The Supreme Court of Canada in Wastech recently added to the case law on the duty of good faith in contract law, specifically in respect of discretionary clauses. In summary, the Court held that all contracts contain a duty of good faith to exercise all contractual discretion reasonably, including absolute discretion. The Court held that this duty is breached where a party exercises contractual discretion “capriciously or arbitrarily” in a manner unconnected to a discretionary clause’s purpose.[1] While the Court held that this is a duty from which a party cannot contract out, there is room for parties to determine the duty’s scope when forming their intentions as to the purpose of a discretionary clause.
The Facts and Background
The Greater Vancouver Sewerage and Drainage District (“Metro”) and Wastech Services Ltd. (“Wastech”), were parties to a long term contract for waste removal services (the “Contract”). Pursuant to the Contract, Wastech was obliged to remove and transport waste to site locations determined in the absolute direction of Metro. Wastech’s compensation under the Contract was based on an operating profit of 11%, but this margin was not guaranteed.
In 2011, Metro re-evaluated its waste allocation plan and exercised its contractual discretion to change waste site locations, incidentally increasing Wastech’s operating costs and reducing its profit. Wastech commenced an arbitration and sought $2.8 million in alleged lost profits. It argued that Metro’s discretion was subject to the duty of good faith and a requirement to consider the long term and relational nature of the Contract and the trust between the parties.
The arbitrator determined that Metro’s discretion was subject to a duty of good faith and that it had breached this duty by not giving “appropriate regard” to Wastech’s interests.[2] The BC Supreme Court allowed Metro’s appeal, holding that such a duty would have to originate from a contract’s terms. The BC Court of Appeal agreed in that result and dismissed the appeal, but held that breaching the duty of good faith required a party to have also “nullified or eviscerated” the contract.[3] Wastech appealed.
The Supreme Court of Canada
The Court unanimously dismissed Wastech’s appeal, holding that all contracts are subject to a duty of good faith requiring parties to act reasonably in respect of discretionary clauses. The Court explained that reasonableness is determined by the purpose of the discretionary clause. If there is ambiguity in the discretionary clause, the court may consider the contract as a whole; to determine purpose; in that analysis, the court must take a “broad view” of a purpose and the “loyalty” it may require.[4]
Where a party exercises its discretion consistent to a clause’s purpose, it will not breach the duty of good faith; however, where a party exercises its discretion capriciously or arbitrarily, it will fall afoul of this duty. As such, the duty does not necessarily prohibit exercising discretion that leads to the nullification or evisceration of a party’s contractual benefit, nor does it require a party to subvert its interests or confer extra-contractual benefits on another party.[5] Rather, it is a party’s reason for exercising the discretion that determines a breach of the duty, not the effect of the discretionary action.
Application of the Duty of Good Faith
Applying this test, the Court noted that the discretionary clause at hand was intended to allow Metro flexibility to maximize efficiency and minimize costs. In fact, the parties had specifically contemplated and rejected a qualified discretionary clause for this reason. Further, the Contract did not guarantee an 11% profit margin for Wastech and instead afforded it other means of protection. In confirming that Metro had exercised its discretion pursuant to the clause’s business purpose, the Court held that Metro had not breached its duty of good faith.
Conclusion
This decision has further developed the duty of good faith so as to strike a balance between preserving the courts’ ability to intervene in private contracts and parties’ freedom to contract. In summary, parties cannot contract out of the duty of good faith to act reasonably in exercising contractual discretion, but they can determine the scope of this duty by defining the purpose of such discretion. As a court may ultimately have to determine this purpose, parties ought to carefully draft any discretionary clauses so as to evidence party intentions.
Regardless, the duty under Wastech is not overburdening in that it does not require parties to subordinate themselves or provide non-contemplated benefits to other parties. However, it remains to be seen how effective this test will be in preventing abusive or opportunistic behaviour while respecting business discretion. Notably, Metro had significant evidence to prove its business purpose for exercising its discretion and its compliance with that purpose. Where the evidence is less clear or parties have less honest motives, courts may take a more interventionist approach. As good practice, parties should not assume that contractual discretion will be exercised selflessly, and where it is not so exercised, parties must allege an arbitrary or capricious purpose to prove a breach of the duty of good faith.
Written by John Fiddick and articling student Karen McLean.
[1] Wastech, at para. 86.
[2] Wastech, at para. 24.
[3] Wastech, at para. 39.
[4] Wastech, at para. 72.
[5] Wastech, at para. 113.
