Honesty is the best policy – what parties need to know about good faith and Canadian contract law

April 2015 | EXPERT BRIEFING | LITIGATION & DISPUTE RESOLUTION

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On 13 November 2014, the Supreme Court of Canada released a landmark decision that will have important implications for all current and future contractual relationships in common law Canada. In Bhasin v Hrynew, 2014 SCC 71 (Bhasin), the court unanimously recognised a general organising principle of good faith in the performance of contracts, which gives rise to a specific requirement that parties act honestly in the performance of their contractual obligations.

As a consequence of the Supreme Court’s decision, every contractual relationship in Canada is now subject to scrutiny based not only on whether the strict terms of the contract are followed, but also with regard to the conduct of the parties as they carry out their contractual obligations. This marks a new and potentially uncertain period for individuals and businesses in Canada, as they must now adjust to a legal landscape with new requirements which has yet to be fully developed or defined.

This article outlines the Supreme Court’s decision in Bhasin as well as its implications for individuals and businesses entering into contracts governed by Canadian law. Since any party that breaches the duty of honest performance may be liable for breach of contract, adhering to Bhasin will be a crucial component of managing contractual risk going forward.

Background

The plaintiff, Mr Bhasin, had a renewable dealership contract with Can-Am to sell its education savings plans to investors. Can-Am eventually decided not to renew its contract with Mr Bhasin, as it was entitled to do under the contract. However, the trial judge found that representatives of Can-Am had acted dishonestly in the events leading up to its decision not to renew the contract. Furthermore, Her Honour found that the decision not to renew was part of an unsuccessful effort on Can-Am’s part to coerce Mr Bhasin into merging his business with that of another one of Can-Am’s dealers. Consequently, it was held that Can-Am breached an implied duty of good faith in performing its contractual obligations, and Mr Bhasin was entitled to damages as a result.

The Alberta Court of Appeal reversed the trial decision, finding that there was no general duty of good faith under Canadian common law. Mr Bhasin appealed this decision to the Supreme Court.

The Supreme Court’s decision

The Supreme Court held in favour of Mr Bhasin, and in doing so established that: (i) there is an organising principle of good faith that underlies and manifests itself in more specific doctrines that govern contract law; and (ii) one such doctrine is a duty to perform contractual obligations honestly.

The Court’s recognition of the good faith principle was inspired by its acknowledgment that commercial parties “reasonably expect a basic level of honesty and good faith in contractual dealings”. Accordingly, the Court ruled that the good faith principle is not a freestanding rule, but rather one that underlies and manifests itself in more specific doctrines of contract law, such as the duty of unconscionability or the duty of disclosure in insurance contracts. Obligations flowing from the good faith principle are contextual, and may be more robust in the context of a longstanding agreement or commercial relationship. As well, considerations of good faith generally have greater significance in contracts involving a power imbalance between the parties. Having established the good faith principle, the Court derived from it a new duty of honesty in the context of contractual performance. The Court also left the door open for new specific duties to be derived from the good faith principle in the future.

Duty of honest performance

The Supreme Court derived a specific duty of honest contractual performance from the broader good faith principle. The Court defined the duty as requiring that “parties must not lie or otherwise knowingly mislead each other about matters directly linked to the performance of the contract”. This duty of honest performance is now a doctrine in Canadian law and applies to all contracts, regardless of their wording (including any attempts to exclude it).

There are, however, important limits to the duty of honest performance. The Court took care to explain that this duty does not generally create a duty of disclosure and is different from the duty of fiduciary loyalty. Parties to a contract need not subordinate their self-interests to those of their partners. Rather, there has to be a minimum standard of honesty that contracting partners can rely on when fulfilling their contractual performances. The duty of honest performance ensures this by prohibiting one party from lying or misleading another about matters related to contractual performance.

Managing contractual risk post-Bhasin

The Supreme Court’s decision in Bhasin has several important implications for individuals and businesses entering into contracts subject to Canadian law.

First, it remains to be seen how broadly the duty of honest performance will be applied. For example, it is uncertain whether only overtly dishonest communications will constitute a breach of the duty, or whether remaining silent or refusing to provide information on an issue will constitute misleading one’s counterparty in some circumstances. Notably, in Bhasin, Can-Am was held to have acted dishonestly in part because it “equivocated” when Mr Bhasin inquired about Can-Am’s intentions with respect to a merger between his business and another dealer’s. For this reason, contracting parties should proceed as cautiously as possible to not be perceived as having misled another party to the contract. Doing so might entail vetting all communications to a contractual partner carefully and avoiding any careless representations (which could arise in situations such as sending emails off the cuff).

Second, the Court held that parties might be “free in some contexts to relax the requirements of the doctrine so long as they respect its minimum core requirements” but that any modifications on the honesty duty “would need to be in express terms”. Consequently, a clause that attempts to exclude the duty of honest performance will not be enforceable, but parties may include in a written contract specific terms that relax the duty’s parameters. Although the Court did not specify the extent to which the duty may be relaxed, it may be prudent to reduce the risk of litigation by including in contracts a clause clarifying the circumstances in which the duty will and will not arise. For instance, one might include a clause in a contract stating that a failure by one party to provide information to the other that is not otherwise required will not constitute deception or a breach of the duty of honesty, as long as no misleading information is communicated.

Third, the Court in Bhasin did not address whether the organising principle of good faith could lead to duties of honesty or candour in the context of contractual negotiations. Aside from contexts where parties expressly agree to negotiate in good faith, Canadian courts have been reluctant to recognise duties in the pre-contractual context. However, the Court’s ruling in Bhasin may inspire a shift towards recognising pre-contractual duties. It is arguable that, to some extent, the same considerations of parties’ reasonable expectations of honesty that underlie the application of a duty of honesty to the act of performing contracts could be applied to negotiating them. Parties would therefore be best served by avoiding representations that could be characterised as deceitful or misleading, even when negotiating contracts.

Conclusion

As a consequence of the Supreme Court’s decision in Bhasin, there will likely be a flurry of litigation as parties seek to determine the scope of the organising principle good faith, as well as the specific duties that emanate from it. Until a substantial body of case law has developed, parties to a contract should carefully vet their conduct to ensure that it cannot be construed as an attempt to undermine their counterparties’ reasonable expectations.

Brandon Kain is a partner and Justin Nasseri and Anu Koshal are associates at McCarthy Tétrault LLP. Mr Kain can be contacted on +1 (416) 601 7821 or by email: bkain@mccarthy.ca. Mr Nasseri can be contacted on +1 (416) 601 7884 or by email: jnasseri@mccarthy.ca. Mr Koshal can be contacted on +1 (416) 601 7991 or by email: akoshal@mccarthy.ca.

Brandon Kain, Justin Nasseri and Anu Koshal

McCarthy Tétrault LLP