In Bhasin v. Hrynew,2 the Supreme Court of Canada recognized a new general duty of honesty in  contractual performance. Writing for the unanimous Court, Justice Cromwell stated that the new duty  falls under the “broad umbrella of the organizing principle of good faith performance of  contracts.”3 In the Court’s view, this decision is not a leap for Anglo-Canadian contract law, but  rather a timely and incremental development which “will make the law more certain, more just and  more in tune with reasonable commercial expectations”.4

The practical implications of this case are potentially wide-ranging and parties will need to  consider their performance obligations and behaviour in light of this ground-breaking decision.

The Facts

A detailed description of the facts of the case is beyond the scope of this piece, but a few key  points are worth remarking on to provide some context for the Court’s decision. Mr. Bhasin, the  appellant, ran a successful business under a contract with Canadian American Financial Corp.  (“Can-Am”). The contract provided for an automatic renewal at the end of the term unless one of the  parties gave six months’ written notice terminating the agreement. Following Can-Am’s exercise of  the non-renewal clause, Mr. Bhasin argued that he suffered damages in the form of the lost value of his business because of Can-Am’s dishonest conduct. This conduct  included (i) misleading Mr. Bhasin about its intentions with respect to a proposed merger of Mr.  Bhasin’s business with the business of one of his competitors; and (ii) deceiving him about certain  related discussions it was having with his competitor and with its provincial securities regulator.

“Two Incremental Steps”

The SCC set out in its decision to resolve the “piecemeal, unsettled and unclear”5 state of  Anglo-Canadian common law dealing with the concept of good faith in contract. In contrast with  Quebec’s civil law and the common law in many jurisdictions in the United States, Anglo-Canadian  common law has resisted a general and independent doctrine of good faith performance of contracts. performance of contracts.

Accordingly, the Court introduced “two incremental steps” to “put in place a duty that is just, that accords with the reasonable expectations of commercial  parties and that is sufficiently precise that it will enhance rather than detract from commercial  certainty.”6

Step One: Good Faith as an Organizing Principle

First, the Court acknowledged an organizing  principle of good faith underlying the existing doctrines in which the common law recognizes obligations of good faith contractual performance. Justice Cromwell explained that the organizing principle “is simply that parties  generally must perform their contractual duties honestly and reasonably and not capriciously and arbitrarily.”7

Good faith as an organizing principle is not a free-standing rule, but rather an underlying  standard which underpins and manifests itself in existing doctrines about the types  of situations  and relationships in which the law requires an element of good faith. The Court stated that this  list is not closed, so it is possible for the courts to recognize additional duties in future decisions.

The organizing principle of good faith is meant to guide the law in a coherent and principled way.  Where the law is found to be wanting, the courts may apply the organizing principle of good faith  to develop the law incrementally. However, any application of the organizing principle of good  faith must be consistent with the fundamental commitments of the common law of contract and in particular,  with the freedom of contracting parties to pursue their individual self-interest.8  The Court was  clear that the organizing principle of good faith is not an invitation for ad hoc judicial  moralism.

Step Two: The Duty of Honest Performance

Second, the Court recognized a new common law duty, applicable to all contracts, to act honestly in  the performance of contractual obligations. The Court declined to adopt a general duty of good  faith in all contractual dealings. Instead, the Court recognized a more narrow common law duty of  honest contractual performance, which it explained to mean “simply that parties must not lie or  otherwise knowingly mislead each other about matters directly linked to the performance of the  contract.”9

The Court also emphasized that this new duty is consistent with commercial parties’ expectation of  a “basic level of honesty and good faith in contractual dealings” for the proper function of   business.10

While the scope of this new duty will be determined in subsequent cases, the Court provided some  helpful examples of what the new duty is not:

  1. The duty of honest performance is not a duty of disclosure. While there is no duty to disclose information, a party may not actively mislead or deceive the  other contracting party in relation to performance of the contract.
  2. The duty of honest performance is not a duty of loyalty. A contracting party is not required  to put the interests of the other contracting party first.
  3. The duty of honest performance is similar to, but is not the same as or subsumed by, the law  relating to civil fraud and estoppel.

Practical Implications

What do these two incremental steps mean for contracting parties? While subsequent case law will  provide the true measure of the impact of this decision, contracting parties can glean several  takeaway points from the Court’s decision:

  1. Negotiations between Parties: While the Court did not recognize a new duty of good faith in  the context of negotiations between parties, based on the logic used in Bhasin, it is not  unfathomable that such a duty may be recognized in the future. At the very least, contracting parties should be wary of any  negotiation conduct that is actively misleading or otherwise deceitful.
  2. Drafting of Agreements: The Court left open the possibility that parties can vary the “precise  content of honest performance” in different contexts (presumably through drafting a contractual  provision that establishes the standards the parties wish to live by). The Court stated that  modifications must be express, and that parties cannot contract out of the “minimum core  requirements” of the duty. Since the parameters of the duty of honest performance, including its  “minimum core requirements”, are yet-to-be determined, it remains to be seen what modifications the  courts will permit.
  3. Communications with Counter-Parties: It is unclear whether the newly-recognized duty will lead  to behaviour between parties which is more aligned with the reasonable expectations of commercial  parties with respect to mutual cooperation and general forthrightness. If parties are concerned  about violating (or appearing to violate) a new duty of honesty in contractual performance with  which they are unfamiliar, they may well be tempted to say less to each other in general. Parties  should balance this cautious disposition with an awareness that, while there is no duty to disclose  information, allegations of “dishonesty by omission” may also contribute to litigation risk. This  risk would be amplified in a situation where one party posed a direct question to another.
  4. Exercise of a Contractual Right: The Court stated that “capricious” or “arbitrary” behaviour was inconsistent with the new duty. To avoid these  characterizations, parties may wish to put in place systems to document their internal  decision-making processes so that they can readily explain their motivations and behaviours with  regard to contractual performance.   This kind of contemporaneous record- keeping may assist them  in defending against a charge of being “capricious” or “arbitrary”. For example, this might prove  useful if one party has always intended to renew a contract with another party (and communicated those intentions to its counter-party) and then  abruptly changes course and decides not to renew the agreement. Is that behaviour capricious or  arbitrary? It might seem that way to the counter-party faced with an unexpected non-renewal.  However, at the same time, it is possible that there was a sudden change in market conditions or an  unexpected loss of a major customer for the non-renewing party. In such circumstances, utilizing a  non-renewal clause is neither dishonest nor unreasonable and having a solid record of when and why  a decision was made could help to lower  the risk of litigation based on misperceived conduct.
  5. Disputes between Parties: While litigants can expect to see a rise in arguments regarding good faith, claims  of good faith will generally fail if they  do not fall within existing doctrines manifesting the organizing principle (such as the duty of  honest performance). Contracting parties engaged in litigation should be prepared to confront  arguments seeking to introduce new duties manifesting the organizing principle of good faith. This  is particularly likely to occur where there is conflicting case law on the role of good faith in  particular contractual doctrines. At a broader level, this case, along with the Court’s decision in  Sattva Capital Corp v. Creston Moly Corp (decided earlier this year),11 should signal to parties  that the Court is ready to tackle areas of uncertainty in contract law and to introduce changes that, while incremental, may have wide-reaching effects.