Supreme Court Of Canada Recognizes Duty Of Good Faith In Exercise Of Contractual Discretion – Corporate/Commercial Law Leave a comment



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Supreme Court Of Canada Recognizes Duty Of Good Faith In Exercise Of Contractual Discretion


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In Wastech Services Ltd. v. Greater Vancouver Sewerage and
Drainage
(Wastech), the Supreme Court of Canada (SCC)
recognized a general duty to exercise contractual discretion in
good faith. This bulletin summarizes the SCC’s decision,
explains the content of the duty and provides some practical
tips to avoid breaching the duty.

WHAT DID THE SCC HOLD?

The SCC affirmed that there is a duty to exercise any
discretionary power in a contract reasonably, which it defined to
mean in a manner connected to the purposes for which the discretion
was granted. The exercise of discretion for an arbitrary,
capricious or extraneous purpose will breach this duty of good
faith. The underlying purpose of a discretionary power is a
fact-specific analysis connected to the interpretation of the
contract.

The SCC acknowledged that there is a range of reasonable
outcomes that can result from the exercise of any discretionary
power. The concept of a “reasonable” exercise of
discretion does not mean that good faith can be used as a pretext
for scrutinizing a party’s motive for exercising discretion in
a particular way, or whether its decision was commercially wise.
Moreover, parties are not obligated to subordinate their own
interests to those of their contracting partners and remain free to
act in their self-interest within the bounds set by the
contract.

The majority of the SCC held that the duty to exercise
discretion in good faith cannot be excluded by the parties in their
contract. However, a minority was of the view that the parties
should be able to create unconstrained discretionary powers in a
contract, provided they do so in clear language.

WHAT HAPPENED IN WASTECH?

Wastech Services Ltd. (Wastech) entered into a waste disposal
agreement with Greater Vancouver Sewerage and Drainage District
(Metro). The contract gave Metro “absolute discretion” to
direct waste to any of three disposal sites. Wastech would be paid
a different rate depending on the disposal site chosen. The
contract contained a target revenue-to-operating-cost ratio (Target
OR) with adjustments to Wastech’s compensation if the Target OR
was not met in a given year. However, the contract did not
guarantee that Wastech would meet the Target OR.

In 2011, Metro re-allocated where to send waste among the three
disposal sites, which resulted in a lower than expected profit for
Wastech. Wastech alleged that Metro acted in bad faith and
therefore breached the contract by exercising its discretion in a
way that deprived Wastech of any opportunity to meet the Target
OR.

The SCC dismissed Wastech’s claim and held that Metro did
not violate the duty to exercise contractual discretion in good
faith. The SCC held that the purpose of Metro’s discretion to
allocate waste was to give it flexibility to maximize efficiency
and minimize costs. The contract did not guarantee Wastech any
specific level of profit and Wastech could not use good faith to
obtain an advantage for which it did not bargain.

WHAT TYPES OF CONDUCT WILL BREACH THE DUTY TO EXERCISE
DISCRETION IN GOOD FAITH?

The SCC was clear that the underlying purpose for which a
discretion was granted is the primary consideration in determining
whether an exercise of discretion is unreasonable. An exercise of
discretion will be unreasonable (i.e., made in bad faith) where
it:

  • is arbitrary or capricious

  • is made for purposes extraneous to the contract

  • falls outside a range of reasonable outcomes contemplated by
    the contract

However, a party is not required to subordinate its own
interests to those of its counterparty or act as a fiduciary. An
exercise of discretion will not breach the duty of good faith
merely because it:

  • is motivated by self-interest

  • causes financial loss to the other party

  • is contrary to the other party’s commercial interests

  • may be unwise from a business perspective

WHAT ARE SOME PRACTICAL TIPS TO AVOID BREACHING THE DUTY TO
EXERCISE DISCRETION IN GOOD FAITH?

  • Defining the nature and purpose of the discretionary
    power in the contract
    . Clearly setting out the nature and
    intended breadth of the discretionary power or the purpose for
    which it has been granted will help avoid uncertainty in the event
    of a dispute.

  • Drafting contract recitals carefully. Recitals
    may be used as evidence of the purpose of the contract as a whole
    or of a specific discretionary clause. They may become important in
    interpreting the scope of a discretionary power or range of
    reasonable outcomes.

The Wastech appeal was heard together with C.M.
Callow Inc. v. Zollinger
, which addressed the duty of honest
contractual performance. (The Callow case is summarized in
our Blakes Bulletin: Callow and the Duty
of Honest Contractual Performance
.

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Marketing Department.

© 2020 Blake, Cassels & Graydon LLP.

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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