously discussed on the blog here and here. As with Callow, the Court in Wastech considered the common law duty of good faith performance in contract law. However, whereas Callow focused mainly on the duty of honest performance, the issue in Wastech centered on the good faith exercise of discretionary contractual powers. Specifically, discretionary powers that related to the respondent’s right to reallocate waste under its contract with the appellant.
Like Callow, the Wastech decision builds upon the SCC’s good faith discourse in the seminal case of Bhasin v. Hrynew, wherein the doctrine of good faith performance in contract law was first articulated by Justice Cromwell. Although Bhasin did not discuss the source or provide detail of the meaning of the duty to exercise discretionary powers under a contract in good faith, Justice Cromwell declared in Bhasin that the duty was part of the legal doctrine of good faith recognized by the courts, and it will apply regardless of the intention of the parties (i.e., good faith performance is required of all contracting parties regardless of whether it is specifically included in a contract).
As we previously discussed, although this principle was also invoked by the appellant in Callow, the SCC left unanswered the issue of what good faith requires in the exercise of a discretionary right under a contract (in Callow, the discretionary power being exercised was a termination right). The majority judgment in Wastech thus expands on the basis upon which the duty to exercise contractual discretion in good faith exists, and the standard required to establish a breach of the duty.
What are discretionary contractual rights?
Discretionary rights under a contract are rights that give contracting parties the discretion to exercise a right, or discretion as to how a party exercises a right, pursuant to the contractual terms. Discretionary rights are typically included in a contract with the language that a party “may at its sole discretion” exercise a right, or that a party may exercise a right “at its discretion, not to be exercised unreasonably”, and can include provisions relating to for example (note that the following is not an exhaustive list):
- approval rights;
- termination rights;
- consent rights, including in cases of assignment or change of control; and
- valuation rights.
Discretionary rights are often found in a variety of contractual provisions, and can include language granting sole or absolute/unfettered discretionary powers (subject to the requirement of good faith discussed below), or the exercise of "reasonable" discretionary powers.
Limitations or qualifications on the exercise of an “absolute” discretionary right can be negotiated by the parties and expressly included in a contract.
Duty is breached where contractual discretion is exercised unreasonably
According to the SCC, the duty to exercise contractual discretionary powers will be breached:
- where the discretion is exercised unreasonably; and
- in a manner unconnected to the purposes underlying the discretion.
For example, the duty to exercise contractual discretion will be breached if:
- the exercise of a discretionary contractual power is arbitrary or capricious; or
- a party uses lies, deception or misrepresentation; or
- there is an identifiable wrong or breach of contract in the exercise of a discretionary power.
The duty does not replace contractual negotiations between parties
The SCC made it clear in Wastech that good faith doctrines will not replace the carefully negotiated bargains that occur in contractual negotiations between parties. As such, parties will not be able to rely on the courts to re-order privately negotiated contractual rights if they choose to bargain away certain advantages or rights. The primary source of justice between parties thus remains the detailed, negotiated bargaining and private ordering of commercial interests through agreements.
What conduct satisfies having “appropriate regard” to the “legitimate contractual interests” of a contracting partner?
Importantly, the SCC was clear that this duty (and the doctrine of good faith contractual performance generally) does not require parties to subordinate their own best interests to those of their contracting counter-parties, and good faith does not act as an injunction for parties to act selflessly in the performance of a contract, or transform a party into its counter-party’s fiduciary. Contracting parties are free to act in their own best interests in the performance of their contractual obligations, absent any lies or deception, or other wrongful conduct.
Here, the SCC found that good faith did not require the respondent to have acted in a manner that would ensure the appellant met its operating target (regarding waste volume). In fact, although both parties believed that such a scenario was highly unlikely, the parties agreed not to include an adjustment provision dealing with that scenario in their contract.
Instead, contracting parties must have appropriate regard to the legitimate contractual interests of their counter-parties. According to the Court, the meaning of "appropriate consideration" and "legitimate interests" in particular situations is highly context-specific and will cover a variety of different levels of conduct depending on the circumstances.
Unfettered discretionary powers are still constrained by good faith
This judgment also reaffirms that even seemingly unfettered or “absolute” discretionary rights under a contract will be constrained by good faith. These discretionary powers will have purposes that reflect the parties’ shared interests and expectations, which purposes will help identify when an exercise is capricious or arbitrary.
Application to discretionary contractual powers going forward
Although the Court ultimately rejected the appellant’s argument that the respondent breached its duty to exercise discretionary powers in good faith, this judgment will likely have a widespread impact on the negotiating and drafting of commercial contracts going forward. The Court’s findings demonstrate the importance of retaining experienced legal counsel for contractual negotiations and drafting, in order to ensure that contracting parties’ best interests are addressed as precisely as possible, and that both rights/benefits and limitations/disadvantages under the contract are expressly contemplated or bargained for. For example, the appellant and respondent in Wastech could have chosen to include an adjustment provision in their contract to ensure that the appellant’s operating targets were met, but chose not to, despite lengthy negotiations and a detailed contract.
Wastech also highlights the notion that good faith performance requires discretionary rights to be exercised reasonably (even if a provision grants a party sole or absolute discretion on its face), based on a highly fact-specific analysis of the party’s conduct and the purposes underlying the discretion. The purpose set by the parties will determine what is reasonable and fair according to the parties’ own bargain, and the courts will not re-order privately negotiated contractual rights. Given the SCC’s findings, it makes sense for contracting parties to consult with experienced legal counsel before considering the exercise of any discretionary contractual rights to ensure that they will not be considered to be in breach of the good faith requirements of contractual performance.
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*This update is intended for general information only on the subject matter and is not to be taken as legal advice.