Supreme Court Of Canada Imposes Good Faith Limits On The Exercise Of Contractual Discretion – Corporate/Commercial Law

Bizar Male

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. 

Background

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.

Conclusion

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.

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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