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

 

 

 

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

 

 

 

Is The Owner Liable For Delaying The Commencement Of The Building Project?

Time is money on a building project. And the obligation of the owner and the contractor to proceed expeditiously with the project may be one of the most important aspects of their relationship.

But what if the owner delays in notifying the contractor of the award, or in signing the building contract?  Can the owner be liable, even if the contract has not yet been signed?  In Bre-Ex Limited v. Hamilton (City), the Ontario Superior Court has recently answered Yes to these questions.  In the process, that court also provided a smorgasbord of answers to many questions arising from a construction claim.

The Background

In the fall of 2001, the City of Hamilton issued a call for tenders for the construction of a new leachate collection system at a landfill site located within its boundaries.  The tender documents stated that a binding contract would exist upon the acceptance of the tender by City council, that the listed documents would constitute the contract between the parties and that the signing of a contract would be a formality. The tender documents also stated that the work would not proceed without the City’s acceptance of the bidder’s methodology and that the “specifications” included “all written and printed descriptions or instructions pertaining to the method and manner of performing the work…”  The tender documents also stated that the City “will require that work commence immediately following the award of the Contract and will require the work to be completed by approximately the end of July, 2002”

Bre-Ex submitted a tender which provided for a methodology that was quite different than the methodology proposed by other bidders.

The tenders were opened on November 6, 2001 and Bre-Ex’s tender was the lowest. Before any contract was awarded, Bre-Ex advised the City that it would be undertaking the work during the winter months, although that statement was not contained in its formal tender. Before awarding the contract, the City and its consultants reviewed Bre-Ex’s methodology and accepted it.

On December 11, 2001, City council accepted Bre-Ex’s bid and authorized the award of a contract to it.  On January 6, 2002, the time expired for Bre-Ex’s tender to remain open.  The City did not advise Bre-Ex of the award of the tender to it until January 24, 2002.  The parties disagreed about whether Bre-Ex’s methodology should form part of the formal contract, Bre-Ex insisting that it did and the City asserting that it did not.  These matters were not sorted out until March 2002 when the City agreed to insert Bre-Ex’s methodology into the formal contract.  Bre-Ex signed the contract on April 12, 2002 and the City signed it on June 12, 2002.

As a result of these delays, Bre-Ex largely lost the ability to perform work during the winter of 2002, and it was forced to do much of the work during the winter of 2003.  It filed a delay claim with the City.

In these circumstances, the Superior Court held that the City was in breach of the building contract arising from the City’s acceptance of Bre-Ex’s tender.  In arriving at this conclusion, the court found as follows:

  1. The City’s failure to advise Bre-ex of the award of the contract from January 6, 2002 to January 24, 2002 was a breach of contract.  As a result of the tender documents, it was reasonable for the contractor to understand that its work was to commence on January 6, 2002 (being the date that its tender expired) if it was awarded the contract.  Moreover, it was reasonable for the bidders to assume that, if the City accepted a tender within the tender period, the City would forthwith advise the successful bidder so that it could marshal the documents and its forces in order to start work on January 6, 2002.
  2. The City was in breach of contract by failing to sign the formal contract until June 2002.  In particular, the City was wrong to assert that the methodology set forth in Bre-Ex’s bid should not be part of the contract.  It was only when the City agreed to put that methodology into the contract that the contract was finally signed.

Contractor’s Tender Methodology Became A Contract Specification

The court’s conclusion on this latter point is instructive.  The court held that the necessary result of the tender documents was that the contractor’s methodology was a “specification” included in the building contract.  This conclusion followed from the working of the tender document, and in particular the statements that:

    • the definition of “specification” included all documents pertaining to the method of performing the work;
    • the work could not proceed without the City’s acceptance of the contractor’s methodology;
    • the City had clearly accepted Bre-ex’s methodology in awarding it the contract; and
    • the subsequent execution of the Contract Documents was a formality.

This conclusion that the methodology in Bre-Ex’s tender became a “specification” is an important one for construction law.  It demonstrates that definitions used in standard form construction contracts and tender documents can include more than just the documents that the parties attach to their “formal” contract.  The tender process itself may well make documents delivered by the contractor during that process part of the contract, as “specifications”.

Owner’s Contractual Obligation To Commence The Project With Dispatch

The court then concluded that the delays by the City breached an implied obligation to perform its contractual duties within a reasonable time.  The Court quoted from Heintzman and Goldsmith on Canadian Building Contracts to the effect that what is a reasonable time for the performance of contractual duties must be decided in light of the “specific work and conditions and the general circumstances in which the contract was entered into”.

In its tender documents, the City had stated that the work was to commence immediately after the award of the contract and was to be completed by approximately July of 2002.  In these circumstances, the Court held that the City breached its implied duty to proceed with the contract with reasonable dispatch by its delay in advising Bre-Ex of the award of the contract and by its delay in executing the contract, all of which caused Bre-Ex to lose the ability to perform the work in the winter of 2002.

The Building Contract Arises From The Tender Process Itself

This conclusion followed from the fact that there were two contracts between the City and Bre-Ex, one relating to the tender itself (known in Canadian law as Contract A), and the other being the building contract arising from the City’s acceptance of Bre-Ex’s bid on December 11, 2001 (known in Canadian law as Contract B).  The City’s duty to proceed with reasonable dispatch might arise from both contracts, but it certainly arose from the building contract, Contract B.  As both parties acknowledged, that contract arose on December 11, 2001 when the City accepted Bre-Ex’s bid.  Accordingly, the implied duty to act with reasonable dispatch arose from that contract.  It did not require the execution of the formal contract in June 2002 for that duty to come into existence.

This conclusion is also an important one for construction law.  The owner’s duty not to delay the project does not just arise during the project.  That duty applies to the commencement of the project.  And it applies even before the execution of the “formal” contract if, as is usually the case for a true tender, the building contract arises from the tender process itself.

Damages awarded to Bre-Ex

The final interesting aspect of this case is the wide scope of the damage relief that was awarded to Bre-Ex.  It was awarded damages for: loss of revenue due to a decline in profit for the first quarter of 2002, fuel and labour escalation costs, refinancing costs, and loss arising from sale of equipment and required rental of replacement equipment.

Important Conclusions

The Bre-Ex decision is a very useful case to consult when allegations of owner’s delay are raised.  The decision reminds us that, when an invitation to tender provides, as it usually does, that a contract arises from the acceptance of the tender, then a building contract is immediately formed.  That contract may well include the methodology or systems proposed by the bidding contractor, as part of the specifications of the contract.  And it will require both parties not to delay pending the execution of a formal contract, but to proceed with reasonable and immediate dispatch.

See Heintzman and Goldsmith on Canadian Building Contracts (3rd ed.) at Chapter 5, part 1(b)

Bre-Ex Limited v. Hamilton (City), 2012 ONSC 147

Construction Law   –   Tenders   –   Implied Duties   –   Performance

Thomas G. Heintzman O.C., Q.C., FCIArb                                                               July 26, 2012

www.heintzmanadr.com

www.constructionlawcanada.com