Recognizing Duty of Honest Contractual Performance

April 2, 2015

Overview

This case provided the Court with the opportunity to address whether there was or should be an over-arching duty of good faith in contract performance, or alternatively if a more limited duty of honest contractual performance should be recognized.

The Court concluded that Canadian common law did not and should not recognize a stand alone broad legal requirement that parties to a contract perform their obligations in good faith.  It did conclude that a duty of honest contractual performance should be recognized.

Background

The appellant owned a business which sold education savings plans.  The corporate respondent established and administered the plans.  It paid the appellant for his sale of the plans.  The parties’ relationship was governed by a director’s agreement.  The agreement would automatically renew every three years unless one of the parties provided notice to the contrary at least six months prior to the expiration date.

The individual respondent was a competitor of the appellant.  The evidence indicated there was a level of animosity between the individuals.  The individual respondent pressured the corporate respondent not to renew its agreement with the appellant.  The corporate respondent eventually agreed.  Mr. Bhasin sued.  He was successful at trial but the decision was overturned on appeal.

Substance of Decision

Justice Cromwell rendered the decision of the Court on November 13, 2014.  His Lordship provided a comprehensive overview of the history and current state of the law in Canada and several other common law jurisdictions on the issue of good faith as an element of contractual performance.  His Lordship described the jurisprudence as “piecemeal, unclear, and unsettled”.  He concluded that the time had come to take two “incremental steps” in order to address this unsatisfactory state of affairs.

The first step was to acknowledge that good faith contractual performance is a “general organizing principle of the common law of contract”.  The second step was to recognize, as a manifestation of the organizing principle, that there is a common law duty which applies to all contracts to “act honestly in the performance of contractual obligations”.

Organizing Principle of Good Faith and Honesty in Contractual Performance

Justice Cromwell stated that an organizing principle is:

“… in general terms a requirement of justice from which more specific legal doctrines may be derived.  An organizing principle therefore is not a free-standing rule, but rather a standard that underpins and is manifested in more specific legal doctrines and may be given different weight in different situations. … It is a standard that helps to understand and develop the law in a coherent and principled way.

The organizing principle of good faith exemplifies the notion that, in carrying out his or her own performance of the contract, a contracting party should have appropriate regard to the legitimate contractual interests of the contracting partner.  While ‘appropriate regard’ for the other party’s interests will vary depending on the context of the contractual relationship, it does not require acting to serve those interests in all cases.  It merely requires that a party not seek to undermine those interests in bad faith.”
Justice Cromwell then stated that under the broader organizing principle umbrella, a new common law duty of honesty in contractual performance should be established. His Lordship’s description of the duty included the following:

“This means simply that parties must not lie or otherwise knowingly mislead each other about matters directly linked to the performance of the contract.  This does not impose a duty of loyalty or of disclosure or require a party to forgo advantages flowing from the contract; it is a simple requirement not to lie or mislead the other party about one’s contractual performance.”

“The duty of honest performance that I propose should not be confused with a duty of disclosure or of fiduciary loyalty.  A party to a contract has no general duty to subordinate his or her interest to that of the other party; however, contracting parties must be able to rely on a minimum standard of honesty from their contracting partner in relation to performing the contract as a reassurance that if the contract does not work out, they will have a fair opportunity to protect their interests.”
The case identifies and summarizes specific types of situations in which the Courts have previously recognized an obligation for one or both contracting parties to exercise good faith in the performance of the contractual requirements.  The general organizing principle which Justice Cromwell describes establishes a framework within which the categories of situations requiring good faith can be expanded.  The initial expansion is the duty of honest performance.  Almost certainly additional categories will be suggested and adopted in future cases.

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