Supreme Court Rules on Exercising Contractual Discretion in Good Faith

On February 5, 2021, the Supreme Court of Canada released its decision in Wastech Services Ltd. v Greater Vancouver Sewerage and Drainage District, 2021 SCC 7 (Wastech). Heard together with C.M. Callow Inc. v Zollinger et al, 2020 SCC 45 (Callow), this decision clarifies the relationship between the duty of good faith and discretionary powers under a contract and the scope of the duty to exercise discretionary contractual powers in good faith.

Key Takeaways

  • Contracting parties have a duty to exercise contractual discretion in good faith. Parties cannot contract out of this duty.
  • Contracting parties breach the duty to exercise contractual discretion in good faith when the discretion is exercised unreasonably. This may occur where the exercise of discretion is arbitrary or capricious. Where the exercise of discretion substantially nullifies or eviscerates the benefit of the contract to the other party, this is not determinative but may be relevant.
  • The exercise of contractual discretion is unreasonable where the discretion is exercised in a manner unconnected to the purposes underlying the discretion. The purpose(s) underpinning the discretion is fundamental when considering whether it can properly be exercised.
  • While contracting parties owe this duty to the bargain, they do not owe loyalty to one another. They are not required to subvert their own interests to accommodate the other nor are they required to confer a benefit on the other party that was not contemplated under the contract.
  • Parties entering into contracts should consider including specific information about any discretions granted in the contract itself. For example, contractual provisions could state the purpose of the overall bargain or the discretion, and address when a discretion may be exercised or what a party may consider in doing so.

Bhasin, Callow and the Duty of Good Faith

In 2014, the Supreme Court of Canada released its seminal decision in Bhasin v Hrynew, 2014 SCC 71 (Bhasin). Through that decision, the Supreme Court articulated a duty of good faith as an “organizing principle,” stating 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.”

As we discussed in Keeping the Faith – Five Years After Bhasin v Hrynew, subsequent Courts have spilled much ink seeking to interpret and apply this organizing principle.

In Callow, the Supreme Court provided additional guidance on the duty of honest performance (see Deceptive Silence and Good Faith Contractual Performance). Now, in Wastech, the Court has done the same for contractual discretion.

Background on Wastech

In 1996, Wastech and Metro entered into a contract for the operation and management of the municipal solid waste disposal system in the Greater Vancouver Regional District. The two had a long-standing commercial relationship, entering into contracts in 1986, 1988 and 1992. Negotiated over the course of 18 months, the 1996 contract was for a term of 20 years – unless terminated sooner.

Wastech was contractually required to transport solid municipal waste to either one of two landfills (the Cache Creek Landfill or the Vancouver Landfill) or to an energy facility (the Burnaby Waste to Energy Facility). Wastech’s compensation for these services was determined based on location – long-haul destinations were more profitable (Cache Creek), whereas short-haul destinations were less so (Vancouver Landfill and Burnaby). This compensation was structured around a “Target Operating Ratio” with an operating profit of 11%.

Metro was required to determine allocations of waste to specific locations in its absolute discretion, and also required to provide these allocations to Wastech annually for the following operating year. When negotiating the contract, the parties realized this discretion might ultimately preclude Wastech from achieving its Target Operating Ratio but believed this scenario was highly unlikely and did not address  this possibility in the contract.

In 2010, Metro decided to significantly redirect waste flow from Cache Creek to Vancouver for 2011. As a result of this redirection, Wastech achieved an operating profit of only 4% and lost approximately $2.9 million. Wastech claimed compensation from Metro and the matter was referred to arbitration.

Arbitral, Review and Appeal Decisions

The arbitrator ruled in favour of Wastech. Applying Bhasin, the arbitrator found that Metro’s reallocation was to maximize efficiency, preserve remaining site capacity at Cache Creek and operate in the most-cost effective manner. But, the arbitrator concluded, Metro was required to have appropriate regard to Wastech’s interests.

Because its exercise of discretion made it impossible for Wastech to achieve its Target Operating Ratio, Wastech lost the fundamental benefit it bargained for. Consequently, the arbitrator found that Metro breached the duty of good faith.

Metro then sought and obtained leave to appeal this decision to the Supreme Court of British Columbia and later appealed to the British Columbia Court of Appeal. Both Courts found that the arbitrator had erred by effectively creating a stand-alone duty not to show disregard to the other party’s contractual interests, something that would be a radical extension of the law.

The Supreme Court’s Decision

Directly at issue before the Supreme Court of Canada was what constitutes a breach of the duty to exercise contractual discretion in good faith, not the duty of honest performance.

Noting that the Court had not recognized this duty in Bhasin itself, it characterized this as a general duty that operates in every contract irrespective of the parties’ intentions. Fundamentally, the Court concluded that the will of the parties guides the content of the duty.

To determine whether a party has breached its duty to exercise discretionary power in good faith, courts consider whether the exercise of contractual discretion was unconnected to the purpose for which the contract granted discretion. The touchstone for unreasonableness is the purpose for which the discretion was created. As long as discretion is exercised in a manner consonant with that purpose, it may be characterized as reasonable. Discretion exercised for an improper purpose – against that which the parties intended or for a purpose ulterior or extraneous to their intentions – is exercised in bad faith.

How, then, do Courts determine purpose?

The Supreme Court identified what courts can consider when determining the purpose of a discretionary power. It noted that the text of the clause itself may make the purpose clear or, in some circumstances, that it can only be understood by reading the clause in the context of the entire contract.

In particular, where the clause is entirely general, courts will have to construe the scope of the power itself. If the power is susceptible to objective measurement – such as operative fitness, structural completion, mechanical utility or marketability – the range of reasonable outcomes will be smaller; where the matter to be decided is not readily susceptible to objective measurement – taste, sensibility, personal compatibility or judgment of the party – the range of reasonable outcomes will be relatively larger.

Ultimately, this means that contractual interpretation is front and centre in any analysis, and that the parties’ intentions are critical.

In its decision, the Supreme Court also emphasized that just because an exercise of discretion causes loss to the other contracting party, this does not automatically equate to bad faith. Nor is depriving the other party of the better part of the benefit of the contract a prerequisite for establishing breach of this duty. That said, it may be relevant to show that discretion had been exercised in an unreasonable manner where the exercise of discretion substantially nullifies the benefit of the contract for the other party.

The Supreme Court concluded that Metro had not breached its duty. Metro had absolute discretion to allocate where waste was transported.

Read together with the parties’ overall objective of ensuring they could adapt to changing circumstances over the life of the contract, the purpose of this discretion was to allow Metro the flexibility necessary to maximize efficiency and minimize the costs of the operation. This was confirmed by the parties’ decision not to include a contractual provision constraining Metro’s discretion nor to guarantee Wastech the Target Operating Ratio each year – meaning Wastech was “asking for an advantage for which it did not bargain” and asking the Court “to have Metro subvert its own interest in the name of accommodating Wastech’s.”

Going Forward

Together with Callow, the Wastech decision further highlights the legal uncertainties flowing from Bhasin and the efforts of the Supreme Court to respond to and clarify these uncertainties seven years later.

In these two decisions, the Supreme Court has clarified that the duty of honest contractual performance obligates a party not to lie or mislead regarding performance or to undermine the other party’s legitimate contractual interests in good faith (Callow). And, that the duty to exercise contractual discretion in good faith must be exercised reasonably, meaning in a manner consistent with the purposes for which it was granted in the contract (Wastech).

The MLT Aikins team would be pleased to assist your organization in drafting contracts with these decisions in mind or in resolving any disputes or challenges your organization may face in interpreting contractual clauses.

Note: This article is of a general nature only and is not exhaustive of all possible legal rights or remedies. In addition, laws may change over time and should be interpreted only in the context of particular circumstances such that these materials are not intended to be relied upon or taken as legal advice of opinion. Readers should consult a legal professional for specific advice in any particular situation.