At Your Discretion: The Art of Contractual Decision-Making

In our most recent blog post, our colleague Erik Holmstrom discusses the Supreme Court of Canada decision in CM Callow v Zollinger et al. There, he discusses the general duty of good faith, and the requirement for parties to refrain from active dishonesty in performing their contractual duties. Rightly so, he points out that this decision does not prevent parties from pursuing their own self-interests, and this is exactly what the Supreme Court sought to clarify in its subsequent decision in Wastech Services Ltd v Greater Vancouver Sewerage and Drainage District, 2021 SCC 7. More specifically, the Supreme Court discussed the concept of good faith as it relates to contracts that provide either one or more parties with discretionary rights.

Background

Wastech Services Ltd. (“Wastech”) is a company in British Columbia that provides waste transportation and disposal services. The Greater Vancouver Sewerage and Drainage District (the “District”) is a statutory body that administers waste disposal programs in the Greater Vancouver area. Wastech and the District had contracted many times, and in 1996 they entered into the agreement before the Court (the “Contract”). The Contract superseded four existing agreements between the parties and was very complex. Essentially, Wastech was to remove and transport waste on behalf of the District to three locations.

Wastech received different compensation rates depending on which landfill it was instructed to bring waste to. The Contract gave the District “absolute discretion” to determine and amend the minimum amount of waste to be transported to Cache Creek Landfill, which is the only location that carried a higher compensation rate. Additionally, the Contract specified a target operating ratio, where Wastech’s operating costs would amount to 89% of total revenue. This would ordinarily result in an 11% profit margin. The parties would share the financial consequences if the actual operating ratio was less than or exceeded the target.

In 2011, the District directed a significant amount of waste away from Cache Creek Landfill to another landfill, which caused Wastech to operate at a 4.5 percent loss. After adjustments and cost sharing, Wastech recorded only 4% profit for 2011 – well short of its 11% target. As a result, Wastech initiated arbitration proceedings under the Contract, arguing that the District breached the Contract and that it was entitled to compensation for the District’s failure to uphold its duty of good faith. The case went through arbitration, and multiple appeals through the Supreme Court of British Columbia and the British Columbia Court of Appeal before ending up at the Supreme Court of Canada.

The Court’s Ruling

The Court held that, while the duty to exercise contractual discretion in good faith is a well-established point of law in Canada, this does not mean that a party must exercise their discretion in deference to the other party’s interests. By contrast, a party will have upheld its duty of good faith if it exercises its discretion reasonably and consistent with the purposes of the parties’ bargain. If a party exercises its discretion dishonestly, it will constitute a breach of contract.

The Supreme Court had held in previous cases that the duty of good faith and honest performance was a “general organizing principle” of contract law. Indeed, this duty expressly covered the exercise of discretionary powers; however, there was very little discussion on what exercising discretion in good faith would look like.[1] In addition to this, the Court acknowledged the further confusion over what this duty would be where a party has unfettered discretion – as the District did in this case.

Wastech argued that it would be “unreasonable for a party to exercise its discretion “in such a way as to deny the other contractual party substantial benefits flowing to it which represent fundamental aspects of the parties’ legitimate contractual expectations.”” By this, they meant that when the District elected to divert waste away from Cache Creek, they did so knowing that it would result in a significant reduction in profits flowing to Wastech, which it had previously received and expected to receive in future. As it had discretion over this, and could potentially have elected to send more waste to Cache Creek, Wastech felt that this was done in bad faith.

The Court disagreed. They stated that good faith should not be used as an excuse for punishing a party’s motives. Even if a decision results in the substantial or total loss of contractual benefits for another party, this alone will not mean that a party has acted in bad faith. Good faith in discretion will be highly-context specific, and the content of a party’s duty is found in the wording of the agreement. This means that parties simply must uphold the objectives of their discretion, as per the negotiations of the parties.

In this case, the Contract gave the District the absolute discretion to determine the minimum amount of waste to be transported to Cache Creek. There was no guaranteed minimum. The purpose of giving the District this discretion was to allow the parties to adjust waste flows to accommodate changing circumstances. The parties knew there would be operational variability when they negotiated the Contract, and that is why the adjustment payments were in place – to compensate parties where there are unfortunate results. The Court was adamant that the Contract did not require the District to subordinate its own interests to Wastech’s interests. The discretion was related to the efficiency and capacities of the landfill sites, and they had the absolute right to make decisions about this. Wastech’s “legitimate expectations” were not guaranteed by the Contract, and thus the District did not breach its duty of good faith.

Takeaways

Despite the Supreme Court’s rulings in CM Callow v Zollinger et al and others, the duty of good faith and honest performance does not necessarily mean that a party exercising contractual discretion must do so with the other party’s interests in mind. In fact, where a party has absolute or unfettered discretion over certain matters, they must simply exercise those powers in reference to the purposes and objectives of their agreement and they must do so honestly.

I note, however, that what this means will vary from case to case. Your contractual duties of good faith will depend on the wording of your contract, and as such you should always seek the advice of experienced and qualified lawyers. Here at McLennan Ross LLP, our team of commercial litigators are ready and waiting to answer your questions and help you should you require assistance with matters like these. So, if you have questions about how you must exercise discretionary powers under a contract, or if you have any other questions about a commercial litigation matter, please contact a member of our Litigation team and we would be glad to assist you.