Beyond the Best Policy: Honesty now a Requirement in Contractual Relationships -

Beyond the Best Policy: Honesty now a Requirement in Contractual Relationships

The Supreme Court of Canada released a decision in November 2014 that could result in significant changes regarding the way that contractual relationships and business disputes are dealt with by the courts.

You may know that, while commercial parties are free to act in their own best interest, there was a general common-law principle that parties to a contract must act in good faith and carry out their contractual obligations reasonably and according to the contract’s intent or purpose.

In Bhasin v. Hrynew (“Bhasin”), our Supreme Court acknowledged the general ‘organizing principle’ or requirement of good faith in performing contractual obligations and recognized a new duty in addition to the principle of good faith: honesty.  To most businesspeople, it likely seems self-evident that parties to a contract should act honestly when carrying out their respective duties.  So what led the Supreme Court to enshrine this new, higher standard?

Summary of Bhasin

In the Bhasin case, Harish Bhasin (“B”), a retailer of financial savings plans, had been doing business with a wholesaler of savings plans since 1998. At one point, the wholesaler began doing business with another retailer (“C”). At one point, the wholesaler altered the wording of its standard contract, and B executed the new contract. A new renewal clause stated that either party could trigger non-renewal of the contract by giving notice before the expiry of a term. When the wholesaler asked that C audit B’s business, B refused to give C access to his confidential information. C was a competitor and was interested in merging with B’s business. The wholesaler ultimately gave notice to B that it would not be renewing B’s contract. B sued the wholesaler and C claiming that they had conspired against him and that the wholesaler had failed to act in good faith when terminating the standard contract; all of which diminished the value of B’s company.  Although an appeal court ruled that there was no implied duty of good faith in a contract (the standard contract did not contain a ‘good faith’ clause), B was ultimately successful at the Supreme Court.

The key part of the Supreme Court’s ruling is as follows:

“It is appropriate to recognize a new common law duty that applies to all contracts as a manifestation of the general organizing principle of good faith: a duty of honest performance, which requires the parties to be honest with each other in relation to the performance of their contractual obligations.

Under this new general duty of honesty in contractual performance, parties must not lie or otherwise knowingly mislead each other about matters directly linked to the performance of the contract.  This does not impose a duty of loyalty or of disclosure or require a party to forego advantages flowing from the contract; it is a simple requirement not to lie or mislead the other party about one’s contractual performance.”

What Does this Mean?

As a result of the Bhasin decision, the duty of honesty in contractual performance is now part of the ‘common law’ – precedents that lower courts are bound to follow, if appropriate based on the facts of a particular case. The Bhasin decision may result in more claims based on one party acting dishonestly being brought forward, and potentially in a variety of different contexts.

As one example, imagine that your business runs out of a key component required in the production of your best-selling product.  Your normal supplier does not have the component in stock and says there is a global shortage of the components.  You approach two other suppliers who tell you they have the components and you choose Supplier A, who offers you the lowest price.  You sign Supplier A’s standard form agreement, and he says that he will deliver the shipment in 10 days.  Five days later, Supplier A calls you and says that he was mistaken and that the components in question were out of stock.  You call Supplier B and find out that they now have no components in stock.  Worse, the next day you learn that your competitor down the street got a big, last minute shipment of components from Supplier A, and apparently at a much higher unit cost than the price set out in your contract with Supplier A.  Your production line is shut down for 2 weeks until your normal supplier is able to provide you with the components.  You could consider suing Supplier A for failing to fulfill the terms of the contract even though there may be a provision in the Supplier A’s standard form of agreement which exonerates Supplier A in such circumstances. Referring to the standard outlined in Bhasin, you could argue that Supplier A breached the duties of good faith and honesty by knowingly misleading you about the status of the components.

Of course, business relationships are just one of many areas where contracts are used.  It will be interesting in the months and years to come to see how the requirement of honest performance from Bhasin is applied in other areas of the law, such as wills and estates, family law (prenuptial or separation agreements) or municipal law.  Depending on how far courts are willing to apply this new requirement of honesty, the ramifications from the Bhasin decision could prove to be profound.

Impacts and What You Need To Do

While the full impact of the Bhasin decision will likely take years to be determined, the old adage about honesty being the best policy applies more now than ever.  Like many of us remind our teenage children: it’s less about what occurred, and a lot more about how you react. In other words, bad things happen sometimes, but did you own up and tell the truth?  In the example above, if Supplier A had honoured the terms of the original contract for the components, he may have received a lower unit price on the transaction, but he would have avoided months if not years of protracted negotiations and litigation that resulted from the lie to the first customer.

If, as a wise businessperson, you operate your business in an honest and ethical manner, then the Bhasin case will likely not impact the way you do things.  If, however, you ever find yourself in the unpleasant position of being harmed by a dishonest party, then you may have a cause of action against that party, regardless of whether or not the action is permitted under the terms of your contract.

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Article written by 

Cameron Mitchell and Nigel Smith, Law Student. Cameron is a business lawyer at SorbaraLaw, specializing in all aspects of corporate-commercial law.

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