Supreme Court Explains Duty To Exercise Contractual Discretion In Good Faith – Corporate/Commercial Law

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Supreme Court Explains Duty To Exercise Contractual Discretion In Good Faith


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In a highly anticipated decision, which took over a year to
release, the Supreme Court of Canada clarified the parameters of
the duty to exercise contractual discretion in good faith
in Wastech Services Ltd. v. Greater Vancouver
Sewerage and Drainage District
.

Contracting parties must be mindful that exercising discretion
under a contract is constrained by the duty of good faith –
that means acting reasonably, consistent with the purpose of the
discretion granted and the intention of the parties as set out in
the terms of the contract. But the duty is not a fiduciary duty.
The duty does not impose an obligation on a party to subordinate
its interests in favour of another party or to confer benefits not
bargained for in the agreement.

Facts and Decisions Below

Wastech Services Ltd. (“Wastech”) and the Greater
Vancouver Sewerage and Drainage District (“Metro”)
entered a 20-year term waste disposal contract. Under its terms,
Wastetech could remove and transport waste to three disposal
facilities and was paid at a different rate depending on the
distance and facility selected. Metro retained absolute discretion
regarding waste allocation and Wastech was not guaranteed profits
per annum. Metro exercised its discretion to reallocate waste from
one facility to another resulting in Wastech not achieving its
operating profit target in 2011. Wastech sought compensatory
damages of almost $2.9 Million at an arbitration against Metro.
Wastech claimed the damages represented the additional amount
Wastetech would have earned in 2011 had Metro not reallocated waste
and deprived Wastetech of the opportunity to achieve its profit
target. The arbitrator ruled in favour of Wastech and found Metro
had breached the duty of good faith in exercising its contractual
discretionary power, which made it impossible for Wastech to
achieve its profit target. The arbitrator noted that Wastech had a
legitimate expectation that Metro would not exercise its discretion
under the contract in such manner. Metro successfully appealed the
decision and the arbitrator’s award was set aside by the
Supreme Court of British Columbia. Wastech’s subsequent
appeal to the Court of Appeal for British Columbia was
dismissed.

Supreme Court of Canada Decision

Wastech’s appeal to the Supreme Court was dismissed, with
Justice Kasirer writing for the majority.

The exercise of discretionary power under a contract, even if
unfettered, is constrained by the duty of good faith, the Supreme
Court held. The duty to exercise discretion in good faith is a
doctrine of contract law and operates in every contract regardless
of the intention of the parties.

Similar to the duty of honest performance considered by the
Supreme Court in Bhasin, and more recently in Callow (see our article 
here
), the duty of good faith limits how a party can exercise
its contractual rights. Contracting parties are required to
exercise discretion reasonably – in a manner connected to the
purposes underlying the discretion granted in the contract. Where,
for instance, a party exercises contractual discretion in an
arbitrary or capricious manner such will amount to a breach of
contract and is a violation of the duty of good faith.

An exercise of contractual discretion that substantially
nullifies or eviscerates the benefit of the contract may be
relevant to demonstrating that a party’s discretion is being
exercised in a manner not connected to the purpose for which it was
granted, but it is not a prerequisite to establishing a breach of
the duty to exercise contractual discretion in good faith, the
Supreme Court noted.

Given there was no allegation that Metro lied or misled Wastech
in its performance of the contract, including in exercising its
discretion to reallocate waste, the duty of honest performance was
not at issue. The issue was whether Metro had breached its duty of
good faith in exercising its discretion in light of the purpose of
the discretion in the contract.

The Supreme Court concluded that Metro’s exercise of
discretion to reallocate waste under the contract was reasonable
and therefore not a breach. Metro had absolute discretion to
determine the minimum amount of waste to be disposed at various
disposal sites in a given period. Considering the terms of the
contract, including the recitals, it was clear that the discretion
was granted to Metro to provide it with flexibility to maximize
efficiency and minimize costs of the operation. Metro’s
decision to reallocate waste was not contrary to those
purposes.  The duty of good faith did not require Metro to
subordinate its interests in favour of Wastech’s interests in
exercising its discretionary power.

The parties were aware of the risks associated with Metro having
absolute discretion to allocate waste and they chose not to limit
that discretion. Given this risk and the fact that the contract did
not guarantee Wastech would achieve target profits in any given
year, it was not a shared, reasonable expectation of the parties
that Wastech would have the opportunity to achieve target profits
every year. The fact that Wastech’s own financial interests
suffered did not mean Metro acted unfairly or in bad faith.

Going Forward

Based on the Wastech decision, contracting
parties will want to carefully draft provisions that set out a
party’s discretionary powers and should consider stating the
purpose of the discretion granted in an agreement. The recitals at
the beginning of a contract are also important and should be
consistent with the overall contract.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.

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