Good Faith in Contractual Performance - The Implications of Recent SCC Decisions for the Franchise Relationship

  • March 23, 2021
  • Andrew MacIver, Siskinds

The Supreme Court of Canada recently released two decisions that revisit and clarify the principle of good faith contractual performance previously formulated in Bhasin v. Hrynew.[1] The first decision, C.M. Callow Inc. v. Zollinger,[2] involved a dispute between a property maintenance company (“Callow”), and a group of condominium corporations and their representatives (collectively, “Baycrest”) over the early termination of a winter maintenance contract with a two-year term. The second decision, Wastech Services Ltd. v. Greater Vancouver Sewerage and Drainage District,[3] involved a dispute between a waste transportation and disposal company (“Wastech”) and a statutory company responsible for the administration of waste removal (“Metro”) over the exercise of contractual discretion by Metro resulting in Wastech achieving lower than expected operating revenue. These two cases were heard alongside one another in December 2019, with the decisions being released in December 2020 and February 2021, respectively.

Although neither case involves a franchise relationship, good faith contractual performance, as recognized by the SCC in Bhasin, is a general organizing principal of the common law of contract. Both the duty of honest performance and the duty to exercise discretionary power in good faith encompassed therein are general doctrines of contract law. Accordingly, the law developed by the SCC in this line of cases applies to the contractual relationship between the parties to a franchise agreement. Whether these developments in the common law of contracts render irrelevant the statutory duty of good faith and fair dealing found in the franchise legislation of certain Canadian provinces remains to be seen. For now, the parties to a franchise relationship must be cognizant of these developing common law principles and doctrines in addition to the specific content of the duty of good faith and fair dealing which has developed under franchise statutes. 

C.M. Callow Inc. v. Zollinger

Facts and History

In 2012, the defendant condominium corporations, Baycrest, entered into two new maintenance contracts with Callow – one for summer maintenance and one for winter maintenance. The winter maintenance contract included a clause that permitted Baycrest to terminate the contract unilaterally, without cause, upon giving Callow 10 days’ notice. After the first winter, Baycrest (under the management of a new property manager) was unhappy with the services and held a meeting where the decision was made to exercise the contractual right to terminate the winter services agreement prior to the next winter season. That decision was never communicated to Callow. The following September, Baycrest provided Callow with at least 10 days’ notice that it was terminating the winter services contract for the second winter season of the two-year term. The trial judge found that, between the end of the first winter and when Baycrest provided notice of termination, Baycrest had “actively deceived” Callow by withholding information regarding the decision to terminate the contract and by continuing to represent that the contract was not in danger of termination.[4]

The trial judge found that Baycrest’s deliberate deception was a breach of the duty of honest performance owed to Callow, and awarded damages for one year of winter maintenance services as well as the costs Callow incurred to lease equipment in anticipation of providing the service for the second winter.[5] The Court of Appeal for Ontario subsequently reversed the trial decision, holding that the duty of honesty “does not impose a duty of loyalty or of disclosure or to require a party to forego advantages flowing from the contract.”[6]

The Supreme Court’s Decision

In allowing the appeal and re-instating the damages awarded by the trial judge, a five-judge majority of the SCC[7] affirmed the duty of honest performance as a general organizing principle of contract law and provided additional guidance on what constitutes “active dishonesty” sufficient to trigger a breach of the duty. After affirming the principle from Bhasin that the duty of honest performance means “that parties must not lie or otherwise knowingly mislead each other about matters directly linked to the performance of the contract”,[8] the majority held that the duty goes further than prohibiting outright lies:

At the end of the day, whether or not a party has “knowingly misled” its counterparty is a highly fact-specific determination, and can include lies, half-truths, omissions, and even silence, depending on the circumstances. I stress that this list is not closed; it merely exemplifies that dishonesty or misleading conduct is not confined to direct lies.[9]

In this case, Baycrest’s failure to correct Callow’s clear misapprehension that the winter services contract would not be terminated was held to be dishonesty directly linked to the performance of the contract. The Court held that this amounted to dishonesty within the meaning of the duty of honest performance set out in Bhasin.

Wastech Services Ltd. v. Greater Vancouver Sewerage and Drainage District

Facts and History

The plaintiff, Wastech, and the defendant, Metro, had a longstanding commercial relationship relating to the disposal of waste from the Greater Vancouver Regional District. In 1996, after extensive negotiations, the parties entered into a new waste disposal agreement setting out what the parties described as “an integrated, comprehensive municipal solid waste transfer system . . . and sanitary landfill in a reliable, cost-effective and environmentally-sound manner.”[10]

Pursuant to the contract, Wastech was to transport waste to one of three facilities and would earn different haulage rates based on the proximity of the destination facility – further hauling distances being more profitable. The contract also provided for adjustments to the payments based on whether or not Wastech’s “actual operating ratio” (profit) fell short of or exceeded a “Target Operating Ratio” of 11%. The parties would share in the financial consequences of the “actual operation ratio” varying from the “Target Operation Ratio,” with greater adjustments for greater variances. Although these adjustments provided Wastech with a certain amount of security, the contract gave Metro the sole right to allocate the amount of waste to be hauled to each facility and did not guarantee that Wastech would achieve the “Target Operating Ratio” in any given year.

In 2011, Metro exercised its discretion to direct a greater portion of waste to another closer facility. This resulted in Wastech realizing a negative “actual operating ratio” that, even after adjustments, was well below the “Target Operating Ratio.”

Wastech referred the matter to arbitration on the basis that Metro’s conduct either breached an implied term of the contract or that Metro’s exercise breached a duty of good faith by depriving Wastech of the ability to achieve the “Target Operating Ratio.” The arbitrator accepted the latter submission, holding that “Metro’s conduct show[ed] a lack of appropriate regard for Wastech’s legitimate expectations”, and this justified a finding there had been a breach of a duty of good faith.[11]

On appeal, the Supreme Court of British Columbia set aside the arbitrator’s award on the basis that Metro did not have a duty to have regard for Wastech’s interests with respect to the allocation of waste since the parties had considered and deliberately reject including such a term in the contract.[12] For different reasons, the Court of Appeal for British Columbia agreed with the result reached by the Supreme Court and dismissed a subsequent appeal by Wastech citing four errors of law committed by the arbitrator.

The Supreme Court’s Decision

The SCC unanimously dismissed Wastech’s further appeal and the majority opinion of six of the nine justices took the opportunity to re-visit the duty to exercise contractual discretion in good faith that was expressly recognized, but not defined, by the SCC in Bhasin. The majority provided the following simplified description of the duty:

Stated simply, the duty to exercise contractual discretion in good faith requires the parties to exercise their discretion in a manner consistent with the purposes for which it was granted in the contract, or, in the terminology of the organizing principle in Bhasin, to exercise their discretion reasonably.[13]

In further exploring the duty, the majority further outlined the following principles:

  • To be reasonable, the exercise of discretionary power must be within the range of choices connected to its underlying purpose.[14]
  • What a court considers reasonable is highly context-specific and will depend on what the contract reveals about the intentions of the parties.[15]
  • The range of choices are ascertained with reference to the contract, interpreted as a whole.[16]
  • “Substantial nullification” or “evisceration” of the benefit of the contract to one party is not a mandatory pre-requisite to a finding of a breach of the duty to exercise contractual power in good faith; however, such circumstances are likely relevant to the determination.[17]

Applying these principles to the facts, the SCC found that Metro’s exercise of discretion was reasonable because the contract expressly contemplated a range of choices for Metro and did not provide any  guarantee that Wastech would achieve the “Target Operating Ratio.”

Practical Implications for the Franchise Relationship

Although these decisions do not involve franchises or the duty of good faith and fair dealing imposed by franchise laws in Canada, both decisions have potentially profound implications for franchise relationships. This is particularly true for franchisors, which invariably have expansive rights under their franchise agreements, many of which are discretionary. Some key takeaways include: 

  • The duty of honest contractual performance goes beyond the high bar of outright lying and includes “knowingly misleading”, which may consist of omissions, partial truths and failure to correct.

Franchisors should take particular care not to knowingly mislead franchisees on matters relating to termination and renewal rights. This scenario has the potential to fall squarely within the facts of Callow. Either or both of the statutory duty of good faith and fair dealing or the common law duty could offer protection to franchisees that have been knowingly deceived regarding a pending termination or a decision to refuse renewal, even where a franchisor was exercising a legitimate contractual right. 

All parties to the franchise agreement should take similar caution with respect to the exercise of all rights flowing from the franchise relationship. Other potentially relevant rights may include: site-selection/approval, renovation/upgrade requirements, approval/removal of suppliers, or consent to transfers/assignments. Although franchisees will typically have less rights to “knowingly mislead” about, the duty equally applies to franchisees. 

  • Damages in cases involving a breach of the duty of honest performance will be calculated on principles similar to those that dictate a franchisor’s obligations on statutory rescission of a franchise agreement. 

The findings on damages in Callow are likely to have persuasive authority in cases involving breaches of the duty of good faith and fair dealing under franchise laws. Therefore, the principles underlying the determination of obligations and damages owing on statutory rescission may be a good indicator of how damages may be calculated after a finding that a franchisor has breached the duty of good faith to a franchisee, either under applicable franchise legislation or at common law.

  • Exercise of contractual discretion may amount to a breach of contract even where the express wording of the contract states that the discretion is sole and absolute.

Even where a franchise agreement states that the franchisor has a sole and absolute right to exercise a discretion, these general principles of good faith operate to ensure that exercise is not unreasonable, misleading, or in bad faith. Any contractual discretion should be exercised cautiously.

Although not addressed in the cases discussed herein, including contractual language whereby the parties acknowledge and agree to what constitutes reasonable exercises of the discretion (for example by a list of reasonable exercises) may prove persuasive to courts considering this question after the fact.

  • The purpose for which discretionary power is granted to a party is important in determining whether or not its exercise was reasonable. 

The purpose of any discretionary powers granted in a franchise agreement should be expressly set out to the extent possible. When exercising discretionary powers, parties to a franchise agreement should consider the express purpose of such power and, in absence of an expressly stated purpose, consider what purpose could reasonable be implied from the contract.

 

[1] 2014 SCC 71 (“Bhasin”): https://canlii.ca/t/gf84s

[2] 2020 SCC 45 (“Callow”): https://canlii.ca/t/jc6vt

[3] 2021 SCC 7 (“Wastech”): https://canlii.ca/t/jd1d6

[4] C.M. Callow Inc. v. Tammy Zollinger et al.,2017 ONSC 7095, at para. 65: https://canlii.ca/t/hp00r

[5] Ibid, at para. 22.

[6] C.M. Callow Inc. v. Tammy Zollinger et al., 2018 ONCA 896 at para. 12, citing Bhasin, at para. 73: https://canlii.ca/t/hw0kb

[7] 3 of the 4 remaining justices delivered concurring reasons, with the final justice dissenting.

[8] Bhasin, at para. 73.

[9] Callow, at para. 90.

[10] Wastech, at para 9.

[11] Wastech, at para 9, citing BCICAC Case No. DCA-1560, February 13, 2015 (Gerald W. Ghikas, Q.C.) at para 94.

[12] Greater Vancouver Sewerage and Drainage District v Wastech Services Ltd., 2018 BCSC 605: https://canlii.ca/t/hrjbf

[13] Wastech, at para 63.

[14] Ibid at para 71.

[15] Ibid at para 76.

[16] Ibid at para 75.

[17] Ibid at para 84.

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