Legal: Duty of Honesty
February 1, 2015 by Krista Johanson
In the recent case of Bhasin v. Hrynew, the Supreme Court of Canada found that the concept of good faith is an “organizing principle” underlying Canadian contract law, and that according to this organizing principle, a duty of honesty exists between parties to all commercial contracts.
While an implied term of good faith performance of contracts is a concept well-established in American law, this is the first time Canada’s top Court has imposed a duty arising out of good faith on parties to a commercial contract.
The case involved Can-Am, a company that marketed education savings plans through retail dealers who were small business owners responsible for building their own sales forces. The plaintiff, Mr. Bhasin, an enrollment director, had a commercial dealership agreement with Can-Am, which owned client lists and implemented branding and other central policies. The agreement allowed Mr. Bhasin to sell or merge his operation only with Can-Am’s consent, and the agreement renewed automatically unless either party gave six months’ notice of termination.
Can-Am appointed a “provincial trading officer” to review its enrollment directors for compliance with securities laws. The appointee was Mr. Hyrnew, a competitor of Mr. Bhasin.
Mr. Bhasin objected to a competitor auditing his confidential records. Can-Am promised—falsely—that Mr. Hyrnew was required to keep such information confidential. In the meantime, unbeknownst to Mr. Bhasin, Mr. Hyrnew pressured Can-Am to merge the two businesses, and Can-Am took steps to arrange the merger. Mr. Bhasin asked whether any merger was
planned, but Can-Am advised that it had made no decision to merge. Can-Am subequently terminated its agreement with Mr. Bhasin, in compliance with the notice requirement. As a result, Mr. Bhasin’s business lost its value, his sales agents were recruited by Mr. Hyrnew’s agency, and he was forced to find lower-paid work. He sued Can-Am and Hyrnew.
The trial judge found an implied contract term that Can-Am would decide to renew or terminate the contract in good faith, which it breached by misleading Mr. Bhasin about the merger and the lack of confidentiality associated with Mr. Hyrnew’s audits. Had he not been misled, he could have protected his business’s value.
The Alberta Court of Appeal overturned this decision, finding that there is no general implied term of good faith in commercial agreements and an “entire agreement” clause prevented the implication of such a term in this particular case.
The Supreme Court held that two incremental steps would make contract law more coherent and just: First, “to acknowledge that good faith contractual performance is a general organizing principle of the common law of contract,” and second, to recognize under this principle a “ common law duty which applies to all contracts to act honestly in the performance of contractual obligations.”
The organizing principle is a standard underpinning more specific legal doctrines. It means that “parties generally must perform their contractual duties honestly and reasonably and not capriciously or arbitrarily.”
This does not require loyalty or putting the other party’s interests ahead of one’s
own. In some circumstances, a contracting party may intentionally cause loss to another party in the legitimate pursuit of economic self-interest, without breaching the good faith principle. However, one must give “appropriate regard to the legitimate contractual interests of the contracting partner” and “not seek to undermine those interests in bad faith.”
The duty of honesty in contractual performance requires parties not to lie or otherwise knowingly mislead about matters directly linked to the performance of the contract.
The Court distinguished between failure to disclose a material fact and “active dishonesty.” For example, if a party to a contract is required to give notice of termination and makes a firm decision to terminate several months before the notice period begins, there is no duty to disclose that decision before the notice period.
The Court found that Can-Am breached the duty of honesty by failing to act honestly in exercising the termination clause. Mr. Bhasin was awarded $87,000, the value of the business that he could have preserved absent Can-Am’s dishonesty.
The Court found that parties are not free to draft contracts that exclude the duty of honesty, because the duty is not an implied contract term but a legal doctrine. As a result, “no representation” or “entire agreement” clauses will not exclude liability for dishonesty.
In this case, the defendant told two direct lies, and the Court cautioned that mere non-disclosure, without more, is not breach of the duty of honesty. However, the scope of the duty is not yet clearly defined and will likely depend heavily on the facts of each case.
Krista Johanson is an associate with Borden Ladner Gervais LLP. Send comments comments to email@example.com