June 23, 2021
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By Derek Ronde and Chris Horkins – Cassels Brock & Blackwell LLP
The contractual duty of good faith has taken on significant importance in the context of franchising in Canada in recent years. Given the overlap between the concepts of statutory good faith and fair dealing in franchising legislation and common law good faith, and given the ongoing franchising case law that involves attempts by franchisees to apply this duty to franchise agreements and franchisor conduct, Supreme Court of Canada decisions on the topic merit close examination. Since 2014, there have been three significant Supreme Court cases (namely Bhasin¹ Callow² and Wastech³) that explore the parameters of the duty of good faith and the extent to which express contractual language can be deviated from in light of the conduct of contractual parties. Franchise parties should be familiar with the developments in the case law on the duty of good faith, as the overarching principles discussed in these decisions can provide broad lessons on how contractual parties are expected to deal with each other in a competitive economic environment.
1. Bhasin: Honest Performance is Paramount
In 2014, the Supreme Court of Canada issued its decision in Bhasin and provided some initial guidance on how the “organizing principle” of good faith in contract was to be practically applied by parties.⁴ Given that Canadian courts have acknowledged that the duty of good faith exists in respect of franchise relationships (both in common law and via statute), this guidance provided some insight into how franchise parties were to treat each other during the course of their contractual relationships, particularly in the context of renewals. In Bhasin, the court explained that the obligation of good faith requires that parties “perform their contractual duties honestly and reasonably and not capriciously or arbitrarily,” and it was this obligation of honesty on which the court focused.
In this case, Bhasin was an enrolment director for Can-Am, a provider of education savings plans for investors. Bhasin and Can-Am had a three-year commercial agreement together, which automatically renewed unless of the parties gave six months’ notice of non-renewal. Can-Am also employed Hrynew as an enrolment director. Hrynew was a competitor to Bhasin, and Bhasin had repeatedly declined overtures from Hrynew for the parties to merge their agencies.
Can-Am appointed Hrynew as Can-Am’s trading officer and he became responsible for reviewing Can-Am’s directors in response to inquiries made by the Alberta Securities Commission (the “ASC”). In their response to the ASC, Hrynew and Can-Am outlined restructuring plans that showed Bhasin working under Hrynew, yet Bhasin had not been advised of this plan. Can-Am was vague and dishonest with Bhasin in respect of the latter’s inquiries concerning Hrynew’s role as trading officer and the future of Bhasin’s agency. Can-Am eventually gave notice of non-renewal of Bhasin’s director agreement. Bhasin’s business largely collapsed afterwards and was subsequently picked up by Hrynew.
The Supreme Court held that Can-Am had acted dishonestly toward Bhasin regarding Hrynew and Can-Am’s plans for Bhasin’s business, and that these actions were connected to the performance of the director agreement and its non-renewal. The Court held that lying or misleading conduct in respect of the performance of an agreement grounded a cause of action for breach of the duty of good faith.
In making its finding concerning the duty of honest performance, the Court held that this duty did not create a freestanding obligation of disclosure in contractual performance. However, the issue of the dividing line between dishonesty and non-disclosure remained a live issue in respect of the parameters of the duty of good faith.
2. Callow: Honest Performance Revisited
In Callow, a 2020 decision, the Supreme Court addressed and expanded on the duty of honest performance in the context of the renewal/termination of a service contract, finding that, in certain circumstances, dishonesty by silence or omission may be sufficient to establish a breach of the duty of good faith. Like Bhasin, this decision is of particular importance to franchisors as renewal and termination are key contractual concepts within the industry.
The plaintiff, Callow, provided winter maintenance services (e.g. snow removal) for the defendant Baycrest condominium complexes (“Baycrest”). The parties entered into a two-year contract from November 1, 2012 to April 30, 2014. Pursuant to the contract, Baycrest could terminate the agreement for any reason upon giving ten days’ notice to Callow.
During the first year of the agreement, there were complaints from Baycrest residents in respect of snow removal. These were raised directly with Callow and there was a general understanding that the issues had been resolved. However, towards the end of the winter of 2012-2013, Baycrest appointed a new property manager, Zollinger, who advised that Baycrest should terminate Callow’s contract and that they could do so without penalty. In March or April 2013, the Baycrest condominium board decided to terminate the contract but did not inform Callow of this decision.
In the meantime, Callow had discussions with Baycrest about a potential renewal of the winter maintenance agreement. Callow continued work on its summer maintenance contract with Baycrest, including “freebie” work “above and beyond” its summer maintenance contract that it believed would incentivize Baycrest to renew the winter contract. Based on communication between the parties, it was generally understood that Callow believed that he would be kept on for the winter of 2013/2014.
Baycrest did not advise Callow of the termination until September 2013 in accordance with the provision in the parties’ agreement allowing for termination on ten days’ notice. Callow sued Baycrest for breach of contract for accepting the free services while knowing Callow would be terminated and alleged that Baycrest knew or ought to have known that Callow would not seek other winter maintenance contracts in reliance of Baycrest’s representations that Callow was providing satisfactory services. The claim against Baycrest was framed as a breach of the duty of good faith – specifically, the duty of honest performance in respect of the enforcement of the termination provision.
The Supreme Court of Canada specifically addressed the issue of what constituted a breach of the duty of honest performance in light of what was an express right of unilateral termination under the winter maintenance agreement. This express right provided only for ten days’ notice.⁵ The Court examined whether Baycrest failed to satisfy its duty of good faith – namely the duty not to lie or knowingly deceive Callow about the status of the winter maintenance agreement. The Court held that Baycrest, despite its right to terminate the contract with minimal notice, had an obligation to exercise that right in accordance with the duty of honest performance. In other words, Baycrest could not lie or otherwise knowingly mislead Callow about issues related to the performance of the contract. The Court relied on the trial court’s finding that Baycrest had represented that the winter contract was not in danger of non-renewal, and that this dishonesty was directly related to the eventual termination of the winter contract. Boiling the issue down to its essence, the Court held that “if someone is led to believe that their counterparty is content with their work and their ongoing contract is likely to be renewed, it is reasonable for that person to infer that the ongoing contract is in good standing and will not be terminated early.”
The Supreme Court also clarified its decision in Bhasin and provided a view on whether the duty of honest performance (as part of the duty of good faith) included a positive obligation of disclosure. The Court held that although Baycrest had no free-standing obligation to disclose its intention to terminate the winter maintenance agreement, it did have an obligation to not mislead Callow or give Callow a false impression that the agreement would not be terminated. The Supreme Court upheld the trial judge’s findings that Baycrest deceived Callow through a series of “active communications.” These active communications including making statements to Callow that the renewal of the winter maintenance agreement was likely and accepting the “freebies” offered by Callow during the summer of 2013 because Callow wanted Baycrest to renew the winter agreement.
In summary, the Court held that Baycrest “intentionally withheld information in anticipation of exercising clause 9, knowing that such silence, when combined with its active communications, had deceived Callow. By failing to correct Mr. Callow’s misapprehension thereafter, Baycrest breached its contractual duty of honest performance.” Baycrest engaged in a series of acts that it knew would cause Callow to draw an incorrect inference and then failed to correct Callow’s misapprehension. This gave rise to a breach of the duty of good faith.
3. Wastech: Good Faith is a Question of Purpose
In Wastech, released shortly after Callow, the Supreme Court addressed the limits of the duty of good faith in respect of the exercise of contractual discretion and provided helpful guidance regarding discretionary contractual decisions that will be relevant to franchisors. To the extent that Callow can be considered an expansion of the duty of good faith, Wastech helps to clarify and rein in that duty, setting clear and confirming that courts will not rewrite an agreement if a party exercises its contractual discretion in a manner that is within the contemplated purposes of the agreement and not arbitrary or capricious.
In this case, Wastech, a B.C.-based waste transportation and disposal company, had a long-standing contractual relationship with Metro, a statutory corporation responsible for the administration of waste disposal for the Metro Vancouver Regional District. Under the parties’ agreement, Wastech would remove and transport waste to three disposal facilities. Wastech was paid at a differing rate depending on which disposal facility the waste was directed to. Importantly, the contract did not guarantee that Wastech would achieve a certain profit in any given year. The contract also gave Metro absolute discretion to allocate waste as it so chose.
In 2011, Metro directed that certain waste was to go to a closer disposal facility rather than one that was farther away. This negatively affected Wastech’s profit for that year. Wastech challenged Metro’s decision and submitted the dispute to arbitration. After successive appeals, the case made its way to the Supreme Court of Canada, which held that Wastech had not breached its duty of good faith.⁶
The Supreme Court confirmed that the duty of good faith contains a duty to exercise contractual discretion in good faith. Importantly, the Court held that this duty exists regardless of whether the contract purports to confer absolute discretion on a particular matter. The Court held that the duty to exercise contractual discretion is only breached when the discretion is exercised unreasonably, in an “arbitrary or capricious” manner. A party exercising its contractual rights must do so having appropriate regard for the legitimate contractual interests of its contracting partner.
In this case, there was no evidence that Metro had acted capriciously, arbitrarily, or in a dishonest fashion. Metro was not required to act in a manner that subordinated its own interests to that of Wastech or give a benefit to Wastech that Wastech did not bargain for. In rejecting the appeal, the Court refused to award Wastech “an advantage not provided for in the agreement between the parties in the absence of any appreciable breach of contract or identifiable wrong.”
It is important to note that Metro had an “honest and reasonable” reason to reallocate its waste distribution. In the initial arbitration, the arbitrator acknowledged that Metro was “guided by the objectives of maximizing [one facility’s] efficiency, preserving remaining site capacity at [another facility], and operating the system in the most cost-effective manner”.
In distinguishing Wastech from Callow, the court noted that the duty of honest performance was not at issue in the case. There were no allegations that Metro lied to or misled Wastech in respect of the parties’ contract. Instead, the Court focused on the duty to exercise contractual discretion in good faith and held that this duty “requires the parties to exercise their discretion in a manner consistent with the purposes for which it was granted in the contract, or…to exercise their discretion reasonably.”
The Court noted that the fact that a party’s exercise of discretion causes its contracting partner to lose some or even all of its anticipated benefit under the contract should not be regarded as dispositive, in itself, as to whether the discretion was exercised in good faith. Rather, “substantial nullification” is likely only potential evidence that discretion has been exercised in a manner unconnected to the relevant contractual purpose. Similarly, evidence of the capricious or arbitrary exercise of a discretionary power is also evidence of the power being exercised for an improper purpose. In this case, the Court held that for Wastech and Metro, the purpose of the parties’ contract was to maximize efficiency and minimize costs, and Metro’s discretion to allocate waste in its “absolute discretion” arose out of this purpose.
In summary, the Court held that the duty of good faith did not require Metro to subordinate its interests to Wastech or guarantee Wastech a benefit (namely, profitability) that Wastech did not bargain for despite engaging in painstaking negotiations on profitability and allocation rights. There was a valid purpose behind Metro’s broad allocation discretion, and Metro properly exercised that discretion in good faith.
4. Takeaways from the Trilogy
The Supreme Court’s reasons in Bhasin, Callow and Wastech are complex and reflect detailed analyses of the nature of good faith in Canadian common law. However, there are some key lessons for franchise parties that can be gleaned from the decisions:
- In dealing with renewal and termination matters, franchisors should exercise care to not actively mislead or misinform franchisees about the prospects of renewal or termination, particularly in circumstances where a decision has been made to terminate or not offer a renewal of the franchise agreement.
- Franchisees also have a duty of good faith, so their conduct in respect of renewals and terminations may be equally scrutinized by Canadian courts.
- There is not, as of yet, a positive obligation of disclosure arising from the duty of honest performance. However, franchise parties should exercise care in respect of dealing with their contractual partners honestly, particularly where there is reliance that results in significant economic decisions or commitments being made by the other party ahead of key decisions. In certain circumstances, silence or omissions in communications between franchisor and franchisee may be held to constitute dishonesty sufficient to trigger a breach of the duty of good faith.
- Whether a franchise party’s contractual discretion is exercised in good faith is a contextual matter that depends on the specific terms of the franchise agreement. A franchise party must not act arbitrarily, capriciously, or dishonestly, but also does not have to subsume its own economic interests to those of their counterpart. Courts will examine the purpose of the franchise agreement to determine if the exercise of discretion aligns with that purpose. The history of negotiation and the purpose of specific contractual terms in the context of the parties’ commercial relationship are important to this exercise.
- In practical terms, franchise parties are always assisted in having documented business and financial support for decisions where their discretion is exercised. Not only is this helpful in communications generally, it is helpful if the decision is ever litigated in Canadian courts.
¹Bhasin v. Hrynew, 2014 SCC 71, [2014] 3 S.C.R. 494.
²C.M. Callow Inc. v. Zollinger, 2020 SCC 45 (“Callow”).
³Wastech Services Ltd. v. Greater Vancouver Sewerage and Drainage District, 2021 SCC 7 (CanLII), <https://canlii.ca/t/jd1d6>
⁴The authors rely on the insights of their colleagues Tim Pinos, Ted Frankel, Colin Pendrith, and Christopher Selby in their article “Supreme Court Expands Obligations of Good Faith and Honesty in Contract Performance.” https://cassels.com/insights/supreme-court-expands-obligations-of-good-faith-and-honesty-in-contract-performance/
⁵The majority decision of the Court is addressed in this article. There were separate concurring reasons provided by three judges, as well as a strong dissent by Cote, J. that expressed concern that the majority’s decision was an unnecessarily confusing application of the duty of honest performance, particularly in light of the express language of the contract.
⁶Three judges wrote a concurring set of reasons.
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