Supreme Court of Canada in C.M. Callow inc. V. Zollinger Interprets Duty of Honest Performance in Contracts at the Risk of Commercial Uncertainty

  • January 14, 2021
  • Gabriela Nagy, senior litigation counsel, The Regional Municipality of York

In December 2020, the Supreme Court of Canada has released a much-anticipated decision on the contractual duty of honest performance, which principle the SCC recognized as a “new” good faith doctrine, formulated in its previous decision Bhasin v. Hyrnew[1]. In Callow, the SCC was divided in its views on the duty of honest performance, with a five-judge panel rendering the majority decision, three judges concurring and one strongly dissenting. 

The SCC majority determined that actively or knowingly misleading or deceiving a contracting party will amount to breach of honest performance, even if one exercises seemingly unfettered rights under the contract, such as unconditional termination clauses.  However, in expanding the list of what constitutes misleading actions, and by leaving the list open-ended, Callow will likely generate more litigation as contracting parties are left pondering how they ought to conduct themselves when exercising their contractual rights, particularly when deciding to terminate a contractual relationship.

BACKGROUND

In 2012 a consortium of condominium corporations, collectively referred to as “Baycrest”, entered into a two-year winter services contract with C.M. Callow (“Callow”) from November 2012 to April 2014 and a summer services contract from May 2012 to October 31, 2013.  Over the course of spring and summer 2013, Callow had numerous discussions with Baycrest regarding the renewal of the winter services contract.  Callow was led to believe that Baycrest was satisfied with its performance and that it would get a renewal of the winter contract for another two years.  During the summer of 2013, Callow performed work at no cost, over and above the summer services contract, hoping to incentivize Baycrest to renew the winter contract for another two years.

Unbeknown to Callow, in March 2013, Baycrest’s Board of Directors decided to terminate Callow’s contract as a result of complaints regarding its winter services.  Baycrest did not inform Callow of its decision to terminate the contract until six months later in September 2013, at which time Baycrest relied on clause 9 of the winter services contract which permitted Baycrest to exercise its discretionary powers and terminate for unsatisfactory services, without cause or any other reason, with 10-days’ notice.  Callow sued Baycrest for breach of contract alleging that while Baycrest was entitled to terminate the winter services contract pursuant to the termination clause, Baycrest breached the duty of honest performance by engaging in deceitful conduct prior to the exercise of Baycrest’s discretion to terminate by not telling Callow there were performance issues that jeopardized the existing contract.  Callow criticized the dishonesty that preceded Baycrest’s exercise of its discretionary right to terminate.[2]  Callow claimed damages for lost profits that it would have earned during the second winter season of the contract.

Baycrest argued that its discussions with Callow after March 2013 were pre-contractual negotiations related to the renewal of the winter services contract, which was a “new” contract, to which the duty of honest performance did not apply.[3]

LOWER COURT DECISIONS

The trial judge held that Baycrest breached the duty of honest performance in that Baycrest’s statements and conduct actively deceived Callow, led it to believe that its winter services contract would not be terminated and caused it not to bid on any other contracts.  At trial, Callow was awarded damages in the amount of $64,000 for lost profits, after deduction of expenses that Callow would have incurred, plus the cost of leasing machinery for one year[4], putting Callow in a place it would have been in had the winter contract not been terminated. 

The Court of Appeal set aside the trial decision stating the duty of honest performance did not impose on Baycrest a requirement of disclosure of its intention to terminate, beyond the 10 days’ notice.  Even if Baycrest misled Callow, the deception related to the renewal of the contract or a new contract not yet in existence.  Moreover, Callow knew that its contract could be terminated on 10 days’ notice which was the extent of entitlement it bargained for.[5]  

The narrow issue to be addressed by the SCC was whether Baycrest satisfied its duty of honest performance by not lying or knowingly deceiving Callow about matters linked to the performance of the contract when exercising the termination clause in the manner that it did.[6] The SCC re-instated the trial judge’s decision in finding that the duty of honesty precluded active deception by which Baycrest knowingly misled Callow by leading it to believe that the winter services contract would not be terminated.

The SCC took the opportunity to expand on the duty of honest performance.  The principles underlying the duty of honesty championed by the SCC apply to all contractual rights, beyond a party’s discretionary powers in the exercise of termination rights.

ANALYSIS

The duty of honest performance is a doctrine of contract law, giving rise to breach of contract

The duty of honest performance falls under the overarching doctrine of good faith in contractual dealings.  The duty of honesty sits on the foundation of corrective justice in contracts which entitles parties to expect honesty in their contractual dealings with their counterparts.  In Bhasin, Cromwell J. articulated the duty of honesty as follows: “[the duty of honest performance] requires the parties to be honest with each other in relation to the performance of their contractual obligations”.[7] In Callow, the SCC clarified the duty of honesty as it applies to “both the performance of one’s obligations and to the exercise of one’s rights under the contract.”[8].  These principles explain why the seemingly absolute or unfettered termination right, inserted solely for the benefit of Baycrest in its winter contract with Callow, was nonetheless tempered by the requirement that Baycrest exercise its termination right in good faith as set out in Bhasin.[9]  

In its simplest assertion, Callow stands for the proposition that all contractual rights, including termination rights, must be exercised honestly, as failing to do so would be contrary to the duty of good faith, resulting in breach of contract.[10] 

The breach of honest performance includes actions and inactions that knowingly mislead a party

The dishonest or misleading conduct of a party must be linked directly to the performance of the existing contract.  In the absence of the link, the reach of liability would be unfairly wide cast[11].  The SCC rejected the Court of Appeal’s conclusion that Baycrest could exercise its termination rights on 10 days’ notice without any consequences; and further rejected the argument that Baycrest’s dishonourable conduct was only about a potential future contract, on account of which there could be no contract breach.

The SCC reasoned that the Court of Appeal failed to consider the manner in which Baycrest exercised its termination rights under the current contract.[12]  Baycrest’s active deception of Callow came in the form of active communications such as (1) statements Baycrest’s representatives made to Callow suggesting renewal was likely; (2) private e-mails confirming Baycrest knew Callow had the wrong impression; and (3) “freebies” or work at no cost offered by Callow and accepted by Baycrest.[13]  Throughout these interactions, Baycrest intentionally withheld information from and made false representations to Callow, while anticipating to exercise its termination rights, having already made the decision to terminate Callow’s services some months prior and knowing that Callow laboured under the misapprehension that its contract would be renewed.  The SCC stated that at minimum, Baycrest should have refrained from making false representations in anticipation of the notice period.[14]

The SCC explained the duty of honest performance extends beyond prohibiting outright lies to refraining from “knowingly misleading” a counterparty, which could include half-truths, silence or omission.  One can mislead either through actions, for example by making certain representations to the other, or through inactions, for example by remaining silent or failing to correct a misapprehension that would undermine the other’s interests.[15] 

While the obligation to refrain from telling lies is an easily understood one, the proposition that a party’s silence or omission to speak up could lead to breach of contract is more controversial as it leaves room for debate about when silence is permissible.  The SCC’s view that Baycrest’s deliberate silence - knowing that Callow had drawn the mistaken inference - amounted to breach of contract, has raised the imperative question of when and in what context can silence get one into trouble.  This is particularly problematic considering the Court’s affirmation of its position in Bhasin that the duty of honesty does not impose a positive duty of disclosure of information or intentions to a counterparty that would require the party to subordinate its interests to the counterparty.[16] 

How are we to reconcile the view that on the one hand, there is no duty to disclose intentions before the exercise of an absolute right (i.e. termination), which equates to permissible silence; while on the other hand, some forms of silence could land one in hot water.  In Callow, Cote J., as the only dissenting judge, has raised this concern by asking “at what point [does] a permissible silence turn into a non-permissible silence”?[17] Inevitably, the fine line between “mere silence” and other types of silence will create disputes among parties which will invite judicial scrutiny to when silence crosses over into breach of duty.  Furthermore, given that misleading actions can be highly fact-driven, it is almost certain that this is not the last time we hear the SCC comment on what exemplifies dishonest acts. 

The duty of honest performance was meant to inject commercial certainty in the contracting parties’ dealings.  The issue of when one’s silence or omission to speak or act amounts to acts misleading a counterparty will certainly bring about some unintended commercial uncertainty the duty seeks to avoid; and with it, the prospect of litigation.

In broad strokes, we can conclude that silence or omission and possibly, any other activity, will breach the duty of honesty, if it actively misleads or deceives the contracting party in relation to the performance of the contract.  A party will be held liable even if it did not intend for the plaintiff to rely on the misleading act.  All that a plaintiff needs to prove is that, but for its reliance on the misleading act, it would not have sustained the loss.[18]  

CONCLUSION

In summary, the three take-aways that must inform a party’s decision when exercising its contractual rights are as follows:

  • To avoid a breach of contract arising out of a breach of the duty of honest performance, a party should focus on the manner in which it exercises its rights, not on whether the right can be exercised: i.e. is the act misleading or deceitful?
  • While there is no free-standing duty to disclose information or intentions to a contracting party about whether one intends to exercise one’s rights under a contract - to the detriment of one’s interests and the un-bargained for benefit of a counterparty - a party nonetheless must correct any known misapprehension on the part of a counterparty, if the party’s actions would mislead or deceive the counterparty.
  • A breach of duty of honesty will give rise to contract damages in the form of expectation damages which entitle a wronged party to be placed in the same position as if the breach had not occurred.
 

[1] Bhasin v. Hyrnew 2014 SCC 71 (CanLII), [2014] 3 S.C.R. 494

[2] Callow, supra note 1, at para. 32 and 138

[3] Ibid, at para. 34

[4] Ibid, at para. 119

[5] Ibid, at para. 25 to 29

[6] Ibid, at para. 31

[8] Callow, supra note 1, at para. 42.

[9] Ibid, at para. 83. 

[10] Ibid, at para. 48. 

[11] Ibid, at 49.

[12] Ibid, at para. 64.

[13] Ibid, at para 95.

[14] Ibid, at para. 104

[15] Ibid, at para 90.

[16] Bhasin, supra note 2, at para. 86 and 87

[17] Callow, supra note 1, at para. 197 (Cote J. dissenting)

[18] Ibid, at para. 146

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