Supreme Court of Canada Takes Another Step towards the Guiding Principle of Good Faith in Contract Performance

The Supreme Court of Canada recently rendered an important decision concerning the duty of honest performance of common law contracts. On appeal from the Ontario Court of Appeal, CM Callow Inc. v. Zollinger marks, for the highest Court in the country, a further step towards solidifying the guiding principle of good faith as the cardinal standard of contract performance in common law.

This decision follows Bhasin v. Hrynew, a landmark decision in which the Supreme Court of Canada (“SCC”) sought to bring consistency and fairness to the common law by recognizing the good faith guiding principle. Thus, since 2014, this principle has been of general application in common law contracts and manifests itself through multiple, more specific rules, each applicable to different situations and types of relationships. One of these manifestations, also developed in the context of the Bhasin decision, is the duty of honest performance of contracts. Under this, the parties must not lie to each other or otherwise intentionally mislead each other on matters directly related to the performance of the contract.

In CM Callow Inc. v. Zollinger ("CM Callow Inc. decision"), the SCC was called upon to rule on the scope of this obligation, particularly with respect to the thorny question of the need for parties to a contract to take into account the interests of their co-contractor. In Quebec civil law, the CM Callow Inc. decision is of particular interest because of the parallel - not to say the connection - that the SCC draws between the duty of honest performance of contracts and our notion of abuse of rights.

The Facts at Issue and Previous Decisions

In 2012, Baycrest, a group of condominium corporations comprising the Respondents, entered into a two-year winter agreement (the “Agreement”) with the Appellant CM Callow Inc. ("Callow") as well as a separate summer maintenance agreement for the Respondents' various properties. Under a provision of the Agreement, Baycrest had the right to terminate the Agreement without notice if Callow's service was unsatisfactory. Baycrest also had the right, under the same clause, to terminate the Agreement for any other reason by giving Baycrest a 10‑day written notice. Discussions between the parties took place between spring and summer of 2013 to renew the Agreement and, in the summer of 2013, Callow performed maintenance work beyond its summer maintenance contract at no costs for Baycrest in order to encourage Baycrest to renew the Agreement. In this context, Callow states that it believed that Baycrest was likely to consent to the renewal of the Agreement. To Callow's surprise, in September 2013, Baycrest announced to Callow its decision to terminate the Agreement for next winter. The evidence at trial showed that Baycrest had made a decision to terminate the Agreement as early as March or April 2013 but chose not to inform Callow immediately. Callow alleges that Baycrest breached the Agreement because Baycrest acted contrary to the requirements of good faith, including the obligation to perform the Agreement honestly, by accepting free services while knowing that Callow was offering them to maintain their future contractual relationship.

The trial judge found that Baycrest actively misled Callow from the moment it made its decision in March or April 2013 and deliberately withheld its decision to have Callow perform the summer maintenance contract while knowing that it was taking on additional work in the sole hope of obtaining renewal of the Agreement. The judge found Baycrest to be of bad faith and ordered it to pay damages. The Ontario Court of Appeal, while acknowledging that Baycrest had acted knowingly, set aside the trial judgment on the basis that the duty of honest performance could not have such a scope.

Does the Duty of Honest Performance Extend to Omission or Silence?

The majority of the SCC judges held that Baycrest, even though it had met the 10-day time limit set out in the Agreement, had dishonestly relied on the termination clause because it intentionally misled Callow into believing that the Agreement would not be terminated. Baycrest breached its duty of honesty on a matter directly related to the performance of the Agreement, and the trial judge correctly found a breach of the Agreement.

The duty of honest contract performance requires that the parties to any contract do not lie to each other or otherwise mislead each other about matters relating to the performance of the contract. Even in the absence of a positive duty of disclosure, in a situation where a party intentionally lies or misleads its co-contractor, that party has an obligation to correct the false impression created by its own actions. Both the duty of honest performance and the duty to exercise discretion in good faith require a party to take into account the legitimate contractual interests of its counterparty, but do not require it to subordinate its own interests to those of its counterparty in a fiduciary manner.

That said, the duty of honest performance is a doctrine of contract law distinct from other areas of law relating to the legal consequences of deception. Consequently, its sanction requires a link with the contractual relationship. A breach must be directly related to the performance of the contract. The duty of honest performance applies to the performance of all contracts and, therefore, to all rights and obligations under such contracts. Without in itself restricting the right of a party to terminate a contract, no right may be exercised dishonestly and contrary to the requirements of good faith. Although similarities exist with civil fraud and estoppel, a breach of the duty of honest performance is not a tort and does not require proof that the party being blamed intended that his or her co-contractor rely on his or her misrepresentation. As such, the doctrine of abuse of rights under Quebec civil law is more useful in illustrating the required connection. A direct connection exists when a party disregards his or her obligation or exercises his or her right under the contract dishonestly, which is tantamount to contravening the requirements of good faith.

The honesty requirement goes beyond the prohibition against lying and may include half-truths, omissions and even silence. This is still a highly factual issue.

In this case, even if Baycrest had an absolute right to terminate the Agreement on a 10‑day notice, that right had to be exercised honestly. Baycrest knowingly misled Callow, and that misleading was directly related to the performance of the Agreement because it was Baycrest's use of the termination clause that was dishonest. Baycrest did not have an independent and positive obligation to disclose its intention to terminate, but it was required to avoid misleading Callow in its use of the termination clause. Baycrest could not misrepresent to Callow that it was satisfied with its work.

In this context, it was reasonable for Callow to infer that the Agreement was not in jeopardy and, since it failed to correct Callow's misconception caused by its misrepresentations, Baycrest breached its duty to act in good faith. The loss of opportunity that resulted from this breach entitles Baycrest to damages.

The Issue of Damages

The duty of honest performance gives rise to damages when a right has been exercised dishonestly, all in accordance with the usual rules applicable in contractual matters. Damages are thus intended to compensate for the loss of expected profit, and thus place the injured party in the position it would have been in if its co-contracting party had fulfilled its obligation. There is no reason why damages should be compensated by way of trust damages, which are conceptually distinct from expectation-based damages. In doing so, the SCC allowed the appeal and restored the trial judgment.

Concurring Reasons: Common Law Principles Apply

In concurring reasons, Brown J., with the agreement of Moldaver and Rowe JJ., was of the view that the majority's approach was flawed in that it relied on the concept of abuse of rights under Quebec civil law and, in so doing, distorted the analysis described in Bhasin, which was applicable in this case. In his view, this approach undermines the distinction between honest performance and good faith in the exercise of contractual discretion. In the presence of well-established, overriding common law principles, there is no justification for relying on external legal concepts. Since the claim is not based on the loss of value of the performance of the contract, but rather on the reliance that a party has placed in the dishonest representations of its co-contractor, the interest that is protected is one that is linked to the reliance. At this level, the principles of estoppel and civil fault apply and, regardless of the intent of the offending party, the contracting party need only to establish that he or she would not have suffered any loss had it not been for the reliance that he or she placed on the misleading statements.

Dissenting Reasons: Stability of Contracts Must Prevail

Côté J. dissented, holding that Callow's action should be dismissed because Baycrest's conduct did not amount to a breach of the duty of honest contract performance. In the judge’s view, the duty of fair contract performance can only be negative so as not to jeopardize the stability of business operations. Thus, silence can only be considered dishonest when there is a positive obligation to speak. However, in the absence of a duty to disclose, such a positive obligation to correct a contracting party's erroneous beliefs can only exist if there has been a significant contribution to that belief.

A Common Law Evolution Marked by Quebec Civil Law

The CM Callow Inc. decision thus represents an interesting evolution of the common law marked by an association with Quebec civil law. That said, as the Court points out, the notion of abuse of rights is mentioned only for illustrative purposes and, given the fundamentally distinct foundations on which the two Canadian legal systems are based, it is possible to raise serious doubts as to the possible application of the principles set out in this decision in Quebec civil law. It will nevertheless remain interesting to see what scope the Quebec and Canadian courts will give to this decision.

It should be noted that the SCC shows that it is well aware of the uncertainty that could be created by a disproportionate expansion of the obligation of honest performance of contracts. Contrary to Côté J., who expressed a marked concern for the stability of commercial transactions, this is a limit that the majority of judges believe this decision does not cross.

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