Good Faith and Honesty: Bhasin v Hrynew

Marc Kestenberg, Partner, Norton Rose Fulbright Canada LLP Marlo Kravetsky, Senior Counsel, TD Bank Group Deborah Reine, Senior Counsel, Royal Bank of Canada

June 9, 2015 Toronto, Ontario

Overview

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• Bhasin v. Hrynew

– The decision and litigation implications

• The Aftermath

– A review of some interesting decisions after Bhasin

• The Implications for your Business

• Some Ethical Considerations for In-House Counsel

• Practical Application

Bhasin v. Hrynew – The Facts:

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• The Appellant, Mr. Bhasin and the Respondent, Mr. Hrynew were enrollment directors for the Respondent Canadian American Financial Corp.

• The parties sold education savings plans to investors.

• The relationship between Can-Am and its enrollment directors was governed by an Enrollment Director’s Agreement.

• The term of the Agreement was three years with automatic renewal subject to six months’ written notice to the contrary.

Facts:

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• Can-Am and Hrynew engaged in deceptive and dishonest conduct.

• Hrynew wished to take over Bhasin’s business – Bhasin refused

• After the ASC raised regulatory concerns, Can-Am appointed Hrynew as the Provincial Trading Officer

• Can-Am told Bhasin that its request to appoint an independent PTO was rejected – which was a lie.

• Bhasin refused to grant Hrynew access to his confidential records.

• Can-Am told Bhasin that Hrynew would treat the records confidentially – which was a lie.

• Can-Am threatened to terminate the agreement if access wasn’t granted.

• Can-Am and Hrynew did not tell Bhasin that they had decided to restructure the business, including a merger of Bhasin and Hrynew’s business.

• When access was not granted, Can-Am gave notice of non-renewal under the Agreement.

Alberta Court of Queen’s Bench:

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• Moen J. held that it was an implied term of the Agreement that decisions on non-renewal be made in good faith.

• The Agreement was analogous to a franchise agreement and the duty of good faith applied as a matter of law.

• In the alternative, the duty of good faith was implied based on the intentions of the parties.

• Can-Am breached the Agreement by exercising the non-renewal clause in a dishonest and misleading manner.

Court of Appeal for Alberta

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• The Court of Appeal allowed the appeal and held that the trial judge erred by implying a term of good faith into the Agreement.

• In particular, the trial judge erred by implying a term of good faith performance in the context of an unambiguous contract containing an entire agreement clause.

• The duty of good faith in employment or franchise contracts cannot be extended by analogy to all commercial contracts.

• Moreover, a term cannot be implied when it goes against an express term of the contract.

• The motive for triggering non-renewal was not dealt with under the Agreement which meant that either party was free to give notice of non-renewal at their own discretion.

Supreme Court of Canada:

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• Anglo-Canadian common law has resisted an independent doctrine of good faith in the performance of contracts and tended to favour the principles of autonomy and freedom to contract.

• The result has been an unsettled and incoherent body of law.

• This approach is out of step with Quebec civil law and most jurisdictions in the United Sates.

• It also produces results that are inconsistent with the reasonable expectations of commercial parties.

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“Commercial parties reasonably expect a basic level of honesty and good faith in contractual dealings. While they remain at arm’s length and are not subject to the duties of a fiduciary, a basic level of honest conduct is necessary to the proper functioning of commerce. The growth of longer term, relational contracts that depend on an element of trust and cooperation clearly call for a basic element of honesty in performance, but, even in transactional exchanges, misleading or deceitful conduct will fly in the face of the expectations of the parties.” (Para 60).

Incremental Development of Duty of Good Faith

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• The Supreme Court of Canada concluded that it was time to take two incremental steps in developing the duty of good faith in contractual performance:

• (1) Acknowledge that good faith contractual performance 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; and

• (2) Recognize, as a further manifestation of good faith, that there is a common law duty which applies to all contracts to act honestly in the performance of contractual obligations.

Good Faith Performance as Organizing Principle

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• The first step is to recognize that there is an organizing principle of good faith in the common law.

• An “organizing principle” is a general requirement of justice from which more specific legal doctrines may be derived.

• “The organizing principle of good faith exemplifies the notion that, in carrying out his or her own performance of the contract, a contracting party should have appropriate regard to the legitimate contractual interests of the contracting partner. While “appropriate regard” for the other party’s interests will vary depending on the context of the contractual relationship, it does not require acting to serve those interests in all cases. It merely requires that a party not seek to undermine those interests in bad faith.” (Para 65).

• Cautioned against ad hoc judicial moralism

Good Faith Performance as Organizing Principle

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• Sometimes causing loss to another party – even intentionally – in the legitimate pursuit of economic self-interest is not necessarily bad faith.

• Economic efficiency

“The principle of good faith must be applied in a manner that is consistent with the freedom of contracting parties to pursue their individual self-interest: “In commerce, a party may sometimes cause loss to another — even intentionally — in the legitimate pursuit of economic self-interest: Doing so is not necessarily contrary to good faith and in some cases has actually been encouraged by the courts on the basis of economic efficiency.”” (para 70)

The Duty to Act Honestly in Contractual Performance

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• The second step is to recognize a new common law duty of honesty in performance of a contract:

• “This means simply that 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.” (para 73)

• The duty of good faith should not be thought of as an implied term, but a general doctrine of contract law that imposes a minimum standard of honest contractual performance.

• The duty of honest performance interferes very little with the freedom to contract, since parties will rarely expect that their contracts permit dishonest performance.

Scope of Duty of Honesty

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• The scope of this duty may be modified by express terms

• “The precise content of honest performance will vary with context and the parties should be free in some contexts to relax the requirements of the doctrine so long as they respect its minimum core requirements.” (para 77).

• The duty of honest performance should not be confused with a duty of disclosure or of fiduciary loyalty.

• A party to a contract has no general duty to subordinate his or her interest to that of the other party. […] However, contracting parties must be able to rely on a minimum standard of honesty from their contracting partner in relation to performing the contract.”(para 86)

Scope of Duty of Honesty

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• It would be incorrect to impose a broad duty of good faith beyond the duty of honesty to all commercial contracts:

• “[I]n the result, [Justice Moen’s] decision turned a three year contract that was subject to an express provision relating to non-renewal into a contract of roughly nine years’ duration. As the Court of Appeal pointed out “[t]he parties did not intend or presume a perpetual contract, as they contracted that either party could unilaterally cause it to expire on any third anniversary” (Para 90).

• This case did not fall into an existing situation or relationship in which the duty of good faith applied.

• Instead, court found that the duty of honesty had been breached.

Damages

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• The manner in which the Supreme Court of Canada assessed damages is somewhat troubling

• As a result of the breach of the duty of honesty, Bhasin was awarded $87,000 – the value of his business

–Did the breach of the duty of honesty directly cause the loss of Bhasin’s entire business?

–What are the implications of this assessment of damages?

Oliver v Elite Insurance Co (NSSC 2014)

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• The plaintiff sued the excess insurer for coverage.

• The defendant insurer relied on a limitations defence.

• The court held in favour of the plaintiff.

• Citing Bhasin and the insurers duty of honest performance, the claim was allowed to proceed on its merits.

Lavrijsen Campgrounds Ltd. v Reville (ONSC 2015)

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• In the context of contract negotiations, the court considered in what circumstances is a failure to disclose a breach of the duty of honesty .

• By selectively disclosing information in the negotiation of the contract, the court found that through non-disclosure, the defendant had breached the duty of honesty as articulated in Bhasin.

Moulton Contracting Limited v British Columbia (BCCA 2015)

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• The Province of British Columbia granted a timber license to Moulton Contracting.

• Access to the area was impeded by protesters, and the plaintiff argued the license had an implied term granting the right to access and harvest timber in a defined area.

• On consideration of Bhasin, the BC Court of Appeal rejected the argument that the requirement to act in good faith could be used to determine whether or not an implied term of a contract existed.

Infinity Gold Mining Inc v Wega Mining AS (ONSC 2015)

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• Where parties negotiated a Share Purchase Agreement subject to financing, the court held that there was no breach by the failure to disclose emails suggesting the deal might not proceed.

• The court held that the duties of honesty as articulated in Bhasin did not require such disclosure.

Chuang v Toyota Canada Inc. (ONSC 2015)

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• In finding for the defendants, the court in Chuang considered the Bhasin decision.

• It found that the requirement to act honestly in the performance of the contract as directed by the organizing principle of good faith applied to this contractual relationship.

• However, the court found that there were no instances of lies told, and there was no reason why the defendant could not keep its reservations about the plaintiffs financial and management resources and the fact that it was considering termination, to itself. Ultimately, the court held in favour of the defendant.

Are good faith and honesty really new?

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•Contracting parties in the United States and Quebec expect good faith •Good faith has already been recognized in certain classes of contracts

•Good faith has already been recognized in certain situations •Good faith and honesty are already a part of most corporate cultures

Effect of decision on our business partners • More litigation (new cases based on the duty of honesty and the

organizing principal of good faith) • A breach of the duty of honesty will be added to many claims

(lead to more costly litigation) • Change communication between parties • Contractual uncertainty

Scope of good faith and honest performance • Not a duty to disclose • Does not apply to pre-contractual negotiations • Not “judicial moralism” • Not a fiduciary duty

How to advise our business partners • Drafting agreements • Communicating with counter-parties • Documenting communications • Creating policies, procedures

Ethical Considerations for In-House Counsel

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• In-house counsel have many roles – including those that go beyond traditional lawyer roles: • Legal roles: dealing with corporate governance, transactions, litigation,

regulators, internal investigations, internal education, etc.

• Quasi-legal roles: compliance, ethics officer, etc.

• Management and business roles: managing other in-house and outside counsel, corporate officer/director, strategic planning, crisis management, risk management, etc.

• “Gatekeeper” function

Ethical Considerations for In-House Counsel

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• In-house counsel are subject to the same ethical and legal obligations as other counsel, even though they may apply differently and present different challenges

“[In-house counsel] are regarded by the law as in every respect in the same position as those who practice on their own account. The only difference is that they act for one client only, and not for several clients…They are subject to the same duties to their clients and to the court. They must respect the same confidences. They and their clients have the same privileges.” (Crompton v. Commissioners of Customs and Excise, [1972] 2 All E.R. 354 (Q.B.), cited in R. v. Campbell, [1999] 1 S.C.R. 565)

Ethical Considerations for In-House Counsel

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Rules of Professional Conduct include: • Honesty and candour Rule 3.2-2: When advising clients, a lawyer shall be honest and candid. • Avoiding knowing assistance Rule 3.2-7: A lawyer shall not knowingly assist in or encourage any dishonesty, fraud,

crime, or illegal conduct or instruct a client or any other person on how to violate the law and avoid punishment.

• Avoiding negligent assistance Rule 3.2-7.1: A lawyer shall not act or do anything or omit to do anything in circumstances

where he or she ought to know that, by acting, doing the thing or omitting to do the thing, he or she is being used by a client, by a person associated with a client or by any other person to facilitate dishonesty, fraud, crime or illegal conduct.

• Up-the-ladder reporting Rule 3.2-8: A lawyer who is employed or retained by an organization to act in a matter in

which the lawyer knows that the organization has acted, is acting or intends to act dishonestly, fraudulently, criminally or illegally, shall follow certain enumerated steps.

Scenario #1

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Oppressive Co. (OpCo) is a manufacturer of sporting apparel in Canada. The Helpful Distributors Inc. (HD) is a distributor. OpCo and HD enter into negotiations for a fixed term distribution arrangement. OpCo is a publicly traded and well financed organization with significant bargaining power. HD is desperately trying to get into the sporting goods distribution market. During the contract negotiations, OpCo makes several demands for concessions from HD that are entirely inconsistent with industry standards. HD’s president (the owner-operator) sends a letter to the president of OpCo accusing it of failing to negotiate in good faith. In the same letter, HD asks OpCo if they are trying to enter into a distribution deal with any other distributors. OpCo is not but wishes to tell HD that it is so as to negotiate a better deal. Question: You are in-house counsel for OpCo. How would you advise the business on (a) any duty to negotiate in good faith and the duty of honesty and (b) how to respond to HD’s specific question?

Scenario #2

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After a difficult negotiation, OpCo and HD work through their differences and agree to a 3 year distribution agreement. Included in the contract is a term that after 2.5 years the parties will enter into negotiations to renew the contract for an additional five years, “on commercially reasonable terms”. As the distribution agreement is approaching expiry, the parties commence renewal negotiations in accordance with the terms of the agreement. By this time, HD has invested much of its available capital in servicing the distribution needs of OpCo. It has hired dedicated employees, leased warehouses and entered into transportation contracts. Simply put, HD cannot afford to lose OpCo’s business and OpCo knows it. Once again, OpCo takes a very hard line in its negotiations. It continues to make commercially unreasonable demands. HD again accuses OpCo of failing to negotiate in good faith. However, this time, HD relies on the contractual obligation to re-negotiate the renewal “on commercially reasonable terms” in partial support of its position. Once again HD asks OpCo if it has entered into negotiations with other distributors. Although OpCo has not, it wants to be vague with HD to further improve its bargaining power. Question: You are in-house counsel for OpCo. How would you advise the business on (a) any duty to negotiate in good faith in these circumstances and the duty of honesty (b) how to respond to HD’s specific question?

Scenario #3

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OpCo and HD have once again worked out their differences. They embark on the renewal period of the distribution contract for a further five years. Two years into the renewal period, OpCo determines that the margins in the sporting goods industry simply aren’t what they used to be. It decides that it will exit its sporting goods business and focus on its more lucrative rabbit rearing business. OpCo determines that it will no longer meet the quotas prescribed by the distribution agreement. A breach of the distribution agreement is inevitable. It is only a matter of time. OpCo knows that its breach will be fatal to the business of HD. Question: You are in-house counsel for OpCo, how would you advise the business about any duty of good faith to inform HD of the anticipated breach of contract and the duty of honesty? Question: How would you advise OpCo about whether it can breach the distribution contract without also breaching any duty of good faith?

Scenario #4

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HD suspects that OpCo is considering exiting the sporting goods industry. It approaches OpCo and specifically asks if OpCo will be able to meet its quotas over the next 6 months. HD reminds OpCo of its complete and utter dependence on the distribution agreement. Question: How would you advise OpCo on how to answer the specific question posed by HD? What are the risks that OpCo must be aware of in deciding how to respond to HD’s question?

Contact Information

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Marc Kestenberg Partner +1 416.216.3977 marc.kestenberg@nortonrosefulbright.com Marlo Kravetsky Senior Counsel, TD Bank Group +1 416.308.4296 marlo.kravetsky@td.com Deborah Reine Senior Counsel, Royal Bank of Canada +1 416.974.0335 deborah.reine@rbc.com

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