Authored by Danielle Maksimow of Norton Rose Fulbright
Canadian Update: The Supreme Court of Canada Explains the Parameters for Exercising Contractual Discretion in Good Faith
On February 5, 2021, the Supreme Court of Canada (the SCC) delivered its third decision in a trilogy of cases on the duty of good faith in contractual performance. In Wastech Services Ltd. v Greater Vancouver Sewerage and Drainage District, 2021 SCC 7, the SCC laid out the scope of the general contractual principle that discretion must be exercised in good faith. The SCC explained that discretion must be exercised within the scope and purpose for which the contracting parties granted it. Provisions that provide for “unfettered” or “absolute” discretion are then necessarily bound by what is reasonable and within the framework of an agreement as a whole.
Wastech, a waste transportation company, entered into a waste disposal contract with Metro, a municipal waste disposal company. The contract established that Wastech would deposit waste at one of three landfills. Wastech was paid differing rates depending on which landfill the waste was directed to and how far away a landfill was located. The contract granted Metro “absolute discretion” to allocate waste to each of the three landfills.
Dispute arose when Metro reallocated waste to the landfills in a manner that caused Wastech to fall short of its target profit. The contract did not, however, guarantee that Wastech would achieve said target. Wastech brought forward a claim and alleged that Metro breached the contract by exercising its discretion in a manner that was in breach of good faith.
At arbitration, Wastech was successful in claiming it was entitled to compensation. The arbitrator concluded that Metro breached the duty of good faith in exercising its discretion. Metro then successfully set aside the arbitrator’s decision in the British Columbia courts. Wastech appealed to the SCC.
The Ruling and the Canadian Approach
The SCC made it clear that the issue in Wastech was not whether the already established duty to exercise contractual discretion in good faith exists, but rather how such discretion should be exercised. Wastech argued that Metro failed to exercise discretion with “appropriate regard to the legitimate interests of [their] contracting party”; an argument founded on one of the SCC’s preceding cases on good faith, Bhasin v. Hrynew, 2014 SCC 71. However, the SCC explained in Wastech that the “legitimate interests” of a party are not necessarily its economic interests. Rather, a party exercising discretion may “substantially nullify” a counterparty’s contractual benefit if such exercise of discretion is contemplated by the purpose for which the discretion was granted and reasonable within the context of the contract.
Here, the SCC observed that the contract granted Metro absolute discretion to allocate waste for purposes of efficiency, cost-effectiveness and for Metro to advance its own business objectives. The contract also did not guarantee Wastech a certain level of profit despite the risk that Wastech’s earnings could be negatively affected by Metro’s discretion. As such, the SCC found that Metro’s discretion to reallocate waste was exercised reasonably within its intended purpose and the context of the contract.
Wastech provides Canadian courts interpretive parameters for the duty of good faith in exercising discretionary provisions. Prior to Wastech, exercising contractual discretion in good faith may have suggested that discretion must be exercised with consideration for the counterparty’s economic welfare. However, as the SCC explained, a party exercising discretion need not subordinate its interests to the economic welfare of a counterparty. Barring an arbitrary or capricious approach, discretion need only be exercised in a way that reflects the freely negotiated bargain between two parties. That is, Canadian courts should not place the economic interests of one party above the purpose for which a discretionary provision was granted, even if that means nullifying all or a portion of that party’s contemplated benefit under an agreement.
Wastech carries important implications for how a creditor may exercise “unfettered,” “absolute,” or other similar discretion in an agreement. Wastech confirms that a creditor may exercise discretion in pursuit of self-interest, even if in a manner contrary to the borrower’s interests. However, Wastech also reinforces the duty for a creditor to exercise its discretion reasonably, not arbitrarily and within the context for which it was granted.
In exercising discretion, a creditor should pay special attention to contractual language that supports why a discretionary provision was granted, and the provision’s purpose when interpreted in the context of an agreement as a whole. Further, any evidence, including records of any internal decision process, that supports that a creditor’s discretion was exercised reasonably and non-arbitrarily should be retained to dispute any counterparty’s claim asserting otherwise.
Where a creditor wishes to include key discretionary provisions in an agreement for a business purpose or as a risk mitigation mechanism, the agreement should be methodically drafted as to clearly indicate such underlying purpose or mechanism. Nonetheless, language to that effect must also not be too narrow as to limit a creditor’s ability to exercise such discretion. Additionally, a creditor should take great care when relying exclusively on discretionary provisions to gain comfort when dealing with high-risk borrowers, especially if there is a risk that exercising such discretion can be construed as falling outside of its intended purpose.
Moreover, when granting discretion to a counterparty in an agreement, a creditor should consider the risk that its economic benefit under the agreement may be negatively affected. Wastech demonstrates that Canadian courts will likely uphold a counterparty’s discretion to pursue self-interest under an agreement, as long as that discretion is reasonable and consistent with its intended purpose under the agreement, even if it leads to the loss of economic benefit for the creditor.