• Incrementalism and Good Faith in Contract Law - The New Duty of Honesty (And Beyond?)
  • January 10, 2015
  • Law Firm: Dentons Canada LLP - Toronto Office
  • Summary
    The Supreme Court of Canada’s (SCC) recent decision in Bhasin v. Hrynew 2014 SCC 71 (Bhasin) attempts to both clarify and extend the role of good faith in contract law. At the same time, the SCC also strongly endorsed a cautious and incremental approach to the development of the common law.

    Before Bhasin, the concept of good faith had been applied in Canada in a variety of discrete circumstances defined by the subject matter of the contract, the nature of the obligation and the relationship between the contracting parties. There was no set of coherent guiding principles as to how and when a duty of good faith would exist. Bhasin represents the SCC’s attempt to give certainty to the place of good faith in Canadian contract law and to provide a coherent and consistent set of principles for future evolution of the law in this respect.

    The key aspects of the SCC decision in Bhasin are:

    1. It refrained from recognizing a general duty of good faith in contract law, instead holding that good faith is a "general organizing principle" of the common law of contracts, being a requirement of justice from which more specific legal doctrines may be derived.

    2. The general organizing principle of good faith has been manifested in various existing doctrines requiring honesty, candid, forthright or reasonable contractual performance in certain types of situations and relationships. These doctrines, which recognize a duty of good faith performance in certain specific contractual contexts, remain unchanged.

    3. Generally, claims based on good faith will not succeed if they do not fall within these existing doctrines. However, incremental development of the good faith principle should occur where the existing law is found wanting, in a way that is consistent with the structure of the common law of contract giving due weight to the importance of private ordering and certainty in commercial affairs.

    4. The general organizing principle of good faith justifies recognition of a new duty of honesty in contractual performance, requiring that a party not "lie or mislead" its counter party or engage in any "active dishonesty" about its performance of the contract.

    5. The parties cannot choose to exclude their duties of honesty in contractual performance but the content of such duty is highly context specific such that it will be influenced by the nature and terms of the contract itself. The parties may "relax" the requirements of this new duty so long as its "minimum core requirements" remain.

    6. The SCC was careful to emphasize the limits of both good faith as an organizing principle, and of the new duty of honesty in contractual performance, stressing a cautious incrementalist approach throughout Bhasin;

      • It framed good faith as an objective concept stating that development "must not" veer into a form of ad hoc judicial moralism or "palm tree" justice. It was specifically stated that the principle of good faith "should not be used as a pretext for scrutinizing the motives of contracting parties"; and

      • It limited the scope of the duty by expressly stating that it is not a duty of fiduciary loyalty, a duty of disclosure or a duty to forgo the advantages of a contract.

    Bhasin left a number of important questions unanswered. Broadly speaking, these concern the precise boundaries of good faith and the duty of honesty, how it must be connected to contractual performance, and what parties can do to define the duty of honesty in their agreements and avoid breaching the duty through their conduct.

    Bhasin’s background, the SCC decision and the questions arising from it are considered further below.

    Background facts

    The parties in Bhasin were the Canadian American Financial Corp. (Can-Am), which marketed registered education savings plans (ESPs) and two dealers of these plans. The dealers, Bhasin (the appellant/plaintiff) and Hrynew, were competitors.

    The agreement at the heart of the dispute (the Agreement) was a commercial dealership contract between Can-Am and Bhasin. The Agreement’s term was three years and it provided for automatic renewal unless one of the parties gave six months written notice of non-renewal. The contract included an entire agreement clause.

    During the term of the Agreement, Bhasin inquired about Can-Am’s intentions for his agency. By that stage, Can-Am had already decided that Bhasin’s agency must merge with Hrynew’s or be terminated but Can-Am did not respond honestly to Bhasin, but rather "equivocated" as to its intentions.

    Can-Am eventually issued a non-renewal notice to Bhasin pursuant to the Agreement. Bhasin lost his ESP dealership business, and Hrynew eventually hired much of Bhasin’s former salesforce. Bhasin sued Can-Am claiming breach of contract, Hrynew for inducing breach of contract, and both for civil conspiracy.

    Lower Court decisions

    The trial judge found in favor of Bhasin with lengthy reasons. She implied a term of good faith in making renewal decisions under the Agreement based on the notion that the Agreement was analogous to employment and franchise agreements. The focus of her analysis was on the motivations of Can-Am in exercising the non-renewal clause. She determined that Can-Am acted dishonestly and in bad faith in "exercising the non-renewal clause" without a "very good reason". She stated that had Can-Am acted honestly, Bhasin could have "governed himself accordingly so as to retain the value in his agency." Damages were awarded on the basis of a perpetual contract, subject to Bhasin’s expected retirement at 65 and reasonable mitigation. The trial judge also held that Hrynew had intentionally induced the breach of contract and that both Hrynew and Can-Am were liable for an "unlawful means" civil conspiracy.

    The Alberta Court of Appeal overturned the trial judge’s decision, finding she had erred in implying a term of good faith into the Agreement which contradicted both the non-renewal right and the entire agreement clause. It held that Can-Am had a contractual power to terminate on appropriate notice for any reason, thus no actionable breach of contract occurred. Claims in civil conspiracy and inducing breach of contract also fell away. Little attention was paid to dishonesty given the Court of Appeal’s view that Can-Am acted within its rights when terminating the agreement and its clear assumption that all damages flowed from the termination.

    The Supreme Court decision

    Good faith as a general organizing principle

    The SCC considered that good faith is not a free standing enforceable obligation but an "organizing principle" of Canadian contract law from which more specific legal doctrines may be derived. Recognition of a broadly applicable good faith principle was said to bring Canadian common law closer to alignment with the law of Quebec and of the United States, Canada’s largest trading partner. The organizing principle of good faith, according to the SCC, is "that parties generally must perform their contractual duties honestly and reasonably and not capriciously or arbitrarily." It exemplifies the notion that a contracting party should have "appropriate regard to the legitimate contractual interests of the contracting partner."

    The SCC noted that good faith underlies and manifests itself in various more specific common law doctrines within the law of contract, including unconscionability and implied terms. Good faith is also recognized explicitly as an obligation in situations involving contractual discretion and where parties must cooperate in order to achieve the objects of the contract. The SCC was explicit that these doctrines should remain unaffected by Bhasin.

    While endorsing good faith as an organizing principle, the SCC repeatedly emphasized its limits. It was very clear that there is no stand-alone enforceable "duty of good faith" beyond existing situations in which the law has required honesty, candid, forthright or reasonable contractual performance. While the list of such situations is not closed, the SCC noted that any change should be incremental, giving weight to the importance of private ordering and certainty in commercial affairs. Accordingly, claims based on good faith should generally not succeed if not tethered to the existing "body of doctrine that has developed which gives effect to aspects of the good faith organizing principle in particular types of situations and relationships."

    The expansion of the good faith principle is further curtailed by the SCC caveat that its application must be consistent with the fundamental commitment of the common law which generally places "great weight" on the freedom of contracting parties to pursue their individual self-interest, even where that causes loss to a counter party. It cautioned that the principle of good faith must not be used as a basis for "ad hoc judicial moralism or "palm tree" justice," and specifically stated that it should not be used as a pretext for scrutinizing the motives of contracting parties. These statements reflect a clear rejection of subjective approaches to good faith such as that taken by the trial judge.

    The duty of honest contractual performance

    The SCC held that giving effect to the organizing principle of good faith called for the recognition of a new common law duty of honesty in contractual performance. This was hailed as a "modest, incremental" step that reflects the universal expectation of contracting parties.
    The SCC explained the duty of honest performance as follows:

    "This means simply that parties must not lie or otherwise knowingly mislead each other about matters directly linked to the performance of the contract. This does not impose a duty of loyalty or of disclosure or require a party to forego advantages flowing from the contract; it is a simple requirement not to lie or mislead the other party about one’s contractual performance."

    This scope of this duty of honesty would appear to be quite limited. It would prohibit lying and other "active dishonesty," though beyond that, its boundaries are unclear. It is expressly not a duty of loyalty to the other contracting party nor does it require disclosure. It does not require a party to forego advantages flowing from the contract.

    This new duty is a general doctrine of contract law that imposes a minimum standard. It is in this respect analogous to equitable doctrines such as unconscionability. Parties are not free to contract out of the duty of honest performance, although they can influence the scope of it by express terms in their contract which contextualize and inform the standard by which performance is to be measured. Entire agreement clauses are therefore ineffective, at least to this extent.

    Applying the new duty of honest performance to the facts

    It is perhaps unfortunate that the SCC did not have a clearer or more illuminating set of facts with which to apply the new good faith-based duty of honesty in contractual performance. As a result, the practical guidance to be taken from the application of this new duty in Bhasin is limited.

    Despite reciting various facts and findings at trial, the basis for the SCC’s ultimate imposition of liability against Can-Am seems to have been based on only two finding of the trial judge. These are:

    • That Can-Am was not honest with Bhasin with respect to its settled intentions concerning renewal when Bhasin made direct inquiries of it (para 100); and

    • That the dishonesty on the part of Can-Am was "directly and intimately connected to Can-Am’s performance of the agreement" and "its exercise of the non-renewal provision" contained in the Agreement (para 103).

    The SCC’s reliance on these findings, without any further analysis or explanation of them, results in little guidance being provided on how the duty of honesty might apply in future cases. The trial judgment is of little assistance, as it does not even refer to a "direct and intimate connection" between any specific dishonesty and Can-Am’s contractual performance. At no point is the criteria or test for what dishonestly would be "directly and intimately connected to contractual performance" ever set out. The meaning of these words may be a critical issue in future cases.

    Moving to damages, the SCC, again, based relief entirely on two specific findings of the trial judge:

    • Had Can-Am acted honestly when Bhasin inquired of its intentions, Bhasin could have "governed himself accordingly so as to retain the value of his agency" (para 109); and

    • Bhasin’s agency was worth "somewhere around $87,000" (as quoted from the trial judgment, para 414) at the relevant time.

    On the strength of these two findings alone, the SCC accepted causation and the $87,000 figure as an appropriate measure of damage to place Bhasin in the position he would have been in had the contractual breach or breaches not occurred. As with the other trial findings relied upon by the SCC, little background or explanation is provided as to the basis of these findings either by the SCC or at trial. Guidance on damages issues is thus limited.

    Unanswered questions

    Though decided with the objective of increasing certainty and coherence, Bhasin leaves a number of important unanswered questions for future judicial consideration. These include:

    • The SCC indicated that good faith exemplifies the notion that a party should have "appropriate regard for the legitimate contractual interests" of its counter party but did not expand what this entailed. How can parties determine what might qualify as "appropriate regard" or "legitimate contractual interests"?

    • The duty of honesty established is expressly limited to contractual performance. However, it is difficult to see precisely what aspect of "contractual performance" was involved when Can-Am misled Bhasin about its intentions concerning the future of his agency. There is no suggestion of a duty of disclosure in the relevant agreement and the SCC expressly rejected the view that the duty of honesty created a contractual obligation of disclosure. Would the result have been different had Can-Am simply refused to answer the inquiry of Bhasin? More broadly, what qualifies as "contractual performance" to which this new duty of honesty applies?

    • The SCC professed to be relying on the trial judge’s finding that Can-Am’s dishonesty was "directly and intimately" connected to Can-Am’s performance of the agreement but the meaning of this phrase is unclear. What is a "direct and intimate connection" to contractual performance? Is such a connection a legal requirement before relief can be granted?

    • How are parties to draft agreements so as to minimize, or in the words of the SCC, "relax" the requirements of the duty while still respecting its "minimum core requirements"? Would express contractual provisions limiting information disclosure obligations have this impact? Do "entire agreement" clauses have any utility in this respect? Are there other mechanisms available?

    • Can the duty of honesty in contractual performance ever expand beyond prohibition of "active dishonesty" to require disclosure? Will the duty of honesty trace tort law treatment of non-disclosure as amounting to intentional misrepresentation in some circumstances?

    These are some of the questions that businesses, lawyers and judges will be forced to grapple with in the wake of Bhasin. The scope of the uncertainty surrounding these questions may be mitigated by heeding the SCC’s repeated and unequivocal endorsement of a cautious and incremental approach to development of the law in this area, and the values of certainty and predictability in commercial dealings. It remains to be seen if Bhasin will ultimately advance these values or will, unwittingly, undercut them.