A Waste of Good Faith: Exercising Discretion in Performing Contracts

In our previous post, we discussed a recent finding by the Supreme Court of Canada which stated that silence can be an indicator of bad faith under a contract. In this week’s post, we will look at another recent Supreme Court of Canada ruling about the duty of good faith in contract law. Specifically, the Court held that if a party to a contract exercises its discretion unreasonably, it may be in breach of the contractual duty of good faith. In the recent case of Wastech Services Ltd. v. Greater Vancouver Sewerage and Drainage District, the Supreme Court ruled that the common law duty of good faith in contract law does not allow a contracting party to use its discretion unreasonably. The question then becomes, in what circumstances can a party be considered to be using its discretion on an unreasonable basis? The answer is an important one which all business’ entering into contractual obligations – particularly those which allow for some discretion on the execution of the contractual terms – should be aware of when performing any contract.

Duty of Good Faith

It’s important to understand first what the duty of good faith in contract law is, given that it is a relatively recent development in Canadian common law, first formulated in 2014 in the Bhasin v. Hrynew. Essentially it is the duty for parties to a contract to provide an honest performance to fulfill the terms of a contract and applies to all contracts. It requires parties to not lie or knowingly mislead each other in matters which pertain to the performance of the contract.  It also requires parties to exercise any discretion allowed for by the contract in good faith. It is the latter consideration – for contractual discretionary performance to be exercised in good faith – which was the issue at hand in the recent Wastech Services case. In particular, the Supreme Court of Canada had to rule on whether a contractual discretionary power was exercised honestly or dishonestly, with the latter constituting a breach of contract.

Contractual Discretion

The case concerned a contract between waste transportation and disposal company (Wastech), and Metro, a statutory corporation responsible for the administration of waste disposal for the Metro Vancouver Regional District, for the removal and transportation of waste to three disposal sites. Wastech was to be paid a different rate depending on the distance the waste disposal facility was, with the contract providing full discretion to Metro to choose which of the facilities to send the waste to. The contract aimed to pay Metro an operating profit of 11 percent on its operating costs, but – crucially – this level of profit was not guaranteed by the contract.

In 2011, Metro decided that it would send waste to a facility that was closer to the city, which meant that Wastech did not meet the operating profit of 11 percent. Wastech then began litigation proceedings against Metro, claiming that they violated the contract via the use of their discretion to send waste to the nearest disposal facility.

The Supreme Court decided against Wastech, setting aside the original award the arbitrator provided. Although the Supreme Court ruled that the good faith doctrine in contract law does not permit a party to a contract to use its discretion in performing the contract unreasonably, it ruled that Metro did not do so on this occasion. The main reason for this is that the Supreme Court determined that Metro’s exercise of their discretion (to choose which of the three disposal sites the waste could be transported to) was connected to the purpose of the contract (as contemplated by and agreed to by the parties), therefore it was not unreasonable.

Metro’s discretionary decision to send the waste to the nearest of three facilities was guided by the objective of managing waste disposal in the most cost-effective manner. They also determined that there was nothing in the contract to suggest that the parties intended Metro’s discretion must be exercised so as to provide Wastech with a guaranteed level of profit.

Had Metro exercised its discretion in a manner that was in some way unconnected to the purposes underlying the discretion, the Supreme Court likely would have ruled differently. They stated, “…where the exercise stands outside the compass set by contractual purpose, the exercise is unreasonable in light of the agreement for which the parties bargained and may be thought of as unfair and contrary to the requirements of good faith.” However, in this case, the contractual terms agreed to by both parties agreed to give Metro the discretion to choose where to send the waste, so as to keep their costs low.

If, for example, the discretion given to Metro was limited by the need to guarantee Wastech a certain level of profit but they kept deciding to send the waste to the nearest facility in order to prevent Wastech from receiving a certain level of profit, the case would likely have been decided differently. However, no such guarantee existed in the contract, nor were there any other indications that Metro had exercised its discretion to choose which site the waste would be sent to for any other purpose than seeking its own best interest within the commercial scope allowed for by the contract.

Drafting Contracts

When entering into contracts, businesses will want to make note of whether the contractual terms allow for too much discretion on the part of the other party. While the duty to exercise contractual discretion in good faith applies to all contracts, the parties may wish to include provisions in their contract that help identify the purposes for which a contractual discretion is granted. As such, if a draft contract provides a wide or unfettered discretion for one party to make decisions that will affect the other party’s ability to make a profit (which was effectively the situation in the Wastech case), the other party in question will want to try to limit or properly define in the contract what the purpose or scope of that discretion is. The Wastech decision has made it clear that whether a party has satisfied the duty of exercising contractual discretion in good faith in any particular contract will depend on the text and context of the contract, so it becomes increasingly important to get the contractual terms correct and as beneficial to one’s business purposes as possible.

The lawyers at Prudent Law in Mississauga are trusted advocates in any type of civil litigation, including contract disputes. We provide practical advice and passionate representation in both litigation and alternative dispute resolution options. If you are facing a legal dispute and you’d like to discuss it with one of our experienced litigation lawyers, please call us at 905-361-9789 or contact us online.

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