In 2014, the Supreme Court of Canada issued a landmark decision in Bhasin v Hrynew, 2014 SCC 71 (Bhasin), recognizing a duty to act honestly in the performance of contractual obligations and in the exercise of contractual rights. The decision sets out the somewhat amorphous concepts that: a) there is an organizing principle of good faith that impacts all contracts which is “highly context-specific” and which underpins existing legal doctrines that requires parties to have appropriate regard for the other contracting party’s legitimate contractual interests; and b) that parties have a common law duty to act honestly in the performance of contractual obligations, and cannot lie or otherwise knowingly mislead each other about matters directly linked to the performance of the contract. The subsequent cases dealing with the application of these principles have attempted to interpret and clarify Bhasin, but the parameters of the principles continue to evolve. The Alberta Court of Appeal recently issued its decision in Styles v Alberta Investment Management Corporation, 2017 ABCA 1 (Styles), in which the Court stressed the limited scope of Bhasin and rejected the proposition that there was a duty to reasonably exercise discretion under a contract. The case is significant in outlining what the principles in Bhasin cannot, and should not do, potentially narrowing the avenue for parties to pursue claims.
In Styles, the plaintiff was terminated from his employment with Alberta Investment Management Corporation (AIMC). His employment was governed by an employment contract which provided that he could receive bonuses through a Long Term Incentive Plan (the Plan). The Plan provided that an employee could receive a bonus after four years of employment and expressly provided that a participant had to be “actively employed” in order to receive the bonus. The plaintiff was terminated by AIMC without cause after three years of employment and accordingly was not “actively employed” on the vesting date stipulated in the Plan. AIMC did not pay the plaintiff any bonus when he was terminated. The plaintiff commenced this action seeking damages in the amount of the unpaid bonus, alleging that AIMC had not acted in good faith when it decided not to pay the bonus.
The trial judge assessed whether AIMC performed its obligations under the employment agreement and the Plan in accordance with principles in Bhasin, in particular focusing on whether AIMC breached its duty of honesty in contractual performance when it terminated Styles without paying him the bonus.
The trial judge determined that AIMC had breached this obligation, finding that the duty of honesty in contractual performance also includes, or should be expanded to include, the recognition of a “common law duty which requires that discretionary powers under a contract must be exercised fairly and reasonably and not in a manner that is ‘capricious’ or ‘arbitrary’” (para 63).
The trial judge held that AIMC exercised two elements of discretion vis a vis Styles with respect to the bonus payment and termination: 1) it exercised its discretion in choosing not to provide a bonus to Styles, as the language of the Plan provided that such a bonus “may be forfeited” if the participant was not actively employed on the vesting date; and 2) it exercised its discretion when it decided to terminate Styles without cause.
The trial judge held that AIMC was not reasonable or fair in its exercise of these two elements of discretion and ordered AIMC to pay the plaintiff the amount of his bonus. The Court held that “although the Defendant employer had the right to terminate without cause under the contract, its decision to exercise that right and the corresponding refusal to pay the Plaintiff any of his earned LTIP grants amounts to an unfair and unreasonable exercise of the employer’s discretionary powers under the terms of the contract” (para 119).
Court of Appeal Decision
As a preliminary issue, the Court determined that the applicable standard of review for the appeal was correctness. While the general rule set out by the Supreme Court of Canada in Sattva Capital Corp v Creston Moly Corp., 2014 SCC 53 provides that the interpretation of a contract is a mixed question of law and fact, the Court relied on the exception to this standard for standard form contracts recently outlined by the Supreme Court of Canada in Ledcor Construction Ltd. v Northbridge Indemnity Insurance Co., 2016 SCC 37. In the Ledcor decision, the Supreme Court held that the standard of review for standard form contracts is correctness because such cases have “precedential value” and “[s]uch contracts cannot have one interpretation in one situation, and another in the next” (paras 26 and 46-48).
The first substantive issue the Court considered was whether there was in fact discretion exercised by the AIMC with respect to the issue of the bonus payment and the termination. The Court rejected the trial judge’s finding that the language that the bonus “may be forfeited” introduced an element of discretion, finding that the language was not in fact permissive based on an analysis of the contract as a whole and the specific provision in question. The Court further held that the decision to terminate without cause was not properly characterized as a “discretion” of an employer, as termination without cause is not a breach of contract and an employer can terminate the contract of employment on reasonable notice without any explanation.
Upon determining that there was no discretion exercised by AIMC, the Court did not have to consider the wider issue of whether there is a common law duty of reasonable exercise of discretionary contractual powers. However, the Court provided a detailed analysis of the issue in obiter comments in order to clarify the current state of the law.
The Court of Appeal emphasized that Bhasin actually considered two related arguments by the appellant. First, whether there is a general duty of good faith in contract and, second, whether there is a duty of honest performance in contractual obligations.
The Court recognized that the first proposition, that there is an organizing principle of good faith, underlies a number of specific situations where the law already recognizes an obligation of good faith (and is not a stand-alone concept). The Court stressed that applying this involves a balancing exercise as parties are entitled to perform their contracts in accordance with their express terms but that at some point that performance cannot be such that it undermines the legitimate contractual interests of the other party. The balancing exercise becomes particularly important as there is danger in construing the “legitimate contractual interests” of the parties in a way that is contrary to the plain wording of the contract or in a way that imports subjective considerations into the analysis.
The Court of Appeal held that the second proposition, the duty to act honestly, is “a very narrow concept” that simply means that “parties must not lie or otherwise knowingly mislead each other about matters directly linked to the performance of the contract” (para 47). This concept does not create any duty of loyalty, duty of disclosure or require the foregoing of contractual advantages.
The Court of Appeal then went on to consider the trial judge’s analysis, noting that the trial judge purported to build on the second proposition in Bhasin in holding that a capricious or arbitrary exercise of power could amount to dishonesty or bad faith within the Bhasin principle.
The Court of Appeal rejected this analysis, explaining that Bhasin in no way supports this analysis, stating at para 49:
… Bhasin does not establish any general principle of “reasonable exercise of discretion” in contractual performance. This radical extension of the law is unsupported by authority, and contrary to the principles of the law of contract.
The Court of Appeal stressed the very limited scope of the principles in Bhasin, finding that in this instance, they could not be relied on to re-write the clear words of the Plan which expressly set out that an employee would not be entitled to a bonus until after four years of employment.
The Court went to great lengths to stress the limited scope of the principles in Bhasin stating that the principles only relate to the performance of a contract and have no application to an interpretation of the terms of that contract. The principles in Bhasin cannot rewrite the terms of a contract and cannot be employed to “award damages to contracting parties that the court regards as being “fair,” even though they are clearly unearned under the contract” (para 54). The Court emphasized that the principles in Bhasin “do not enable either party to insist on covenants and provisos that are not set out in writing in the agreement, nor do they allow the parties to ignore the plain wording of the agreement” (para 64) and do “not allow the insertion of provisions inconsistent with the actual terms of the contract” (para 64).
With respect to the exercise of discretion under a contract the Court stressed that where parties have negotiated discretion into a contract “that is a method of risk allocation between the parties to the contract” (para 60), further providing at para 59:
… discretion may be exercised “unreasonably”, “subjectively”, “idiosyncratically” or “selfishly” without it following that the discretion has been exercised arbitrarily or dishonestly.
The Court stated that the Plan clearly provided that a participant must be actively employed on the vesting date and that no application of the principles in Bhasin (or any extension of them) could be relied upon to insist on an interpretation of the Plan that ignored the plain language of that agreement.
This decision provides an important clarification and limitation on the application of the principles outlined in Bhasin. The Court emphasized that Bhasin created two concepts that are distinct and that each is very limited in application. On the organizing principle of good faith, the Court in Bhasin expressly acknowledged that there would be opportunities to extend the principle beyond the scope of the decision in Bhasin, however, such extensions are to be limited and the Court of Appeal stressed the comment in Bhasin that the principle cannot be used to “veer into a form of ad hoc moralism or ‘palm tree’ justice” (para 53). On the duty to act honestly, the Court emphasized the limited application of the duty, clearly providing that the duty is only to act honestly and the standard is not to perform reasonably or in any way contrary to the terms of the contract or against a party’s own self interest. In sum, the decision emphatically limits the scope of the principles in Bhasin, clearly setting out that the principles in Bhasin are not an invitation to create ambiguous and amorphous obligations. Litigants will have to be mindful of these limitations and the “boxing-in” of the principles in Bhasin in pursuing claims.