by Peter Major, Q.C., Q.Arb. and Matthew McCarthy, Student-at-Law
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Contract superseded four existing agreements between the parties and was very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.
