Supreme Court of Canada Establishes Duty of Honesty in Performance of Contracts

On November 13, 2014, the Supreme Court of Canada (the “SCC”) released its decision in the case of Bhasin v. Hrynew which has implications for all persons who enter into and perform under contracts.  In its decision, the SCC established that good faith contractual performance is a general organizing principle of the common law of contract and, moreover, recognized that there exists a common law duty to act honestly in the performance of all contracts.

Facts

Canadian American Financial Corp. (Canada) Limited (“CAFC”) was in the business of marketing registered education savings plans through retail dealers, known as enrollment directors.  Harish Bhasin was an enrollment director for CAFC and built a successful business for which he received recognition from CACF as one of its top enrollment directors.  Mr. Bhasin’s agreement with CAFC provided that he was obliged to sell CAFC products exclusively and owed it a fiduciary duty.  In addition, Mr. Bhasin could not sell, transfer or merge his operation without CAFC’s consent.  The agreement provided that it would automatically renew at the end of its initial three-year term unless one of the parties provided notice of non-renewal at least six months prior to the end of the term.

Larry Hrynew, also an enrollment director for CAFC and a competitor of Mr. Bhasin, was interested in merging his business with Mr. Bhasin’s.  Mr. Hrynew approached Mr. Bhasin on several occasions to propose a merger and also actively encouraged CAFC to force such a merger, including making veiled threats that he would leave if no merger took place.  Mr. Bhasin refused to participate in such a merger.

CAFC had also appointed Mr. Hrynew as its provincial trading officer to review and audit its enrollment directors for compliance with securities laws, which required Mr. Bhasin (and others) to share his confidential business records with one of his competitors.  Mr. Bhasin refused to allow Mr. Hrynew to audit his records.  CAFC subsequently gave Mr. Bhasin notice of non-renewal under the agreement and at the expiry of the term Mr. Bhasin lost the value in his business and the majority of his sales force was successfully solicited by Mr. Hrynew’s agency.

The trial judge found that CAFC, as a result of concerns with losing its licence, had formulated a plan (unbeknownst to Mr. Bhasin) to restructure its operations that included Mr. Bhasin working for Mr. Hrynew’s agency.  The trial judge further found that CAFC had repeatedly misled Mr. Bhasin about, among other things, its intentions with respect to the merger and that it was working closely with Mr. Hrynew to restructure its operations with Mr. Hrynew’s agency being the main agency in Alberta.   The trial judge concluded that CAFC had misled Mr. Bhasin with respect to the matters that led to the non-renewal of the agreement and that it therefore breached an implied duty of good faith.   The Alberta Court of Appeal dismissed Mr. Bhasin’s action on the basis that the trial judge erred by implying a term of good faith in the context of an unambiguous contract that did not contain an express duty of good faith and that contained an entire agreement clause.

The SCC Decision

In a unanimous decision, the SCC allowed Mr. Bhasin’s appeal and in doing so articulated two incremental steps in order to make the common law more coherent and more just.  The first step was to acknowledge that good faith contractual performance is a general organizing principle of the common law of contract that underpins and informs the various rules in which the common law recognizes obligations of good faith contractual performance.  The second step is to recognize that, as a further manifestation of this organizing principle of good faith, there is a common law duty which applies to all contracts to act honestly in the performance of contractual obligations.  In carrying out the performance of the contract, a party should have appropriate regard to the legitimate contractual interests of the other party and it should not seek to undermine those interests in bad faith.  Put another way, parties must not lie or otherwise knowingly mislead each other about matters relating to the performance of the contract.

As applied to the facts in Bhasin v. Hrynew, CAFC failed to act honestly with Mr. Bhasin in exercising the non-renewal clause under the agreement and acted dishonestly with Mr. Bhasin throughout the period leading up to the exercise of the non-renewal clause.  As a result, CAFC was found to be liable for damages on the basis of what Mr. Bhasin’s economic position would have been had CAFC fulfilled its duty based on the value of Mr. Bhasin’s business at the time of non-renewal of the agreement.

What does it mean?

The duty of honesty established by the SCC imposes a contractual duty that a minimum standard of honesty be adhered to in the performance of a contract.  While this duty does not impose a duty of loyalty or of disclosure or require a party to forego advantages flowing under a contract, parties to a contract must not lie or mislead the other party about contractual performance.   The SCC stated that a duty of honesty operates irrespective of the intention of the parties and that contracting parties must be able to rely on a minimum standard of honesty from their contracting partner in respect of the performance of the contract.

As a result of the SCC’s decision, all contracts are subject to a duty of honest performance, whether or not the agreement expressly provides for or excludes such requirement.  Accordingly, parties must be mindful of their actions when performing contracts to ensure that they are doing so in a manner that discharges this duty.  Conduct that could be construed as deceptive, misleading or dishonest may give rise to litigation even if a specific exercise of a right may be permitted by the terms of the agreement.

This update is intended as a summary only and should not be regarded or relied upon as advice to any specific client or regarding any specific situation.

If you would like further information regarding the issues discussed in this update or if you wish to discuss any aspect of this commentary, please feel free to contact us.