Discretionary powers and the duty of good faith

A fundamental principle of contract law in Canada is that the parties to a contract are usually free to negotiate and agree upon any terms which will advance their respective (and sometimes mutual) interests. That being said, there are certain situations where the law will intervene to restrict such freedom. Some examples of this intervention include employment standards and consumer protection legislation, both of which generally operate in the face of any contractual provisions to the contrary.

A common contractual clause which we often review or draft for our clients is what is referred to as a discretionary clause, i.e. a clause written in favour of one party which usually relies on words such as “may in its sole discretion”, and other variations. Notwithstanding the ubiquity of such clauses, in the wake of the 2014 Supreme Court of Canada decision Bhasin v. Hrynew, 2014 SCC 71 [Bhasin], questions arose as to whether such discretionary clauses may be restricted, due to a newly recognized principle of good faith that Bhasin introduced to contract law in Canada.

In Bhasin, the Supreme Court recognized a general organizing principle of good faith in the performance of contracts throughout Canada. The Supreme Court summarized this duty of good faith as one where parties generally must perform their contractual duties honestly and reasonably and not capriciously or arbitrarily.[i] It is a duty that underpins more specific legal doctrines – not a free-standing rule, and it is a duty that will be given different weight in different situations.[ii]

The concern with discretionary clauses in light of Bhasin relates to the uncertainty associated with whether or not a discretionary power may be exercised by one party in its sole discretion to the detriment of the other party, or whether the party exercising its discretionary power must always do so in good faith, thereby fettering that party’s discretion. Prior to Bhasin, we would generally expect that a party with a discretionary power could exercise such power indiscriminately, regardless of the consequences for the other party(ies) to the contract. However, there is concern that the duty of good faith, as stated in Bhasin, may prevent a party from exercising its discretionary powers under a contract where such exercise might run contrary to the contracting parties’ expectations when they first entered into the contract.

Unfortunately, Bhasin did not directly address what would happen if a party to a contract was given a discretionary power and exercised that power in that party’s sole discretion. Bhasin stated that a contracting party should have “appropriate regard” for the “legitimate contractual expectations” of the other party as to how the contract will be performed. The Supreme Court clarified that:

(a)          “appropriate regard” will vary depending on the context of the contractual relationship;[iii]

(b)          good faith performance does not require the contracting party to put the interests of the other party first;[iv] and

(c)          the principle of good faith must be applied consistently with the fundamental commitments of contract law, where there is importance that the contracting parties have freedom to pursue their individual self-interest even if a party may sometimes cause loss to another — even intentionally — in the legitimate pursuit of economic self-interest.[v]

While Bhasin did not provide any guidance on the interplay between the duty of good faith and the use of discretionary powers, a decision from the Alberta Court of Appeal, Styles v. Alberta Investment Management Corporation, 2017 ABCA 1 [Styles], has now clarified the use of discretionary powers in light of and in direct reference to Bhasin.

Styles overturned a 2015 judgment of the Alberta Court of Queen’s Bench[vi] which had found, in an extension of the Bhasin decision, that there is “a common law duty of reasonable exercise of discretionary contractual powers” and that a contracting party’s discretion had to be exercised “fairly and reasonably”.[vii]

In overturning the lower court’s decision, the Court of Appeal was clear that Bhasin did not establish any general principle of “reasonable exercise of discretion” in contractual performance. Instead, the Court of Appeal found that the principle proposed from the 2015 judgment was a “radical extension of the law” which was unsupported by authority, contrary to the principles of the law of contract, and inconsistent with Bhasin.[viii]

The Court of Appeal also emphasized that the Bhasin principle of good faith relates to contractual performance and not to the negotiation or the terms of contract. Furthermore, the principle in Bhasin cannot be relied upon as an invitation to the court to examine freely negotiated contractual terms.[ix] The duty of good faith regarding the performance of contractual obligations is not a licence to invent obligations divorced from the actual terms of the contract between the parties.[x]

Building on the decision from Styles, and assuming the other jurisdictions in Canada follow the decision of the Court of Appeal in Styles, there would appear to be no binding duty for a party to a contract to exercise its discretionary contractual powers fairly or reasonably. Parties to a contract should be free to propose discretionary clauses negotiated, written and agreed to in their favour. Provided the contract is negotiated freely and does not violate public policy, it would not be dishonest, in bad faith, or arbitrary to perform the contract, including exercising discretionary powers, in accordance with its terms.[xi]

Notwithstanding the helpful analysis provided by the Court of Appeal in Styles, it remains to be seen how Bhasin will be interpreted in other jurisdictions throughout Canada. While we are hopeful that the decision in Styles will be adopted here in British Columbia, uncertainty as to the scope of discretionary powers in this province currently exists.

 

[i] Bhasin, para. 63.

[ii] Bhasin, para. 64.

[iii] Bhasin, para. 65.

[iv] Bhasin, para. 65.

[v] Bhasin, para. 70.

[vi] Styles v. Alberta Investment Management Corp., 2015 ABQB 621.

[vii] Styles v. Alberta Investment Management Corporation, 2017 ABCA 1, para. 9.

[viii] Styles – ABCA, para. 49 and 54.

[ix] Styles – ABCA, para. 51

[x] Addison Chevrolet Buick GMC Limited v General Motors of Canada Limited, 2015 ONSC 3404, para. 19.

[xi] Styles – ABCA, para. 52.