Duty of Good Faith in Contracts

Before 2014, Canadian common law recognized good faith obligations only piecemeal, in particular situations and types of relationships. In Bhasin v. Hrynew, 2014 SCC 71, the Supreme Court of Canada took two steps. It recognized an organizing principle of good faith, which it stated simply: "parties generally must perform their contractual duties honestly and reasonably and not capriciously or arbitrarily." And it recognized a new duty of honest performance that applies to all contracts.

An organizing principle is not a free-standing rule that lets a judge rewrite a bargain that seems unfair. It is a standard that underpins more specific doctrines. Drawing on academic commentary, the Court noted three broad situations in which good faith duties had already been found: where the parties must cooperate to achieve the objects of the contract, where one party exercises a discretionary power under the contract, and where a party seeks to evade its contractual duties.

Two later decisions filled in the detail. C.M. Callow Inc. v. Zollinger, 2020 SCC 45, applied honest performance to the way a contract is ended. Wastech Services Ltd. v. Greater Vancouver Sewerage and Drainage District, 2021 SCC 7, set the test for exercising contractual discretion. Together, these cases govern Ontario business contracts of every kind, from supply and services agreements to shareholder and purchase agreements.

The core rule from Bhasin is that "parties must not lie or otherwise knowingly mislead each other about matters directly linked to the performance of the contract." The Court stressed that this does not impose a duty of loyalty or of disclosure, and does not require a party to give up advantages the contract gives it.

In Bhasin, an Alberta retail dealer of education savings plans, known as an enrollment director, was misled by the company whose plans he sold about its intentions for his agency, and the company then used a non-renewal clause to end the relationship. The Court awarded him $87,000, the value of his business around the time of non-renewal, because honest performance would have let him keep that value.

The duty cannot be excluded. A generic entire agreement clause does not displace it. The Court left room for parties to set standards for honest performance in some contexts, but only in express terms that respect its minimum core.

Callow showed how far the duty reaches. A group of Ontario condominium corporations had a winter maintenance contract covering two winters that they could terminate for any reason on ten days' notice. They decided to terminate months before telling the contractor, and in the meantime led him to believe the contract was safe while he did extra summer work for free in hopes of a renewal. The majority, written by Justice Kasirer, held that the corporations had no duty to announce their decision early, but could not actively mislead the contractor about it. Knowingly misleading conduct is not limited to outright lies; depending on the circumstances, it can include half-truths, omissions and even silence. Eight of nine judges allowed the contractor's appeal and reinstated the trial judgment in its favour.

Many contracts give one party a choice: how to allocate work, whether to approve a transfer, whether a condition is satisfied. Wastech involved a 20-year waste disposal contract in British Columbia under which the regional district could decide how much waste to send to each disposal site. When it shifted waste to a closer site in 2011, the contractor's earnings fell short of a target ratio in the contract. An arbitrator found a breach of good faith; the courts set the award aside, and the Supreme Court of Canada agreed with them.

The Court held that a party breaches its duty of good faith if it exercises a discretion unreasonably, meaning in a way unconnected to the purposes for which the parties agreed to grant the discretion. The district's discretion existed so that it could operate efficiently and keep costs down, not to guarantee the contractor's profit, so its decision was within bounds. The duty is not a fiduciary one, and a party may consider its own interests.

Common business examples include:

• operating decisions that affect an earn-out, where the buyer runs the business after closing;
• a buyer's due diligence condition that is satisfied "in its sole discretion", one of the conditions precedent in many purchase agreements; and
• consents to assignment, renewals and approvals of new locations or suppliers.

Even a discretion described as sole or absolute is not unlimited. The practical drafting step is to state why the discretion exists and what a party may take into account, because those purposes define what counts as reasonable.

No duty to negotiate in good faith. Bhasin is about performance. In Martel Building Ltd. v. Canada, 2000 SCC 60, the Supreme Court of Canada declined to recognize a duty of care in commercial negotiations, so a party can generally walk away from talks or from the non-binding terms of a letter of intent. Express promises to negotiate in good faith are treated unevenly, as our guide on whether a letter of intent is binding explains.

No general duty to disclose. A party need not volunteer information that helps the other side, as long as it does not actively mislead.

No override of clear terms. A party can still rely on a termination for convenience right, a liability cap in a limitation of liability clause or a strict deadline. Good faith governs how those rights are exercised, not whether they exist. Ending a contract for a material breach is likewise judged on the contract's terms, though the communications around it must be honest.

The lesson for drafting is to write down the conduct you expect, such as response times, approval criteria and notice obligations, rather than relying on a bare promise of good faith. Our guide to business agreements covers the contracts where this matters most.

Franchise agreements in Ontario carry a second, statutory duty on top of the common law. Section 3 of the Arthur Wishart Act (Franchise Disclosure), 2000 gives each party to a franchise agreement a duty of fair dealing in its performance and enforcement, which includes acting in good faith and in accordance with reasonable commercial standards. It binds franchisor and franchisee alike.

Three points of comparison matter in practice:

• Standard. Section 3 names reasonable commercial standards as well as good faith, but whether that makes it more demanding than the common law is unsettled. In 1250264 Ontario Inc. v. Pet Valu Canada Inc., 2016 ONCA 24, the Court of Appeal overturned a decision that had treated section 3 as broader than Bhasin, and left open whether non-disclosure during the relationship can ever breach it.
• Contracting out. Any purported waiver or release by a franchisee of rights under the Act is void. At common law, parties also cannot exclude honest performance or the duty to exercise a discretion in good faith, but they can shape what those duties require, for example by stating why a discretion exists.
• Remedy. A breach gives a statutory right of action for damages, not only a claim for breach of contract.

The duty of fair dealing entry sets the two duties side by side and explains how Ontario courts have applied section 3.

Kwame Asante's company holds a three-year cleaning contract for a Mississauga office park. The owner can terminate for convenience on 60 days' notice. In February, the owner decides to put the contract out to tender. In March, its property manager, Rebecca Lindqvist, tells Kwame the owner is very happy and plans to keep him, and encourages him to buy $40,000 of floor-care equipment for the site. Kwame buys it. In May, the owner gives 60 days' notice.

Kwame's lawyer advises that the owner was entitled to terminate and had no duty to tell Kwame about the tender. Its reassurances after the decision was made, however, are the kind of knowingly misleading conduct the Supreme Court found in Callow. Damages would be measured by Kwame's position had the owner been honest: he would not have bought the equipment and would have bid for other work that spring.

Kwame resells the equipment for $14,000, documents a $26,000 loss and the contracts he did not pursue, and sends a demand. The owner settles for $30,000 rather than defend the March conversation in court.