February 14, 2021
The duty of honesty in the performance of a contract applies to all contracts and means “simply that parties must not lie or otherwise knowingly mislead each other about matters directly linked to the performance of the contract”.
This quotation from the 2014 decision of the Supreme Court of Canada, Bhasin v. Hrynew, in which the court first the recognized the duty of good faith performance of a contract, is repeated in the court’s most recent clarification of the scope of the duty in C.M. Callow Inc. v. Zollinger . The phrase “directly linked” takes on new significance in the dispute in Callow.
Specifically, dishonesty during negotiations under a renewal clause were captured by this duty. This is somewhat surprising, given that since Bhasin, courts have repeatedly said that there is still no duty to negotiate in good faith, and that each negotiating party is entitled to look out for their own interests. It will require further decisions to see just how far Callow has shifted the balance.
For now what we know is that the Supreme Court is encouraging judges to use this doctrine flexibly, to encourage honesty in business dealings. This is an important step away from from the traditional rule of “the freedom of contracting parties to pursue their individual self-interest”. Courts have to date been reluctant to interfere with the rights of “private ordering”, fearing that if the doctrine is expanded too broadly, it will result in what Bhasin called ad hoc or “palm tree justice”.
Just a few months before the Callow decision, the Supreme Court said that “not every contract imposes actionable good faith obligations on contracting parties. While good faith is an organizing principle of Canadian contract law, it manifests itself in specific circumstances” (Atlantic Lottery Corp. Inc. v. Babstock).
Freedom of contract remains the general rule, but it has its limits. In exploring the limits, Callow suggests that they are broader than earlier thought.
The Callow case involved a relationship involving two property maintenance contracts – a summer contract and a winter contract. In early 2013, the owner made a decision to not renew the winter contract. Throughout the summer, it pretended to negotiate. During the negotiations, the contractor performed extra work under the summer contract, in the hopes of securing the renewal of the more lucrative winter contract. Once the contractor was told that there was to be no renewal, it was too late for them to find a new winter contract, so they sued.
At trial, the judge found as a fact that the owner had lied to the contractor, and, applying Bhasin, awarded damages. The Court of Appeal disagreed, finding that since the lies took place during the performance of the summer contract, there was not the required ‘direct link’ between the dishonesty and the winter contract. The non-renewal decision was communicated within the time required by the winter contract – in other words, complying with the ‘private ordering’ or rules set by the parties – and as there is no duty to negotiate in good faith, the doctrine did not apply.
This might appear to be a sound technical reading of the law, but is a somewhat surprising verdict given how much the courts generally dislike liars and favour the party with the moral high ground.
The Supreme Court reinstated the trial judgment. They agreed with the Court of Appeal that there must be a direct link between the bad faith and the contract, but agreed with the trial judge that the manner in which the decision to terminate the winter contract was dealt with provided that link. The decision not to renew itself did not require “good faith”, but the timing of the communication of the decision was subject to the duty. Technical compliance with the time limit in the contract was not enough.
The Court also went out of its way to give guidance to lower courts about how to approach damages in breach of duty of good faith situations.
There are generally two types of contract damages: “expectation damages” and “reliance damages”.
Expectation damages are those usually awarded to put the injured party back into the position it would have been if the contract had been performed. This typically means lost profits.
Reliance damages are more rare in breach of contract cases. They put the injured party into the position they would be in if it had not entered into the contract at all. They are similar to damages for torts (civil wrongs). Reliance damages may be ordered in breach of contract cases where it is difficult to prove the loss of profits.
Reliance damages often repay the injured party for expenses incurred in reliance on the contract.
There has been confusion since Bhasin as to whether expectation or reliance damages apply to breach of good faith claims.
The Supreme Court now clearly states that expectation damages remain the normal measure, but there are wrinkles on the facts of Callow that illustrate how judges might be flexible in assessing these damages.
In Callow, the trial judge awarded the anticipated profit from the renewal that never happened, plus the costs spent in anticipation of the contract.
The owner argued that since there was no right to the renewal, there was no loss. It suggested that what the trial judge did was in effect awarding reliance damages.
The majority of the Court disagreed. If the contractor had not been lied to, they could have secured another winter maintenance contract. This lost opportunity leads to damages. The Court inferred that the resulting lost profit that would have been achieved had the contractor been given the opportunity to obtain another winter contract was equal to that anticipated under a renewal. It also agreed with the trial judge that the wasted expense of leasing a piece of machinery for the winter contract was part of the damages.
It is important to note that if the owner had said nothing about renewal, there would have been no claim for damages. It was the active misleading, or lying, that cost the owner in Callow.
Callow is a reminder that judges will still favour the party with the moral high ground, that they dislike liars, and where they decide that one party to a contract has acted in bad faith, they will find in favour of the injured party, with a goal of making them whole again. The trend to be generous in damages were the party breaching the contract acted in bad faith is not new; it is just emphasized by this result.
Good faith in performing contracts, like good deeds generally, will be rewarded. Bad faith will be costly.