2015.05

Acting in Good Faith Now the Rule in All Contracts

By: Morris Sosnovitch

The recent Supreme Court of Canada decision in Bhasin v. Hrynew has changed the principles of contract law in Ontario by imposing the duty to perform all contractual obligations honestly and recognizing the principle of good faith performance as “a general organizing principle” of contract law.  Previously this principle was recognized only in certain contracts where there tends to be unequal bargaining positions, such as employment or insurance contracts.  The Supreme Court has now tried to rationalize and clarify the law and explicitly recognize an implied term in every contract that the parties must both act honestly and in good faith in the performance of their obligations. This “organizing principle” means that parties must perform their contractual duties honestly and reasonably and not capriciously or arbitrarily.

The case involved a company which marketed Registered Education Savings Plans (“RESP”) to investors through retail dealers.  One such dealer, who was the plaintiff in this action, had a ten year history in selling these plans and had built up a substantial business.  Its dealership contract had provided for a three-year term which automatically renewed unless one party gave six months written notice to the contrary. No reason was required in the contract to exercise this non-renewal right. The defendant RESP marketing company decided to restructure its agencies and tried to force a merger between the plaintiff’s agency and a competing agency.  It tried to persuade the plaintiff company to disclose confidential business information to its competitor by using misleading statements.  The plaintiff resisted the merger and the marketing company terminated the agreement at the end of the term by giving the required notice.  As a result the plaintiff lost its business and most of its salesforce was picked up by the favoured competitor. The plaintiff then sued the marketing company (and its competitor) for damages on the basis that the marketing company had acted dishonestly and had misled it and terminated its agency contract in bad faith in order to benefit its competitor.

The crux of the plaintiff’s case was that the marketing company had misled it about its intentions and had made arrangements with its competitor which affected the plaintiff’s business’ future viability behind his back.  It claimed that had the marketing company acted honestly and advised in a timely manner that it would not renew the contract, the plaintiff would have been able to make alternate arrangements to retain the value of the agency notwithstanding the termination.  Even though the contract provided that the marketing company had an unrestricted right not to renew at the end of the term, the plaintiff asked for damages on the basis that this unrestricted right still had to be exercised in good faith.

The Alberta trial court found it was an implied term of the contract that decisions on whether to renew the contract had to be made in good faith and the marketing company had misled the plaintiff as to its intentions. The Court found the competitor and the marketing company guilty of a civil conspiracy to induce breach of contract and awarded damages. The Court of Appeal overturned the trial ruling and decided in favour of the marketing company on the basis of the wording of the contract.

The Supreme Court decided that good faith contractual performance is a general principle of contract law in all contracts and not just in cases where there is an inequality of bargaining power and restored the trial decision.  As a underlying legal principle, it need not be explicitly set out.  The Supreme Court also indicated that courts should not in the ordinary course allow parties to enforce clauses in contracts which provide that this principle does not apply.

The Supreme Court’s decision is based on the implied understanding that parties when entering into a contract expect that each side will adhere to a minimum standard of conduct, being that neither side will lie or intentionally mislead the other. The parties must have appropriate regard to the legitimate contractual interests of the other party and not seek to undermine those interests in bad faith.  This does not mean that there is a duty to disclose information to the other party nor is there a fiduciary obligation.  The Court recognizes that parties may pursue their self-interests and may cause loss to the other, even intentionally, but cannot do so by lying or knowingly misleading the other.

The detractors of such a principle retort that implying this principle will cause uncertainty in contractual performance by potentially interfering with express contractual wording.  Indeed in the case being discussed, the wording did not require the marketing company to have any reason to refuse to renew the contract.  By implying a requirement for contracting parties not to act solely in their own best interests, the Supreme Court is certainly adding a wrinkle to the laissez faire free market system.

The practical application of this principle is hard to quantify but is bound to lead to interesting litigation in the future.  At the minimum it does require parties to deal honestly with each other.  Whenever a party tells a “white” lie or misrepresents its true intentions, the other party may have a right to sue based on bad faith.  Compliance with the black-and-white letter of the contract is not necessarily a defence if a party has lied or not acted in good faith.

This decision will certainly make life a lot more complicated for lawyers and clients in determining how far you can go in pursuing your own interests without running afoul of this principle. Without a doubt, if someone actively and intentionally lies to the other side in a contract there will be cause of action for damages suffered, but beyond that there is a grey area and it will be necessary to keep track of how the courts delineate the boundaries of this “organizing principle”.

 

For further information,  please contact Morris Sosnovitch by phone at (416) 368-6444 or by email at msosno@businesslawyers.com.

 © Morrison Brown Sosnovitch LLP, 2015. All rights reserved.

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