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New good-faith duty of honesty in contractual performance

There is more to contracts in Canada than the words on the page. With its very recent decision in Bhasin v Hrynew (2014 SCC 71), the Supreme Court of Canada has reshaped the way that Canadian courts will look at contractual performance. In a unanimous decision, the Court: (1) recognized good faith contractual performance as a "general organizing principle of the common law of contract"; and (2) recognized a new duty of "honest performance", which requires the parties to be honest with each other in relation to the performance of their contractual obligations. The decision has broad implications, and raises several issues that will likely be the subject of further litigation.

The notion of a general, stand-alone duty of good faith is well established in a variety of jurisdictions, including Québec and the United States. It had historically been resisted in Anglo-Canadian common law. Common law courts previously only recognized context-specific duties of good faith, applicable in certain narrow circumstances (such as between employer and employee, or franchisor and franchisee). The duty of honesty recognized in Bhasin is something less than a full duty of "good faith" (a term which has broader connotations than just honesty), but it applies universally, regardless of the context.

The potential implications of imposing a duty of honesty are illustrated by the facts of Bhasin. At issue in the case was a contract between Canadian American Financial Corp. (Can-Am), a provider of education savings plan investments, and Mr Bhasin, one of Can-Am's retail dealers. The contract renewed automatically, unless notice of non-renewal was given six months prior to the end of the term. Can-Am terminated the contract with the required notice, but had deceived Bhasin about its intention to do so. Bhasin asked Can-Am questions about the possibility of termination, and Can-Am's response was equivocal, despite Can-Am having long since made up its mind to terminate. Had Can-Am been honest with Bhasin, he could have transitioned and preserved his business to a greater extent than he was able to without such notice. Despite Can-Am's compliance with the express terms of their agreement, Bhasin was awarded damages for breach of contract.

Writing for the Court, Justice Cromwell held that good faith is a "general organizing principle of the common law of contract which underpins and informs the various rules in which the common law, in various situations and types of relationships, recognizes obligations of good faith contractual performance." The duty of honesty was described as a "further manifestation" of this general organizing principle.

Justice Cromwell explained the duty of honesty as meaning that parties must not lie or otherwise knowingly mislead each other about matters directly linked to the performance of the contract. He clarified that it is not a duty of loyalty or of disclosure and it does not require a party to forego advantages flowing from the contract.

The most surprising feature of this new duty of honesty is that it operates irrespective of the intentions of the parties. In other words, the duty of honesty will apply even where it contradicts the express terms of a contract. This is an unusual phenomenon in contract law, where the written terms of an agreement are usually sacrosanct, especially in the commercial context. The Court recognized the possibility of contractually "modifying" the duty of honesty, but only "so long as [the parties] respect its minimum core requirements".

In the Court's view, the recognition of a duty of honesty poses no risk to commercial certainty in the law of contract and is clear and easy to apply. Justice Cromwell characterized it as an incremental step – less drastic than recognizing a broader duty of good faith – and pointed to the experience in Québec and the United States as reason for comfort.

Despite the Court's attempt at clarity, Bhasin does add a layer of complexity and uncertainty to litigation involving contracts. The Court's precision in defining the duty of honesty is somewhat undermined by its broad pronouncements about the important role of "good faith" in the law of contracts, and the accompanying invitation to develop other, new good-faith duties "where the existing law is found to be wanting". In just the four months since Bhasin was decided, the decision has been cited in over 25 reported judicial decisions – a significant number, given the typical lag time between when cases are argued and decided.

Three developments to watch for, as lower courts grapple with the implications of Bhasin, are:

(1) Will courts confine themselves to the narrower duty of honesty when applying Bhasin, or will they also latch on to some of the Justice Crowell's broader pronouncements about the "organizing principle of good faith"?

(2) In what ways can the duty of honesty be modified, without offending its "minimum core requirements"? What if, for example, a large corporation limits the duty of honesty to certain designated representatives, to minimize the risk of contractual breaches by rogue employees?

(3) How will courts deal with the distinction between a duty of honesty versus a duty of disclosure? The distinction may not always be easy. What if, for example, a party says something that it later realizes to be false? Or what if, as in Bhasin, a party is asked a pointed question and it does not want to disclose the honest answer?

Bhasin imports a new duty of honesty into Canadian contract law; but the true impact of this on the future of contracts remains open. Of course, honesty is always the best policy.