Parting ways in good faith: SCC clarifies contract termination disclosure requirements

Contracting parties may have to disclose an intention to terminate the contract, despite the existence of a clear contractual provision allowing for unilateral termination. Under the duty of honesty in contract performance, this obligation arises where non-disclosure would constitute knowingly misleading the counterparty. This result will surprise many who would not expect to be in breach despite strict compliance with a clear and valid termination clause in a written agreement, particularly when providing earlier notice could damage their own interests.

This was the holding of the recent decision by the Supreme Court of Canada ("SCC") in C.M. Callow Inc. v Zollinger^[1]. In this decision, the Court took the "opportunity to clarify what constitutes a breach of the duty of honest performance"^[2]. This is the first time Canada's highest court has engaged in depth with this relatively new contract law doctrine since its formulation in the landmark decision, Bhasin v Hrynew^[3]. In that case, the Court held that the defendant/respondent had breached its duty of honest performance by misleading the plaintiff/appellant about its intention to exercise a non-renewal clause in their agreement.

The SCC strove in Bhasin to clarify the law of good faith contractual performance, which it identified as unsettled and incoherent. With the goal of enhancing commercial certainty, the Court made two broad findings. First, it acknowledged good faith performance as a general organizing principle of the common law of contract, and second, it recognized a new common law duty to act honestly in the performance of contractual obligations as a specific manifestation of that principle.

Yet far from clarifying the law, many commentators have observed that Bhasin further obfuscated the obligations of contracting parties to act in good faith. The Court recognized that "the precise content of honest performance will vary with context and the parties should be free in some contexts to relax the requirements of the doctrine so long as they respect its minimum core requirements"^[4]. The SCC did not, however, shed much light on which contexts may vary the doctrine, nor did it clearly identify the "minimum core requirements". Unsurprisingly, the legal field has struggled to interpret and apply Bhasin, and court decisions endeavoring to do so have come to inconsistent results.

Callow may serve as a clarifying application of the principles set down in Bhasin, but the decision still leaves open many of the questions raised since. It remains to be seen to what extent this decision offers much needed certainty to contracting parties.

Facts

A group of condominium corporations, their management group and their property manager ("Baycrest") engaged contractor C.M. Callow Inc. ("Callow") in a commercial winter maintenance agreement with a two-year term, from November 1, 2012 through April 30, 2014 (the "winter contract"). The agreement included a provision that Baycrest could unilaterally terminate the contract without cause after giving 10 days' notice. The parties had a separate agreement for summer maintenance, which ran from May 1, 2012 through October 31, 2013 (the "summer contract").

In April 2013, Baycrest decided to terminate the agreement before the following winter due to multiple complaints received regarding snow removal. Meanwhile Callow continued work under the summer contract. To avoid souring the relationship with Callow during the remainder of the summer contract, and having considered the termination notice requirement under the written agreement, Baycrest decided to delay informing Callow of the termination decision until after the completion of summer work.

Throughout the spring and summer, Callow had discussions with some directors at Baycrest to renew the winter contract for an additional two-year term. In the context of these discussions, Baycrest did not disclose its intention to terminate the existing winter contract. The courts found that Baycrest management was aware that Callow expected the winter contract would continue through April 2014, and that he expected its renewal for another two years. The courts also found that Baycrest knew that during that summer, Callow performed extra services at no charge to entice them to continue with their contractual relationship. The Condominium informed Callow of the termination of the winter contract in September 2013, shortly before the expiry of the summer contract, and well within the 10-day termination provision under the winter contract.

Lower Court decisions

In an action for breach of contract before the Ontario Superior Court of Justice ("Superior Court"), Callow alleged that Baycrest had breached the common law duty of honest performance. Baycrest argued that the contract permitted them to terminate the contract on 10 days' notice, and that was all Callow had bargained for and was entitled to. They also took the position that it was reasonable to delay informing Callow of the termination until the fall to avoid jeopardizing performance of the summer contract, and to require otherwise would be requiring actions damaging to their interests.

The trial judge found that Baycrest had breached their duty of honest performance, acting with bad faith in not informing Callow of their intention to terminate the winter contract in order to ensure performance of the summer contract, and in representing to Callow that they would renew the contract.

The Ontario Court of Appeal ("Court of Appeal") reversed the Superior Court decision, holding that the trial judge had expanded the duty of honest performance formulated in Bhasin. The Court of Appeal found that Baycrest' conduct was not honourable, but it did not "rise to the high level required to establish a breach of the duty of honest performance"^[5]. It further noted that Bhasin explicitly excluded a unilateral duty to disclose information from the duty of honest performance, when there is no active duty to disclose.

Supreme Court of Canada decision

The SCC allowed the appeal, finding that Baycrest had breached the duty of honest performance, and found that Baycrest had knowingly misled Callow into believing they would not terminate the winter contract. Callow, the majority finds, represents a simple application of the law in Bhasin. It clarifies that the duty of honest performance applies to both the performance of obligations and the exercise of rights under a contract. The majority's reasons also raise and address two questions left by Bhasin: what limits the scope of the duty of honest performance, and what may constitute misleading conduct.

In its answer to the first, the SCC finds that the scope of the duty is controlled by its link to the performance of the terms of a contract. The reasons emphasize that the duty of honest performance does not imply a new contractual term into the agreement, nor is it used to interpret the language of a contractual provision, impugn the appropriateness of the bargain, or invalidate the provision itself. Instead, the common law doctrine merely requires valid provisions must be exercised or performed honestly.

Despite the clause giving Baycrest the "unfettered right" to terminate the contract on 10 days' notice, that right must be exercised in keeping with the duty to act honestly. Baycrest could not "lie or otherwise knowingly mislead" Callow about its exercise of the termination clause.^[6]

To address the second question, the decision takes steps to illuminate what constitutes dishonest performance, but finds that this will be a "highly fact-specific determination"^[7]. It can include "lies, half-truths, omissions and even silence, depending on the circumstances"^[8]. While affirming the law from Bhasin that the duty of honest performance does not equate to a duty to disclose material information where such disclosure is not otherwise required by contract, the SCC holds that an omission to inform can rise to knowingly misleading in some circumstances. As in this case, parties may be found to mislead where they fail to correct a misapprehension caused by their own conduct.

Uncertainty remains

While it is clear that parties cannot knowingly mislead their counterparties about exercising non-renewal or termination clauses, it has yet to be seen what could constitute dishonesty in the performance of other contractual obligations. Callow also explicitly leaves open the possibility that circumstances may arise under which parties must not exercise contractual rights capriciously or arbitrarily, or where a duty to cooperate may be imposed.

Furthermore, what constitutes "knowingly misleading" is a notably fact-specific finding, so it will not always be clear when omissions or silence will rise to this bar. The SCC in Callow suggests the law of misrepresentation and abuse of rights from Quebec civil law can inform and guide courts in this analysis, but uncertainty will remain while litigants test the boundaries in coming years.

Finally, the SCC heard Callow together with Wastech Services Ltd. v Greater Vancouver Sewerage and Drainage District^[9] ("Wastech Services"). That case deals with another doctrine of good faith in contractual performance, specifically the duty to exercise discretionary powers in good faith. The SCC noted in Callow that while this doctrine is distinct from the duty of honest performance, the two rules of law are not disconnected, because they are different manifestations of the same organizing principle of good faith. As such, legal principles from one may serve as a useful analytical tool for applying the other. The SCC has yet to release their decision in Wastech Services, and these forthcoming reasons may offer further insight to the duty of honest performance.

Take-away

Callow advances the law on the duty of honest performance by clarifying the scope of the duty and what is meant by honest performance in circumstances where a contract grants a party some unfettered or unilateral right. However, this is still a relatively young area of the law, and many issues surrounding the application of the doctrine remain unsettled. While parties cannot contract out of the duty of honesty in contractual performance, this issue may be a consideration when drafting a new contract. Specifically, an expressly strong termination provision may clarify the parties' rights and obligations. One of the main challenges for parties wanting to avoid breaching the duty will be the difficulty in determining what exactly a court might consider misleading conduct. Because these new issues are both highly technical and fact-specific, we encourage you to contact one of our professionals to discuss your particular circumstances.