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For decades, lawyers, Judges and academics have debated whether there is, or should be, a duty of good faith implied in all contracts.

Last week, the Supreme Court of Canada, in its decision of¬†Bhasin v. Hrynew, did not go so far as to find that a duty of good faith is an implied term of all contracts. However, the Court did take a significant step in that direction by ruling that the common law of contracts in Canada includes a legal “duty of honest performance” which the Court described as a manifestation of the “general organizing principle of good faith that underlies many facets of contract law”.

An obligation to act in good faith has been previously found to be an implied term of certain classes of agreements, such as insurance contracts (insurance companies have an obligation to deal with claims under an insurance policy fairly and in good faith) and employment contracts (employers are required to act in good faith in the manner of termination of employees).

The Court conducted a detailed review of good faith in the law of contracts not only in Canada but in other common law jurisdictions, including Australia, the United Kingdom and the United States. That review made it clear that Canada lagged behind other common law countries in clarifying the extent to which parties to contracts are required to act in good faith in their dealings with one another. The Court noted (at paragraph 59) that Canadian law on this issue “is piecemeal, unsettled and unclear”.

Noting that “[c]ommercial parties reasonably expect a basic level of honesty and good faith in contractual dealings” (para. 60), the Court determined that the time had come to take two steps in the advancement of the law of contracts in Canada.

The first step, the Court ruled,

…is to recognize that there is an organizing principle of good faith that underlies and manifests itself in various more specific doctrines governing contractual performance. That organizing principle is simply that parties generally must perform their contractual duties honestly and reasonably and not capriciously or arbitrarily¬†(para. 63).

This “organizing principle”, the Court explained, is not a “free standing rule”, but rather a standard that “underpins and is manifested in more specific legal doctrines and may be given different weight in different circumstances” (para. 64).

The second step, the Court found, was to find

…that there is a general duty of honesty in contractual performance. 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 form the contract; it is a simple requirement not to lie or mislead the other party about one’s contractual performance (para. 73).

Importantly, the Court noted that because the duty of honest performance “is a general doctrine of contract law that applies to all contracts, like unconscionability, the parties are not free to exclude it” (at para. 75). In other words, any provision in a contract that purports waive or eliminate this duty – for example: “the parties expressly agree that they do not owe one another a duty of honest performance” – will be of no legal effect.

That said, in a nod to the importance of the principle of freedom of contract, the Court ruled that parties will be permitted to establish terms “influencing the scope of honest performance in a particular context” provided that it doing so the parties “respect [the duty’s] minimum core requirements”. (at para. 77) What this means in terms of how far contracting parties can go in limiting or defining the scope of honest performance remains to be determined in future court decisions.

For my part, I question how far any business person will want to go in proposing a contract term designed to limit their obligation to be honest with the person they propose doing business with. Certainly, I expect we will find that those with significant bargaining power (like employers and large companies such as major telephone, cable and internet providers) may try to include limiting provisions in their standard contracts. Those companies will need to tread carefully, however, as I suspect the imbalance of bargaining power will be a significant factor the courts will consider in deciding whether any limit in the scope of the duty of honest performance sufficiently respects its “core requirements” and is therefore enforceable.

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