Supreme Court discusses Good Faith in Exercising Contractual Discretion in Wastech v Greater Vancouver
Wastech Services Ltd v Greater Vancouver Sewerage and Drainage District, 2021 SCC 7 [Wastech] is the second case in a matter of months that the Supreme Court of Canada (“SCC”) has released relating to the “general organizing principle” of good faith in contracting.
The SCC has recognized four doctrines as part of good faith in contracting and these have the following corresponding duties: 1) a duty of cooperation between the parties to achieve the objects of the contract; 2) a duty to exercise contractual discretion in good faith; 3) a duty not to evade contractual obligations in bad faith; and 4) a duty of honest performance (Bhasin paras 49-73).
Wastech concerns the duty to exercise contractual discretion in good faith. In this case, Wastech Services Ltd. (“Wastech”), a waste removal company, claimed that the Greater Vancouver Sewage and Drainage District (“Metro”) breached their duty when they made discretionary choices that diminished Wastech’s profit. In a 9-0 decision on the result, with Brown, Rowe, and Coté JJ offering a concurring opinion, the SCC clarified what constitutes a breach of this duty.
Facts of the Case
Wastech has had an ongoing commercial relationship with Metro since at least 1986. In 1996, the two parties entered into a 20-year contract. The purpose of the contract was to ensure that the municipal waste system would be handled in “a reliable, cost-effective, and environmentally-sound manner” (para 9). The contract was complex and thorough; it was negotiated for about 1 ½ years and contemplated waste removal and transportation to three different sites: the Burnaby Waste to Energy Facility, the Vancouver Landfill, and the Cache Creek Landfill. As per the contract, Wastech would be charged a reduced rate for transporting waste to the closer Burnaby Waste to Energy Facility and the Vancouver Landfill compared to the farther Cache Creek Landfill.
To ensure that the contract meets the objective of being cost-effective while remaining a financially viable endeavour for Wastech, a compensation structure around a “target operating ratio” (“Target OR”) of 0.890 was devised. This meant that Wastech’s target operating costs would be 89% of its total revenue, allowing for an 11% profit margin (para 11). Target OR was not guaranteed; however, if Wastech’s actual operating cost (“Actual OR”) was more or less than Target OR, the party that was financially enriched as a result would pay 50% of the difference between the Target OR and the Actual OR to the other party. Moreover, the contract provided that if the Actual OR of any given year was below 0.860 or above 0.920, the rates paid to Wastech would be adjusted for the following year (para 12). During negotiations, the parties were aware that Metro could reduce the amount of waste making the long-haul trip to the Cache Creek Landfill and re-route waste to the Vancouver Landfill. This would cut costs for Metro but also put Wastech at risk of not meeting their Target OR. Nonetheless, the contract gave Metro absolute discretion to determine how much waste would go to the Cache Creek Landfill (para 13).
To help Wastech plan for each coming year, Metro committed to providing Wastech with an annual waste allocation plan. In September 2010, Wastech received Metro’s 2011 annual waste allocation plan and found that Cache Creek Landfill would receive 31% less waste than in 2010 while Vancouver Landfill would receive 36% more. As a result of the allocation, Wastech operated at a loss, with an operating ratio of 1.045. After applying the adjustments pursuant to the contract, their Actual OR was 0.960, a 4% profit. Wastech referred the issue to arbitration pursuant to s.18.3 of the contract, claiming that Metro made choices that deprived Wastech of being able to meet their Target OR. They sought compensatory damages of $2,888,162 (para 18).
Arbitrator finds for Wastech
At arbitration, Wastech argued that Metro’s discretionary power to determine how to allocate waste was subject to a duty of good faith. As such, Metro’s discretion could not be exercised in a manner that would make it impossible for Wastech to achieve the Target OR. The arbitrator agreed, finding that Metro’s decision to reallocate waste in the way that it did was to further its own business interests. As a result, this deprived Wastech of the “fundamental benefit for which [it] bargained for—the opportunity to achieve the Target OR (“para 27”). Given the fact that Wastech and Metro had a long-standing, relational agreement, the arbitrator found that Metro ought to have had “appropriate regard” for the contractual interests of Wastech when exercising its discretionary power. Disregarding Wastech’s interests, thus, constituted a breach of Metro’s duty of good faith and required appropriate compensation.
British Columbia’s Supreme Court and Court of Appeal deny a finding for Wastech
Metro appealed the award granted to Wastech to the British Columbia Supreme Court (“BCSC”) where McEwan J set aside the award. McEwan J found that Wastech’s contractual interests did not place “reasonable constraints” on how Metro exercised its discretion (para 33). McEwan J observed that any claim that Wastech’s contractual interests bound Metro’s action had to be grounded in the terms of the contract itself. During negotiations of the contract, the parties were aware that Metro could choose to reduce waste disposal at Cache Creek Landfill but did not include a provision dictating minimum amounts that should go to Cache Creek Landfill. Rather, the parties agreed to give Metro absolute discretion. Thus, McEwan J found that no reasonable constraints were contemplated in the contract and accordingly, Metro exercised its discretion within the bounds of the contract. Even though such discretion was at odds with Wastech’s interests, exercising their contractual discretion in that manner did not amount to a breach of the duty.
Wastech appealed to the British Columbia Court of Appeal (“BCCA”) but their claim was also dismissed. Writing for the Court, Newbury JA stated that the arbitrator failed to properly determine the actual contractual interests and expectations of Wastech. Though Wastech argued that they needed to be able to meet their Target OR, this was only a goal, not a guarantee. The arbitrator also concluded, incorrectly, that Metro’s conduct did not need to be examined in order to determine if they breached their duty of good faith. This finding would have found a “stand-alone duty not to show ‘disregard of [the other party’s] contractual interests” (para 37). Finally, Newbury JA found that the arbitrator was incorrect to find that Metro acted unfairly when they had exercised their contractual rights as permitted in the contract. While their choices were not in the interests or expectations of Wastech, that alone does not infer a breach on the part of Metro.
The Supreme Court dismisses the Appeal, finds for Metro
The SCC found for Metro 9-0 on the result of the case, with Kasirer J writing the majority opinion and Brown and Rowe JJ writing a concurring opinion. The SCC was asked to consider two issues:
- Whether the BCCA reviewed the case on the incorrect standard of review; and,
- Whether the BCCA erred in finding that Metro did not breach their duty to act in good faith.
On the first issue, Wastech argued that BCCA was bound by the arbitrator’s findings and if the decision were to be reviewed, it needed to be on the reasonableness standard, not on the correctness standard, as was done at the BCCA. Kasirer J decided to forgo an answer to that specific question, finding instead that on either the reasonableness or correctness standard, the decision of the arbitrator would be overturned. In their concurring opinion, Brown and Rowe JJ believed that the SCC should have determined the appropriate standard of review.
As for the second issue, Wastech argued that Metro breached their duty of good faith, specifically their duty to exercise contractual discretion in good faith. The SCC agreed that the duty of good faith was not breached by Metro because they performed their rights as provided for in the contract. Kasirer J explained that the duty to exercise contractual discretion in good faith places limits on how a party can exercise its duty. It requires that parties exercise their absolute discretion honestly, not capriciously or arbitrarily and requires reasonable contractual performance. A breach of the duty of exercising contractual discretion in good faith would be found where discretion was exercised in a way that was unconnected to the purpose of the contract (para 49). Kasirer J observed that reasonableness is “highly context-specific” and “depends upon the intention of the parties as disclosed by their contract” (para 52).
In this case, the purpose of the contract was to “maximize efficiency and minimize costs” (para 98). In accordance with this purpose, the contract allowed Metro flexibility to account for variable factors by giving them absolute discretion to determine the waste allocation between Cache Creek Landfill and Vancouver Landfill. The risk that the Vancouver Landfill could be maximized by reducing the amount of waste allocated to the Cache Creek Landfill, was acknowledged by both parties. However, no mechanism was included in their very meticulous and thorough contract. Kasirer J found this to be intentional. The contract did not guarantee that Wastech would meet its Target OR. In the event that Wastech did not meet Target OR, a mechanism was adopted to ensure that this venture remained financially rewarding. This did not make Wastech Metro’s fiduciary, nor did they have to deprive themselves for Wastech’s benefit. As a result, Metro did not breach its duty to exercise contractual discretion.
Maintaining the Expectations of Commercial Life Wins the Day
Arguably, it seems that the nature of the commercial activity is an underlying consideration in this decision. The SCC’s more deferential approach appears to do a better job of balancing the needs of the parties without making any drastic changes to what is expected in commercial life. To this point, Kasirer J argued that the common law recognizes that business requires parties to promote themselves to the disadvantage of others. This conduct is encouraged and protected by the common law, not prohibited. This helped inform his reasoning that a breach of the duty to exercise contractual discretion should only be considered when it is arbitrary and outside of the reasonable expectations of the contracting parties. Kasirer J also stressed that this duty should not be used as a means to scrutinize business decisions nor as a conduit for “judicial moralism” (para 74). The way to “police” or restrict the behaviour of the contracting party is through the contract itself. As such, the purpose of a contract must be clear and explicitly state what is intended and, if there is contractual discretion, its limits should be contemplated. A contract without clear specifications, particularly amongst sophisticated parties, should not by way of a breach of duty to exercise contractual discretion in good faith prevent the “aggressive pursuit of self-interest” that defines commercial life (para 74).