In Wastech Services Ltd. v. Greater Vancouver Sewerage and Drainage District, 2021 SCC 7 (“Wastech”), the Supreme Court of Canada (SCC) reinforced its previous holdings that a duty of good faith imposes limits on the exercise of contractual discretion, and clarified the nature of these limits. Specifically, the duty to exercise discretionary powers in good faith requires that the discretion be exercised reasonably. This means that the exercise of discretion must be connected to the purposes for which that discretion was granted even where unfettered discretion is specified. This is the Supreme Court’s second decision on the duty of good faith in two months. See our blog post on the first decision (Callow) here.

Contractual provisions granting discretionary power are common in contractual agreements, particularly where the agreement is complex or is to apply to a long-term business relationship. Wastech is therefore an important decision for Canadian businesses and should be considered when drafting contracts and when exercising discretionary powers.

Background

In Bhasin v Hrynew, 2014 SCC 71, the SCC described the “organizing principle” of good faith as requiring a contracting party, in carrying out his or her own performance of a contract, to have appropriate regard to the legitimate contractual interests of its counterparty. In all contexts, this requires honesty in performance. Other good faith duties such as reasonableness, fairness and forthrightness will be required in specific situations. One such situation is the exercise of contractual discretion. The appeal in Wastech concerned the nature and scope of the duty of good faith in this context.

The appellant, Wastech Services Ltd. (“Wastech”) (a waste transportation company) and the respondent, Greater Vancouver Sewerage and Drainage District (“Metro”) (a corporation responsible for municipal waste disposal) were parties to a complex, long-term contract for waste disposal services.

The contract provided that Wastech would transport Metro’s waste to three facilities. Wastech was to be paid at a reduced rate for short-haul transportation of waste (two of the facilities were considered short-hauls). The contract provided Metro with “absolute discretion” in directing the amount of waste directed to each of the three facilities. Metro’s allocation has been relatively fixed for a number of years. The contract only set out a “target” for Wastech’s operating profit and contained price adjustment mechanisms to mitigate deviations from that target where profit deviated from the “target”.

In 2011, Metro exercised its discretion by directing a significantly higher percentage of waste to the two short-haul facilities for the upcoming year, in order to minimize its own long-term costs and maximize efficiencies. As a result, Wastech was unable to achieve target profit levels for the year. Wastech complained that Metro’s exercise of its discretion in this way breached the duty of good faith because the reallocation would prevent Wastech from earning the “target” profit for the relevant years.

The matter first went to arbitration where the arbitrator found in favor of Wastech. Metro appealed to the British Columbia Supreme Court, which set aside the arbitrator’s award. The Court of Appeal for British Columbia affirmed the decision.

The six-justice majority of the SCC dismissed the appeal and clarified how the duty of good faith applies to parties exercising seemingly unfettered discretionary rights under a contract.

The Duty to Exercise Contractual Discretion in Good Faith

As the Supreme Court recognized in Bhasin, the duty of good faith is an organizing principle that applies to all contracts regardless of the parties’ intentions.  The specific duties arising from this organizing principle include the duty of honesty in contractual performance and the duty to exercise contractual discretion in good faith.[1] What constraints does the duty of good faith place on the exercise of contractual discretion, particularly in circumstances where the exercise of contractual discretion appears to be unfettered?

The majority of the Supreme Court held that the duty to exercise contractual discretion in good faith is one of reasonableness, requiring that discretion be exercised in a manner consistent with the purposes for which it was granted in the contract. Courts “must only ensure parties have not exercised their discretion in ways unconnected to the purposes for which the contract grants that power” (para. 74). Establishing a breach of this duty will therefore turn on contractual interpretation: “[i]t is in properly interpreting the contract and the purposes for which discretion was granted that the range of good faith behaviour comes into focus and breaches can be identified” (para. 76). The wording used in setting out the discretionary power will be of significant influence in determining its purpose, as will the commercial context and factual matrix surrounding the agreement.

When considering the exercise of discretionary powers under contract parties must consider the purposes for which the contractual discretion was granted. These may in some cases be clear from the text of the relevant provision. In other circumstances, the purposes may only be understood by reading the relevant provision in the text of the contract as a whole.  

To this end, the majority explained that the allowable exercise of any discretionary power will involve a range of possible choices that may be considered reasonable in light of the purposes for which the discretionary power was granted. The duty to exercise contractual discretion in good faith does not eliminate choice. Rather, it limits the range of legitimate ways in which that power may be exercised. It is not the role of the Court to ask whether the discretion was exercised in a “morally opportune or wise fashion from a business perspective” (para. 73).

The majority provided general guidance on how the duty might apply to particular discretionary powers. It explained that where the discretion involved is a matter “readily susceptible of objective measurement”, the range of reasonable outcomes will be relatively small. Examples include “operative fitness, structural completion, mechanical utility or marketability.” In contrast, discretionary powers involving matters not readily susceptible of objective measurement, the range of reasonable outcomes will be relatively larger. Such matters include “taste, sensibility, personal compatibility or judgment of the party.”  While “substantial nullification” or “evisceration” of the entire benefit of a contract is not determinative of whether a party properly exercised a contractual discretion in bad faith, it may be relevant to show that the contractual discretion has been exercised unreasonably.

Metro exercised its discretion reasonably

The Supreme Court was unanimous in finding that Metro was within its legal rights in exercising its discretionary power to allocate waste disposal as it did regardless of the impacts on Wastech’s ability to earn the target profit. The purpose of giving Mero “absolute discretion” to determine waste allocation was to allow it “the flexibility necessary to maximize efficiency and minimize costs of the operation.” In so finding, the Supreme Court considered the discretionary provisions in the context of the contract as a whole as the discretionary provision itself did not express any purpose. The majority seemed to place significant reliance in assessing the purpose of the discretion on the contractual recitals, among other things, that described the parties’ intention to “maximize efficiency and minimize costs”.

The majority rejected the view that the contract required that Wastech have the opportunity each year to achieve its target profit levels. The parties were aware of the risk that Metro’s exercise of discretion represented to Wastech’s profitability and specifically chose not to constrain the discretion. Wastech was therefore “asking for an advantage for which it did not bargain” (para. 101). The exercise of discretion was therefore connected with the purposes for which it was granted, to allow Metro to maximize efficiency and minimize costs. Metro’s exercise of contractual discretion was in good faith “even if the exercise meant that Wastech’s own interest suffered as a consequence” (para. 106).

The concurring reasons agreed with the outcome, but disagreed with various aspects of the majority’s reasoning. In particular, they disagreed with the majority’s view that even unfettered contractual discretion must be considered in light of the purposes for which it was granted. According to the minority, the analysis should begin and end with the intentions of the contracting parties. The minority stated that “[w]ith careful drafting, parties can largely immunize the exercise of discretion from review” (para. 133). Thus, where a contract discloses a clear intention to grant a discretion that can be exercised for any purpose, courts should give effect to that intention. This is in contrast to the majority’s view that the duty to exercise contractual discretion in good faith operates in every contract regardless of the parties’ intentions. 

Key takeaways

In considering the exercise of discretionary powers in contracts, businesses must carefully consider the purposes for which discretion was granted. This determination will be far from straightforward in many cases and will be a highly context-specific analysis. Key takeaways in this respect include:

• The duty to exercise discretion in good faith will be breached where the exercise of discretion is unreasonable, that is, unconnected to the purposes for which it was granted. As the duty of good faith applies to all discretionary powers granted via contracts, regardless of the intentions of the parties, businesses should be mindful of the scope of any contractual discretion provisions, the language of the relevant provision, other parts of the agreement (including recitals) and the prevailing commercial context. It may be possible to limit the scope of what could be considered “unreasonable” through careful drafting. Consideration should be given to these issues both at the timing of drafting and at the time that discretionary rights are exercised.

• The duty to exercise discretionary powers in good faith does not require a party to confer a benefit on the other party, nor does it require a party to subordinate its own interests to those of the other party. A party can cause a loss to another in the legitimate pursuit of its own economic self-interest, and exercising a discretionary power in a way that causes such loss is not bad faith, even if it is intentional. An obligation of good faith does not make for a fiduciary duty.

• Substantial nullification or evisceration of contractual benefit is not necessary to establish bad faith, but may be a relevant consideration. Establishing substantial nullification is not the appropriate standard for deciding whether there was a breach of the duty to exercise a discretionary power in good faith. However, it may be an indicator that the action was outside of the spectrum of reasonableness as it relates to the purpose of the allocation of discretion, and the initial bargain of the parties. If intending to grant discretion to substantially nullify the benefit of the contract for the opposing party, careful drafting is recommended.