Trash Talk: Supreme Court Considers Contractual Discretion In Good Faith – Corporate/Commercial Law

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Trash Talk: Supreme Court Considers Contractual Discretion In Good Faith


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In its recent decision in Wastech Services Ltd. v. Greater Vancouver
Sewerage and Drainage District
 (Wastech)
, the Supreme
Court of Canada recognized that parties need to exercise contractual discretion in good faith.
This means making decisions that are reasonable in light of the
bargain the parties made.

What you need to know

  • The Court held that the organizing principle of good faith
    requires that, where a contract gives a party the ability to make a
    discretionary decision, the party must exercise that
    discretion reasonably in light of the bargain the parties
    made
    .

  • The Court held that the duty to exercise discretion reasonably
    is imposed externally on the contractual relationship, and
    therefore the parties cannot contract out of it.

  • This means that parties cannot contract for absolute,
    completely unfettered discretion
    .

  • The Court heard this case at the same time as CM Callow Inc. v. Zollinger (CM
    Callow)
    , which considered the duty of honest performance.
    Together, the decisions add breadth and depth to the Canadian law
    of good faith in contracts.

  • The concurring reasons also considered the standard of review
    of an arbitrator’s decision.

Background

This case concerns a trash collection contract between Wastech
and the City of Vancouver to collect solid waste and transport it
to three landfills – two closer to Vancouver and one farther
away. Wastech received premium pay for the waste it had to
transport to the farther landfill, but Metro Vancouver had absolute
discretion under the contract to determine what percentage of the
waste collected would go to which landfill.

The contract was heavily negotiated, and in various clauses
contemplated the impact on Wastech’s profit margins. However,
one clause gave Vancouver sole discretion to
allocate the waste as between the three landfills. The clause did
not limit the discretion, nor did it guarantee any profit for
Wastech.

Duty of good faith and contractual discretion

The Supreme Court held that a duty to exercise contractual
discretion in good faith is well established at common law. In the
Court’s language from Bhasin v.
Hrynew
 (Bhasin)
, this requires parties to exercise
contractual discretion reasonably. The key holding, which is a new
development in the law, is that exercising discretion reasonably
means exercising discretion in a manner consistent with the
purposes for which it was granted in the contract
.
However, the Court was clear that this does not create a
fiduciary-like duty, and the party with the discretion need not
place the other party’s interest before its own.

In other words, an exercise of discretion will not be reasonable
when it is exercised in a way that is not consistent with the
purpose for which the discretion was granted. This requires a
highly context-specific analysis, whose outcome ultimately depends
on a process of contractual interpretation to determine the
parties’ intention. However, the Court indicated that the range
of reasonable outcomes generally would be smaller if the issue
subject to the discretion is capable of objective measurement, and
larger if it is not.

In the Wastech case, the Court considered the
commercial structure of the parties’ bargain to determine the
scope of reasonableness. With respect to the specific discretion at
issue – how to allocate waste disposal between landfills
– the Court found that the intention behind giving Vancouver
discretion was to give the city flexibility to allocate waste
efficiently and minimize operating costs. Though this reduced
Wastech’s profit margin, the Court found that the parties did
not intend Vancouver’s discretion to be constrained by this
consideration. This was evident from the fact that the contract
took into account the effect on Wastech’s profit margin in
other contexts, but not when the city was deciding how to allocate
waste between sites.

The majority of the Court held that the duty to exercise
discretion reasonably is a general doctrine of contract law, and is
not an implied term of any particular contract. The implication is,
therefore, that parties cannot contract out of this duty.

Finally, the Court rejected the notion that an exercise of
discretion will be unreasonable only if the exercise of discretion
“substantially nullifies” the benefit of the contract for
the other party. On the other hand, the fact that a party’s
exercise of discretion causes a party to lose some or even all of
its anticipated benefit – as happened in this case – is
not dispositive in itself, as long as the exercise of discretion is
within the bounds contemplated in the contract.

Takeaways

Arguably, more so than in CM Callow, in
Wastech the Supreme Court expanded the organizing
principle of good faith in contracts by holding that a party cannot
exercise contractual discretion in a complete and unfettered
manner. However, the principle retains some predictability because
this aspect of good faith is rooted in the contract, such that
parties have a concrete and accessible standard by which to judge
their actions.

The history of the Supreme Court’s development of the
doctrine of good faith in contracts also suggests that the law may
develop toward a point where parties owe to all co-contracting
parties good faith obligations similar to those they currently owe
only to more closely related parties.

The first areas in which the Court found duties of good faith to
exist were the close relationships that exist in the employment and
franchise contexts. Then, in Bhasin, the Court established
good faith as a general organizing principle in contract law.
Recently in CM Callow and Wastech, the Court
applied this organizing principle to import certain aspects of good
faith from close relationships to all contracts – duties to
act honestly and exercise discretion reasonably.


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