On November 13, 2014, the Supreme Court of Canada updated Canadian common law by extending for the first time the principle of good faith to all contracts. Previously, the duty of good faith existed only in employment and insurance contacts in Canada. The ruling now aligns Canadian common law with Civil Law in Quebec and the law in most U.S. jurisdictions. The Court expects its decision to bring certainty and coherence to this area of law.

The Court, in its decision in Bhasin v. Hrynew, recognized good faith performance of contract as a general principle of the common law and further introduced a new common law duty to act honestly in the performance of contractual obligations. Justice Thomas Cromwell stated for the Court:

“In my view, it is time to take two incremental steps in order to make the common law less unsettled and piecemeal, more coherent and more just. The first step is to acknowledge that good faith contractual performance is a general organizing principle of the common law of contract which underpins and informs the various rules in which the common law, in various situations and types of relationships, recognizes obligations of good faith contractual performance. The second is to recognize, as a further manifestation of this organizing principle of good faith, that there is a common law duty which applies to all contracts to act honestly in the performance of contractual obligations.”

The case stems from a commercial dispute between two parties to a contract for services over the circumstances by which one party exercised a non-renewal clause in the contract. The Court found that the actively dishonest actions of one party breached the implied term of good faith in the contract. The defendant was ordered to pay damages based on the economic position the other party would have been in had the defendant breaching party fulfilled its duty under the contract.

The important aspects of this case with respect to commercial law are: (1) the implied principle of good faith and (2) the duty of honesty, in contractual performance.

The Court explained that the organizing principle of good faith in contractual performance means that:

• parties must perform their contractual duties honestly and reasonably and not capriciously or arbitrarily;
• a contracting party should have appropriate regard to the legitimate contractual interests of the contracting partner;
• a party must not seek to undermine those contractual interests in bad faith;
• it has strong conceptual differences from the much higher obligation of a fiduciary;
• in certain respects, it requires honest, candid, forthright or reasonable contractual performance.

What amounts to good faith will depend on the context of the commercial relationship, the type of contract and the circumstances involved. It may be easier to figure out what good faith is, by considering first what it is not. “Bad faith” as the Court pointed out, is a conduct that is contrary to community standards of honesty, reasonableness or fairness.

While the concepts of reasonableness and fairness have been well examined in the courts in the past, the Court took the time to examine the new duty of honesty in contractual performance. The Court explained that this means that:

• parties must not lie or otherwise knowingly mislead each other about matters directly linked to the performance of the contract;
• it is not an imposition of a duty of loyalty or disclosure on the parties; and
• it imposes a minimum standard of honest performance as general doctrine of contact law.

The precise content of honest performance, like good faith, will also vary with context.

To conclude, parties currently performing obligations under a contract in Canada must be aware that they now owe each other a duty to act honestly in their contractual dealings. Exactly what this entails will depend on a number of factors and circumstances, so if you are concerned about whether you or someone you are contracting with may not meet the duty, please contact us and we can discuss the implications of the Bhasin v. Hrynew case with you.

Editor’s note: This decision represents a major development in contract law in British Columbia and Canada’s other common law jurisdictions. While the decision is certain to give rise to plenty of commentary and debate, it remains to be seen how it will impact the drafting of contracts. In the first instance, the Court indicates that the duty of good faith is a general doctrine of contract law that operates irrespective of the intentions of the parties, imposes limits on freedom of contract and is not subject to exclusion. However, the Court goes on to state that the duty of honesty of performance could be modified by the express terms of a contract. As is often the case with these sorts of decisions, we will have to wait to see how the law develops.

In the meantime, we will be studying the decision further and anticipate drafting certain contractual terms to address issues relating to the duty of good faith. For example, we anticipate the decision will change the manner in which we draft and negotiate sandbag and anti-sandbag clauses in purchase and sale agreements. We will have more to say about that and the decision generally in upcoming blog posts. Stay tuned.