Honesty is the best policy when it comes to commercial contracts
Take-aways from the Supreme Court of Canada’s ruling in Bhasin v Hrynew et al, 2014 SCC 71
Facts of the case
The corporate respondent Canadian American Financial Corporation (“Can-Am”) is a company that markets education savings plans to investors through agents, here known as enrollment directors. The appellant Bhasin and the individual respondent Hrynew were both enrollment directors.
Bhasin had been an enrollment director for nearly a decade. He had signed several agreements with Can-Am, including one in 1998 which carried a three year term. These “enrollment director agreements” laid out the rights and obligations of the parties. The 1998 agreement contained provisions which allowed Can-Am to terminate the agreement on short notice for misconduct or other cause. It also provided that the contract would automatically renew, unless one of the parties gave six months’ written notice to the contrary.
Bhasin and Hrynew were competitors in the marketplace. Hrynew had propositioned Bhasin with a merger numerous times in the past, but Bhasin had always refused. Hrynew, who was well-connected in Calgary business circles, tried to get Can-Am to apply pressure to Bhasin to merge, but this tactic did not work either.
In late 1999, the Alberta Securities Commission raised concerns about Can-Am’s compliance with securities regulations. The Commission required that Can-Am appoint a “provincial trading officer” (“PTO”) to review its enrollment directors for compliance. Can-Am appointed Hrynew to that position. This meant that he would have access to all the confidential records of the other enrollment directors, including Bhasin’s. Bhasin protested having a competitor review these records. Can-Am represented to Bhasin that Hrynew was under a duty of confidentially in his role as PTO, and that the Commission had rejected a proposal of theirs to have an outside PTO appointed. Neither of these statements were true.
While Hrynew carried out his review, Can-Am told the Commission that it was considering reorganizing its business. In their new proposed structure, Bhasin’s business would be absorbed by Hrynew’s. Bhasin heard news of this through a third party, and asked representatives of Can-Am if it was true. They did not provide him with a straight answer.
Bhasin never allowed Hrynew access to his records. Can-Am threatened to terminate the agreement as a result of this perceived misconduct. They did not do so, but they did give notice of non-renewal in May of 2001, effectively rendering Bhasin’s business worthless.
Did Can-Am owe Bhasin a duty of good faith? If so, did it breach that duty?
The Organizing Principle of Good Faith
The Court held that good faith is an “organizing principle” of contract law. An “organizing principle” is defined as a principle which “states in general terms a requirement of justice from which more specific legal doctrines may be derived. [It] is not a free-standing rule, but rather a standard that underpins and is manifested in more specific legal doctrines and may be given different weight in different situations.” Therefore, an organizing principle can’t be breached in and of itself, but it does provide an overarching standard that helps to develop the common law in a principled fashion.
Justice Cromwell, writing for a unanimous Court, found that the recognition of this new organizing principle was an “incremental step” required to unify the common law. The Court noted that good faith already underlies many current doctrines. The Court complained, however, that it often wasn’t clear whether good faith was being imposed as a matter of law, or as a matter of interpretation. The line between the two had been blurred or ignored. Thus, the Court reasoned that the organizing principle would serve to add principle to the application of good faith as a legal concept.
Further, the Court supported the acknowledgement of the organizing principle because it was in line with the reasonable expectations of contracting parties. To quote Justice Cromwell, “a basic level of honest conduct is necessary to the proper functioning of commerce.” For that reason, the Court saw it necessary to make the adjustment to the common law that it did.
The Court noted that the duties of good faith in existing categories (i.e. contracts of employment/insurance) ought not to be disturbed. The organizing principle is to serve as “the primary guide to future development”.
The Duty of Honest Performance
With that in mind, Justice Cromwell reasoned that a second incremental step was also necessary. He found that there ought to be a general duty of honesty in contractual performance. This duty doesn’t rise to the level of a fiduciary duty; parties need not place the needs of the other party in advance of their own. Nor does it necessarily make every agreement into a contract of utmost good faith. In fact, all that this duty requires is that the parties not lie or otherwise knowingly mislead each other about matters directly linked to the performance of the contract.
This duty of honest performance is a doctrine of general application, like unconscionability. Therefore, parties are not free to exclude it. In that sense, the duty acts as a restriction on the freedom to contract. In response to that concern, the Court did write that parties are free to modify its scope. This allows the parties to determine the necessary standards by which their “honest performance” is to be measured.
The Court repeated its opinion that a duty of honest performance makes good commercial sense. In fact, the Court viewed the acknowledgment of the duty as bringing the common law in line with the expectations of modern commercial parties.
Finally, it is important to note that the Court wrote that the duty of honest performance is not the only manifestation of the organizing principle of good faith; it is likely to have a much broader application. For example, the Court mentioned that good faith may require that contracting parties should have “appropriate regard” to the legitimate contractual interests of the contracting partner.
Application to the Facts
The Supreme Court was of the opinion that Can-Am’s several acts of dishonesty (i.e. lying about Hrynew’s duty of confidentiality as a PTO, not being forthright with their intentions to merge Bhasin’s business with Hrynew’s) were “directly and intimately connected to Can-Am’s performance of the Agreement.” Therefore, they found that Can-Am breached the agreement with Bhasin by not acting honestly with him in choosing to let the agreement expire.
The Court is not saying that Can-Am had a duty to renew the agreement. That would undermine the express terms of the contract. The contract had a clear three year term, with rights on either side providing for non-renewal. There was no breach of contract here in terms of failing to meet an explicit obligation, but rather a breach of the new duty to perform the contract honestly. This is why it is important that the Court found Can-Am’s acts of deceit to be connected to their performance of the enrollment director agreement.
Takeaways from Bhasin
- The duty does not apply to negotiations. The Court only speaks about performing contractual provisions, not about negotiating them. However, keep in mind that the law of negligent and fraudulent representation still patrols this area.
- For the sake of certainty, it may be advisable that you negotiate what will be deemed “honest performance” at the outset. It is likely that the Court will require some minimum standard of honesty, but that is not made clear by this decision. There will almost certainly be more litigation on this fact in the future.
- A common concern regarding the effects of Bhasin appears to be that it will hinder mutual co-operation between contracting parties. This stems from the fact that the duty of honest performance requires parties not to lie, but does not create any positive duty to disclose. Therefore, silence limits your risk of litigation. Parties may be overly careful as to what they say to one another, at least until the scope of the duty is defined by subsequent case law.
- In reality, chances are most companies already perform contracts in accordance with the organizing principle of good faith and the duty of honest performance. This is mostly because it would be bad for your reputation to be constantly lying to your business partners. However, it is always tempting to get an edge when the opportunity presents itself, and misleading a counterparty can certainly be an effective way of doing so.