SCC Expands the Application of the Principle of Good Faith: What You Should Know When Exercising Discretionary Power at Contract

What You Need to Know

• In Wastech Services Ltd. v. Greater Vancouver Sewerage and Drainage,¹ the Supreme Court considers the contours of the duty to exercise contractual discretion in good faith.
• The Supreme Court held that parties must exercise discretion reasonably, “in a manner consistent with the purposes for which it was granted in the contract.”² Importantly, parties cannot exempt themselves from this requirement.
• Courts will not scrutinize business motivations when assessing whether an exercise of discretion was made in good faith. Provided that such discretion is consistent with the contract’s purpose, a good faith exercise of discretion could deprive a counterparty of substantially all the benefit of the contract.

Background

The respondent, the Greater Vancouver Sewerage and Drainage District (“Metro”), had a long-standing commercial relationship with the appellant, Wastech Services Ltd. (“Wastech”), for the removal and transportation of waste. Under the contract, Metro allocated waste transportation among three sites for which Wastech was paid varying rates. The contract was structured around a certain target operating ratio pursuant to which Wastech would generally achieve a target profit of eleven percent. However, the contract did not guarantee that Wastech would achieve the target in any given year. In addition, Metro retained absolute discretion over each year’s waste allocation among the three sites.   

In 2010, Metro reallocated waste transportation among the three sites thereby affecting Wastech’s profits under the contract, which fell below the eleven percent target. Pursuant to the contract, Wastech referred the dispute to arbitration seeking damages of more than $2.8 million; its lost profits in 2011.

Prior Decisions

Wastech initially succeeded at arbitration. The arbitrator, basing his ruling on the Supreme Court’s decision in Bhasin v. Hrynew³, found that Metro’s discretionary power to reallocate waste breached its duty of good faith by not showing appropriate regard for Wastech’s legitimate expectations as to how the contract would be performed.

Metro obtained leave to appeal the arbitrator’s decision at the Supreme Court of British Columbia and thereafter the British Columbia Court of Appeal set aside the arbitrator’s award. Among other reasons, the courts held it inappropriate to apply a duty of good faith because during contractual negotiations, the parties considered and rejected a term constraining Metro’s discretion. The matter was thereafter appealed to the Supreme Court of Canada.

The Duty to Exercise Discretion in Good Faith

The Supreme Court began its analysis by affirming that all contractual rights and obligations—even a party’s unfettered discretion—are subject to the requirements of good faith. The good faith organizing principle requires parties to “perform their contractual duties honestly and reasonably and not capriciously or arbitrarily.”⁴

The Supreme Court previously recognized that a duty of honest performance flows from this good faith organizing principle.⁵ In Wastech, the Supreme Court formally recognized certain new contours of the good faith organizing: the duty to exercise discretion in good faith. Put simply, contractual parties must exercise their discretionary powers reasonably.

Which begs the question: what is an unreasonable exercise of an otherwise unfettered discretionary power?

The Supreme Court held that good faith “requires the parties to exercise their discretion in a manner consistent with the purposes for which it was granted in the contract.”⁶ Determining the purpose of a discretionary power, and therefore a range of permissible (i.e. good faith) discretion available to a party, is a highly fact-specific exercise of contractual interpretation. Accordingly, courts should interpret the discretion in the context of the contract as a whole.

The Supreme Court also stated that a reasonable exercise of discretion could deprive the non-exercising party of all or substantially all of its benefit under the contract.⁷ However, such a degree of deprivation may well be relevant to an analysis that the discretionary power was exercised in a manner unconnected to the purposes for which the discretion was granted in the contract. Put simply, substantial nullification of the contract’s fundamental benefit is neither necessary nor sufficient to demonstrate that a discretionary power was exercised in bad faith.

Application to the Facts in Wastech

The Supreme Court held that Metro’s reallocation of waste transportation was a reasonable exercise of discretion because it was connected to the purposes for which it was granted in the contract. Looking at the clause in the context of the contract (including the recitals to the contract), the Supreme Court found that the purpose of Metro’s discretionary power was “to allow it the flexibility necessary to maximize efficiency and minimize costs” of municipal waste disposal in the region given the variability both parties foresaw.⁸

Metro’s decision to reallocate waste in 2011 was made in connection with its own business interests to maximize each site’s efficiency while preserving capacity and minimizing costs. In light of the contracts purpose, Metro’s reallocation “point[ed] to an exercise of discretion that cannot be said to be unconnected to the contractual purposes for which it was granted.”⁹ Looking specifically at the contract’s profit adjustment clauses, the Supreme Court reasoned that the parties knew profit could vary based on how waste was allocated. Despite this risk, the parties left Metro’s unfettered discretionary allocation power in place.

Conclusion

Exercising discretion in good faith does not require one party to subordinate its interest to another party. Commercial parties can take comfort that they should be able to avoid liability by exercising discretion in accordance with the underlying purpose of contract. In this regard, it may be helpful to ensure that the recitals illustrate the intended purpose in some degree of detail. Based on Wastech, courts should not scrutinize a party’s business motivations when determining whether their contractual discretion was exercised in good faith. Good faith does not require your counterparts to place your interests ahead, or even on par, with their own.

When negotiating discretionary powers in a contract, parties should continue to protect themselves against foreseeable risks. Parties seeking to narrow the range of good faith discretion should include objective measurements in respect of such discretionary powers. Wastech, for example, could have pressed Metro to include adjustments where waste allocation caused profit to drop below certain levels.

It is clear from this and other recent decisions that the Supreme Court will continue to define the contours of the principle of good faith in contracts law. Parties should ensure that the purpose of a contract is clear and consistently applied throughout the contract. Those with questions should reach out to their counsel in drafting new contracts and interpreting old ones in light of the new legal principles.