While contracting parties entering into a contract are largely free to craft any agreement they wish, there are certain limits to that freedom, which can’t be overridden by any contractual provision. In particular, parties can’t contract out of the duty of good faith in contractual performance, which requires parties to exercise their contractual rights and perform their contractual obligations honestly. But how does this duty apply to unfettered contractual rights, such as termination for convenience clauses?
Parties must not mislead counterparties in the course of exercising a contractual right
The Supreme Court of Canada recently commented on the duty of good faith in the context of a termination for convenience clause in CM Callow Inc v Zollinger, 2020 SCC 45 [“Callow”]. In Callow, the contract at issue included a clause permitting the agreement to be terminated without cause upon 10 days’ notice. While the terminating party in Callow abided by the terms of the clause on its face, a dispute arose as to whether the right to terminate the contract had been exercised honestly and in accordance with the duty of good faith in contractual performance.
Specifically, Mr. Callow’s landscaping service contract was terminated by the parties for whom the services were provided (“Baycrest”) pursuant to the termination clause. However, it turned out that Baycrest had decided to terminate the contract several months prior, while nonetheless accepting free work performed by Mr. Callow in hopes of him securing a contract renewal and with full knowledge that Mr. Callow believed a renewal was likely. In fact, the Court found that Baycrest’s representatives actively suggested they were satisfied with Mr. Callow’s performance and the contract was likely to be renewed.
In reaching its decision, the Supreme Court focused its analysis on the duty to honestly perform a party’s rights and obligations under a contract as a component of the duty of good faith in contractual performance. In particular, the Court considered: (1) when the duty arises; and (2) how it may be breached.
When: The duty of honest performance arises when there is a direct link between the alleged dishonesty and the exercise of a right or obligation under the contract. A direct link exists where a party performs its obligations or exercises its rights under the contract dishonestly.
How: Whether the duty of honest performance has been breached requires a highly fact-specific analysis. While there is no active duty to disclose information or subordinate one’s own interests to those of the other party, a failure to act honestly can arise in a number of ways. A party may commit a breach if it “knowingly misleads” the other party in any manner, including by way of lies, half-truths, omissions, or even silence, depending on the particular circumstances at issue.
Ultimately, the Supreme Court concluded that the duty had been breached on the facts of this case. In the course of exercising the termination clause, Baycrest intentionally withheld information, knowing that its silence and other active communications had deceived Mr. Callow. By failing to then correct Mr. Callow’s misapprehensions, Baycrest breached its duty of honest performance.
What does this mean for you?
While your contract might include a provision allowing you to terminate for any reason whatsoever, the Supreme Court of Canada's most recent decision means you have to take a closer look at the conduct surrounding the termination and carefully consider whether exercise of your termination rights could be challenged based on the parties' behaviour. This is a potentially difficult and confusing task, though an important one when assessing the risk associated with termination. As a party whose contract is terminated without cause, there may be recourse depending on the actions of the parties in connection with the termination.
If you have questions about a termination for convenience clause in your contract, or if you would like to learn more about the contractual duty of good faith, please contact Catriona Otto-Johnston, Partner, at Rose LLP for further information. Contributions to this article were also made by Elisa Stewart, a former Associate at Rose LLP.
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