Following the landmark decision Bhasin v. Hrynew in 2014, the Supreme Court of Canada heard two cases with respect to the duty of good faith in late 2020. One of those cases was Wastech Services Ltd. v. Greater Vancouver Sewerage and Drainage District, for which the Supreme Court released its decision in February 2021.
Wastech Services Ltd. (“Wastech”) had a contract with Greater Vancouver Sewerage and Drainage District (the “City”) to remove and transport waste to three disposal facilities (the “Contract”). The Contract was entered into in 1996, after 18 months of negotiations.
Pursuant to the Contract, Wastech was to be paid a different rate depending on which facility the City directed the waste to – the further away the facility, the more profit Wastech would earn. The Contract did not guarantee Wastech a certain profit, although it did contain an 11% profit “target”. Importantly, the Contract gave the City “absolute discretion” to direct and allocate waste between the three facilities.
Wastech referred the dispute to arbitration. Wastech alleged that the City breached the Contract by allocating waste in a manner that deprived Wastech of the possibility of achieving the 11% profit “target”. Wastech sought $2,888,162, which was the additional amount Wastech would have earned if the waste had not been reallocated. In an award issued in February 2015, the Arbitrator ruled in favour of Wastech. The Arbitrator found that the duty of good faith applied, and the City breached that duty. Specifically, the Arbitrator held that since the Contract was a long term, relational agreement, good faith required the City to have appropriate regard for the legitimate contractual interests of Wastech. The Arbitrator noted that Wastech had a legitimate contractual expectation that the City would not use its “power” to deprive Wastech of the opportunity to achieve the 11% profit “target”.
The British Columbia Supreme Court
Following the City’s successful petition for leave to appeal, the Supreme Court of British Columbia set aside the Arbitrator’s decision. The Court decided that imposing a duty to have regard for another party’s interests should be based on the Contract itself. In this case, the parties did not include a clause limiting the City’s absolute discretion to reallocate waste. Also, given the circumstances in which the Contract was negotiated and developed, the Court did not see how the principle of good faith could be applied.
Court of Appeal
Wastech appealed the decision from the British Columbia Supreme Court. The Court of Appeal dismissed Wastech’s appeal, after finding four errors in the Arbitrator’s decision:
- The Arbitrator applied the wrong legal test for determining whether the City nullified Wastech’s benefits under the contract;
- The Arbitrator erred by concluding that his rejection of Wastech’s proposed implied term did not “add anything” to his good faith analysis, when his rejection actually substantially took away from Wastech’s arguments for a breach of a duty of good faith;
- The Arbitrator erred in holding that he did not need to decide whether the City’s conduct nullified or eviscerated the contract to conclude whether the City breached its duty of good faith; and
- The Arbitrator erred in holding that dishonesty included exercising contractual rights in a way that is at odds with the legitimate contractual expectations of the other party to the contract.
Decision from the Supreme Court
The Supreme Court was tasked with deciding what constraints the duty to exercise contractual discretion in good faith imposes on parties.
The Supreme Court outlined in detail the duty to exercise discretion in good faith, which the Court categorized as a general doctrine of contract law. This duty applies to all contracts, no matter the intentions of the parties or the language of the contract. Parties who provide for discretionary power in a contract cannot “contract out” of the implied undertaking that the discretion will be exercised in good faith, in accordance with the purpose for which it was given.
The exercise of discretionary power must be done in good faith. Thus, discretionary power pursuant to a contract is constrained by good faith; to exercise discretionary power arbitrarily or capriciously is a breach of contract.
Importantly, the Supreme Court stated the duty to exercise contractual discretion in good faith requires the party to exercise discretion in a manner consistent with the purpose for which the discretion was given in the contract. When this is done, the “bargain” between the parties is being followed.
The Court therefore needs to ask “was the exercise of contractual discretion unconnected to the purpose for which the contract granted discretion?”. If yes, the party has not exercised the contractual discretion in good faith. The Court needs not ask if the discretion was exercised in a moral or savvy way.
To complete this analysis, the Court must look to the purpose for which the discretion was created. When the discretion is exercised in accordance with that purpose, the exercise may be reasonable according to the bargain between the parties.
Whether the duty has been breached is highly fact specific. The Court will look to the discretionary clause and then the contract as a whole to make this determination.
Wastech argued that the City’s discretion amounted to a nullification or evisceration of Wastech’s benefits under the contract, particularly given that the Arbitrator found that the City’s allocation of waste made it impossible for Wastech to achieve its profit “target”.
The duty is breached only where the discretion is exercised unreasonably, in a manner not connected to the underlying purpose for which the discretion was granted.
Application to the Facts
The Supreme Court ultimately found that the City’s decision was reasonable, given the purpose of their discretion in the Contract. The purpose of the discretion in the Contract was to give the City flexibility to maximize efficiency and minimize cost. The City’s discretion to reallocate the waste distribution was guided by the objectives of maximizing efficiency and minimizing cost. Thus, the City’s choice was within the range of permitted choices under the Contract.
The duty of good faith did not require the City to subordinate its interests to those of Wastech. It also did not give Wastech a benefit that it did not bargain for. There is no fiduciary relationship between the parties. Any “loyalty” the City was required to follow was loyalty to the bargain between the parties, not to Wastech or its interests.
Application to Construction Contracts
The Supreme Court’s explanation of the duty to exercise discretion in good faith provides helpful guidance to parties with contracts containing discretion. Construction contracts are replete with these clauses. Clauses for suspension, termination, payment certification, and inspection all include some element of discretion.
The case raises questions about what conduct might breach the duty to exercise discretion in good faith. Luckily, additional commentary from the Court helps answer this question.
As a general guide, the Court noted that where the matter to be decided is readily susceptible to objective measurement, the range of reasonable outcomes will be relatively smaller. This may include discretion with respect to operative fitness, structural completion, mechanical utility, or marketability. Where the matter to be decided is not susceptible to objective measurement, the range of reasonable outcomes will be relatively larger. This may include discretion with respect to taste, sensibility, or judgement.
Given that the duty to exercise discretion in good faith is highly contextual and fact specific, each case must be assessed on its own merits.