Keep the Faith! Good Faith in Contracts Returns

Despite the age old maxim of “freedom of contract”, parties should nevertheless continue to keep their duty to act in good faith when performing their contractual obligations, even if such obligations are to the sole benefit of one party. In the Supreme Court case C.M. Callow v Zollinger et al, the Supreme Court discusses a contracting party’s duty to act in good faith when utilizing a clause that enabled a party to unilaterally terminate a contract.

Background

In this case C.M. Callow Inc. (“Callow”), a landscaping company, was hired by a condominium management group and property manager to perform various services for 10 condominium corporations (collectively called “Baycrest”).

In 2012, the parties entered into two maintenance service agreements for both winter and summer seasons. The winter service agreement spanned the winter months between November 2012 and April 2014. Pursuant to clause 9 of that agreement, however, Baycrest was entitled to terminate their agreement if Callow failed to perform their services, such as snow removal, satisfactorily. The clause further enabled Baycrest to terminate the agreement if Callow’s services were no longer required by providing Callow with 10 days’ written notice.

After the first year however, complaints began to arise regarding Callow’s work. In 2013, Callow’s owner attended a meeting with the condominium corporations’ management group to discuss such service issues. The meeting’s notes showed that Callow had properly dissuaded the committee’s concerns.

Months later Tammy Zollinger was brought on as the new property manager, and after reviewing the agreement, advised the management group that Baycrest could terminate Callow’s services without any financial penalty. Without informing Callow, Baycrest subsequently voted to terminate Calllow’s winter service agreement in the spring of 2013

As the summer of 2013 continued, Callow began discussing with Baycrest the possibility of renewing their winter service agreement. After providing various free services for Baycrest in an effort to bolster his chances, and after various conversations with management, Callow was led to believe his contract would be renewed after the April 2014 contract expired.

Around September 2013, however, Baycrest issued the required 10 days’ notice to Callow of their decision to terminate the current winter service agreement. In response, Callow sued for breach of contract, alleging that Baycrest had acted in bad faith by accepting Callow’s free services and communicating that Callow’s services were sufficient leading Callow to believe that his agreement would not be pre-maturely terminated. As a result of Baycrest’s representations, Callow claimed, Callow did not bid on other contracts, and lost other work opportunities.

The Supreme Court took this case as an opportunity to clarify the law surrounding the duty of good faith, and what constituted a breach of the duty of honest performance in relation to a unilateral termination clause. The focus of the decision, however, was not directed at whether the termination clause was valid, or whether Callow’s termination was unjustified, but whether Baycrest failed to satisfy its duty at law to not lie, or knowingly deceive Callow about matters directly linked to the performance of their maintenance agreement. In other words, whether Baycrest breached its duty to exercise the termination clause in good faith.

The Doctrine of Good Faith

In law there is a distinct organizing principle of good faith which requires a contracting party to exercise their contractual rights and obligations under their contract in an honest and reasonable manner by refraining from capricious or arbitrary actions.

In the seminal decision, Bhasin v Hrynew, the Supreme Court set out this principle of good faith, explaining that the principle was not itself a free-standing rule, but rather manifested itself through various enforceable doctrines, such as the doctrine that parties had duty to act honestly in the performance of their contracts. Under this doctrine, any dishonest or misleading conduct directly linked to the performance of a contract would result in that party breaching the contract, thereby resulting in damages.

Such conduct, the court explained, is not simply the duty to refrain from lying. Instead, the duty encompassed a wide array of actions ranging from a party’s failure to disclose a material fact to the other party to knowingly misleading another party through one’s actions. However, such a duty does not compel a contracting party to be completely transparent. So long as a party performs their own self-interest honestly, their obligations will be met.

Decision

In rendering their decision, the court reiterated that the duty of honest performance required a direct link between the alleged dishonest conduct, and the performance of the contract. On this point the Supreme Court disagreed with the conclusion reached by Ontario’s Court of Appeal that Baycrest’s dishonest conduct was related to a future, potential, contract, and was therefore not directly linked to the performance of the current winter service agreement. Instead, the Supreme Court clarified that the alleged dishonesty was directly linked to the winter service agreement because Baycrest’s use of the termination clause provided to it under the agreement was dishonest.

In concluding that Baycrest acted dishonestly, the court took note of various conversations and communications between the management group and Callow which suggested that Callow was under the impression that the winter agreement would be renewed.

Secondly, the court explained that Baycrest’s conduct was deceptive when one of Baycrest’s board members acknowledged in an email that Baycrest knew they were accepting free work from Callow as an incentive to renew the winter services agreement, and that the board member had informed Callow that he would relay Callow’s efforts to the other board members.

Given Baycrest’s conduct, the court concluded that Callow was unfairly led to infer that their current agreement would not be terminated given that Baycrest would be renewing it next year. Baycrest also made no attempts to correct Calloway’s false impression that the contract would be renewed. As such, Baycrest breached their duty to honestly perform their contractual duties.

The court subsequently awarded Callow damages related to his lost opportunities in the amount of $64,306.96, and $14,835.14 for the cost of machinery leased in relation to the winter maintenance agreement.

Takeaway

This decision effectively broadens the applicability of a contracting party’s duty of honest performance. When a party’s failure to correct a misapprehension amounts to active dishonesty in a manner directly related to the performance of the contract, a contracting party is now seen as having breached their duty of honest performance, and liable to damages resulting therefrom.

It must be remembered however, that such a determination involves a heavy factual review by the court. Therefore, as a contracting party it is important to consider whether any of your actions or inaction have led a counterparty to misapprehend anything related to the performance of the contract, before exercising your rights.

However, this decision should not be read as the courts attempting to limit a party from pursuing their own self-interest. Such a duty does not impose a duty to disclose or fiduciary-like obligation on contracting parties. Instead, parties should simply be aware that in pursuing their own interests, they should do so honestly, and correct any misapprehensions that arise from their conduct.

If you’re worried about the potential ramifications of exercising your own contractual rights, McLennan Ross has a strong and experienced commercial litigation team capable of providing superior advice and representation in relation to such matters. Please contact us with any contractual or litigation issues you may have.