Entertainment and IT contracts are often full of uncertain promises about future possibilities – such as exercise of options, working together on various manifestations of an entertainment or IT property, serving in various capacities if a project moves ahead, co-producing/developing if certain financing and other factors are satisfied, etc. Canada’s top court has now imposed a duty of good faith over all contractual relations, which will need to be kept in mind when dealing with such clauses which require the parties to cooperate together. You could face liability for bad faith conduct even if you are compliant with the strict wording of the contract.
In its November 13, 2014 decision, Bhasin v. Hrynew, the Supreme Court of Canada (SCC) unanimously ruled that “good faith contractual performance is a general organizing principle of the common law of contract.” This also includes a specific duty to act honestly in the performance of contractual relations.
Here are the facts:
Harish Bhasin built up a sales force over ten years selling education savings plans for Canadian American Financial Corp (Can-Am) in Alberta. His business thrived and Can-Am gave Bhasin numerous awards for his work.
The contract at issue was signed in 1998 by Can-Am and Bhasin. It obliged Bhasin to sell only Can-Am products, and Can-Am owned the customer lists. Bhasin could not sell his business without Can-Am’s consent.
The contract had an initial three year term, and automatic renewal, but either party could terminate by giving at least 6 months notice prior to the end of that term.
Can-Am chose not to renew and provided such notice to Bhasin in May of 2001.
But incidents leading to that termination were found to be contrary to the duty to act in good faith.
The defendant Hrynew was a competitor of Bhasin, and he wanted Bhasin’s market share. Hrynew pressured Bhasin to merge, and he threatened Can-Am that he would leave if Can-Am did not force a merger. But Bhasin refused.
In 1999 the Alberta Securities Commission became concerned with compliance of Can-Am’s sales force. The Commission required Can-Am to appoint a compliance officer, and Can-Am appointed Hrynew. This meant that Hrynew would be required to audit Bhasin’s business, to which Bhasin vigourously objected. Can-Am told Bhasin that Hrynew was bound to treat any information confidentially, which was found by the trial court to be false. Can-Am threatened to terminate if Bhasin did not permit Hrynew to audit.
In June of 2000 (a year prior to termination), Can-Am made submissions to the Alberta Securities Commission which showed restructuring plans for Can-Am which included Bhasin working for Hrynew. A couple of months later Bhasin asked Can-Am if such a merger was a “done deal” but Can-Am did not offer a clear answer – notwithstanding that Can-Am “wanted to force a merger”.
After Can-Am gave notice to terminate in May 2001 Bhasin sued.
The Court noted that in earlier court cases a good faith obligation had been found in specific situations, including where the parties must cooperate to achieve certain objects (e.g. seeking planning permission), where one party has a discretionary power (e.g. to determine fair market value), or where a party seeks to avoid contractual duties (e.g. repudiating for a cause which the same party brings about). The Court also noted that good faith had been imported into classes of relationships, such as employment, insurance and tendering.
The Court chose to expand good faith to all commercial contracts, and described the basic obligation as follows:
The organizing principle of good faith exemplifies the notion that, in carrying out his or her own performance of the contract, a contracting party should have appropriate regard to the legitimate contractual interests of the contracting partner. While “appropriate regard” for the other party’s interests will vary depending on the context of the contractual relationship, it does not require acting to serve those interests in all cases. It merely requires that a party not seek to undermine those interests in bad faith. This general principle has strong conceptual differences from the much higher obligations of a fiduciary. Unlike fiduciary duties, good faith performance does not engage duties of loyalty to the other contracting party or a duty to put the interests of the other contracting party first. [para 65]
This principle is not to be used “as a pretext for scrutinizing the motives of the parties” [para 70].
Under this new “organizing principle” the Court then chose to establish a new specific duty:
….there is a general duty of honesty in contractual performance. This means simply that parties must not lie or otherwise knowingly mislead each other about matters directly linked to the performance of the contract. This does not impose a duty of loyalty or of disclosure or require a party to forego advantages flowing from the contract; it is a simple requirement not to lie or mislead the other party about one’s contractual performance. [para 73, underlining added]
The Court said this is not an implied term but a “general doctrine of contract law”, and the parties are not free to exclude it. However the parties may “relax the requirements” by agreement as long as the core requirement is respected.
The Court was explicit that a failure to disclose may be acceptable where “active dishonesty” would not. (How well this distinction works in reality remains to be seen – withholding information can have impact).
The duty of honest performance does not require that the defendant intend that their representations be relied on.
The Court found that Can-Am acted dishonestly (and repeatedly) about the desired merger of Bhasin’s business with Hrynew, and about Hrynew’s role in the required audit of Bhasin, and that “this dishonesty on the part of Can-Am was directly and intimately connected to Can-Am’s performance of the Agreement with Mr. Bhasin and its exercise of the non-renewal provision.” [para 103].
The Supreme Court awarded damages for Bhasin’s value of the business ($87,000), “on the basis that if Can-Am had performed the contract honestly, Mr. Bhasin would have been able to retain the value of his business rather than see it, in effect, expropriated and turned over to Mr. Hrynew” [para 109]. Presumably Bhasin would have been in a position to prepare his sales force to sell alternative products, though the Court is vague on that point.
It is noteworthy that the Court did not accept the trial judge’s much larger award based on lost income over a period of nine years, which failed to recognize the clear right of either party to terminate.
This case is likely just the start of the expansion of the organizing principle of good faith in contractual matters, and new duties may be established by the courts going forward. But for the moment one should consider the following:
- It may be helpful to add detail in contracts about the agreed requirements to permit future changes in the relationship such as termination, exercise of options or otherwise, to remove room for argument that the chosen route is not one of good faith;
- Despite the Court’s statements to distinguish between active dishonesty and a duty of disclosure, one will need to be cautious where silence in the face of questions is a lie (the Court indeed found Can-Am liable for failing to provide straight answers when Bhasin asked about a possible merger with Hrynew);
- Conduct and communications with another party may need to be given greater attention despite contractual provisions which appear to put you in a position of strength.