The Supreme Court’s decision in (“Wastech”) clarifies the scope of the duty to exercise a contractual discretion reasonably, establishing that the duty is only breached where the discretion is exercised in a manner unconnected to its purpose. As well, the decision clarifies that a party can act in its own commercial best interests, even if its counterparty is deprived of all or substantially all of the benefit of the contract. These are welcome clarifications. However, and as with the Court’s decision in CM Callow Inc. v Zollinger (“Callow”), the majority decision also raises questions about the precise scope of the duty given the findings regarding the requirement of reasonableness.

Background

Wastech and Greater Vancouver Sewerage (“Metro“) were parties to a long-term waste removal agreement, which provided Metro with the discretion to allocate waste among various. In 2011, Metro substantially re-allocated the waste between different destinations, which increased Wastech’s costs such that it could not meet a “Target Operating Ratio” (which represented the proportion of Wastech’s costs versus revenues). Various adjustments were provided for in the agreement, but the parties had consciously chosen not to provide adjustments beyond a certain threshold. As a result, the operating ratio was several percentage points higher than the target. In the result, given Metro’s reallocation, Wastech did not achieve its Target Operating Ratio.

Wastech initiated arbitration, arguing that a term should be implied or that a duty of good faith should apply, such that Metro could not exercise its discretion in a way that would deprive Wastech of the opportunity to achieve the Target Operating Ratio. The arbitrator declined to imply a term, but found that Metro had failed to give “appropriate regard” to Wastech’s legitimate interests or expectations, and that this constituted “dishonesty” for the purposes of the duty of good faith as explained in Bhasin. Metro successfully sought leave to appeal the arbitrator’s award to the British Columbia Supreme Court (“BCSC“).

Decisions of the Courts Below

Metro appealed on the basis that the arbitrator 1) erred in finding that Metro’s conduct was dishonest and in bad faith, and 2) confused the organizing principle of good faith (which is not a duty) with a free-standing duty. The BCSC declined to review the first ground, as it would trespass on the arbitrator’s fact-finding jurisdiction. On the second ground, the BCSC concluded that since the arbitrator had ruled against implying a term, and since duties of good faith (apart from the duty of honest performance) existed only as implied terms, it was not open to find a duty of good faith (or a breach of such duty). The BCSC rejected the argument that if a contract provides one party with a contractual discretion without expressly stipulating that the discretion is unfettered, then that discretion must be exercised reasonably.

Wastech appealed to the British Columbia Court of Appeal (“BCCA”), which upheld the BCSC’s decision but found the BCSC had created confusion by making unnecessary additional remarks. The BCCA observed that Canadian law recognized that a contractual discretion cannot be exercised so as to “nullify the benefits reasonably expected to be obtained from the contract by the other party”. To this extent, a contractual discretion must be exercised in a manner consistent with the parties’ expectations. However, those expectations must be found in the agreement, and the exercise of the discretion must nullify those expectations – not simply infringe upon them. Here, the parties had expressly considered and rejected a contractual term that would have protected the expectation for which Wastech was seeking a remedy.

The BCCA also observed that “dishonesty” in the context of bad faith entails some subjective element of improper motive (e.g. malice, untruthfulness, ulterior motive, or recklessness), rather than the failure to reach an objective standard. Thus, a remedy would only be available where a contracting party undermines their counterparty’s contractual expectations in bad faith.

The Supreme Court’s Decision

The Majority

Writing for the majority, Kasirer J declined to address the applicable standard of review based on his finding that the outcome of the appeal did not depend on the standard of review.

With respect to good faith, the majority made several important findings. First, the majority concluded that the duty to exercise a contractual discretion in good faith requires the parties to exercise their discretion in a manner consistent with the purposes for which it was granted in the contract. This behaviour amounts to the “reasonable” exercise of discretion, while exercising a discretion in a manner unconnected with that purpose will be unreasonable.

Notably, the majority also confirmed that the purpose of the discretion can often be discerned from the text of the clause in question, but where the discretion is general in nature, the purpose will only be discernable by reading the clause in the context of the contract as a whole. In the latter circumstance, a court will have to construe the ambit of the discretion.

Relatedly, the majority observed that the determination of whether a party’s exercise of a discretion resulted in “substantial nullification” of the other party’s benefit is not the correct method of determining whether that party exercised their discretion in good faith. The Court noted that a party, in exercising a discretionary power, is “merely doing what the other party agreed it could do in the contract”.

In addition, the majority confirmed that as a general proposition, the range of reasonable outcomes will be smaller for a contractual discretion that is susceptible to objective measurement – such as operative fitness, structural completion, mechanical utility or marketability – but will be relatively larger for a contractual discretion that is more subjective – such as matters involving taste, sensibility, personal compatibility, or judgment. More broadly, exercising the discretion capriciously or arbitrarily will be contrary to the purpose of the discretion.

Perhaps most importantly, the majority concluded that the duty is a general doctrine of contract law, as is the case with the duty of honest performance, rather than an implied term. Although the terms of the contract will shape the precise form of the duty, parties will be unable to contract out – entire agreement clauses, for example, will not be able to preclude the application of the duty.

Finally, the majority noted that recourse to Quebec’s civil law was of no assistance to Wastech in this case because Wastech had not alleged that Metro had acted “imprudently or negligently, in an intemperate manner, or with an intention to harm”, and because, even accepting the applicability of the Quebec concept of a duty to cooperate, that duty was not applicable in this case.

Parenthetically, the majority also observed that the duty of honest performance was not at issue in this case, since there was no allegation that Metro lied or knowingly misled Wastech. However, the majority also appeared to suggest that the duty of honest performance also plays a part in determining whether a party has exercised a contractual discretion in good faith; unfortunately, the majority did not expand on this brief observation, such that it remains a point of some uncertainty.

The Concurrence

Writing for the concurrence, Brown and Rowe JJ. agreed that the appeal should be dismissed, but differed from the majority in four respects.

First, the concurrence concluded that because the arbitration legislation applicable in this case referred to an “appeal” of the arbitral award, the appellate standard of review (correctness on questions of law, palpable and overriding error for questions of fact) applied.

Second, the concurrence disagreed that where a discretion is unfettered on its face, a court must nevertheless determine the contractor’s general purpose and then refer to that purpose to determine the limits of the discretion. In the concurrence’s view, this approach undermines freedom of contract and distorts the parties’ bargain by imposing constraints to which they did not agree.

Third, the concurrence took issue with the majority’s suggestion that the duty of honest performance is a preliminary step in assessing whether there has been a breach of the duty to exercise discretionary powers in good faith, noting that this unnecessarily conflates two distinct doctrines of good faith and creates conceptual confusion. In this regard, the concurrence reiterated the same concern that Brown J had expressed in Callow v Zollinger.

Fourth and finally, the concurrence observed that recourse to Quebec law was an unnecessary digression and inappropriate in the circumstances. In this regard, the concurrence reiterated another concern that Brown J had expressed in Callow v Zollinger.

Analysis

Wastech has conclusively established in Canadian common law a duty to exercise a contractual discretion in good faith as a doctrine of general application rather than an implied term, making it consistent with the duty of honest performance first articulated in Bhasin. This fact is particularly significant for those contracts where a contractual discretion is ostensibly unfettered, since a court will nevertheless read in certain limits to such “unfettered” discretion. In particular, the discretion must be exercised in a way that is connected to the purpose for which the contract granted that discretion.

Importantly, the majority decision also raises a number of questions that make the exact boundaries of the duty uncertain, and difficult to predict whether a discretion will be found to have been exercised reasonably.

Bearing in mind that a discretion exercised in a manner unconnected with the purpose for which the contract granted the discretion will be unreasonable, the decision raises the question of whether a discretion exercised with good intentions in circumstances not contemplated by the discretionary clause or the contract could nevertheless amount to a breach of the duty.

This dovetails with another concern, being the uncertainty surrounding how a court will determine the purpose of a discretion. While the exercise may be more circumscribed where the clause in question is narrow in its application, determining the purpose of a discretionary clause of general application may prove more challenging. The majority concluded that courts will read the clause in the context of the contract as a whole, which does not leave readers with a precise understanding of how best to draft contracts in a manner that preserves the enforceability of a discretionary clause.

The majority’s potential suggestion of the duty of honest performance as a preliminary step in assessing whether there has been a breach of the duty to exercise discretionary powers in good faith may be clarified in subsequent cases, given the concurrence’s observation that this phraseology potentially conflates the two distinct duties and reiterates the same concern raised in the concurrence to Callow.

Bearing all of the foregoing in mind, Wastech represents an important step forward for good faith in the Canadian common law, but presages a potentially uncertain future concerning the limits to the exercise of a contractual discretion. We look forward to seeing how this area of law continues to evolve as Wastech and Callow are interpreted by lower courts.