Written by Scott Bower, Mike Theroux, Ranjan Agarwal, Preet Bell, Russell Kruger and Patrick Schembri
Good faith requires a party who has a discretionary power under a contract to exercise that discretion in accordance with the purposes for which it was conferred, the Supreme Court of Canada recently held in Wastech Services Ltd v Greater Vancouver Sewerage and Drainage District, 2021 SCC 7. This duty applies to all contracts and operates irrespective of the parties' intentions.
The Organizing Principle of Good Faith, and its Manifestations
In Bhasin v Hrynew, 2014 SCC 71, the Supreme Court of Canada recognized the organizing principle of good faith in contract law. In CM Callow Inc v Zollinger, 2020 SCC 45, reviewed in Supreme Court of Canada: Silence Can Breach the Contractual Duty of Good Faith Honesty, the Court expanded on the doctrine of honesty in contractual performance that flows from the organizing principle. In Wastech, the Court clarified the content of another doctrine flowing from the organizing principle: the duty to exercise contractual discretion in good faith.
Wastech involved a waste transportation company (Wastech) and a corporation responsible for municipal waste disposal (Metro). In 1996, Wastech and Metro entered into a contract for waste disposal services that contemplated disposing waste in three landfills, one of which was much farther away than the others. The contract stated Metro had "absolute discretion" in allocating the amount of waste to go to this farther facility.
In 2011, Metro exercised this discretion by directing less waste to go to the farther facility, causing Wastech to receive a lower level of compensation. Wastech disputed this decision, and referred the matter to arbitration. The arbitrator ruled in Wastech's favour. The British Columbia Supreme Court set aside the arbitrator's award. On appeal, the Court of Appeal affirmed this decision (reviewed in Supreme Court of Canada to Revisit Bhasin and Contractual Parties' Duty of Good Faith). Wastech appealed to the Supreme Court of Canada.
The Supreme Court of Canada Decision
A six-member majority dismissed the appeal. The majority held that when a party exercises a discretion conferred by contract it must do so reasonably. This means that parties to a contract must exercise their discretion in accordance with the purposes for which that discretion was conferred. A failure to do so is a breach of the duty to exercise contractual discretion in good faith, which applies to all contracts.
a) The Purpose of the Discretion
The purpose of a contractual discretion is determined mainly by reference to the contract:
Sometimes, the text of the discretionary clause itself will make the parties’ contractual purpose clear. In other circumstances, purpose can only be understood by reading the clause in the context of the contract as a whole.
If the purpose is "entirely general," courts will look to the broader business relationship the contract is intended to implement.
b) The Reasonable Exercise of Discretion
What constitutes an unreasonable exercise of discretion is a "highly context-specific" determination. A discretionary power will allow for a range of different but equally legitimate choices to be made by the party exercising the discretion. If a discretion relates to a matter that is "readily susceptible" to objective measurement, "the range of reasonable outcomes will be relatively smaller." On the other hand, where the discretion relates to a matter that is not as susceptible to objective measurement, "the range of reasonable outcomes will be relatively larger." It is only the choice made and the purpose of the discretion that is assessed by the court, and not the morality or business judgment of the party exercising the discretion.
The duty is breached when the exercise of discretion "is unconnected to the purposes for which the discretion was granted" which will notably be the case when the exercise is capricious or arbitrary. The majority clarified that the “fact that the exercise substantially nullifies or eviscerates the fundamental contractual benefit may be relevant but is not a necessary [or sufficient] pre-requisite to establishing a breach." In addition, this duty "does not require a party to confer a benefit on the other party that was not a part of their original agreement, nor does it require a party to subordinate its interests to those of the other party." The test is not whether the exercise had “appropriate regard for the legitimate contractual interests of the counterparty”.
c) Applying the Principles
In applying these principles to the facts, the majority determined the purpose of Metro's discretion to allocate waste, concluding it was "to allow it to structure the disposal of waste for which it had contracted Wastech in an efficient and cost-effective manner given the operational variability the parties foresaw." Metro was provided "absolute discretion" in allocating the relevant waste under the contract. That said, the recitals stated the parties intended to maximize efficiency and economy, and to be responsive to changes in operating methods. These recitals aligned with the contract as a whole, which provided for flexibility to account for future variability.
In assessing Metro's exercise of discretion, the majority held it had been exercised reasonably given the purposes of the contract. Metro had decided to allocate the waste in order to promote the objectives of efficiency, economy, and its own business interests. Since deciding to reallocate the waste in a manner that might impact Wastech's compensation was contemplated by the purpose of the discretion, exercising it in that way did not amount to bad faith.
The Minority View
A three-member minority concurred in result, but would have held parties can exclude the duty of good faith in contractual discretion with clear language to that effect. The minority also addressed the appropriate standard of review, and held that since the applicable arbitration legislation provided for an appeal on questions of law, the standard of review was correctness.
The Supreme Court of Canada's decision firmly establishes that the duty of good faith in exercising contractual discretion applies to all contracts, irrespective of the intentions of the parties. When a party exercises discretion conferred by contract, it must do so reasonably, in accordance with the purposes for which that discretion was given. Whether or not a particular exercise of discretion breaches this duty is a highly fact-specific determination. In consideration of this decision, any clause conferring an exercise of discretion should be carefully drafted and reviewed, with close consideration given to the purpose of that discretion. Drafting the recitals to the contract and managing the evidence of the negotiation history will also have heightened importance in the future, as the majority relied on both to determine the purpose for which the discretion was given.