Supreme Court of Canada Clarifies Duty to Exercise Contractual Discretion in Good Faith

In 2020, the Supreme Court of Canada (SCC) heard arguments in Wastech Services Ltd. v. Greater Toronto Sewage and Drainage District, 2021 SCC 7 (Wastech) and C.M. Callow Inc. v. Zollinger, 2020 SCC 45 (Callow), both of which addressed the duty of good faith in contractual performance recognized in Bhasin v. Hrynew, 2014 SCC 71.  The SCC’s decision in Callow, which expanded a contracting party’s duty of honesty, was released in December 2020; however, the SCC’s decision in Wastech, which clarifies the duty to exercise contractual discretion in good faith, was not released until early this month.  Although Wastech involved a commercial contract, it has implications for all contracts in which a party has discretionary power, including any such contracts entered into by employers.

Background

In 1996, Wastech Services Inc., a waste transportation company, entered into a long-term contract for waste disposal with the Greater Vancouver Sewerage and Drainage District (Metro), a corporation that disposed of municipal waste.  The contract provided that waste could be disposed of in three landfills, one of which was much farther away than the others.  Wastech’s profits under the contract were highest when it disposed of waste in the landfill farthest away; the contract provided that Metro had “absolute discretion” in allocating how much waste would go to that landfill.   

In 2011, Metro exercised its discretion when it redirected waste that had been going to the landfill farthest away, to a landfill that was closer.  As a result, Wastech’s profits for 2011 were lower than its target.  Wastech referred the matter to arbitration, arguing that Metro exercised its contractual discretion to decide which landfill the waste would be allocated to contrary to the common law duty of good faith.  Wastech claimed compensation for its lost opportunity.    

Decisions of the Arbitrator and the Lower Courts

The arbitrator decided in favour of Wastech.  In his view, Metro’s conduct showed a lack of appropriate regard for Wastech’s legitimate expectations and, therefore, Metro had breached the duty of good faith, which applied to its discretionary power under the contract.  The arbitrator stated that, according to Bhasin, the exercise of a “bargained-for contractual right [is] ‘dishonest’ where it is wholly at odds with the legitimate contractual expectations of the other party” and no additional form of dishonesty, such as “half-truths, lies or deceit,” needs to be shown.  Wastech was entitled to damages.      

Metro appealed the arbitrator’s decision to the British Columbia Supreme Court (BCSC), which set aside the arbitrator’s award.  Wastech’s appeal of the decision of the BCSC to the Court of Appeal for British Columbia (BCCA) was unanimously dismissed.

Supreme Court of Canada’s Decision

Wastech appealed the decision of the BCCA to the SCC.  Justice Kasirer issued his decision dismissing the appeal on behalf of six justices; three other justices concurred.  The SCC held that in exercising its contractual discretionary power, Metro did not breach the duty to exercise discretion in good faith.  Accordingly, the decision of the arbitrator should be set aside.

Justice Kasirer established that:

  • Even an unfettered discretionary power must be exercised in good faith.  When the duty of good faith is violated, the contract is breached;
  • The duty to exercise contractual discretion in good faith is a general doctrine of contract law that operates irrespective of the intentions of the parties.  It is obligatory in all contracts and it cannot be contracted out of; 
  • The duty to exercise contractual discretion in good faith requires the parties to exercise their discretion in a manner that is consistent with the purposes for which the discretion was granted in the contract, i.e., reasonably and not capriciously or arbitrarily;
  • Fairness is measured by what is reasonable according to the purpose set by the parties, and not by what a court sees as fair based on its view of what is the proper exercise of the discretion; 
  • “Demonstrating a breach will necessarily centre on an exercise of contractual interpretation. It is in properly interpreting the contract and the purposes for which discretion was granted that the range of good faith behaviour comes into focus and breaches can be identified.” (para. 76)
  • As only a general guideline, the range of reasonable outcomes will be smaller when the grant of discretionary power is measured objectively. When the grant of discretionary power is measured subjectively, the range of reasonable outcomes will be relatively larger; and
  • It may be relevant that the exercise of discretion substantially nullifies or eviscerates the fundamental contractual benefit; however, it is not a necessary pre-requisite to establishing a breach of the duty of good faith.

Application to Metro’s exercise of discretion

Justice Kasirer held that because Metro’s exercise of discretion was not unreasonable with regard to the purposes for which the discretion was granted, Metro did not violate the duty of good faith.  He noted that the contract gave Metro the “absolute discretion” to determine the minimum amount of waste that would be transported to the landfill farthest away, and that the contract provided no explicit guidance regarding the purposes underlying this grant of discretion to Metro.  He determined, however, that when the clauses (including the recitals) were read in the context of the contract as a whole, it became clearer that the purpose was to allow Metro the flexibility necessary to maximize efficiency and minimize costs of the operation.  This served the overall objective of allowing the parties to adapt to changing circumstances over the life of the contract to ensure this operational efficiency.  Justice Kasirer concluded that Metro’s exercise of discretion was connected to the contractual purposes for which it was granted:

Reading the Contract as a whole, one understands that there was no guarantee that Wastech would achieve the Target OR in any given year. The risk that revenues could vary from one year to the next was in the contemplation of the parties, and this variance could well be based on factors such as the exercise of Metro’s discretion to reallocate waste. This risk was addressed in the Contract, notably through the adjustment clauses. The risk that the exercise of discretion would affect profitability of either party in a given year was thus a considered one and, that risk notwithstanding, the discretionary power was left in place. In these circumstances, the purpose of the clause was plainly to give Metro the leeway, based on its judgment as to what was best for itself, to adjust the proportions of the allocations of waste amongst the three sites as it required to ensure the efficiency of the operation. The ability to make that allocation was not only permitted, but it could be said to reflect the purpose of the clause. [emphasis added] (para. 105)

Finally, Justice Kasirer emphasized: “…the duty to exercise discretionary powers in good faith does not require a party to confer a benefit on the other party that was not a part of their original agreement, nor does it require a party to subordinate its interests to those of the other party.” (para. 113)

Bottom Line for Employers

As the decision of the SCC in Wastech applies to all contracts in which a party has discretionary power (including unfettered discretionary power), it applies to any such contracts entered into by employers.  Wastech puts employers on notice that they and their counterparties have a duty to exercise any contractual discretionary power they have been granted in a contract in good faith.  The duty of good faith is obligatory and cannot be contracted out of. 

Accordingly, if employers are a party to a contract that gives them or a counterparty discretionary power, this power should be exercised in a manner that is consistent with the purposes for which it was granted, i.e., reasonably and not capriciously or arbitrarily.  If the discretionary clause does not itself make its purpose clear, its purpose may be interpreted in the context of the contract as a whole.  It may be relevant if discretion is exercised in a manner that substantially nullifies or eviscerates the fundamental contractual benefit; however, this is not a necessary pre-requisite to establishing a breach of the duty of good faith.

In view of the decision of the SCC in Wastech, employers are encouraged to seek the guidance of experienced employment lawyers before entering into a contract that gives any party the power to exercise discretion.  The contract should be drafted carefully to clarify when the discretionary power may be exercised, its extent, and purpose. Precise drafting will assist in establishing whether the discretionary power has been exercised in accordance with its purpose (i.e., reasonably) and in good faith, if challenged.  Furthermore, employers are encouraged to document the reasons why it decided to exercise its discretionary power as it was exercised.  Meticulous documentation of an employer’s decision-making process will support it in establishing that its discretionary power was exercised in good faith.    

Information contained in this publication is intended for informational purposes only and does not constitute legal advice or opinion, nor is it a substitute for the professional judgment of an attorney.