How Contractual Discretion is Limited by Good Faith

Good Faith & Contractual Discretion

In the recent Supreme Court of Canada decision of Wastech Services Ltd. v. Greater Vancouver Sewerage and Drainage District, 2021 SCC 7[1] (“Wastech”), the Court ruled that in order to comply with the duty of good faith a party who is exercising their discretionary power within a contract must do so in a reasonable manner.

THE ORIGINS

In Bhasin v. Hrynew, 2014 SCC 71[2] (“Bhasin”), also a Supreme Court decision, the Court recognized the existence of an organizing legal principle of good faith in the performance of contacts. A legal principle is not a specific rule that can be broken. Rather, it is a framework that allows for the development of new legal doctrines, and to help courts interpret and apply current legal doctrines. The Court in Bhasin also recognized that there is a general duty of good faith and honesty in the performance of contracts. That duty can be broken. 

In Wastech, the Supreme Court of Canada, discussed the legal issue of how the duty of good faith in contracts would apply to a contracting party’s exercise of discretion.

Wastech Services Ltd. (“Wastech Services”) was a waste disposal company that was contracted by the Greater Vancouver Sewerage District and Drainage District (the “City”) to dispose of waste in three landfills. The contract provided the City with discretion in choosing which landfill to use. The City exercised this discretion when it decided to change the location of the disposal facility, which ended up reducing Wastech Services’ profit margin. Wastech Services argued that the City did not exercise their discretion in good faith, and, as such, breached the contract. In determining this issue, the Supreme Court asked: how does the duty of good faith govern the exercise of contractual discretion?

THE LAW:

To reiterate, the Supreme Court concluded that in order for a contracting party to adhere to their duty of good faith, the contractual discretion must be exercised in a reasonable manner. In making this determination, the court will determine if the discretion was exercised in a manner consistent with the purpose for which it was granted, as outlined in the contract, and not for an extraneous or ulterior purpose.

The purpose behind the discretion can be understood by looking at the wording in the contract. At times, the discretionary clause itself will explain the purpose; other times the purpose can only be understood by reading the clause in the context of the contract in its entirety. If the clause is general, the courts will determine the purpose by looking at the broader business relationship between the parties.

With the purpose behind the discretion established, a court will then determine if the exercise of the discretion was in line with this purpose. A party is not required to subordinate their own interests, or required to confer benefits on the other party that was not contemplated in the contract. However, if the discretion was exercised in a manner that substantially nullified or eviscerated the benefits of the other party, this might show evidence that the discretion was exercised in an unreasonable manner. 

The type of discretion also determines the range of outcomes that would be considered reasonable. For contracts where the discretionary power could be objectively measured, the range of reasonable outcomes will be smaller.

APPLICATION:

The Supreme Court determined that the purpose of giving the City the absolute discretion in choosing the landfill site was to maximize efficiency and minimize the operation’s costs. The City had discretion to change which landfill would be used (as opposed to using a fixed schedule) to maintain efficiency, economy, and its own business interests. Furthermore, when Wastech Services entered into the contract they were aware that the City’s discretion was to be exercised in this way.

Having identified the purpose for the discretion, the Supreme Court concluded that the discretion exercised by the City was reasonable as it aligned with the purpose for which the discretion was granted; namely, to maintain efficiency. Therefore, the City had not breached it’s duty of good faith.

CONCLUSION:

As the duty of good faith in contract law becomes further refined, it will become increasingly important to carefully contemplate how much discretion a party should have within a contract, and more importantly, for what purpose. A carefully drafted discretion clause can help protect parties from future contract disputes and liability.

However, the duty of good faith should be understood as a broad principle available to protect those who are victims of bad faith. The duty of good faith in contract law is still young and developing.

For more information, please reach out to Narinder Sidhu at nsidhu@kmblaw.com or another member of our commercial litigation group.

[1]Wastech Services Ltd. v. Greater Vancouver Sewerage and Drainage District, 2021 SCC 7, <https://canlii.ca/t/jd1d6>

[2]Bhasin v. Hrynew, 2014 SCC 71, [2014] 3 SCR 494, <https://canlii.ca/t/gf84s>