Often contracts provide one party with a discretionary power. The limits of that discretionary power were recently considered by the Supreme Court of Canada in Wastech Services Ltd. v. Vancouver Sewerage and Drainage District, 2021 SCC 7. In particular, Wastech considers when a party can act in its own self-interest and when the act amounts to bad faith. While the Supreme Court of Canada recognized a duty to exercise contractual discretion in good faith in 2014[1], until Wastech the limits of that duty were not identified.
Wastech considered an appeal from an arbitral decision arising from a contractual dispute. The Greater Vancouver Sewerage and Drainage District (“Metro”) entered into a long-term relational contract with Wastech Services Ltd. (“Wastech”) for the removal and transportation of waste to one of three disposal sites. The contract provided that Metro would be paid a different rate depending on which site waste was transported to, and granted it absolute discretion in deciding how waste was to be allocated between the sites. Metro’s discretionary allocation decisions in 2011 resulted in Wastech’s costs increasing such that it could not meet its “Target Operating Ratio”, causing a lower operating profit than expected. Wastech sued, but did not claim that Metro exercised its discretion in an arbitrary or dishonest manner. Instead, Wastech argued that Metro failed to show appropriate regard to Wastech’s “legitimate contractual expectations”. The arbitrator agreed, concluding that Metro breached the duty of good faith.
The BC Supreme Court and Court of Appeal overturned the arbitrator’s decision, holding that Metro’s exercise of discretion, in this case, did not constitute a breach of the duty of good faith. The Supreme Court of Canada upheld the decisions of the lower courts, but for different reasons.
The majority of the Supreme Court of Canada held that if a contract grants a party discretionary power – that is, when a contract offers a party some latitude of choice when acting under a contract – that party is required to
exercise their discretion in a manner consistent with the purposes for which it was granted in the contract, or, in the terminology of the organizing principle in Bhasin, to exercise their discretion reasonably.[2]
This rule will operate irrespective of the intentions of the parties and is obligatory in all contracts.
Reasonableness in this context requires only that the party who is exercising the discretionary power do so in a manner connected to the purpose for which the power was created. Where such a connection does not exist, the party’s exercise of discretion will be considered unreasonable and a breach of the duty of good faith.[3] This will occur when the discretion is exercised arbitrarily or capriciously.
Importantly, the duty of good faith does not require that a party subordinate its interests to those of the other contracting party, or to confer a benefit on the other party that was not part of the original agreement. This means that, where the overarching requirement of reasonableness is met, a party may sometimes cause its contracting partner loss in the “legitimate pursuit of self-interest” without being found to have exercised its discretion wrongfully or in bad faith[4].
Applied to this case, the Supreme Court of Canada concluded that Metro’s exercise of discretionary power was connected to the purposes of the agreement. In other words, it was reasonable and not contrary to the duty of good faith. The purpose of granting Metro absolute discretion was to give it the flexibility it required to maximize efficiency while minimizing costs of operation. This was particularly important in light of the operational variability the parties themselves foresaw. Metro acted in connection with that purpose.
Critically, the duty of good faith did not require that Metro subordinate its interests to those of Wastech when determining how to allocate waste. The parties were aware of the risk that Wastech might fail to meet its Target Operating Ratio in any given year, but chose to leave that risk in the contract. The contract also did not guarantee to Wastech that it would make a profit or that it would achieve its target. Metro’s choice, though disadvantageous to Wastech, was within the “range permitted by the purpose of the clause” and therefore consistent with the duty of good faith, even if its contracting partner suffered as a result.[5]
The key takeaway from Wastech is that contracting parties can exercise discretion selfishly in the pursuit of their own profits as contemplated in a contract, even where the result is an erosion of the other parties’ profits. The duty to exercise contractual discretionary powers in good faith will only be breached when the exercise of discretion is unreasonable, in the sense that it is unconnected with the purpose for which it was granted. It remains open for parties to act in their own self-interest, even if it causes their contracting partner a loss, so long as this overarching requirement of reasonableness is met.
If you have any questions relating to the article, please contact Judy Rost or a member of our Business Disputes Group.
With thanks to articling student, Matthew Nakatsu for his assistance.
[1] Bashin v. Hrynew, 2014 SCC 71
[2] Wastech Services Ltd. v. Vancouver Sewerage and Drainage District, 2021 SCC 7 [Wastech] at para 63
[3] Wastech at para 69
[4] Wastech at para 112
[5] Wastech at para 106
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