Choices, Choices: What You Now Need To Know About Contractual Discretion – Corporate/Commercial Law

Bizar Male

Since 2014, the Supreme Court of Canada has recognized that all
commercial contracts must be performed honestly, in accordance with
the principle of good faith: Bhasin v. Hyrnew, 2014
SCC 71 and C.M. Callow v. Zollinger, 2002 SCC 45.

A recent decision of the Court, Wastech Services Ltd. v.
Greater Vancouver,
2021 SCC 7, now establishes that good faith
includes not only honest contractual performance, but also a duty
to exercise any discretion under the contract
“reasonably”. 

What that may mean for your commercial agreement is a question
of fact and interpretation.

A Wasteful Affair

Wastech arose out a commercial agreement between the
plaintiff waste disposal service and a statutory corporation that
administered waste in the Vancouver region (“Metro”).

The services provided by the plaintiff to Metro over the years
were set out in a complex commercial agreement (the
“Contract”). Broadly speaking, the Contract provided that
the plaintiff would remove and transport waste for Metro to one of
three disposal facilities. The plaintiff would receive more
compensation for its services if the site chosen by Metro was
further away.

Specifically, the plaintiff’s compensation depended on a
target operating ratio (“TOR”) which was 0.89, meaning
costs amounted to 89% of revenue, leaving a profit of 11%. The
Contract, however, in no way guaranteed that the plaintiff would
achieve the TOR in any particular year.

The Contract further required Metro to provide the plaintiff
each year with a prediction of the allocated waste to be handled in
the following year.

Most important, the Contract gave Metro the “absolute
discretion” to determine and change the minimum quantity of
waste to be transported to a landfill of its choice. 

Both parties knew that it was possible that Metro’s exercise
of “absolute discretion” could prevent Wastech
from achieving its TOR. Since both parties assumed such a situation
was unlikely, no mechanism was set out in the Contract to address
this situation.

In 2011, Metro chose to send waste to a closer location, which
had the effect of depriving the plaintiff of reaching its TOR that
year. The plaintiff only earned a profit of 4%. 

At arbitration, the plaintiff argued that Metro’s discretion
to allocate waste between the facilities in 2011 violated the duty
of good faith as it deprived the plaintiff of the opportunity to
achieve the TOR. The plaintiff sought compensation of $2.9 million,
representing the additional amount of money the plaintiff allegedly
would have earned had Metro not breached its duty.

The arbitrator agreed with the plaintiff. Both the British
Columbia Supreme Court and Court of Appeal overturned the
arbitrator’s decision, holding that recognizing a breach of
good faith contradicted the agreement between the parties and
extended the legal principle beyond its conceptual boundaries.

The majority of the Supreme Court of Canada upheld the B.C.
Court’s decision and set aside the arbitration award. 
 

Reading the Contract as a whole, the Court held that it in no
way guaranteed that the plaintiff would achieve the TOR in any
given year. The risk that revenues to the plaintiff would vary from
one year to the next based on the way Metro exercised its
discretion under the Contract was clearly within the parties’
contemplation when they entered into the Contract. 

The plaintiff was asking the Court to constrain Metro’s
discretion under the Contract “so that it c[ould] achieve a
result – an advantage – for which it did not bargain
and, in fact, that it might have been said to have bargained
away”.

What Does Exercising Contractual Discretion in Good Faith
Mean?

In reaching its decision on the facts, the Supreme Court of
Canada made a number of important points about the meaning of good
faith and its effect on contractual discretion.  They are:

1.       The duty of
honest contractual performance and the duty to exercise contractual
discretion in good faith are not the same thing.

The Court was careful to note that the Wastech decision
was not about the duty of honest contractual performance
established in the Bhasin and Callow decisions,
supra. There was no allegation that Metro had lied to the
plaintiff in this case.

Rather, Wastech concerns another aspect of the
principle of good faith which applies to all contracts in Canada:
the duty to exercise contractual discretion in good faith.

Accordingly, while honest contractual performance and the
exercise of contractual discretion are both informed by the legal
principle of good faith, they remain discrete doctrines.

2.       Contractual
discretion must be exercised “reasonably
“.

The Court noted that a discretionary power in a contract,
“even if unfettered”, is necessarily constrained by good
faith. 

This means the power must be exercised “reasonably”,
i.e. not arbitrarily and capriciously. It further means that the
discretion must be exercised in a “manner consistent with the
purposes for which it was granted in the contract”.

This duty accords with notions of “corrective
justice”, which is the foundation of all contractual relations
in Canada:

Where a party to a contract exercises its discretion
unreasonably, which in this context means in a manner not connected
to the underlying purpose of the discretion granted by the
contract, its conduct amounts to a breach of the duty to exercise
contractual discretionary powers in good faith – a wrongful
exercise of the discretionary power – and thus a contractual
breach that must be corrected. Requiring a party to pay damages to
repair such a wrong accords with the theory of corrective justice
and does not amount to a reallocation of the benefits as determined
by the parties or [to] a gift from one party to another.

Thus, where the discretion is exercised for an improper purpose,
“ulterior or extraneous to” the parties’ intentions,
it is exercised in bad faith.

3.       Good faith does
not require one contractual party to subordinate its interests to
the other.

The Court was very careful to narrow the scope of how good faith
can constrain contractual discretion. The fact that a party
exercises its contractual discretion somehow causes the other party
to lose some or all of its anticipated benefit under the agreement
is “not dispositive” of whether the duty of good faith
has been violated.

Good faith in no way requires a party to confer a benefit on the
other party that was not part of the original contract, nor
“does it require a party to subordinate its interests to those
of the other party”.

4.       Good faith
discretion is a free-Standing, contract law doctrine.

As with the duty of honest contractual performance, the duty of
good faith contractual discretion does not depend on the intention
of the parties, nor does it depend on implying any terms into the
contract itself. 

Rather, the doctrine applies to all
contracts in Canada and is a free-standing legal duty, regardless
of how broad the contractual discretion at issue may be.

5.       The court is
confident the duty will not hinder freedom of
contract.

The Court noted that its recognition of a duty to exercise
contractual discretion reasonably would not have a significant
impact on the principle that contractual parties ought to be free
to structure their relations as they best see fit. 

The Court’s belief is grounded in two principles:

  • Contracting parties will never expect
    discretion under a contract to be exercised “in a manner
    unconnected to the purposes for which it was conferred”;
    and

  • Good faith discretion is consistent
    with the parties’ contractual bargain. The “content of the
    duty is guided by the will of the parties as expressed in their
    contract”.

A Narrow Doctrine?

Wastech seeks to abate any alarmism caused by the
Court’s recognition of a duty of good faith
discretion. 

The majority of the Court took pains to emphasize that
exercising discretion reasonably would have little to no impact on
the principle of freedom of contract: no one would ever expect that
they have entered into a contract where one party has the power to
make choices that could affect them in an arbitrary or capricious
way. But no one would also expect that they must subordinate their
own commercial interests to that of the opposing contracting party
either. It’s a fine balance.

There is no doubt that the duty of good faith discretion will
inevitably affect how parties structure and operate under their
respective commercial agreements. As a free-standing common law
doctrine, good faith will curtail how parties behave, even where
they expressly enjoy a right of “unfettered” discretion
under the agreement that could otherwise be exercised
unreasonably. 

Knowing their conduct may become the object of judicial
scrutiny, commercial parties may very well behave differently now
– in a manner that does not necessarily impair their
commercial interests, but certainly forces them to consider what it
means to act “reasonably”.

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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