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Supreme Court of Canada Confirms Contractual Discretion Must be Exercised in Good Faith

March-11-2021

Lawyer Samantha Galway, Peter Kolla, Peter Ruby
Area Corporate and Commercial, Litigation

Summary

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In an important case for anyone who drafts, performs or enforces contracts, the Supreme Court of Canada recently considered the scope of the duty to exercise contractual discretion in good faith. Many contracts provide one or more parties a discretion to act or not act with respect to a particular aspect of the contract. That discretion may be constrained by the terms of the contract, or it may be without express restriction. In Wastech Services Ltd v. Greater Vancouver Sewerage and Drainage District, the Supreme Court held that the duty of good faith requires contracting parties to exercise their contractual discretion reasonably. This case was heard concurrently with Callow v. Zollinger, another decision concerning the duty of good faith, which we discussed in our January 21, 2021 Update: Supreme Court of Canada Revisits Duty of Good Faith in Contract Performance. Together, these decisions clarify the nature of the duty of good faith recognized by the Supreme Court in Bhasin v. Hrynew.

Background

Wastech Services Ltd. and Greater Vancouver Sewerage and Drainage District (“Metro”) were engaged in a 20-year contract for the disposal of waste from the Vancouver regional district. The parties’ complex contract provided that Wastech would transfer municipal waste from transfer stations around the Lower Mainland to designated landfills. The contract granted Metro “absolute discretion” to allocate waste between the landfill sites and provided that Wastech’s payment rate would be determined by which site the waste was allocated to. Wastech’s compensation was structured around a “Target Operating Ratio” – a target ratio between operating costs and operating profit. The actual operating ratio determined how much profit Wastech would make.

In 2010, Metro invoked the discretionary clause and reallocated a significant volume of waste from one landfill that was farther away and was more lucrative for Wastech, to another landfill. This reallocation made it impossible for Wastech to meet its “Target Operating Ratio” for that year. Wastech referred the matter to arbitration, where it alleged Metro breached the parties’ contract by exercising its discretion to allocate waste in a manner that deprived Wastech of the possibility of achieving its “Target Operating Ratio” for the year.

Decisions Below

The arbitrator concluded that, while it was open for Metro to exercise its discretion in a manner that negatively impacted Wastech financially, Metro could not do so to an extent that precluded Wastech from achieving its “Target Operating Ratio”. On this basis, the arbitrator ordered Metro to pay damages to Wastech. The British Columbia Supreme Court and the British Columbia Court of Appeal disagreed with the arbitrator’s decision.

Supreme Court of Canada Decision

The Supreme Court unanimously dismissed Wastech’s appeal. A majority of the Supreme Court recognized the duty to exercise contractual discretion in good faith as a general doctrine of contract law and held that this duty requires contracting parties to exercise their discretion “reasonably”. Justice Kasirer wrote the majority decision (with five other judges), while Justices Brown and Rowe wrote a decision concurring in the result (with one other judge).

Duty to Exercise Contractual Discretion in Good Faith

The majority of the Supreme Court in Wastech v. Greater Vancouver held that the duty to exercise discretion in good faith prohibits contracting parties from exercising their discretion dishonestly, and requires them to exercise their discretion reasonably – meaning, in a manner consistent with the contractual purpose for which the discretion was granted. Under this approach, an exercise of discretion will be unreasonable where it “falls outside of the range of choices connected to its underlying purpose.”

Whether the duty has been breached is rooted in the parties’ contract: “[i]t is in properly interpreting the contract and the purposes for which discretion was granted that the range of good faith behaviour comes into focus and breaches can be identified.” Where a discretionary clause itself does not state the purposes for which discretion is granted, the reviewing court may ascertain this purpose by reading the contract as a whole.

According to Justice Kasirer, the fact that an exercise of discretion results in a partial or total loss of an anticipated benefit under the contract is not determinative of whether the duty has been breached, but could be relevant to show the discretion was exercised in a manner unconnected to the relevant contractual purposes.

The judges in the majority held that the duty to exercise discretion in good faith is a general doctrine of contract law. Accordingly, parties cannot contract out of this duty and it need not be found as an implied term of a contract to apply. The majority explained that even unfettered grants of discretion contain “some minimum constraints” as this duty operates regardless of the parties’ intentions. For instance, an exercise of discretion that is capricious or arbitrary will necessarily breach the duty to exercise discretion in good faith. A breach of the duty to exercise contractual discretionary powers in good faith can give rise to a claim for damages.

On the facts of this case, the majority in Wastech v. Greater Vancouver held that Metro did not breach the duty to exercise discretion in good faith. In coming to this conclusion, Justice Kasirer noted that the parties’ contract granted Metro “absolute discretion” to determine how waste was to be allocated. This discretion, when read in the context of the entire contract, permitted Metro to make choices to ensure the efficiency of the entire operation and necessarily meant that the parties had contemplated that revenues could vary from year to year. It followed that Metro was not obligated to exercise its discretion in a manner that guaranteed Wastech would achieve its “Target Operating Ratio”. Rather, Metro was entitled to act in its own self-interest when deciding to reallocate waste since its exercise of discretion was consistent with the purposes for which it was granted.

In a separate judgment, the concurring judges agreed that Metro had not breached the duty to exercise discretion in good faith. In doing so, however, Justices Brown and Rowe expressed their concern that the majority judgment risked interfering with freedom of contract by limiting the manner in which parties may exercise grants of unfettered discretion. In their view, where a contract provides that discretion can be exercised for any purpose, reviewing courts must give effect to the parties’ intention to immunize an exercise of discretion from this type of review. In this way, the concurring judges held that with careful drafting, parties could immunize the exercise of discretion from review on the basis of a breach of the duty to exercise discretion in good faith.

The concurring judges also stated that the majority should have addressed the issue of the proper standard of review for appeals from arbitrations. They held that where a statute provides for an “appeal” from the arbitration award, as the British Columbia Arbitration Act that was at issue does, then the standard of review should be correctness.

Concluding Remarks

In its decision in Wastech v. Greater Vancouver, the Supreme Court affirmed that the agreement itself remains the primary source for ascertaining the purpose for which a discretion was granted, although overlain with contractual duties of good faith. The Supreme Court’s decision reinforces the importance of carefully drafting discretionary clauses in contract.

For more information concerning Wastech v. Greater Vancouver, please contact any member of our Litigation Group.

The authors would like to Rachel Oster, Articling Student-at-Law, for her assistance in preparing this Update.

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