Contractual good faith: What every businessperson needs to know

Since the Supreme Court of Canada's landmark decision in Bhasin v. Hrynew, 2014 sec 71, all contracts in Canada are governed by the principle of good faith. 

Good faith applies to a myriad of commercial agreements, including shareholders' agreements, joint venture contracts, standard-form construction agreements and agreements to purchase real property, for example. Perhaps less known are the real-world implications of the Bhasin decision and its progeny. 

How do sophisticated business parties conduct themselves in the performance of the contract if they are bound by a duty of good faith to one another? Should they subordinate their own commercial interests and priorities to avoid breaching the agreement? Does the duty of good faith actually require them to do so? 

A number of pragmatic considerations emerge from the trilogy of Supreme Court of Canada decisions that govern good faith in contractual dealings, namely: Bhasin, supra; C.M. Callow Inc. v. Zollinger, 2020 sec 45; and Wastech Services Ltd. v. Greater Vancouver Sewerage and Drainage District, 2021 sec 7. 

Businesspersons unaware of the principles of good faith and how they shape contractual conduct face potential lawsuits and accusations of breach of contract. There is significant value, then, for all commercial parties to have a basic knowledge of how good faith operates in the business context. 

Here are the top five things all contractual parties in Canada should know:

1. Breach of the duty of good faith gives rise to a breach of contract claim.

As a component of every contract in Canada, a breach of the principle of good faith gives rise to a claim for breach of contract: Bhasin, supra at para. 106. That is to say, if a party acts in bad faith in the performance of the contract, there is no separate or discrete cause of action for which the party can be sued. There is no "standalone" claim for breach of good faith. Rather, a breach of contract claim subsumes a claim for breach of good faith. 

2. There are (thus far) two identified branches of good faith in contract.

Broadly speaking, there are two categories of good faith which govern all Canadian contracts: 

• The duty of honest contractual performance: This includes the "simple requirement not to lie or mislead the other party about one's contractual performance": Bhasin, supra at para. 73. Whether or not a party has "knowingly misled" its counterparty is a question of fact. Such deceit can "include lies, half-truths, omissions, and even silence, depending on the circumstances": Bhasin, supra at para. 91; and
• The duty to exercise contractual discretion reasonably: Any discretion under the agreement has to be exercised "reasonably." This means that the discretion has to be exercised "in a manner ... connected with the underlying purposes granted by the contract." A wrongful exercise of a discretionary power results in a breach of contract, requiring a party to pay damages to repair the wrong: Wastech, supra at para. 111.

Despite the recognition of the two aspects of the duty of good faith above, the Supreme Court of Canada has made it clear that this list is "not closed." Courts may come to recognize other elements of good faith as they apply the doctrine to the parties' contractual dealings: Bhasin, supra at para. 66. 

3. The duty of good faith does not require a subordination of commercial interests.

While it is a robust doctrine, good faith operates in the real business world. So, while contracting parties have a duty not to actively deceive one another or exercise contractual discretion unreasonably, good faith does not require the parties to "subordinate" their interests, including commercial interests, to the other party. 

Nor does good faith require that a benefit be conferred to the counterparty, which the parties did not contemplate under the agreement: Wastech, supra at para. 6. 

In other words, courts impose a basic level of decorum on how the contracting parties conduct themselves - but that does not mean that parties cannot act in their own economic self-interest. To the contrary, the principle of freedom of contract requires that parties have the ability to put their interests ahead of the counterparty's. Canadian courts did not create good faith as a means to restrict free enterprise. 

4. Commercial reasonableness informs the scope of good faith.

Business considerations inform the scope and nature of the good faith. In the commercial context, Canadian courts calibrate breaches of the duty of good faith by considering industry practice and custom: see, for example, Stericyc/e ULC v. HealthPRO Procurement Services Inc., 2021 ONCA 878, at paras. 52 and 53. 

This approach ensures that contracting parties who act in accordance with business norms do not attract liability for ordinary commercial behaviour. Commercial reasonableness forms part of the court's calculus in determining if a party has violated the duties of honest contractual performance or reasonable contractual discretion. 

5. Breach of good faith results in ordinary contractual damages.

Because breach of good faith claims are subsumed under the conceptual umbrella of breach of contract, the measure of damages for breach of good faith is the same as it would be for any other breach of contract. The aggrieved party will be awarded what courts call "expectation damages," i.e., damages that place the plaintiff in the same position it would have been in had the duty been performed: see Callow, supra at para. 107, citing Atlantic Lottery Corp. Inc. v. Babstock, 2020 sec 19, at para. 108. 

Expectation damages are contrasted to "reliance damages," i.e., damages that put the injured party in the position it would have been in had it not entered into the contract at all: Callow, supra at paras. 108-09. While reliance damages may be awarded in tort, i.e., claims of misrepresentation, negligence or fraud, the ordinary measure of damages in contract is "expectation damages" instead. 

Why an understanding of good faith matters in business 

The principle of good faith has guided all contractual relationships in Canada since 2014. At a bare minimum, it imposes a duty not to lie in the performance of the contract itself and an obligation to exercise any contractual discretion reasonably. 

In the commercial context, reasonableness and good faith are measured in accordance with industry practice and custom. An understanding of the rudiments of good faith is essential to how corporate and commercial parties operate during the course of the contract. Without such knowledge, parties face significant liability for breach of contract, even where the subjective perception of their behaviour appears acceptable. 

This article was originally published by Law360 Canada, part of LexisNexis Canada Inc.