April 20, 2016

Good Faith in Canadian Contract Law

Introduction 

The purpose of this article is briefly to review the development of the concept of good faith as seen in Canadian contract law with some comparison to how the concept is viewed in other jurisdictions.

Good faith as a concept is difficult to define. It has no technical or statutory meaning. Good faith obviously may include the requirement to act honestly and without malice or fraud, but beyond these basic principles, what acting in good faith means can be somewhat of an intangible concept. In fact, the application of the concept of good faith is so dependent on the facts of each instance that it is sometimes said that the term itself is devoid of meaning without a set of facts to which it can be applied. This makes the ability of legal counsel to provide conclusive advice to clients difficult and the results of litigation uncertain. Nowhere has the ambiguity surrounding good faith been more apparent than in Canada. 

It should be noted that, with the exception of Quebec, all provinces and territories of Canada use the common law as originally derived from England. In Quebec, the law of general application is the civil law as originally derived from the laws of France and, in particular, the French civil code. Of course, the common law of Canada and the civil law of Quebec have evolved considerably on their own over time, based on both Canadian jurisprudence and statutory law. 

Good Faith in Common Law Canada

Traditional Position

Canadian common law historically has refused to recognize a general duty of good-faith contractual performance. The absence of this duty has been so striking that one commentator noted that the Canadian legal system has taken a “kind of perverted pride” in the absence of a duty of good faith, as if accepting it “would be admitting to the presence of some kind of embarrassing social disease.” John Swan, Whither Contracts: A Retrospective and Prospective Overview, in Special Lectures of the Law Society of Upper Canada 1984 – Law in Transition: Contracts 125, 148 (De Boo, 1984). 

Despite this disdain towards good faith, however, Canadian courts have long found ways to sanction behavior that generally would be considered to breach the doctrine. For example, in one case, 6781427 Holdings Ltd. v. Alma Mater Society of University of British Columbia, (1987), 7 A.C.W.S. 3d 28 (Can. B.C. Super. Ct.), a landlord who led a tenant to believe that its application to expand would be considered was prohibited from claiming that the tenant failed to renew its original lease on time on the grounds that this would be inequitable. In another case, AMJ Campbell Inc. v. Kord Products Inc., [2003] O.J. No. 329 (Can. Ont. Super. Ct. Justice), a party who amended the draft of a contract without drawing the amendment to the attention of the other party, knowing it would not notice, was estopped from enforcing the amendment. In a third case, Bercovici v. Palmer, [1966] 59 D.L.R. 2d 513 (Can. Sask. C.A.), a buyer who discovered that the contract by which it purchased land listed, among the parcels sold, a lot that neither party had intended to include in the transaction was simply prohibited from benefiting from the mistake. 

These ad hoc, piecemeal solutions to behaviors that violated good faith developed into an “unsettled and incoherent body of law.” (Ontario Law Reform Commission, Report on Amendment of the Law of Contract (Ministry of the Attorney General, 1987)). Adding to the confusion was the fact that Canadian courts did accept a duty of good-faith performance in certain well-defined situations. Notably, these included cases where the parties had a duty to cooperate in order to achieve the objectives of the contract, those where one party was granted a discretionary power, and those where a party attempted to evade its contractual duties. 

Even in these types of situations where a duty of good-faith performance existed, however, there was no clear consensus as to what this duty meant. Courts often considered good faith to be simply the absence of bad faith, which they defined as conduct contrary to community standards of honesty, reasonableness, and fairness. In other cases, however, courts refused to sanction behavior unless the absence of good faith was tantamount to fraud. 

In response to the unsettled and unclear role of good faith, almost three decades ago the Ontario Law Reform Commission recommended statutory recognition of good faith in order to “synthesize the various strands of good faith analysis in the case law.” (Ontario Law Reform Commission, Report on Amendment of the Law of Contract (Ministry of the Attorney General, 1987)). Moreover, it is argued, a generalized doctrine of good faith would conform to commercial realities. The recommendation was not adopted, however, and Canadian courts continued to apply – or fail to apply – the doctrine indiscriminately. 

Good Faith as an Organizing Principle – Bhasin v. Hrynew 

It was only in November 2014 that the Supreme Court of Canada was granted the opportunity to establish clarity in the law in Bhasin v. Hrynew, [2014] 3 S.C.R. 494. 

In this case, the appellant, Mr. Bhasin, sold educations savings plans for a company called Can-Am. Their relationship was governed by a dealership agreement that would automatically renew at the end of its three-year term unless either party provided six months written notice to the contrary. In a series of convoluted events, which triggered an investigation by the Alberta Securities Commission, Can-Am collaborated with Mr. Hrynew, one of Bhasin’s competitors, in an attempt to force Bhasin to merge his business with Hrynew’s. When Bhasin refused, Can-Am gave notice that it would not renew his contract. Bhasin instituted proceedings against both Can-Am and Hrynew, alleging conspiracy and bad faith. 

The matter reached the Supreme Court, which deemed it time to take two incremental steps in order to make the role of good faith in Canadian law more coherent and more just. The first was to acknowledge that good faith is a general organizing principle of contract law, 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.” As such, it requires that parties perform their contractual duties “honestly and reasonably and not capriciously or arbitrarily.” According to the court, this means that contracting parties must have appropriate regard for the legitimate interests of their contractual partners. “Appropriate regard” for the interests of one’s contractual partner will vary based on context, but will not require that a party act to serve those interests in all cases. Instead, it simply forbids a party from seeking to undermine them. The court was also adamant that, unlike a fiduciary duty, good faith does not engage duties of loyalty to the other party, nor require that a party put the interests of its contractual partner before its own. 

The court added that the organizing principle of good faith manifests itself through the existing doctrines in the law which require honest, reasonable, candid, or forthright performance, and that claims generally will not succeed if they do not fall within one of these doctrines. However, it emphasized that this list is not closed, and that the new organizing principle may give rise to new duties “where the existing law is found to be wanting.” 

The court deemed that Bhasin did not fit into any of the existing doctrines governed by good faith. As the second step, therefore, it created a new duty of honest contractual performance. This duty means simply that parties must not lie or otherwise knowingly mislead each other about matters directly linked to the performance of the contract. The court was emphatic that the duty of honest performance does not impose a duty to disclose information, but simply prohibits a party from actively misleading or deceiving the other in relation to the performance of the contract. 

Criticism of the New Organizing Principle 

Bhasin sent shockwaves through the Canadian legal community, with lawyers and scholars alike referring to the decision as “seminal” (Geoff R. Hall, Bhasin v. Hrynew: Towards an Organizing Principle of Good Faith in Contract Law, 30 Banking & Fin. L. Rev. 335, 335 (2015)), “a landmark” (Brad Hanna & Calie Adamson, Let’s Be Honest: The New Duty of Good Faith in Contractual Performance, Mcmillan Litigation Bulletin, November 2014), and “perhaps the most important contract decision in the past 20 years” (David Dias, SCC establishes duty of honesty between contracting parties, Legal Feeds, (Nov. 13 2014)). Much of this frenzy has not been positive, however. Three critiques of the decision merit particular attention.

The first is that the Supreme Court failed to provide a concrete definition of good faith, instead offering vague guidelines about how good faith requires behavior that is “reasonable” and “not arbitrary.” As one lawyer stated, the lack of a true definition of good faith “introduces uncertainty, so that the courts have become a bit of a casino if you’re looking to them to determine what conduct will be sanctioned and how to advise clients” Julius Melnitzer, Did the Supreme Court clarify or muddy the duty of good faith?, Lexpert Magazine (May 25, 2015). Such criticism is not surprising in the common law, which holds a widespread belief that legal certainty resides in straightforward and precise propositions of law. Others argue, however, that a principle as broad as good faith, which will be applied across a wide range of contexts and circumstances, must necessarily be defined at a high level of abstraction. This is so that it remains malleable enough to be adapted and applied to any given case. As will be discussed below, good faith has received similarly broad definitions in other jurisdictions, which have left it up to appeals courts to determine the contours of the doctrine in various contexts or domains. 

The next criticism of Bhasin is that it creates confusion with regard to whether good faith in itself is actionable. According to the court, good faith is not a freestanding rule, but rather a principle which gives rise to rules. As such, it follows that an aggrieved party ought not to be able to plead a breach of good faith. Instead, it should be required to plead a breach of one of the duties that good faith creates. Some post-Bhasin courts have concluded exactly this, holding that in order to succeed in its claim, a party must demonstrate a breach of one of the distinct doctrines falling under the umbrella of good faith. Others, however, have ruled directly on whether good faith was breached. 

A third criticism of Bhasin is that the duty of honest performance prohibits active dishonesty, or lying, but does not impose a positive duty of disclosure. One likely consequence of this distinction is that contracting parties may be tempted to remain silent rather than make representations that risk to be found untrue. This desire to err on the side of caution is understandable, but will undoubtedly hinder communication between parties. Another anomaly of this distinction is that the consequences of failing to disclose relevant information can be just as injurious as those of actively misrepresenting information. It is not difficult to conceive that a party wishing to deceive its contractual partner could develop a way to do so without actively communicating false information. 

The result of all of this ambiguity undoubtedly will result in an increase in litigation as litigants attempt to push the boundaries of the new organizing principle as far as they can. The open-endedof the doctrine will also provide significant work for appellate courts “on whom the burden of interpreting the organizing principle will primarily fall but whose own jurisprudence contains almost nothing on point.” Geoff R. Hall, Bhasin v. Hrynew: Towards an Organizing Principle of Good Faith in Contract Law, 30 Banking & Fin. L. Rev. 335, 342 (2015). 

Duties in Contractual Negotiations 

As mentioned above, good faith as articulated in Bhasin does not extend to the period of contractual negotiations. During this period, the behavior of parties is governed in some cases by the doctrine of unconscionability, which allows a party to annul a contract that is manifestly unfair at the time it is created. In order to establish that a contract was unconscionable, a party must demonstrate that: (1) there was an inequality of bargaining power; (2) the stronger party preyed upon or took advantage of the weaker party; and (3) the resulting contract was improvident. The doctrine of unconscionability is not intended to provide relief against foolish bargains or to remedy a party’s lack of vigilance. Instead, it aims to protect the weaker party in a situation of inequality. In this sense it differs from good faith, which governs all contracts regardless of the power balance between the parties. 

The relationship between good faith and unconscionability was recently raised in front of the Ontario Court of Appeal in Bank of Montreal v. Javed, 2016 ONCA 49. The appellant in this case had been the director of a corporation and had personally guaranteed a small business loan taken out in the corporation’s name. He later resigned as director but remained bound by the guarantee. After his resignation, he contacted the bank to request information about the loan. His request was denied on the grounds that the corporation had withdrawn its authorization to provide him with the information in question. The corporation later defaulted on the loan and the bank sought to enforce the guarantee. 

The appellant argued that the bank’s behavior had rendered the loan transaction unconscionable. He submitted that, in imposing a general organizing principle of good faith and a duty to perform contracts honestly, Bhasin extended the application of unconscionability from the inception of a contract to its execution. The appellant accepted that unconscionability was not present at the moment of contract formation, but claimed that the bank’s subsequent failure to provide him with information about the loan was unconscionable. The court rejected his claim, holding that Bhasin provided no basis for the extension of unconscionability. The court emphasized that Bhasin simply created a duty of honest performance and that there was no evidence that the bank had acted dishonestly. Moreover, the duty of honesty does not create a duty to disclose. 

The United States – A Different Approach 

In the United States, good faith is codified in the Uniform Commercial Code (UCC) and the Restatement (Second) of Contracts. The UCC defines good faith as “honesty in fact and the observance of reasonable commercial standards of fair dealing.” Over time courts have interpreted this requirement – no more precisely than in Bhasin – as imposing an obligation not to hinder performance or prevent the other party from obtaining the fruits of its bargain. 

As is now the case in Canada, the duty of good faith exists only from the moment an agreement is concluded; the law does not require parties to negotiate in good faith. Unlike in Canada, however, good faith can be excluded from commercial contracts in some states. Another difference from the Canadian position is that, in most cases, good faith in the United States imposes a positive duty of disclosure on contracting parties. 

Quebec – A Civil Law Position 

Unlike in common law Canada, good faith is firmly rooted in the civil law governing the province of Quebec. The Civil Code of Quebec (CCQ) provides that contracting parties “shall conduct themselves in good faith both at the time the obligation arises and at the time it is performed or extinguished.” The CCQ also provides that “no right may be exercised with the intent of injuring another or in an excessive and unreasonable manner and therefore contrary to the requirements of good faith.” In contrast to the situation under Bhasin, therefore, the obligation to act in good faith exists during the precontractual and negotiation periods, and the CCQ in principle provides a standard of conduct in contractual relations. 

During contractual negotiations, a party will have violated the duty of good faith if its behavior is abusive or unreasonable, or if it engages in deception or violence to compel the other party to conclude the contract. The duty to negotiate in good faith does not oblige parties to necessarily conclude the contract, though it does prohibit them from using their positions to gain confidential information about the other party or pursuing negotiations they know are doomed to fail. 

Despite its express requirement that contracting parties act in good faith, the CCQ does not explicitly define the term other than to provide a standard of conduct as noted above. Quebec courts have interpreted good-faith contractual performance to require benevolent and proactive behavior that allows all parties to benefit from the contract. It is also well established that good-faith performance in Quebec requires cooperation and – unlike under Bhasin – loyalty between contracting parties. 

It is also well established in Quebec law that good faith cannot simply be equated to the absence of bad faith. Indeed, even in the absence of malice or intent to harm, if a party’s behavior violates the norms generally accepted in society, Quebec courts have concluded there was a breach of good faith. This was illustrated by Hydro-Québec c. Construction Kiewit Cie, 2014 QCCA 947, a case recently in front of the Quebec Court of Appeal. The case resulted from a contract by which Construction Kiewit (Kiewit) was to build a hydroelectric dam for Hydro-Québec (Hydro), the provincial electricity supplier. Essentially, the debate revolved around who was to bear the financial burden for changes and delays that had occurred during the construction. The court concluded that no Hydro employees had demonstrated malice or an intent to harm. However, the evidence indicated that Hydro had repeatedly reassured Kiewit that the cost issue would be discussed, but subsequently refused to address it. According to the court, these empty words constituted a lack of cooperation and of transparency and created false expectations. The court concluded that this unreasonable behavior amounted to “institutional bad faith.” 

Another way in which good faith in Quebec differs from the doctrine as elaborated by Bhasin is that it is well accepted in Quebec that good faith imposes a positive duty to inform. More precisely, this obligation requires that, at every step of the execution of the contract, a party provide its contractual partner with all the information that it could require to provide its free and enlightened consent. On top of this general duty of information, the CCQ also prescribes duties to inform in more precise situations. For example, section 2354 provides that a creditor must provide the surety, upon request, with any useful information as to the content and the terms and conditions of the principal obligations and as to the stage reached in its performance. 

The role of good faith in Quebec is similar to its role in France, another civil law jurisdiction. Indeed, like the CCQ, the French civil code expressly requires good faith in the performance of contracts. The extension of the doctrine to contractual negotiations, which has been well-established by French case law, is soon to be codified as part of current reform of the French civil code. This reform will also add a reference to good faith in the preliminary article of the code, which illustrates the importance of the doctrine in civil law. 

The United Kingdom – The Resistance Persists 

In the United Kingdom, courts have long rejected a general obligation of good faith in contract law. Instead, UK courts have responded to problems of unfairness through piecemeal solutions similar to those previously seen in Canada.

Recently, however, this resistance has begun to soften. In a frequently cited 2013 decision, Yam Seng Pte Ltd. v. International Trade Corp. Ltd., [2013] EWHC 111, the High Court of Justice of England and Wales was faced with a dispute resulting from a distributorship agreement which had turned sour. Essentially, one party argued that it had been an implied term of the contract that the parties would act in good faith and that the other had violated this obligation. The court held that, although English hostility towards good faith is both “misplaced” and “swimming against the tide,” English law was not yet ready to recognize a general implied duty of good faith performance. The court also held, however, that in certain contracts the relationship between the parties and the terms used in the agreement make it evident that the parties expect a basic level of honesty and cooperation. The court deemed that when this is clearly the intention of the parties – as in the agreement at issue – a term of good faith can be implied. More recently, in Bristol Groundschool Ltd. v. Intelligent Data Capture Ltd., [2014] EWHC 2145 (Ch.), the same court took this reasoning one step further, concluding that a term of good faith is to be implied to all of these “relational” contracts, regardless of whether the parties appear to have intended it. 

It will be interesting to see how the courts in the United Kingdom further develop the concept of good faith in jurisprudence. 

Conclusion

The common law of good-faith contractual performance in Canada is currently at a major turning point. What has long been a point of contention and uncertainty in the law has undergone a major transformation, yet it remains to be seen whether this will in fact lead to more stability and coherence in the law. Based on early indications, and in comparison to the state of the law in other jurisdictions, it appears that Bhasin is merely a first step towards a much-needed new approach to good faith in the Canadian common law of contract.

Additional Resources

For other materials on this topic, please refer to the following. 

Business Law Today 

Delaware Supreme Court Affirms Award of Expectation Damages Resulting from a Party’s Failure to Negotiate the Terms of a Final Agreement in Good Faith
By Gary W. Lipkin
Vol. 25 No. 7 March 2016

“Promise Not to Lie”: The Duty of Honest Contractual Performance in Canada
By Marco P. Falco
Vol. 24 No. 4 December 2014