Wastech v Greater Vancouver: The Supreme Court narrows the scope of review over the exercise of ‎contractual discretionary power

In Wastech Services Ltd. v. Greater Vancouver Sewerage and Drainage District, the Supreme Court of Canada has given further guidance on the overarching organizing principle of good faith performance of contracts, narrowing its imposition in the context of contractual exercise of discretion.

In the landmark decision of Bhasin v. Hrynew, the Court recognized the principle of good faith contractual performance. This principle was further considered in last year’s Callow v. Zollinger case, reviewed by DLA Piper (Canada) LLP here, which dealt with the duty of honest performance of contracts.

Wastech v Greater Vancouver turned on the good faith exercise of discretionary powers: where a contract provides that a party has “absolute discretion”, when can it be liable for damages when it exercises that discretion in a way that harms its counterparty?

In short, the Court held that courts will only intervene in respect of the exercise of discretionary powers where it has been proven that the discretion was exercised in a manner unconnected to the purposes of the discretion. This is not a wide scope of review for the courts, and this decision should be considered as a business-friendly judgment that gives accord to the primacy of the contract.

Metro’s exercise of discretion

Wastech considered an appeal from an arbitrator’s decision of a contractual dispute relating to the transportation of waste. The arbitrator had found that Greater Vancouver Sewerage and Drainage District (“Metro”) had breached the duty of good faith in how it allocated waste to its waste disposal facilities. Metro’s allocation resulted in the waste transportation service, Wastech Services Ltd. (“Wastech”), recording operating profit far less than it had anticipated.

The contract between the parties gave Metro absolute discretion to make such waste allocation decisions. Significantly, Wastech did not allege that Metro had exercised its discretion capriciously or dishonestly -  it was common ground Metro had made the allocation decisions for its own operational interests. Rather, Wastech alleged that Metro exercised its discretion without “appropriate regard” for Wastech’s “legitimate contractual interests”, which Wastech further argued was a breach of the duty of good faith exercise of discretion. The arbitrator agreed, and found in favour of Wastech.

The lower courts overturned the decision, finding that Metro had not breached the duty of good faith performance of the contract.

The Supreme Court of Canada dismissed the appeal, with Justice Kasirer writing for the six judge majority, and Justices Brown and Rowe writing concurring reasons.

Key findings from the Supreme Court of Canada’s decision

The appeal considered the constraints of the duty of good faith on contractual exercise of discretion. As the Court noted, the duty to exercise discretionary powers in good faith is nothing new — it has been a part of Canadian law for at least 25 years, predating Bhasin. In Bhasin, the Court held that the organizing principle of good faith requires honest, candid, forthright or reasonable contractual performance, but did not discuss the impact of its decision on the contractual exercise of discretion.

In its decision in Wastech, the majority of the Court unified the concepts of good faith and reasonableness by focus on the purpose for which the discretion conferred in the contract. As the Court explained:

Stated simply, the duty to exercise contractual discretion in good faith requires the parties to exercise their discretion in a manner consistent with the purposes for which it was granted in the contract, or, in the terminology of the organizing principle in Bhasin, to exercise their discretion reasonably.

In this context, “reasonableness” is nothing more than exercising discretionary powers in a manner consistent with the purpose for which the discretion was granted. If the exercise of discretion is unconnected with that purpose, the party has not acted reasonably or in good faith. The purpose for the discretion is the touchstone for the determination.

Pursuant to this approach, the Court puts the focus of the analysis on the contract itself. Sometimes the clause under consideration will make clear the purpose for the discretion; in other cases, one will need to review the contract as a whole to make such a determination. The Court noted that the circumstances at issue between Metro and Wastech had been contemplated during negotiations, but the parties had deliberately rejected a proposed clause constraining the exercise of discretion to allocate waste. Further, the contract included other provisions carefully allocating risk between the parties.

The Court reasoned that capricious or arbitrary exercise of contractual discretion is simply an example of a party exercising powers in a manner unconnected to the contractual purposes and for that reason is unreasonable and bad faith. It is not a matter of what the court sees as fair, but, as the Court expressed it, “the measure of fairness is what is reasonable according to the parties’ own bargain.”

The majority noted the earlier case law that drew a distinction between the exercise of discretion measured by objective standards compared to subjective standards. Where discretionary power relates to a decision that can be objectively measured, the range of reasonable outcomes will be smaller. This would apply, for example, if the discretion related to an issue of operative fitness. Conversely, where the decision to be made is not readily susceptible to such objective measurement - for example, if the discretion related to personal compatibility - the range of reasonable exercises of discretion would be larger. However, the Court noted that this distinction is a guideline only and is not determinative.

The Court also made clear what was not needed to prove a lack of good faith. A party’s deprivation of substantially all the benefit by reason of the other party’s exercise of discretion is neither a necessary precondition for a finding of bad faith, nor is it dispositive if it is proven. The latter point is significant: it is not enough to show that the exercise of discretion would deprive the counterparty of the benefit of the bargain. More is needed.

Critically, the Court held that a party exercising discretion is not required to subvert its own interest in the name of accommodating another party. Contracting parties are not fiduciaries. The loyalty required in the exercise of discretion is loyalty to the bargain, not loyalty to a contractual partner. Similarly, the duty of good faith cannot be used to confer a benefit on a party beyond the negotiated terms of the contract.

Finally, the majority found that this duty of good faith in relation to discretionary powers is not an implied term of the contract, as some previous authority had suggested. Rather, this duty is obligatory in all contracts — parties cannot contract out of the obligation that discretionary power will be exercised in good faith.

The Court concluded that Metro had not exercised its discretionary powers in a manner unconnected with the purposes of the contract. To the contrary, the purpose of the discretion, as determined from the contract, provided “flexibility to account for various factors”. As a result, the exercise of discretion was reasonable and not a breach of good faith obligations. By seeking a constraint on Metro’s discretion that the parties had expressly considered and rejected, Wastech was attempting to obtain a benefit for which it had not bargained.  

In a concurring decision that was highly critical of the majority, the minority of the Court agreed with the disposition, but would have resolved it more simply. They reasoned: “the parties contemplated that Metro could exercise the discretion so as to advance its own interests” and that is exactly what happened here. There was no need to inquire into the purpose of the discretion, and indeed the minority argued that this exercise risked the imposition of judicial view and undermined freedom of contract. As the minority argued, “where a contract discloses a clear intention to grant a discretion that can be exercised for any purpose, courts, operating within their proper role, must give effect to that intention.”

Also notable was the minority’s disapprobation for the majority’s discussion of civil law. The majority had dismissed the application of the civil law, but for the minority, merely entertaining the discussion was inviting confusion and instability.

Lessons to be drawn from this third instalment on good faith

For businesses entering into contracts (and their corporate counsel), it is well worth paying close attention to discretionary powers in the contract. Both the majority and minority in Wastech specifically invited parties to draft “purposes” clauses in sections dealing with discretionary powers. There is nothing stopping parties to a contract to expressly say what would, or would not, be within the purpose of that type of clause. Litigation can be avoided by careful drafting.

Beyond that, these are some conclusions that can be drawn from the Supreme Court’s multiple forays into this area of law:

• Exercising a contractual power dishonestly will constitute a breach of the duty of honest performance in contracts: Bhasin
• Knowingly misleading or failing to correct a misunderstanding of a counterparty may constitute a breach of contract: Callow
• Exercising discretionary powers in a manner that is unconnected to the purposes of the contract will constitute a breach of the duty of good faith: Wastech
• Exercising discretionary powers arbitrarily or capriciously will constitute a breach of the duty of good faith: Wastech
• Parties cannot contract out of the duty of honest performance or the duty to exercise discretionary power in good faith, although they can define the “purposes” for which discretionary power can be exercised within the contract: Bhasin and Wastech

By tying the analysis to the purposes of the discretion, with specific regard to the words chosen by the parties to the contract, the Court has arguably narrowed the scope of review. Defining reasonableness with express reference to the terms of the bargain between the parties similarly preserves commercial certainty Further, the Court is inviting commercial parties in Canada to fix their problems themselves: simply draft clauses about the scope of discretion to be afforded, and the Court should give effect to the parties’ intent.

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