The Duty Good Faith in Contractual Discretionary Powers – Dominus/Cityzen Brampton SWQRP Inc. v. The Corporation of the City of Brampton

The Ontario Superior Court of Justice (the “Court”) recently dealt with the question of what constitutes a breach of the duty of good faith contractual performance in the context of a construction contract. In Dominus/Cityzen Brampton SWQRP Inc. v. The Corporation of the City of Brampton, 2020 ONSC 5806 (“Dominus”), the Court held that the City of Brampton’s failure to consent to significant reduction in the amount of a security deposit when much of the contracted work had been completed because of a third party dispute amounted to a breach of the general (and in this case contractual) duty to act reasonably and in good faith in the exercise of contractual discretion.

While decided in 2020, the Court’s decision in Dominus remains consistent with the Supreme Court of Canada’s (the “SCC”) more recent decision in Greater Vancouver Sewerage and Drainage District v. Wastech Services Ltd., 2021 SCC 7 (“Wastech”),[1]Wastech Services Ltd. v. Greater Vancouver Sewerage and Drainage District, 2021 SCC 7 [Wastech]. and provides a useful, construction-specific example of when a party is found to be exercising their discretion unreasonably and therefore contrary to the duty of good faith. In short, refusing (or choosing) to exercise contractual discretion based on an overly rigid interpretation is unreasonable and contrary to the duty of good faith.

Good Faith Principle and Discretionary Contractual Clauses

As outlined below, the general organizing principle of good faith contractual performance was first recognized by the SCC in Bhasin v. Hrynew, 2014 SCC 71 (“Bhasin”).[2]Bhasin v. Hrynew, 2014 SCC 71, at para. 63. The organizing principle underlies and manifests various other more specific doctrines governing contractual performance. One such specific doctrine, as identified in Bhasin, is the duty of good faith performance in exercising contractual discretion. Despite being decided before the SCC’s more recent decision in Wastech, the Court in Dominus provides some useful and detailed commentary regarding the exercise of such discretion.

In Wastech, the SCC held that the duty to exercise contractual discretion in good faith requires that a party exercise their discretionary powers reasonably.[3]Wastech at para. 67. Reasonableness is determined based on the purpose for which the discretionary powers were granted under the contract;[4]Ibid, at para. 88. an unreasonable exercise of discretion is one which is unconnected to the contractual purpose and is a breach of the duty of good faith.[5]Ibid, at para. 75. In Wastech, the Greater Vancouver Sewerage and Drainage District (“Metro”) was in a long-term contract for the removal and transportation of waste by Wastech Services Ltd. The contract gave Metro the discretion to choose which site to send the waste to and Wastech’s rate was dependent on the distance the waste was transported. Metro exercised their discretion by choosing the closer site, resulting in Wastech earning less revenue. Contrary to the ruling of the arbitrator, the SCC determined that the contract did not require Metro to use its discretion to ensure Wastech reached its target operating ratio in any given year. As such Metro, was not in breach of the duty of good faith because their exercise of discretion was connected to the purpose of the contract and was therefore reasonable.[6]Ibid, at para. 100.

Summary of the Decision

Facts

Dominus CityZen Brampton SWQRP Inc. (“Dominus”), the developer, was contracted by the City of Brampton (the “City”) to complete an expansion of the Brampton City Hall. Dominus and the City entered into a Site Plant Agreement (the “SPA”) pursuant to the Planning Act.[7]Planning Act, R.S.O. 1990, c. P.13. Under the SPA, the City had two roles: first as the owner of the lands and occupier of the City Hall constructed thereon, and second as the regulator acting on behalf of the community and public interests that are protected by the SPA. The Court was ultimately tasked with the interpretation of a security deposit provision of the SPA. Dominus was required by the SPA to post a deposit of $646,510.00 (the “Security Deposit”) as a performance guarantee for the estimated cost of all works required to be completed as part of the City Hall project.

Section 15 of the SPA provided that Dominus may, “from time to time, apply to the [City] for a reduction in the amount of the security by an amount up to ninety per cent (90%) of the value of the works for which security was deposited […]”.[8]Dominus/Cityzen Brampton SWQRP Inc. v. The Corporation of the City of Brampton, 2020 ONSC 5806 at para. 26 [Dominus].

Further, section 29 of the SPA contained a provision requiring the parties to act reasonably and in good faith:

Where approval or consent is required hereunder, such approval or consent shall not be unreasonably withheld. Where something is required to be done hereunder to the satisfaction of or in the discretion or opinion of a party or official thereof, such party or official shall act reasonably in exercising such satisfaction, discretion or opinion.[9]Ibid, at para. 30.

Dominus completed the redevelopment of the City Hall with the exception of two relatively minor items: a trench drain and a wooden privacy fence. Dominus took the position that it was unable to complete the two remaining items because of an ongoing suit that the owners of the neighboring properties had commenced against the City and Dominus for nuisance and trespass, claiming damages in excess of $2MM. Dominus requested that a portion of the Security Deposit be returned in amounts relative to the value of the work completed. However, the City denied Dominus’ request for two reasons:

  1. Under the City’s interpretation of the SPA, all work must be completed before any release of funds would be considered or made;[10]Ibid, at paras. 6 and 8. and,
  2. Because of the presence of an indemnity provision contained in the SPA, under which the City was claiming a right to set-off the indemnity claims against the Security Deposit[11]Ibid, at para. 6.
Issues and Decision

In considering the parties’ submissions and arguments, the Court distilled the dispute into six key questions.[12]Ibid, at para. 32. For the purposes of this blog post, we will focus on four of those questions:

  1. Does the SPA Allow for a Partial Reduction of the Security for Completed Works When Some Remain Outstanding?
  2. Was the City in breach of the SPA or any independent duty of good faith, or did it act unreasonably or in bad faith, by refusing to consider this request and/or for refusing to reduce the Security Deposit?
  3. Did the Security Deposit cover, or could it be set-off against, the City’s right to claim indemnity?
  4. If the entitlement to a reduction or refund is established, how much of the Security Deposit is Dominus entitled to receive?

Ultimately, the Court found the City’s refusal to release or reduce the Security Deposit was not reasonable in the circumstances and was contrary to the organizing principle of good faith in the performance of contracts, including under the specific terms of the SPA. Further, the Court held that the SPA did not give rise to any right of set-off against the Security Deposit, and ordered that the City release $596,510.00 plus pre-judgement interest.[13]Ibid, at para. 78.

Analysis

In the result, the OSC found that a proper interpretation of the SPA based on the principles of contractual interpretation would allow for a partial reduction in the Security Deposit, as sought by Dominus.[14]Ibid, at para. 38. The Court held that the City’s interpretation of the SPA was too rigid and therefore unreasonable,[15]Ibid, at paras. 41 and 51. holding that the SPA did not link the Security Deposit to the indemnity provisions, nor did it expressly allow for setting-off of other claims against the Security Deposit.[16]Ibid, at para. 72. Therefore, the presence of the indemnity clause was held to be not relevant to the City’s determination of whether the deposit should be reduced or released, such that its refusal to do same was in breach of its general and contractual good faith obligations.[17]Ibid, at para. 72.

Did the SPA Allow for a Partial Reduction of the Security for Completed Works When Some Remain Outstanding?

The Court found that on a proper, contextual and purposeful interpretation of the SPA that a partial reduction of the Security Deposit for completed works was available even when some works remained outstanding.[18]Ibid, at para. 7. The City argued that in their role as a regulator and holder of public funds they were entitled to insist on strict adherence to the requirements of the SPA because of the recognized overarching planning and public interest objectives of the SPA.[19]Ibid, at para. 50. However, the Court determined that interpreting the SPA to allow for a partial reduction of the Security Deposit did not undermine the public interest or planning objectives associated with the SPA; instead, the Court held that such an interpretation “reflects an appropriate balance between the commercial realities of a significant contract such as this and the objective of securing the completion of the remaining outstanding works in furtherance of the planning objectives embodied in the SPA.”[20]Ibid, at para. 40.

The Court reached the following conclusions regarding the proper interpretation of section 15 of the SPA:

Section 15.3 explicitly provides that Dominus may, from time to time, apply to the City for a reduction in the amount of the security by an amount up to ninety per cent (90%) of the value of the works for which security was deposited. The contemplation of applications from time to time suggests that more then one request may be made and considered before the 90% cap is reached.[21]Ibid, at para. 38.

It makes common and commercial sense that these applications, from time to time, would correspond with the completion of certain works for which the certification requirements have been met to enable a partial release of the security deposit. Section 8 requires an engineering certificate prior to any reduction in security posted for public works purposes or occupancy of the building and section 13.5 requires an architect’s certificate prior to the release of any landscaping securities. The City emphasizes the word “any” in these provisions and says that it should be read as prohibiting “any” reduction in or release of security until all of the works have been completed. The word “any” could be equally read to be referring to any one of a number of potential requests for reductions or releases of the security. Reading the word “any” in this way is harmonious with the contemplation in section 15 that there may be releases or reductions to the security from time to time, for completed works that have received the necessary certifications.[22]Ibid, at para. 39. [emphasis added]

Ultimately, the Court found that the City’s interpretation of the SPA, namely that it did not allow for any opportunity for Dominus to apply for and potentially receive a reduction in the Security Deposit until all work was completed, “is too rigid an interpretation and application of the SPA.”[23]Ibid, at para. 41.

Was the City in breach of the SPA or any independent duty of good faith, or did it act unreasonably or in bad faith, by refusing to consider this request and/or for refusing to reduce the security deposit?

In addressing the issue of good faith, the Court cited Bhasin for the following general proposition regarding the duty of good faith in contractual discretion: “Failing to exercise contractual discretion without any reasonable justification is contrary the common law good faith principles in the performance of a contract.”[24]Ibid, at para. 27.

The City made three main arguments as to why they had reasonable justification for their failure to exercise the discretion granted to them under the SPA:

  1. Based on the overarching planning and public interest objectives of the SPA, they could insist on strict compliance with the SPA, such that all work must be completed before a reduction is to be considered;
  2. The general language in section 21.5 of the SPA, “together with all other applicable provisions of the SPA” gave the City discretion to withhold the Security Deposit until all incomplete works had been completed; and
  3. The existence of the third party tort claim triggered an indemnity by Dominus to the City.

The Court rejected the three justifications provided by the City and found that they were unreasonable for the following reasons.

In response to the first justification, the Court found that the reasonableness of this justification is dependent upon whether the SPA allowed for a partial reduction in the Security Deposit.[25]Ibid, at para. 50. As summarized above, the Court found that the City’s interpretation of the SPA was unreasonable, and therefore overarching planning and public interest objectives of the SPA did not give rise to a reasonable justification.[26]Ibid, at para. 51.

In response to the second justification, the Court determined that the City’s interpretation of section 21.5 of the SPA as “granting unfettered discretion to say no to a reduction of the Security Deposit as long as any of the works remain incomplete” was also incorrect.[27]Ibid, at para. 53. Under section 21.5 of the SPA, Dominus acknowledged that the City would not be required to reduce or release the Security Deposit until it was satisfied that Dominus had: (i) complied with the Construction Lien Act;[28]Construction Lien Act, RSO 1990, c C-30 (now the Construction Act, RSO 1990, c C-30). (ii) paid and discharged any and all liens under same; and (iii) indemnified the City for any claims arising out of a failure to comply with the Construction Lien Act. Based on contractual interpretation principles, the Court reiterated that a general phrase “must be read to be qualified by the sections identified immediately before it.”[29]Dominus, at para. 53. Therefore, the Court held that the general phrase in section 21.5 only applied to the specific lien claims contemplated in the sections regarding the Construction Lien Act, and did not provide the City with a general unfettered discretion to reject Dominus’ request.[30]Ibid.

In response to the third justification, the Court found that “the security deposit does not apply to the tort claims, nor has the City even made an indemnity claim against Dominus in respect of the tort claims.”[31]Ibid, at para. 58. Therefore, the existence of the third party tort claim did not provide the City with a reasonable justification to refuse or reduce the Security Deposit. This issue is discussed further below.

Ultimately, the Court concluded:

The City has, in this case, fettered the exercise of its discretion by too narrow an interpretation of the SPA (that unless all works are complete, nothing will be returned) and extraneous and irrelevant self-serving considerations (as security that was not contracted for or a set off for a contingent indemnity claim in tort). The City’s refusal to release or reduce the security deposit is not reasonable in the circumstances and is contrary to the organizing principle of good faith in the performance of contracts and section 29 of the SPA.[32]Ibid, at para. 32. [emphasis added]

Did the security deposit cover, or could it be set-off against, the City’s right to claim indemnity?

Pursuant to the indemnity provision contained in section 20 of the SPA, Dominus agreed to indemnify the City for all actions arising based on Dominus’ performance of the contract.[33]Ibid, at para. 66. However, the Court found that the SPA did not link the Security Deposit to the indemnity provision, noting that the SPA clearly “earmarked” the Security Deposit only to secure the cost of the work Dominus undertook to complete.[34]Ibid.

The City also claimed that it was able to retain the Security Deposit based on a right of set-off. However, the Court noted that the parties did not make substantial submission in this respect. Nonetheless, the Court identified two somewhat tenuous instances that a right to set-off could exist, but which ultimately did not.[35]Ibid, at para. 72. First, for a potential contingent indemnity claim against Dominus in respect of the tort claims.[36]Ibid, at paras 69 and 70. However, the capacity in which the City was being sued in the tort claim and the capacity that the City had entered into the SPA (i.e. their two roles) may affect this right of set-off.[37]Ibid. Second, the uncertain costs to access the neighboring land could result in a contractual claim under section 15.2, however the Court determined that such an interpretation would be a stretch of the indemnity language.[38]Ibid, at para. 71.

If the entitlement to a reduction or refund is established, how much of the security deposit is Dominus entitled to receive?

Having found that the SPA allowed Dominus to be eligible for a possible reduction in the Security Deposit and that the City was in breach of the SPA for failing to exercise their discretion regarding same, the Court determined that Dominus was entitled to a receive a portion of the Security Deposit referable to the completed works.[39]Ibid, at para. 73.

Pursuant to section 15.4 of the SPA, Dominus was eligible to receive up to 90% of the value of the completed works until the two-year warranty lapsed.[40]Ibid, at para. 74. Given that five years had elapsed, the Court determined that Dominus would receive 100% of the Security Deposit, minus the value of the anticipated costs of the two uncompleted items.[41]Ibid. Evidence was given regarding the estimated value of that uncompleted work to be $10,000.00. The Court then multiplied this number by four to allow for a significant buffer given the uncertainty surrounding the additional costs associated with completing the outstanding work. Therefore, the reasonable estimation of the outstanding work, which included a reasonable holdback for uncertain additional costs associated with such work, was held to be $50,000.00.[42]Ibid, at para. 75. As such, the Court ordered the City to release $596,510.00 ($646,510.00 less $50,000.00) of the Security Deposit to Dominus.[43]Ibid, at para. 78.

References

References
↑1 Wastech Services Ltd. v. Greater Vancouver Sewerage and Drainage District, 2021 SCC 7 [Wastech].
↑2 Bhasin v. Hrynew, 2014 SCC 71, at para. 63.
↑3 Wastech at para. 67.
↑4 Ibid, at para. 88.
↑5 Ibid, at para. 75.
↑6 Ibid, at para. 100.
↑7 Planning Act, R.S.O. 1990, c. P.13.
↑8 Dominus/Cityzen Brampton SWQRP Inc. v. The Corporation of the City of Brampton, 2020 ONSC 5806 at para. 26 [Dominus].
↑9 Ibid, at para. 30.
↑10 Ibid, at paras. 6 and 8.
↑11 Ibid, at para. 6.
↑12 Ibid, at para. 32.
↑13 Ibid, at para. 78.
↑14 Ibid, at para. 38.
↑15 Ibid, at paras. 41 and 51.
↑16 Ibid, at para. 72.
↑17 Ibid, at para. 72.
↑18 Ibid, at para. 7.
↑19 Ibid, at para. 50.
↑20 Ibid, at para. 40.
↑21 Ibid, at para. 38.
↑22 Ibid, at para. 39.
↑23 Ibid, at para. 41.
↑24 Ibid, at para. 27.
↑25 Ibid, at para. 50.
↑26 Ibid, at para. 51.
↑27 Ibid, at para. 53.
↑28 Construction Lien Act, RSO 1990, c C-30 (now the Construction Act, RSO 1990, c C-30).
↑29 Dominus, at para. 53.
↑30 Ibid.
↑31 Ibid, at para. 58.
↑32 Ibid, at para. 32.
↑33 Ibid, at para. 66.
↑34 Ibid.
↑35 Ibid, at para. 72.
↑36 Ibid, at paras 69 and 70.
↑37 Ibid.
↑38 Ibid, at para. 71.
↑39 Ibid, at para. 73.
↑40 Ibid, at para. 74.
↑41 Ibid.
↑42 Ibid, at para. 75.
↑43 Ibid, at para. 78.

Evaluation Breached Tender Conditions: Alberta Queen’s Bench Court

You would think that the owner would get one thing right before issuing an invitation for tenders: its standard for evaluating the tenders.

Yet, in Elan Construction Limited v South Fish Creek Recreational Association, the Alberta Court of Queen’s Bench recently found that the owner’s tender evaluation criteria were unfair and did not reflect the terms of the tender, and awarded nominal damages to the unsuccessful bidder. The decision is a good checklist for owners in establishing tender evaluation standards.

Background

In July 2010, the South Fish Creek Recreational Association (“SFCRA”), issued an invitation for tenders for the construction, as additions to its existing recreational facilities, of two ice surfaces and multi-purpose rooms and other spaces. Elan was a pre-qualified bidder and filed a bid.

The published evaluation matrix provided for a maximum of 100 points and contained the following elements: Price, 35 points; Date of completion, 35 points; Previous community and arena experience, 20 points; References, 10 points.

Elan was not awarded the contract and sued for damages. The trial judge found the following with respect to the bid criteria:

Price: Elan’s bid was the lowest by $400,000.

Completion Date:  The Invitation to Bid stated that SFCRA wanted the Project to be substantially completed by August 1, 2011, with that date highlighted in bold. The Instructions to Bidders contained a liquidated damages clause providing for liquidated damages in the event of late completion in the amount of $15,000 per day, later reduced to $3,000 per day.

Elan’s bid provided for substantial completion by August 1, 2011 and completion of deficiencies by August 15, 2011. The successful bidder’s completion date was August 31, 2011.

The adjudicator did not use August 1, 2011 as the relevant date. Instead, he took the average of the completion dates of certain, but not all, of the bidding contractors considered most relevant, arriving at a completion date of September 5, 2011; and then awarded bidders points out of 30 based on their proximity to that notional date. As a result, Elan received 25 points for its on–time date of August 1, 2011 for substantial completion, while the successful bidder received 34 points for its later substantial completion date of August 31, 2011.

The evaluator used the same approach to deal with the estimated time to complete deficiencies, arriving at an average figure of 45 days after his notional completion date of September 5, 2011. As a result, Elan received zero points for its 14 day estimate while the successful bidder received four points for its longer 30 day projection.

LEED: Leadership in Energy and Environmental Design (“LEED”) experience was used as a factor in the evaluation criteria factor, but there was no indication in the Bid Documents to this effect.

Court’s Decision

The Court of Queen’s Bench found that on various accounts the evaluation factors used by the owner had not been disclosed in the bid documentation, and therefore the owner breached the implied duty of fairness inherent in the tender process. Here are the reasons of the court on some of the factors:

Substantial Completion Date

“Mr. Quinn’s methodology, as described above, created an arbitrary standard that could not have been within the contemplation of the bidders. His testimony as to his method and rationale served only to underscore the arbitrary nature of his evaluation. Moreover, his approach created, in my view, the kind of undisclosed evaluation criterion that the Supreme Court of Canada has said constitutes a breach of Contract A.”

Experience

“….SFCRA’s approach to evaluating the relative experience of the bidders cumulatively amounted to breach of the Bid Contract….While I agree that it would not be unreasonable for SFCRA to put greater emphasis on arena experience given the nature of the Project, in my view, that emphasis should have been disclosed in the Bid Documents…..an explicit preference for such experience could and should have been indicated in the Bid Documents….”

Other undisclosed criteria

“I find that other undisclosed criteria influenced SFCRA’s assessment of the bidders’ experience. ….any consideration of LEED in the assessment of experience…..should have been brought to the attention of bidders….Similarly, while interviewing candidates may be useful and may fall within SFCRA’s right to seek further information, bidders should have been made aware that interviews were a possibility. Further, Elan should not have been forced into the position of attending an important interview without key employees who were designated to work on the Project. In my view, both the use of interviews and the process by which they are conducted must be fair to all bidders.

In its analysis the court referred to the recent decision of the Supreme Court of Canada in Bhasin v Hrynew. In that decision, the Supreme Court held that there is a duty to perform contracts honestly. Applying that principle, the Court of Queen’s Bench said:

“I hasten to add that there is no suggestion that SFCRA acted dishonestly or with malice. Nevertheless, as the Supreme Court of Canada held in Bhasin, a duty of good faith may require more than honesty. Where a bid evaluation has been conducted in an arbitrary manner or on the basis of undisclosed criteria, that is sufficient to constitute breach.

The court concluded that, absent the owner’s breaches of contract, Elan would have been the successful bidder.

In assessing damages, the court held that either the cost of preparing the bid, or the lost profit on the construction contract that would have been awarded to Elan, is the proper measure of damages, but not both. In assessing damages under the second approach the court reduced Elan’s claim:

  1. because Elan had, in the court’s view and based on the next lowest tender, underestimated the subcontracts. On this account Elan’s claim should be reduced by $185,000, from $704,908 to $519,908
  2. because the contractor who was actually awarded the contract was anticipating a $300,000 profit and made a loss of $600,000, and Elan would likely have encountered a similar experience. Accordingly, Elan’s claim should be reduced from $519,908 to nominal damages of $1,000.

Having awarded damages based upon loss of profit, the court said that no damages could be awarded for the cost of preparing the bid, and in any event no proof of that cost had been provided.

Discussion

This decision is a good illustration of two perils relating to claims for breach of an invitation to tender, and the “smell tests” which the court will likely apply in the course of litigation over a tender.

First, a court will be very unsympathetic to an owner that has not prepared and applied tender evaluation criteria that fairly reflects the bid conditions. There is really no excuse for an owner applying criteria that do not accurately reflect the bid conditions which it has itself prepared and published. Interestingly, the court used the concept of “honest performance” of a contract, enunciated in the Bhasin case, to judge the owner’s performance of its obligations under the invitation to tender.

Second, the court will carefully scrutinize the bidder’s claim for damages. The court may well think: “Well, this contractor was fortunate not to have won that contract!”

Elan Construction Limited v South Fish Creek Recreational Association, 2015 ABQB 330

Construction law – tenders- Contract A/Contract B – honest performance – damages

Thomas G. Heintzman O.C., Q.C.,  FCIArb                                                      December 20, 2015

www.heintzmanadr.com

www.constructionlawcanada.com

What Is An “Organizing Principle”, a “Duty” And A “Term” Of A Contract?”

In the last two articles I have been considering the recent decision of the Supreme Court of Canada in Bhasin v. Hrynew. In its decision, the Supreme Court of Canada established two fundamental principles for the Canadian common law of contract.

First, it is an “organizing principle” of contract law that the parties must perform the contract in good faith.

Second, the parties have a duty to act honestly in the performance of contracts.

In its decision the Supreme Court said that this “organizing principle” and “duty” are not “terms“of the contract, so the parties cannot contract out of them. Yet, the court found that the defendant had breached the contract by acting dishonestly. How could the defendant breach the contract if this obligation or duty are not terms of the contract?

Background

A reminder about the facts which were found by the trial judge. Bhasin and Hrynew were both retail dealers who marketed education savings plans developed by Canadian American Financial Corp. (“Can-Am”). Bhasin’s agreement with Can-Am was for a term of three years and automatically renewed unless one of the parties gave six months’ notice of termination.

Hrynew was a competitor of Bhasin and wanted to take over Bhasin’s agency. He campaigned with Can-Am to direct such a merger of the agencies. Can-Am had discussions with the Alberta Securities Commission about restructuring its agencies. Can-Am did not tell Bhasin about these discussions. Can-Am repeatedly misled B about its future plans for its agencies. Can-Am gave notice of non-renewal of the agreement. As a consequence, Bhasin lost his business and his workforce went to work for Hrynew. Bhasin sued Can-Am and Hrynew.

The trial judge held that a term of good faith performance should be implied based on the intentions of the parties in order to give business efficacy to the agreement. The trial judge found that Can-Am had breached that implied term in its contract with Bhasin. He found that Can-Am had dealt dishonestly with Bhasin.

The Supreme Court of Canada restored the trial judge’s finding that Can-Am had breached its contract with Bhasin by dealing with him dishonestly.

Decision of the Supreme Court relating to Organizing Principles and Terms of the Contact

Speaking for a unanimous court, Justice Cromwell stated the following propositions:

“…good faith contractual performance is a general organizing principle of the common law of contract which underpins and informs the various rules in which the common law, in various situations and types of relationships, recognizes obligations of good faith contractual performance. …a further manifestation of this organizing principle of good faith…is a common law duty which applies to all contracts to act honestly in the performance of contractual obligations.” (underlining added)

The Supreme Court explained what it meant by “an organizing principle.” Such a principle “states in general terms a requirement of justice from which more specific legal doctrines may be derived. An organizing principle therefore is not a free-standing rule, but rather a standard that underpins and is manifested in more specific legal doctrines and may be given different weight in different situations.”

Having recognized the organizing principle of good faith performance of contracts, Justice Cromwell held that the court should now recognize a contractual duty of honest performance:

“I would hold that there is a general duty of honesty in contractual performance. 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. Recognizing a duty of honest performance flowing directly from the common law organizing principle of good faith is a modest, incremental step.”

Justice Cromwell then summarized the position:

“(1) There is a general organizing principle of good faith that underlies many facets of contract law.

(2) In general, the particular implications of the broad principle for particular cases are determined by resorting to the body of doctrine that has developed which gives effect to aspects of that principle in particular types of situations and relationships.

(3) It is appropriate to recognize a new common law duty that applies to all contracts as a manifestation of the general organizing principle of good faith: a duty of honest performance, which requires the parties to be honest with each other in relation to the performance of their contractual obligations.” (underlining added)

Justice Cromwell then discussed the nature of these duties and organizing principles. He held that:

“a new duty of honest performance….should not be thought of as an implied term, but a general doctrine of contract law that imposes as a contractual duty a minimum standard of honest contractual performance. It operates irrespective of the intentions of the parties, and is to this extent analogous to equitable doctrines which impose limits on the freedom of contract, such as the doctrine of unconscionability.”

He then noted that;

“There is a longstanding debate about whether the duty of good faith arises as a term implied as a matter of fact or a term implied by law… I do not have to resolve this debate fully, which…casts a shadow of uncertainty over a good deal of the jurisprudence.  I am at this point concerned only with a new duty of honest performance and, as I see it, this should not be thought of as an implied term, but a general doctrine of contract law that imposes as a contractual duty a minimum standard of honest contractual performance. It operates irrespective of the intentions of the parties……. Viewed in this way, the entire agreement clause in cl. 11.2 of the Agreement is not an impediment to the duty arising in this case. Because the duty of honesty in contractual performance is a general doctrine of contract law that applies to all contracts, like unconscionability, the parties are not free to exclude it.” (underlining added)

In any event, he concluded that since “the duty of honest performance interferes very little with freedom of contract, since parties will rarely expect that their contracts permit dishonest performance of their obligations.” However, Justice Cromwell did not discount the possibility that the parties might try to limit their obligations of good faith and honesty. He said:

“I would not rule out any role for the agreement of the parties in influencing the scope of honest performance in a particular context. The precise content of honest performance will vary with context and the parties should be free in some contexts to relax the requirements of the doctrine so long as they respect its minimum core requirements.”

When it came time to apply these principles to the actual facts, Justice Cromwell found that “Can-Am breached its duty to perform the Agreement honestly.” He concluded that:

“this dishonesty on the part of Can-Am was directly and intimately connected to Can-Am’s performance of the Agreement with Mr. Bhasin and its exercise of the non-renewal provision. I conclude that Can-Am breached the 1998 Agreement when it failed to act honestly with Mr. Bhasin in exercising the non-renewal clause.”

Discussion

This decision leaves us asking a number of questions:

Did Can-Am breach a term of the contract? If it didn’t, how could it be in breach of the contract? If it did, what term did it breach?

Is the “organizing principle” of good faith performance a term of the contract?

Is the duty of honest performance a term of the contract?

The answer to the last two questions seems to be No. The Supreme Court differentiated between an “organizing principle” and a duty and a term. It held that good faith performance fell into the first category, an organizing principle. It held that honesty fell into the second category, a duty. It held that neither the “organizing principle” of good faith nor the ”duty” of honest performance amounted to a term, with the result that the parties cannot contract out of them and the entire agreements clause does not apply to them.

If that is so, it is hard to see how a breach of these non-terms can amount to a breach of the contract. In addition, how should drafters of contracts deal with these non-terms? The parties may want to define what is permissible conduct so that no argument can be made that it is in bad faith or dishonest. While Justice Cromwell said that the parties are entitled to “relax the requirements of the doctrine” of honest performance as long as they respect the “core requirements” of the doctrine, how do they do so since these concepts are, according to the Supreme Court, not part of the contract? Will the terms that the parties write into the contract be effective, and to what degree?

The concept of “organizing principles” has been adopted by the Supreme Court in various areas of the law. For instance, it has been used by that court in the law relating to conflict of laws, criminal law, constitutional law and employment law. But contract law is very different from those areas of law because, in their contract, the parties can make their own law and contract out of other legal principles, unless precluded by some principle of law from doing so.

In those other areas of law, there has been a tension between “organizing principles” and the substantive law. In the Provincial Judges’ Reference (1997), Chief Justice Lamer noted that the preamble to the Constitution Act, 1867 “recognizes and affirms the basic principles which are the very source of the substantive provisions of the Constitution Act, 1867.” He continued:

“although the preamble is clearly part of the Constitution, it is equally clear that it has no enacting force…In other words, strictly speaking, it is not a source of positive law, in contrast to the provisions which follow it. …But the preamble does have important legal effects. Under normal circumstances, preambles can be used to identify the purpose of a statute, and also as an aid to construing ambiguous statutory language…. The preamble to the Constitution Act, 1867, certainly operates in this fashion. However, in my view, it goes even further……It recognizes and affirms the basic principles which are the very source of the substantive provisions of the Constitution Act, 1867. As I have said above, those provisions merely elaborate those organizing principles in the institutional apparatus they create or contemplate. As such, the preamble is not only a key to construing the express provisions of the Constitution Act, 1867, but also invites the use of those organizing principles to fill out gaps in the express terms of the constitutional scheme. It is the means by which the underlying logic of the Act can be given the force of law.” (underlining added)

If the “organizing principles” of contract law are of this nature, can a breach of them amount to a breach of contract?

A further question arises. Does the decision in Bhasin v. Hrynew re-introduce, in one form or another, the doctrine of fundamental term or fundamental breach that the Supreme Court of Canada discarded in the Tercon v. British Columbia decision (2010)? Is the Supreme Court saying in Bhasin v. Hrynew that there are some core elements of contractual conduct –now defined more by morality than by the terms of the contract – which the parties cannot contract out of?

Bhasin v. Hrynew, 2014 SCC 71

Building Contract – Performance – Good Faith –  Honest Performance

Thomas G. Heintzman O.C., Q.C., FCIArb                                        December 20, 2014

tgh@heintzmanadr.com

constructionlawcanada.com

 

 

 

The Supreme Court Of Canada Avoids The Open Windows Issue

In my last article, I dealt with the recent decision of the Supreme Court of Canada in Bhasin v. Hrynew. In that decision, the Supreme Court of Canada established two fundamental principles for the Canadian common law of contract:

First, that the parties are under a general obligation to perform contracts in good faith; and

Second, that the parties have a duty to act honestly in the performance of contracts.

There was a third issue before the court, and that was whether the plaintiff had suffered any recoverable damage. The Alberta Court of Appeal had held that, whether or not the defendants had acted honestly or in bad faith, the defendant Can-Am had the right to not extend the contract and had chosen not to. Therefore, Bhasin had no right to recover any damages. The Alberta Court of Appeal said:

[Can-Am] had a right to end the contract at the end of three years. The law of damages presumes that a party will use the least expensive method to perform. So (for example) employment contracts do not yield damages beyond the date at which the defendant could have ended the contract. See Hamilton v. Open Window Bakery Ltd. (2003), 2004 SCC 9, [2004] 1 S.C.R. 303, 316 N.R. 265(S.C.C.) (paras 11-20). Therefore, since the contract was performed up to its expiry date, in law there was no loss, and no damages are payable. That is an additional reason to dismiss the suit.”

In its decision in Bhasin v. Hrynew, the Supreme Court did not mention its decision in Open Windows Bakery and the principle stated in that case. Accordingly, it is necessary to determine if any hints can be derived from the Bhasin case about how to deal with the principle in Open Windows Bakery.

Background

The following facts were found by the trial judge in Bhasin v. Hrynew. Bhasin and Hrynew were both retail dealers who marketed education savings plans developed by Canadian American Financial Corp. (“Can-Am”).   Bhasin’s agreement with Can-Am was for a term of three years and automatically renewed unless one of the parties gave six months’ notice of termination.

Hrynew was in effect a competitor of Bhasin and wanted to take over Bhasin’s agency and he campaigned with Can-Am to direct such a merger of the agencies. Can-Am had discussions with the Alberta Securities Commission about restructuring its agencies. Can-Am did not tell Bhasin about these discussions. Can-Am repeatedly misled B about its future plans for its agencies. When Bhasin continued to refuse to allow Hrynew to review his records, Can-Am gave notice of non-renewal of the agreement. As a consequence, Bhasin lost his business and his workforce went to work for Hrynew.  Bhasin sued Can-Am and Hrynew.  The trial judge held that Can-Am breached the implied term in its contract with Bhasin that the contract would be performed in good faith. He found that Can-Am had dealt dishonestly with Bhasin.

The Supreme Court of Canada restored the trial judge’s finding that Can-Am had breached its contract with Bhasin by dealing with him dishonestly. It was then a question of determining the damages to which Bhasin was entitled.

Supreme Court’s Decision re Damages

The Supreme Court referred to the trial judge’s finding that, even though Can-Am had a right to not extend the term of the agency, the agency still had value and Bhasin could have sold it. The Supreme Court said:

“The trial judge specifically held that but for Can-Am’s dishonesty, Mr. Bhasin could have acted so as to “retain the value in his agency”: paras. 258-59. In reaching this conclusion, the trial judge was well aware of the difficulties that Mr. Bhasin would have in selling his business given the “almost absolute controls” that Can-Am had on enrollment directors and that it owned the “book of business”: para. 402.  She also heard evidence and made findings about what the value of the business was, taking these limitations into account.  These findings, in my view, permit us to assess damages on the basis that if Can-Am had performed the contract honestly, Mr. Bhasin would have been able to retain the value of his business rather than see it, in effect, expropriated and turned over to Mr. Hrynew.”

The Supreme Court then referred to the evidence of Can-Am’s expert who said that the value of Bhasin’s agency around the time of non-renewal was $87,000. The court was satisfied that the trial judge had found that Bhazin’s business was worth $87,000 at the time that his agreement with Can-Am expired. In the appeal to the Supreme Court, Can-Am argued that the evidence of their expert established that the value of Bhazin’s agency was $87,000. Accordingly the Supreme Court concluded that Bhazin’s damages were $87,000.

Discussion

It is, perhaps, not very useful to discuss what the Supreme Court of Canada did not decide, but any chance to discuss the Open Windows Bakery decision must be taken. That case presents a challenge to those trying to understand and fairly apply the Canadian law of contract damages.

The Alberta Court of Appeal correctly stated that, in Open Windows Bakery, the Supreme Court held that contract damages are to be calculated on the basis that the defendant was entitled to use the least expensive method to perform. If the defendant could have terminated the contract in another way which would have entitled the plaintiff to no damages, then that is the amount to which the plaintiff is entitled. Apparently, that formula is to be applied no matter how unlikely it would have been for the defendant to have so acted. To what extent the defendant is entitled to unscramble events which have actually occurred, and which involved third parties, tax implications and other facts totally outside the contractual performance itself, is as yet unclear.

In Bhazin v. Hrynew, the Supreme Court held that because the Bhazin agency was worth a certain amount at the time of the breach of contract, therefore Bhazin was entitled to that amount of damages. However, the connection between the two – the value of the agency and the entitlement of the plaintiff to damages in that amount – is not clear. If Can-Am was entitled to allow the agency to terminate, what difference does it make how much it was worth?

The Supreme Court did not mention Open Windows Bakery in its decision, so we are left to draw the conclusions ourselves. It is clear that the Supreme Court held that the dishonesty of Can-Am was a separate breach of contract, quite apart from the termination of the contract by expiry of its term. Based upon that holding, it may be that the Supreme Court has held that damages for dishonesty may be assessed without regard to the principle in Open Windows Bakery. Or that a breach of contract arising from dishonesty gives rise to separate causation, and therefore the entitlement of the defendant to terminate the contract is not relevant. Or it may be that Open Windows Bakery does not apply to contracts which expire but only to contracts which are terminated in a less onerous way by the defendant.

Other possible explanations about why Open Windows Bakery did not apply will certainly be drawn from the decision in Bhazin v. Hrynew. There seems little doubt that the latter decision will be relied upon in the future to narrow what some argue is the unfair rule in the former.

Bhasin v. Hrynew, 2014 SCC 71

Building Contract – Damages – Least Onerous Performance  – Honest Performance

T.G. Heintzman O.C., Q.C., FCIArb                                             December 7, 2014

www.heintzmanadr.com

www.constructionlawcanada.com

Contracts Must Be Honestly Performed Says The Supreme Court of Canada

In its recent decision in Bhasin v. Hrynew, the Supreme Court of Canada has established two fundamental principles for the Canadian common law of contract.

First, parties are under a general obligation to perform contracts in good faith.

Second, the parties have a duty to act honestly in the performance of contracts. These contractual obligations can no longer be relegated to some kinds of contracts or situations. Rather, they are principles that apply to every sort of contract.

It is, perhaps, somewhat surprising that these principles were still in dispute under Canadian contract law and that the Supreme Court had not previously ruled on them. Having now done so in Bhasin v. Hrynew, this decision is of great importance to the common law of contract in Canada and should be well understood by anyone concerned with the performance of contracts.

Background

The following facts were found by that trial judge:

Bhasin and Hrynew were both retail dealers who marketed education savings plans developed by Canadian American Financial Corp. (“Can-Am”).   Bhasin’s agreement with Can-Am was for a term of three years and automatically renewed unless one of the parties gave six months’ notice of termination.

Hrynew was in effect a competitor of Bhasin and wanted to obtain capture Bhasin’s market. On many occasions, Hrynew had proposed to Bhasin that they merge their dealerships and he campaigned with Can-Am to direct such a merger. Bhasin had resisted any such merger. Can-Am appointed Hrynew as the officer to review dealership compliance with securities laws, but Bhasin object to Hrynew reviewing his business records.

Can-Am had discussions with the Alberta Securities Commission about restructuring its agencies. Can-Am did not tell Bhasin about these discussions. Can-Am repeatedly misled B about its future plans for its agencies. When Bhasin continued to refuse to allow Hrynew to review his records, Can-Am gave notice of non-renewal of the agreement. As a consequence, Bhasin lost his business and his workforce went to work for Hrynew.

Decisions of the Trial Judge and Alberta Court of Appeal

Bhasin sued Can-Am and Hrynew.  The trial judge held that Can-Am breached the implied term in its contract with Bhasin that the contract would be performed in good faith. He found that Mr. Hrynew pressured Can-Am not to renew its Agreement with Mr. Bhasin and that Can-Am dealt dishonestly with Mr. Bhasin and ultimately gave in to that pressure.

The Court of Appeal allowed the appeal and dismissed B’s lawsuit. The court held that there was no self-standing contractual duty of good faith in Canadian law. In addition, the court found that Bhasin had suffered no recoverable damages because, quite apart from any alleged bad faith conduct by it, Can-Am was entitled in any event to give notice of non-renewal of the contract.

Decision of the Supreme Court of Canada

The Supreme Court forthrightly stated that it was necessary to clarify – or some might say, reform – the Canadian common law relating to the performance of contracts. Speaking for a unanimous court, this is how Justice Cromwell approached the matter:

“In my view, it is time to take two incremental steps in order to make the common law less unsettled and piecemeal, more coherent and more just. The first step is to acknowledge that good faith contractual performance is a general organizing principle of the common law of contract which underpins and informs the various rules in which the common law, in various situations and types of relationships, recognizes obligations of good faith contractual performance. The second is to recognize, as a further manifestation of this organizing principle of good faith, that there is a common law duty which applies to all contracts to act honestly in the performance of contractual obligations.” (emphasis added)

The Supreme Court explained what it meant by “an organizing principle.” Such a principle “states in general terms a requirement of justice from which more specific legal doctrines may be derived. An organizing principle therefore is not a free-standing rule, but rather a standard that underpins and is manifested in more specific legal doctrines and may be given different weight in different situations.”

Having recognized the organizing principle of good faith performance of contracts, Justice Cromwell held that the court should now recognize a contractual duty of honest performance:

“I would hold that there is a general duty of honesty in contractual performance. 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. Recognizing a duty of honest performance flowing directly from the common law organizing principle of good faith is a modest, incremental step.”

Justice Cromwell then summarized the position in three paragraphs which should be duly noted for application in future cases:

“A summary of the principles is in order:

(1) There is a general organizing principle of good faith that underlies many facets of contract law.

(2) In general, the particular implications of the broad principle for particular cases are determined by resorting to the body of doctrine that has developed which gives effect to aspects of that principle in particular types of situations and relationships.

(3) It is appropriate to recognize a new common law duty that applies to all contracts as a manifestation of the general organizing principle of good faith: a duty of honest performance, which requires the parties to be honest with each other in relation to the performance of their contractual obligations.” (emphasis added)

Having stated the legal principles, Justice Cromwell found that Can-Am had breached its contractual duty of honest performance. Can-Am wanted to force a merger of the Bhasin and Hrynew agencies, effectively giving Mr. Bhasin’s business to Mr. Hrynew. To accomplish that end, it acted dishonestly with Bhasin throughout the period leading up to its exercise of the non-renewal clause. It told the Alberta Securities Commission that Bhasin’s agency was to be merged under Hrynew’s but it said nothing of this to Bhasin. Can-Am was working to forestall the Commission’s termination of its license in Alberta and was prepared to do whatever it could to forestall that possibility.  When questioned by Bhasin about Can-Am’s intentions with respect to the merger, it equivocated and did not tell him the truth. Nor was it truthful with Bhasin about its dealings with the Commission and the Commission’s intentions, and repeatedly misrepresented to Bhasin that he was bound by duties of confidentiality. Can-Am continued to insist that Hrynew audit Mr. Bhasin’s agency, on the supposed basis that it required to do so by the Commission, even though it arranged for its own employees to conduct the audit of Hrynew’s agency.

The Supreme Court noted that the trial judge had found that this dishonesty on the part of Can-Am was directly and intimately connected to Can-Am’s performance of its agreement with Bhasin and its exercise of the non-renewal provision. The court concluded that “Can-Am breached the 1998 Agreement when it failed to act honestly with Mr. Bhasin in exercising the non-renewal clause.”

Discussion

The decision in Bhasin v. Hrynew is significant on three levels.

First, it firmly establishes good faith performance as an organizing principle in the common law of contract in Canada. From now on, the interpretation of all contractual obligations of performance involves asking this question: is this interpretation consistent with good faith performance? Similarly, the actual performance of contracts can be analyzed by asking this question: does this conduct amount to the good faith performance of the contract?

Second, every contract will now have an implied term that the contract will be performed honestly. In Bhasin v. Hrynew, the Supreme Court noted that Bhasin was not a franchisee of Can-Am. Nor was there any fiduciary obligation between the two parties. Bhasin’s claim was dealt with on the basis of the general law of contract. Accordingly, the court’s conclusions will apply to all contracts.

It appears that the parties cannot contract out of these duties. In the Bhasim decision, the Supreme Court said that “because the duty of honesty in contractual performance is a general doctrine of contract law that applies to all contracts, like unconscionability, the parties are not free to exclude it”. However, Justice Cromwell did say that he would “not rule out any role for the agreement of the parties in influencing the scope of honest performance in a particular context. The precise content of honest performance will vary with context and the parties should be free in some contexts to relax the requirements of the doctrine so long as they respect its minimum core requirements.” In any event, it’s hard to imagine parties to a contract expressly agreeing that ‘dishonest performance of this contract shall be permitted” or words to that effect.

Third, the facts in the Bhasin v. Hrynew case provide good examples of the kind of circumstances that may constitute dishonest contractual performance. Misleading or acting untruthfully toward the other party, particularly in the lead-up to the termination of the contract or contractual rights; misrepresenting the intentions of a regulatory tribunal or dealings with the tribunal; and preferring one contracting party over another in a like position; all have the potential to amount to dishonest performance of the contract.

Honesty is, however, a word which may have different meanings in different circumstances. It may mean one thing for the principles of equity and another thing for the principles of criminal law. Using the conclusions in Bhasin v. Hrynew, Canadian courts will now, through actual cases, develop the scope of that word for Canadian contract law, just like they have with the words “reasonable”, and “good faith”. This is a serious matter for building contracts and one which American courts have wrestled with. Thus, for a cost plus contract, what sort of unjustified additions to the costs amount to “dishonesty”? What sort of mis-management of a project site amount to “dishonesty”? Perhaps we just know it when we see it.

Bhasin v. Hrynew, 2014 SCC 71

Building Contract – Performance – Good Faith – Honest Performance

Thomas G. Heintzman O.C., Q.C., FCIArb                                                              November 30, 2014

www.heintzmanadr.com

www.constructionlawcanada.com