O Come, All Ye (Good) Faithful (in Contract): Supreme Court expands duty of honest performance in contract

Today, in its decision in C.M. Callow Inc. v. Zollinger¹, the Supreme Court continued to incrementally expand the duty of honesty in contractual performance, affirming that dishonesty giving rise to a breach of contract goes beyond outright lies and includes half-truths, omissions, and sometimes even silence.

What you need to know

• The duty of honest contractual performance goes beyond lying to include knowingly misleading a counterparty.
  • Knowingly misleading a counterparty can occur not only by active statements, but also by an omission. Such a determination is highly fact-specific.
• The Court reaffirmed that there is no positive duty to disclose a material fact such as a decision to terminate a contract; however, it may be a breach of the duty of honest contractual performance to fail to correct a party’s misapprehension.
• Dishonest conduct must be tied to a contractual obligation or right in order to give rise to a claim.
• Breach of the duty of honest contractual performance is remedied by putting a party in the position it would have been in had the contract been performed (expectation damages), not by reimbursing their out-of-pocket costs (reliance damages).

Background

CM Callow Inc., owned and operated by Christopher Callow (Callow), provided maintenance services to a group of condominium corporations (Baycrest) under two contracts: a winter contract, and a summer contract. These contracts were to expire in April 2014 and October 2013, respectively. The winter contract contained a termination clause providing that if, for any reason, Callow’s services were no longer required, Baycrest could terminate the contract on 10 days’ written notice. Baycrest decided to terminate the winter contract in early 2013, allegedly because of issues with Callow’s performance, but it chose not to inform Callow of its decision at that time. Instead, Baycrest waited until September 2013 to provide notice of termination, after Callow had completed its obligations under the summer contract. Baycrest was concerned that Callow would abandon the less profitable summer contract if the winter contract was cancelled.

While performing the summer contract in the summer of 2013, Callow performed extra “freebie” landscaping work in the hope that this would encourage Baycrest to renew the winter contract. Baycrest was aware of this work, as well as the reason for it. But they deliberately declined to inform Callow that they would be terminating the winter contract, instead representing to him that they were happy with his maintenance services and that the winter contract was likely to be renewed. When the winter contract was terminated, Callow sued for breach of contract.

Lower court decisions

The trial judge applied the Supreme Court’s landmark 2014 decision in Bhasin², which recognized an “organizing principle of good faith” in contract law and created a new duty of honest contractual performance requiring that parties “not lie or otherwise knowingly mislead each other about matters directly linked to the performance of the contract”³.

The trial judge ruled that that Baycrest breached this duty, and thus the winter contract, by “actively deceiving” Callow from the time the termination decision was made in early 2013 to the time when notice of termination was given in September 2013. Specifically, she found that Baycrest “acted in bad faith” by (i) withholding the fact that it intended to terminate the winter contract in order to ensure that Callow performed the summer contract, and (ii) falsely representing that the winter contract was not in danger. In the trial judge’s view, the “minimum standard of honesty” required Baycrest to address the alleged issues with Callow’s performance, provide prompt notice of termination, or refrain from making any representations regarding contractual renewal.

The Court of Appeal accepted that Baycrest “actively deceived” Callow but nevertheless ruled that there was no breach of the duty of honest contractual performance.

Supreme Court of Canada’s decision

A five-member majority of the Supreme Court—joined by three judges in concurrence, with Justice Côté dissenting—ruled that the duty of honest performance precludes active deception, and that Baycrest breached this duty by knowingly misleading Callow into believing that the winter contract would not be terminated. This was a matter “directly linked to the performance of the contract” because Baycrest had exercised the termination clause dishonestly, even if the 10-day notice period was satisfied⁴.

The Court clarified three main issues regarding the duty of honest performance: (i) when dishonesty will be considered a matter “directly linked to the performance of the contract”; (ii) what “dishonesty” means in this context; and (iii) the measure of damages for the breach of the duty of honest performance

Standard of honesty required under the organizing principle of good faith

Eight members of the Court agreed that the requirement in Bhasin not to “knowingly mislead” the contractual counterparty extends beyond outright lies and can include “half-truths, omissions, and even silence, depending on the circumstances”⁵. In such cases, failing to correct a misapprehension caused by one’s own misleading conduct can result in a breach of the duty of honest performance where this has the effect of misleading the counterparty about matters directly linked to the performance of the contract⁶.

In this case, the majority agreed with the trial judge that Baycrest deceived Callow through a series of “active communications,” namely, (i) communicating to Callow that renewal of the winter contract was likely and that all was fine with his performance, and (ii) gladly accepting the “freebie” services offered by Callow, which suggested that there was hope for renewal and that the current contract would not be terminated⁷.

Importantly, however, the majority agreed with the Court of Appeal’s observation that the trial judge went too far in concluding that “[t]he minimum standard of honesty would have been to address the alleged performance issues, to provide prompt notice, or to refrain from any representations in anticipation of the notice period.” In the majority’s view, these first two requirements would amount to substantively altering the bargain struck between the parties⁸. In addition, the Court affirmed that there is no free-standing positive duty to disclose information to a contractual counterparty⁹.

Measure of damages

The significant split between the majority and the concurrence addressed how damages should be measured for a breach of the duty of honest performance. The majority held that the plaintiff should be put in the position it would have been in had the duty been performed (i.e., expectation damages)¹⁰. This is the ordinary measure of damages for breach of contract. The Court found that expectation damages would have a positive deterrent effect, by resulting in larger and more certain damages than the measure preferred by the concurrence¹¹. The majority assumed that the appropriate measure of damages in this case was the value of the contract that Callow had with Baycrest, without requiring evidence on this point.

The concurrence disagreed: where a party breaches the duty of honest performance, the issue is not that the defendant has failed to perform the contract, thus defeating the plaintiff’s expectations; rather, the defendant did perform the contract, but caused the plaintiff loss by making misrepresentations on which the plaintiff relied (i.e., reliance damages)¹². Contrary to the majority’s view, the concurrence held that this approach to damages for breach of the duty of honest performance is what Bhasin contemplates¹³.

The division between the majority and the concurrence is largely driven by a different view of the role of civil law in interpreting common law private rights. The majority continues the Court’s trend of using the civil law and common law frameworks to interpret each other.

Practical implications

Today’s decision in Callow continues the Court’s incremental expansion of good faith in contract, specifically the duty of honest performance. It is clear that honesty cannot be narrowly construed as simply not lying; courts must engage in a fact-specific determination of whether the counterparty was misled by action or inaction, including half-truths, omissions, or silence. Importantly, the prohibition against knowingly misleading a counterparty is not unbounded; the Court has maintained its position from Bhasin that there is no positive extra-contractual duty to disclose. But the space between these two bounds—where disclosure is required to prevent the other party from being misled—appears to be fertile ground for future litigation.

Callow is also instructive in day-to-day practice. Parties need to turn their mind to whether their counterparty is under a mistaken belief with respect to contractual performance and consider correcting such a misapprehension—whether about termination, contract renewal, pricing, or otherwise. This is especially true when a party has made an internal decision and the counterparty asks about it. While the Court again emphasized there is no positive duty to disclose a decision to terminate, it may be a breach of the duty of honest performance not only to lie, but also to give an answer that knowingly gives rise to a misapprehension.

Finally, Callow will not be the last word on good faith in contracting from the Supreme Court. Callow was heard with a companion case Wastech Services Ltd. v. Greater Vancouver Sewerage and Drainage District, which dealt with broader issues of the organizing principle of good faith in contracts. Unusually for the Supreme Court, it was not released with Callow, and we expect good faith to be an issue to watch in 2021.

_________________________

¹ 2020 SCC 45 [Callow].

² Bhasin v. Hrynew, 2014 SCC 71 [Bhasin].

³ Bhasin at para. 73.

⁴ Callow at para. 5.

⁵ Callow at para. 91.

⁶ Callow at para. 90.

⁷ Callow at paras. 95-97.

⁸ Callow at para. 104.

⁹ Callow at paras. 47, 80.

¹⁰ Callow at paras. 106-107.

¹¹ Callow at para. 109.

¹² Callow at para. 142.

¹³ Callow at paras. 140, 142-145.

To discuss these issues, please contact the author(s).

This publication is a general discussion of certain legal and related developments and should not be relied upon as legal advice. If you require legal advice, we would be pleased to discuss the issues in this publication with you, in the context of your particular circumstances.

For permission to republish this or any other publication, contact Janelle Weed.

© 2024 by Torys LLP.

All rights reserved.