The British Columbia Court of Appeal’s recent decision in Greater Vancouver Sewerage and Drainage District v. Wastech Services Ltd (“Wastech”) confirms the Canadian courts’ conservative approach to good faith law, but nevertheless raises important questions to be addressed on appeal to the Supreme Court of Canada regarding the exact limits of good faith, and in particular, the limits on a party’s ability to exercise a contractual discretionary right.

The Facts

Wastech and Greater Vancouver Sewerage (“GVS“) were parties to a long-term agreement providing for the removal and hauling of solid wastes by Wastech on behalf of GVS. The agreement provided GVS with the discretion to allocate waste among disposal facilities at different destinations. GVS substantially re-allocated wastes in 2011 between short-and long-haul destinations, which increased Wastech’s costs such that it could not meet a so-called “Target Operating Ratio” as defined in the Agreement.

The Target Operating Ratio, which represented the proportion of Wastech’s costs versus revenues, would give Wastech an operating profit of 11%. Various adjustments were provided for in the agreement, and GVS paid Wastech some $2.8 million as a result of the re-allocation, but the parties had consciously chosen not to provide adjustments beyond a certain threshold. The actual Target Operating Ratio for the year after the adjustment was several percentage points higher than the target, thus eroding Wastech’s profits.

Wastech initiated arbitration, arguing that a term should be implied into the contract or that a duty of good faith should apply, so as to entitle it to an additional $2.8 million. The arbitrator declined to imply a term in light of the parties’ deliberate choice not to include such an adjustment, but found that although GVS’s conduct had been honest and reasonable from its own point of view, it had failed to give “appropriate regard” to Wastech’s legitimate interests or expectations. The arbitrator found that this constituted “dishonesty” for purposes of the duty of good faith as explained in Bhasin v Hrynew. GVS successfully sought leave to appeal the arbitrator’s award. Wastech unsuccessfully appealed the leave order.

The British Columbia Supreme Court Decision

GVS brought its appeal before the British Columbia Supreme Court (“BCSC“) on two issues: first, whether the arbitrator erred in finding that GVS’s conduct was dishonest and in bad faith simply because it was contrary to Wastech’s expectations (which expectations were not embodied in the contract); and second, whether the arbitrator erred in confusing the organizing principle of good faith (which principle is not an actual duty the breach of which gives rise to a remedy) with a free-standing duty of good faith.

The BCSC found that an inquiry into the first ground of appeal would trespass on the arbitrator’s fact-finding jurisdiction. On the second ground of appeal, the BCSC concluded that since the arbitrator had ruled against implying a term into the agreement, it was not open to find a duty of good faith (and therefore not open to him to find a breach of such a duty). The BCSC also rejected Wastech’s argument on the second issue that if a contract provides one party with a contractual discretion without expressly stipulating that that discretion is unfettered, then that discretion must be exercised reasonably. The BCSC summarized its findings by concluding that the arbitrator had attempted to do “what is fair, not as grounded in the [agreement] but [in] a more general sense.”

The British Columbia Court of Appeal Decision

The British Columbia Court of Appeal (“BCCA”) upheld the BCSC’s decision on both issues, reaching that result based on slightly different reasons. In this regard, the BCCA noted that the BCSC reached a clear conclusion in overturning the arbitrator’s award, but had created unnecessary confusion by making additional remarks that went beyond the issues raised on appeal.

With respect to the first issue, the BCCA observed that even prior to Bhasin, Canadian law recognized that a contractual discretion cannot be exercised so as to “nullify the benefits reasonably expected to be obtained from the contract by the other party”. To this extent, a contractual discretion has to be exercised in a manner consistent with the parties’ expectations. However, the BCCA stressed that those expectations must be founded in the agreement, and the exercise of the discretion must nullify those contractually-based expectations – not simply infringe upon them.

In the present case, the parties had expressly considered and rejected a contractual term that would have protected the expectation for which Wastech was seeking a remedy. This fact proved significant, as it confirmed that Wastech’s expectation was not grounded in the agreement.

The BCCA also observed that “dishonesty” in the context of bad faith entails some subjective element of improper motive (e.g. malice, untruthfulness, ulterior motive, or recklessness), rather than merely the failure to reach an objective standard. Thus, the BCCA emphasized that a remedy will only be available where contracting parties undermine their counterparties’ contractual expectations in bad faith.

Analysis

Much like the Ontario Court of Appeal’s recent decision in CM Callow Inc. v, Zollinger which we discuss separately available here, this case is indicative of the conservative approach applied by Canadian courts in addressing good faith law following Bhasin. Here, the BCCA stressed that good faith only protects those expectations that are based in the parties’ agreement, and those expectations will only be protected to the extent that an improper motive can be imputed to the offending party – a high evidentiary bar.

Nevertheless, Wastech raises several interesting questions and ambiguities. First, the BCCA’s analysis leaves uncertain the extent to which, as a matter of fact, a party’s contractual expectations must be undermined in order to reach the status of being “nullified”. Although the BCCA confirmed that this standard requires depriving a party of all or substantially all of the benefit for which it bargained, this standard is difficult to predict in advance – especially with respect to when the threshold of “substantially all of the benefit” is met.

Second, it is unclear how Wastech interacts with certain other Canadian case law on the exercise of a contractual discretion. In particular, the Ontario Court of Appeal found in Greenberg v Meffert that a contractual discretion may be subject to an objective standard of reasonableness where the subject matter of the contract is readily susceptible to objective measurement, such as operative fitness, structural completion, or mechanical utility. While Wastech is not necessarily inconsistent with Greenberg, it will be interesting to see if the Supreme Court resolves the tension between these two cases.

Third, Wastech indirectly raises an interesting question about the nature of a “freestanding rule” such as the duty of honest performance established in Bhasin. Readers will recall that in Bhasin, the Supreme Court established that the duty of honest performance is not an implied term which parties can contract out of, but rather is a mandatory term that is imposed on the contract and which the parties cannot exclude from the agreement. Since the question was indirectly raised in Wastech whether the good faith exercise of a contractual discretion should be a similar “freestanding rule”, it remains to be seen whether the Supreme Court will address this issue and potentially make a similar finding. Needless to say, such a finding would have a significant impact on Canadian contract law.

Together with the Callow decision, Wastech confirms that good faith is an area of law in which Canadian courts  have, to date, been careful to remain within the boundaries established by the relevant case law. That said these two cases have raised several interesting issues that could potentially subject good faith to significant change depending on how the Supreme Court rules. It remains to be seen if the Supreme Court will replicate the significant steps it took in Bhasin, or join other Canadian courts in applying a conservative treatment.