While parties are largely free to craft any agreement they wish, there are certain limits to that freedom that cannot be overridden by any contractual provision. In particular, parties cannot contract out of the duty of good faith in contractual performance, which requires parties to exercise their contractual rights and perform their contractual obligations honestly. But how does this duty apply to seemingly unfettered contractual rights, such as termination for convenience?
The Supreme Court of Canada recently commented on the duty of good faith in the context of a termination for convenience, or termination without cause, clause in CM Callow Inc v Zollinger, 2020 SCC 45. The majority of the Court in Callow concluded that the duty of good faith arises when there is a direct link between the dishonest act and the performance of an obligation or exercise of a right under the contract. The duty may be breached, depending on the circumstances at issue, if a party knowingly misleads the other party in any manner.
However, far from clarifying the state of the law on the contractual duty of good faith, the Supreme Court of Canada’s decision seems to have left room for further clarification, particularly given the vigorous debate appearing in the Court’s concurring and dissenting reasons. Overall, the decision in Callow creates potential for uncertainty in the exercise of termination for convenience clauses.
Good faith and termination for convenience clauses prior to Callow
The function of a termination for convenience clause is to permit the parties to bring their contractual relationship to an end without cause, as long as the right is exercised in accordance with the termination provision. The very nature of such a clause is to allow the parties to act without regard to their counterparties’ performance or interests, as contractually agreed upon by the parties.
Since the Supreme Court of Canada’s landmark decision in Bhasin v Hrynew, 2014 SCC 71, the duty of good faith in contractual performance has been a central organizing principle in the assessment of contractual performance. Specifically, the Supreme Court of Canada in Bhasin established a common law duty, applicable to all contracts, which requires the parties to act honestly in the performance of contractual obligations.
Prior to Callow, there had been some hesitancy by Courts to apply the duty of good faith in contractual performance to the exercise of termination for convenience clauses.
For example, in Styles v Alberta Investment Management Corporation, 2017 ABCA 1, leave to appeal to SCC ref’d [2017] SCCA No 76, the Alberta Court of Appeal indicated that the scope of the duty is narrow and, when exercising a termination for convenience clause, largely inapplicable. The Court in particular found Bhasin did not go so far as to establish a general principle requiring the reasonable exercise of discretion in contractual performance. Rather, the language of the contract is to be relied upon to determine the parties’ reasonable expectations. In Styles, an employee was terminated just prior to gaining eligibility to a bonus that he was entitled to receive after four years of employment. The Court rejected the employee’s claim that the termination was unfair and not in good faith, given the express language of the termination for convenience clause.
Conversely, in Ontario, the duty of good faith has been relied upon to limit an employer’s right to rely on a termination for convenience clause when an employee was terminated on the basis of his criminal record, which was known to the employer prior to entering into the employment contract (see Mohamed v Information Systems Architects Inc, 2018 ONCA 428).
Given these conflicting outcomes, the Supreme Court of Canada’s discussion of the duty of good faith in termination for convenience clauses was eagerly awaited. However, as discussed below, the decision in Callow raises more questions than it answers.
The allegedly dishonest behaviour in Callow
In Callow, the contract at issue included a clause permitting the agreement to be terminated without cause upon 10 days’ notice. While the terminating party in Callow abided by the terms of the clause on its face, a dispute arose as to whether the right to terminate the contract had been exercised honestly and in accordance with the duty of good faith in contractual performance.
Specifically, the decision in Callow turned on the decision by Baycrest to terminate Mr. Callow’s contract several months prior to doing so, while nonetheless making statements to Mr. Callow about his contract likely being renewed and accepting free work performed by Mr. Callow in hopes of securing a contract renewal. The majority of the Supreme Court of Canada agreed with the trial judge that Baycrest’s representatives actively suggested they were satisfied with Mr. Callow’s performance and the contract was likely to be renewed.
The majority’s reasons
The majority’s decision was delivered by Justice Kasirer, writing on behalf of Justices Wagner, Abella, Karakatsanis, and Martin.
In reaching its decision, the Supreme Court of Canada focused its analysis on the duty to honestly perform a party’s rights and obligations under a contract as a component of the duty of good faith in contractual performance. In particular, the Court considered: (1) when the duty arises; and (2) how it may be breached.
When. The duty of honest performance arises when there is a direct link between the alleged dishonesty and the exercise of a right or obligation under the contract. A direct link exists where a party performs its obligations or exercises its rights under the contract dishonestly.
How. Whether the duty of honest performance has been breached requires a highly fact-specific analysis. While there is no active duty to disclose information or subordinate one’s own interests to those of the other party, a failure to act honestly can arise in a number of ways. A party may commit a breach if it “knowingly misleads” the other party in any manner, including by way of lies, half-truths, omissions, or even silence, depending on the particular circumstances at issue.
The Supreme Court of Canada applied this test in determining whether the duty of honest performance was breached when Baycrest terminated Mr. Callow.
First, the Court held that the alleged dishonesty was directly linked to the exercise of a right because it was in the course of exercising a right to terminate without cause that Baycrest’s allegedly dishonest behaviour occurred.
Then, the Court found that Baycrest’s behaviour amounted to active communications that knowingly mislead Mr. Callow, thereby breaching the duty of honest performance. The Court relied on statements made by Baycrest representatives to the effect that a renewal was likely as well as the fact that Baycrest knowingly accepted free work that Mr. Callow was offering as an incentive for the contract renewal. Considering Baycrest’s conduct as a whole over the course of several months, it was therefore reasonable for Mr. Callow to infer that Baycrest was not going to terminate the ongoing contract.
Ultimately, the majority of the Supreme Court concluded that the duty had been breached on the facts of this case. In the course of exercising the termination clause, Baycrest intentionally withheld information, knowing that its silence and other active communications had deceived Mr. Callow. By failing to then correct Mr. Callow’s misapprehensions, Baycrest breached its duty of honest performance.
The duty of good faith in the exercise of contractual discretion
Justice Brown, writing on behalf of Justices Moldaver and Rowe, delivered a thorough concurring decision.
In addition to addressing the aspect of the duty of good faith relating to honesty in the performance of contractual rights and obligations, the concurring Justices commented on the duty of good faith in the exercise of contractual discretion, which the entirety of the Supreme Court of Canada agreed was not necessary to deciding the dispute in Callow.
Justice Brown expressly distinguished between those two aspects of the duty of good faith. In Callow, the parties agreed that Baycrest was entitled to exercise the termination clause as it did, without cause and with only 10 days’ notice. It was the conduct preceding the termination that was at issue, rendering the duty of honest performance as the applicable duty in the circumstances.
Where a party appears to have unfettered discretion pursuant to a contract, the duty to exercise discretion in good faith may apply. In those circumstances, the complaint relates to whether the party was entitled to make the decision it made, as opposed to whether the party was dishonest in performing the contract.
However, the duty of good faith in the exercise of contractual discretion under a contract does not apply to every exercise of discretion. In fact, the Court explicitly refrained from deciding on the applicability of this duty in the context of termination for convenience clauses, noting the uncertainty in the case law as it stands.
The Supreme Court of Canada has recently released its reasons in the appeal of Wastech Services Ltd v Greater Vancouver Sewerage and Drainage District, 2021 SCC 7, which was heard alongside Callow. The dispute in Wastech relates to the exercise of contractual discretion, albeit in circumstances not involving a termination for convenience clause.
A strong dissent – what constitutes dishonest behaviour
Finally, Justice Côté delivered a strong dissenting decision, disagreeing in particular with the majority’s assessment as to how the duty of honesty in contractual performance may be breached.
Justice Côté noted that the duty of honest performance creates only negative obligations, such that silence cannot be considered dishonesty without a positive obligation to speak, even where the other party is operating under a mistaken belief. She concluded that, absent a duty of disclosure, a party has no obligation to dissuade his or her counterparty from persisting in a mistaken belief.
Rather, there is only an obligation to correct a mistaken belief where the party’s active conduct materially contributed to the mistaken belief.
On the facts of this case, Justice Côté felt that Baycrest did not materially contribute to Mr. Callow’s mistaken belief. While Baycrest’s behaviour might have been inappropriate, such that other recourse could be available to Mr. Callow, it was Mr. Callow’s own opinion that the contract would be renewed. Justice Côté felt that there was no evidence to support any active steps taken by Baycrest to contribute to the mistaken belief, and accordingly would have dismissed the appeal.
Conclusion
Given the extensive debate between the Justices of the Supreme Court of Canada, many questions remain as to the nature of the duty of honesty in contractual performance when exercising a termination for convenience clause. In addition, it remains unclear whether, and to what extent, the right to terminate without cause constitutes an exercise of discretion subject to the duty of good faith.
While the Supreme Court of Canada was trying to clarify Bhasin and the applicability of the duty of good faith to termination for convenience clauses, the decision in Callow unfortunately leads to more questions for clients, who will turn to legal counsel for advice.
As a result, depending on the circumstances, exercise of termination for convenience clauses may no longer be as straightforward as it was pre-Callow. Contracting parties should now consider and analyze discussions with counterparties to determine if there have been communications that might be construed as leading someone to believe that a contract would not be terminated, despite having seemingly unfettered contractual rights to do so for any reason, without cause.
Published previously in the Construction Law Letter (LexisNexis) and republished with permission.
Catriona Otto-Johnston is a partner and Elisa Stewart is an associate at Rose LLP. Both are members of the CBA Construction and Infrastructure Law Section.