Ponce v. Société d’investissements Rhéaume ltée: Good Faith and the Measure of Damages in Québec

In its recent decision, Ponce v. Société d’investissements Rhéaume ltée., 2023 SCC 25 (“Ponce”), the Supreme Court of Canada rendered a decision in the civil law context regarding duties of loyalty, good faith obligations, and the availability of disgorgement of profits as a remedy, which provides an intriguing point of comparison for common law practitioners regarding the obligation to perform one’s contractual obligations in good faith.

Background

The Appellants  were presidents of a group of insurance companies known as “Groupe Excellence”. The Respondents were the majority shareholders of each of the companies comprising Groupe Excellence.

The Appellants and Respondents entered into an “incentive pay agreement” (the “Agreement”), which was based on the parties’ commitment to the common goal of ensuring the ongoing success of Groupe Excellence, with a view to a potential sale.

In April 2005, Industrial Alliance Insurance and Financial Services Inc. (“IA”) informed the Appellants of its interest in acquiring Groupe Excellence. The Appellants and IA entered into an “Undertaking of Confidentiality” and a series of discussions occurred between IA and the Appellants.  In addition, and at the Appellants’ request, an exclusivity clause was also included in the undertaking, the purpose of which  was to prevent IA from dealing directly with  the Respondents. This materialized when one of the Respondents asked the Appellants whether IA would be interested in buying his shares, and the Appellants, despite directly knowledge to the contrary, advised that IA was not interested.

As such, the Respondents – unaware of IA’s interest –  agreed to sell their interests to the Appellants, who  in turn resold to IA the interests they had acquired from the Respondents, for a significant profit (the “Excess Profits”). The Respondents  only learned of IA’s acquisition of Groupe Excellence via IA subsequently publishing a press release. In response, the Respondents commenced proceedings in the Quebec Superior Court.

Decisions of the Courts Below

Before the Quebec Superior Court, the Respondents (at the time, the plaintiffs) alleged that the Appellants breached (1) their contractual and legal obligations, (2) their fiduciary obligations, and (3) their obligations to act in good faith, with loyalty and transparency, by intentionally failing to inform them  of IA’s interest.

The Superior Court ruled in the Respondents’ favour, finding that under both the Civil Code of Québec (the “CCQ”) and the Canada Business Corporations Act, the Appellants (in their capacity as directors) owed duties of honesty, loyalty, prudence and diligence to Groupe Excellence. By extension, these duties could be extended to the Respondents, where there was an “independent relationship between the directors . . . and the shareholders”, which independent relationship existed due to the Agreement.

The trial judge concluded that the Agreement entailed three implied obligations: (1) to maximize the profits and value of Groupe Excellence; (2) to report to the Shareholders, in a full and transparent manner, all information that might enable them to assess the value of Groupe Excellence or make a decision to sell their shares and to determine a sale price; and (3) not to use information for personal benefit without obtaining the Shareholders’ consent.

The trial judge accordingly found that the negotiations with IA constituted intentional concealment, and that the Appellants had consequently breached their duties of good faith and loyalty as well as their duty to inform.

With respect to damages, the trial judge found that the injury corresponded to the lost business opportunity. The loss was therefore equivalent to the profits made by the Appellants when they resold the shares to IA.

On appeal, the Court of Appeal affirmed the lower court’s decision, although it noted that the trial judge erred in finding that the duties of honesty and loyalty provided for in the CCQ could be extended to the Respondents as shareholders. In any event, this error was moot insofar as the Agreement was the source of the obligations in question.

With respect to the duty to inform, the Court of Appeal held that the Appellants’ conduct fell within the three criteria set out in Bank of Montreal v. Bail Ltée, [1992] 2 S.C.R. 554. The Court of Appeal focused on the fact that it had been impossible for the Respondents to inform themselves of IA’s interest, as well as on the atmosphere of trust that had existed between the parties. On these bases, the Court concluded that the Appellants breached the obligation of contractual good faith and the obligation to inform.

The Presidents then sought, and were granted, leave to appeal to the Supreme Court of Canada.

The Supreme Court’s Decision

On appeal, the parties’ arguments – and the Court’s analysis – focused on two key issues:

• whether the Presidents’ failure to inform the Shareholders of IA’s interest was a breach of an obligation, be it contractual or legal; and
• (2) if the Presidents were liable, what would be the appropriate measure of damages.

Kasirer J, for the unanimous Court, addressed each of these issues in turn.

Whether the Failure to Inform Constituted a Breach of a Contractual or Legal Duty

On the first issue, the Court considered four possible bases for the proposition that the Appellants held a duty to inform the Respondents of IA’s interest:

• an obligation of loyalty arising from a legal power conferred on the Presidents that they had to exercise in the Shareholders’ interest;
• an extracontractual obligation to inform related to good faith in the formation of the contracts for the sale of the Shareholders’ shares to the Presidents;
• an implied contractual obligation to inform the Shareholders under the Agreement; or
• an obligation to perform the Agreement in accordance with the requirements of good faith.

The Court considered each of these issues separately.

Obligation of Loyalty

The Court quickly rejected the proposition that any duty to inform could be a fiduciary-related obligation of loyalty, which would have required the Appellants to subordinate their interests to those of the Respondents. Put another way, no duty of loyalty could be extended to the Respondents as shareholders of the companies making up Groupe Excellence.

Here the Court distinguished between two types of loyalty: a contractual loyalty arising from good faith, which requires a contracting party to take the other party’s interests into account; and a loyalty in the exercise of a power, which must be exercised only in the beneficiary’s interest or to achieve the goal that led that power to be conferred.

In this case, the Appellants did not have the latter type of loyalty, which the Court termed a “maximalist” loyalty (similar to a fiduciary obligation at common law). It bears noting that  the Court confirmed that under both the civil law and the common law, duties associated with the general principle of good faith in contractual performance have “strong conceptual differences from the much higher obligations of a fiduciary”.

In this case the Appellants were not required to exercise their powers for the benefit of the Respondents, and thus,  there was no obligation of “maximalist” loyalty owed.

That being said, the Court clarified that in Quebec civil law, the concept of loyalty does not refer solely to “maximalist” loyalty, but also encompasses duties of good faith which, although they do not require a party to subordinate their interests below others’, nevertheless affect the way in which that party can exercise certain of its legal rights, as detailed further below.

Extracontractual Duty to Inform in the Course of the Share Sale by the Shareholders

The Appellants argued that because the allegations against them related to the formation of the contracts by which the Respondents sold their interests to the Appellant, the Agreement therefore did not apply because it did not govern buy-out negotiations. Accordingly, the Appellants argued that liability could not arise from the Agreement and must instead be extracontractual.

On this point, the Appellants acknowledged that at the stage of contract formation, the requirements of good faith give rise to a duty to inform (unlike at common law); however, on the facts, they maintained that this duty did not require them to disclose IA’s interest.

Interestingly, the Court declined to consider this issue in detail – despite the fact that it recognized that the topic would have been the subject of “meaningful debate” – because no  argument based on pre-contractual liability had been raised.

Implied Obligation to Inform under the Agreement

On this issue, the Appellants argued that  the Agreement did not contain an implied obligation to inform as it was simply a “remuneration agreement”, as a result of which the non‑disclosure of IA’s interest could not be a contractual fault.

In rejecting this argument, the Court observed that the nature of the Agreement led to the conclusion that it necessarily contained an implied obligation to inform. The Agreement was the cornerstone of the relationship between the parties, and clearly defined their roles. Furthermore, the “general scheme” of the Agreement indicated that it was intended to formalize a mutually beneficial business relationship. In this sense, the Court concluded that the Agreement  reflected a high level of trust on which the entire enterprise rested. The sharing of Groupe Excellence’s profits and increase in value was the centrepiece of the Agreement, because this mechanism encouraged the Appellants to increase their efforts to ensure its success, which would ultimately benefit all parties.

In that regard, the CCQ bound the parties not only to what was specifically expressed in the Agreement, but also “as to what is incident to it according to its nature and in conformity with usage, equity or law”. This was a long-term agreement that formalized a business relationship in which the parties played different roles in order to maximize the value of Group Excellence; regardless of whether the Agreement was characterized as a relational contract, the Court confirmed that it required reciprocal contractual loyalty.

Having regard to the nature of the Agreement, the Court concluded that the Appellants had an implied obligation to maximize the value of Groupe Excellence, including with a view to a sale, as well as an implied obligation to inform the Respondents of any fact that might enable them to assess the companies’ profits and value and decide whether to sell their shares and, if so, at what price. These implied obligations served to “ensure the Agreement’s internal coherence”.

In addition, the Court confirmed that the Appellants breached not only their duty to inform, but also their duty under the CCQ to perform the Agreement in a manner consistent with requirements of god faith. The Court concluded that regardless of the duty to inform under the Agreement, the requirements of good faith imposed a separate duty to inform as an “obligation of public order” (i.e. a duty that does not arise from the contract itself).

On this point, the Court observed that there is a fundamental difference between non‑performance of a contractual obligation and performance of the obligation in a manner contrary to the requirements of good faith. While the former relates to the implementation of the content of the obligation, the latter relates instead to the manner in which the obligation is performed. In this regard, where the Appellants worked to maximize the value of Groupe Excellence but secretly took action to prevent the Respondents from reaping the benefits in the event of a sale, the Appellants would have performed their obligation but would have done so in a manner contrary to the requirements of good faith. Although this point was somewhat academic insofar as the facts of this case led to the conclusion that there was a wrongful act by the Appellants in any case, evidence of an additional breach of the requirements of good faith could have an impact at the remedy stage, as discussed below.

Obligation to Perform the Agreement in Good Faith

The Appellants argued that they were not bound to disclose IA’s interest because such disclosure did not meet the criteria set in Bank of Montreal v. Bail Ltée, [1992] 2 S.C.R. 554 (“Bail”) regarding a duty to inform arising from good faith; rather, IA’s interest was simply an indication of market value, or information that the Respondents could and should have obtained for themselves.

The Court rejected this argument, observing first that good faith, in Quebec civil law, is an “enacted standard of public order” – that is, it infuses every contract as if a clause provided for it, and through the combined effect of certain articles of the CCQ, good faith performance is an obligation that must be included in every contract. Put differently, the justification for such an implied obligation is an idea of contractual fairness grounded in public order rather than the parties’ autonomy, and its implementation varies depending on the circumstances.

As a result, although the Appellants did not have a maximalist obligation of loyalty to the Respondents in the exercise of their powers, they did have an obligation of contractual loyalty towards them  – in other words, a “minimalist” loyalty. This did not require the Appellants to act in the sole interest of the Respondents, but did require them to consider their interests when performing the Agreement.

In that regard, the Court observed that loyalty has both prohibitive and proactive dimensions – that is, entails certain negative obligations (refraining from a course of action) and positive obligations (being compelled to take a course of action).

The prohibitive dimension requires that parties to a contract not act dishonestly in performing it; that they conduct themselves loyally by not unduly increasing the burden on the other party or behaving in an excessive or unreasonable manner; and not jeopardize the existence or equilibrium of the contractual relationship.

In this case, the Appellants conducted themselves in a disloyal manner when they failed to disclose IA’s interest. Conversely, the Respondents were entitled to expect the Appellants refrain from scheming in any way to enrich themselves at the Respondents’ expense. The Appellants therefore engaged in dishonest conduct that thwarted the legitimate expectations of the Respondents, which was for all parties to maximize the profits and value of the Groupe Excellence.

The proactive dimension requires that parties engage in active behaviour that is intended to assist their contracting partner but that still remains compatible with the party’s own interests. This requires a contracting party to provide the other party with the information that is relevant to the performance of their obligations, in order to facilitate it or avoid making it more onerous. In the context of this case, the proactive dimension entailed a duty to inform.

Accordingly, the final point for determination in this case was the precise extent of the duty to inform. Relying on Bail, which set out the criteria for when information falls within the scope of this duty, the Court concluded that IA’s interest in Groupe Excellence met all of the criteria, and that as a result, the Appellants’ duty to inform included this information.

What was the Appropriate Remedy?

With respect to the appropriate remedy, the Court was left to determine whether the Respondents were entitled to the profits made by the Appellants in reselling their shares to IA – that is, disgorgement of profits.

The Court observed that disgorgement is, in principle, available only where a person is charged with exercising powers in the interest of another (i.e. in the case of maximalist loyalty). In that regard, disgorgement is meant to ensure compliance with such loyalty, whereas damages are intended to compensate the victim for the injury they have sustained.

The Court furthermore concluded that the relevant case law did not support extending disgorgement to situations in which there was simply a breach of the obligation of good faith, and similarly concluded that an amount equivalent to disgorgement could not be award as damages without proof of injury.

Moreover, the Court found  that where a breach of good faith obligations prevents the injured party from proving the injury sustained, it should be presumed that the injury is equivalent to the profits made by the party at fault. However, this presumption is rebuttable, as it can be displaced by evidence to the contrary showing that the quantum of damages differs from the amount of the profits.

In this case, the Appellants were unable to rebut this presumption; as a result, the Respondents were entitled to the difference between (1) the sale price received by the Respondents when initially selling their shares to the Appellants, and (2) the sale price received by the Appellants on the resale of those shares to IA.

Key Take-Aways

Ponce is of course a Quebec case based in the civil law, and therefore fundamentally different in many respects from analogous concepts in the common law; for example, it has been well-established many times that at common law, good faith does not entail a duty of disclosure. That being said, Ponce nevertheless offers many points of comparison that elucidate their corresponding common law analogues.

First, the Court’s discussion of relational contracts affirms the characteristics necessary to constitute such a contract, and how it impacts the parties’ obligations. As readers will recall from Churchill Falls (Labrador) Corp. v. Hydro-Québec, 2018 SCC 46, the fact that a contract is long-term and interdependent in nature does not, in and of itself, result in a relational contract, which imports heightened obligations on the parties. Rather, a relational contract requires close cooperation over the long term, with an emphasis on the parties’ relationship and achievement of a common goal. Although relational contracts are not a well-developed topic at common law, their brief reference in Bhasin v Hrynew suggests that the Court’s discussion in Ponce may be relevant to some extent in the common law context and it will be interesting to see how the Court further considers this question.

Second, the distinction between the prohibitory and proactive dimensions of loyalty provides a useful reference point for understanding the different aspects of good faith at common law. The Supreme Court’s holdings in recent cases like Bhasin, Wastech, and Callow have almost unanimously been framed in prohibitory terms, insofar as parties cannot (i.e. must refrain from) lying, and cannot (i.e. must refrain from) exercising a contractual discretion unreasonably. That being said, these cases also admit some degree of proactive obligation, insofar as Callow found that a party must correct a misrepresentation that it thought was true at the time of the representation, but later learned was false. Accordingly, Ponce serves as a reminder to common law parties that good faith duties do not exclusively entail negative obligations.

Third, the Court’s discussion of the appropriate form of relief and measure of damages calls to mind a number of parallels with, and distinctions from, the common law. With respect to the availability of disgorgement, the Court’s discussion recalls its recent judgment in Atlantic Lottery Corp. Inc. v. Babstock, 2020 SCC 19 – whereas the Court in Ponce clarified that disgorgement “straddles restitution and compensation” at civil law, the Court in Babstock confirmed that disgorgement is distinct from restitution at common law because only the latter requires that a defendant’s gain correspond to the plaintiff’s loss. Conversely, the Court in both instances was in agreement that disgorgement is available in situations of fiduciary (or analogous) relationships, with only the dissent in Babstock finding that it was an arguable issue as to whether “quasi-fiduciary” relationships could justify disgorgement.

Similarly, the discussion of the measure of damages calls to mind Ontario courts clarifying this point at common law. Ponce confirms that at civil law, where a breach of good faith prevents a party from proving their injury, it is presumed that the injury is equivalent to wrongdoer’s gain. Kasirer J in Callow similarly concluded that it could be presumed that the plaintiff lost an opportunity, because the defendant’s dishonesty prevented him from conclusively proving that the opportunity was lost. This latter point, was further discussed by the Court of Appeal for Ontario in Bhatnagar v. Cresco Labs Inc., 2023 ONCA 401 (which we discuss here), where the Court observed that it may make such a presumption, and that the claimant must show some evidence that it lost an opportunity. Accordingly, Bhatnagar raises the question of whether at civil law, a court has the discretion to make such a presumption, or whether it is mandatory.

It is notable that regardless of whether this case arose at civil law or common law, it is possible that the result would have been similar. As the Court observed, the Respondents specifically asked if IA had an interest in Group Excellence and were lied to.  This accordingly would have likely qualified at common law as a breach of the duty of honest performance. Similarly, it is entirely possible that the measure of damages would have been similar, given the Appellants’ failure to rebut the presumption of damages.

Ultimately, Ponce emphasizes the point illustrated by the Supreme Court in recent years that although the civil law and common law traditions have fundamentally different bases, they can nevertheless serve as useful points of comparison in the understanding various areas of law.

We await with interest to see whether Ponce may be applied to common law good faith in future.

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