Discretionary Rights within Contracts Must be Exercised in Good Faith

In addition to the precise obligations required from parties to a contract, a common feature seen among contracting parties are options more formally referred to as “discretional rights”. As the name suggests, these rights afford parties certain latitude in the manner in which contractual rights may be performed. Although these tools afford parties flexibility with respect to contractual performance, the Supreme Court of Canada (the “SCC”) has recently decided that these rights (or options) must be exercised in good faith.

The general doctrine of “good faith” is a longstanding organizing principal recognized under Canadian contract law. This duty imposes a minimum standard of honesty upon the parties to a contract. This was reiterated in the in the 2014 case of Bhasin v. Hrynew (“Bhasin”) wherein the SCC stated that more specific legal doctrines may be derived from the generality of good faith. In fact, in that very same case, the SCC recognized the specific doctrine of “duty of honest performance” which precludes contracting parties from lying or otherwise knowingly misleading each other about matters directly linked to the performance of the contract.

Almost seven years after the date upon which Bhasin was heard, on February 5, 2021, the SCC has released their long awaited judgment to the case of Wastech Services Ltd. v. Greater Vancouver Draining District (“Wastech”) which recognizes another dimension to the general duty of good faith: the duty to exercise contractual discretionary powers in good faith. Simply put, in circumstances where a party is afforded discretionary rights pursuant to a contract, said party cannot exercise such rights arbitrarily and unfettered, but will instead be required to exercise those powers “reasonably”.

Facts of Case

The facts of Wastech will help to illustrate this principle. The parties to this case had a long standing relationship whereby the plaintiff agreed to provide waste disposal services for the District. In short, the contract afforded the District the “absolute discretion” to choose between three disposal facilities located in either Vancouver, Burnaby or Cache Creek where the waste was to be transported. Pursuant to the terms of the contract, the further facility of Cache Creek earned the plaintiff additional “haul rates” relative to the two closer facilities. In 2011, the District elected to allocate more waste to said closer facilities thereby resulting in reduced profits for the plaintiff and impeding it from meeting its targets. This ensued in arbitration wherein the plaintiff alleged the District exercised its discretion in a manner contrary to good faith before eventually being heard before the highest court in the country.

Decision

Although the SCC ultimately decided in favour of the District, the majority of the Court clarified that (similar to the duty of honest performance) the duty to exercise discretional powers in good faith stems from the organizing principle and therefore cannot be contracted out of. The SCC further held that this duty will be breached where a party exercises its discretion “unreasonably” which is an exercise of discretion unconnected to the purpose of the underlying grant of discretion. Unsurprisingly, what will be considered (un)reasonable will be highly contextual.

Interpretation

A court will first look to the relevant provision granting the discretionary right in an attempt to construe the purpose of the underlying grant. Where such purpose cannot be ascertained by the provision itself, the court will then look to the contract as a whole for further guidance.

In this particular case, a recital to the contract stated the intention to “maximize efficiency and minimize costs.” Furthermore, the SCC accepted that during negotiations, the parties were both aware that the District’s allocation to closer facilities could preclude the plaintiff from achieving their target. Accordingly, this factor had a powerful impact as the SCC was unwilling to grant benefits and protections to the plaintiff which it had not bargained for. Lastly, the SCC considered the plaintiff’s position that a contracting party may not exercise its discretion to “substantially nullify” the benefit of the other party. Although the SCC held that this would be a relevant factor in determining whether one’s discretion was exercised unreasonably, it is not sufficient in and of itself to deem a decision as unreasonable.

Takeaways

Once again, a party who exercises its discretion unreasonably will be found to have breached its contractual obligations. The duty of good faith to exercise discretionary powers will subsist notwithstanding a broad sweeping discretion allotted to a party. Practically speaking, contracting parties should note the following points:

  • The Good News. Overall, the decision from Wastech should serve as reassurance to contracting parties that their counterparts may not have carte blanche with any discretion they may have been afforded. Of course, this decision may run counter to the interests of parties granted “unfettered” discretion with their decision making; however, this new dimension for duty of good faith should overall lead to the predictability for the enforceability for Canadian contracts.
  • Put It in Writing. As discussed, determining whether one’s use of discretion was reasonable will turn on the purpose of granting such discretion. Therefore, when granting discretion between parties, provisions should be drafted in a manner to reduce ambiguity and make this purpose clear to the world.

Please do not hesitate to contact us with any questions or concerns regarding your commercial agreements:

Tony R. Anderson
tanderson@owenbird.com
(604) 691-7528

Lucky D. Johal
ljohal@owenbird.com
(604) 691-7541

Categories: Business Law, Commercial Real Estate