Clarity on the duty to exercise contractual discretion in good faith: Wastech Services Ltd. v Greater Vancouver Sewerage and Drainage District, 2021 SCC 7

Overview

The Supreme Court of Canada released its decision in Wastech Services Ltd v Greater Vancouver Sewerage and Drainage District [1] (the “Wastech Decision”) on February 5, 2021. The Wastech Decision was heard together with the case of C.M. Callow Inc v Zollinger, [2] and both are important elaborations on the manifestations of the organizing principle of good faith in contract enunciated in the Supreme Court’s seminal decision of Bhasin v Hrynew. [3]  In particular, the Court in the Wastech Decision was tasked with clarifying the basis and scope of the common law duty to exercise contractual discretion in good faith and the applicable standard against which to determine its breaches.

Facts

The Appellant, Wastech Services Ltd. (“Wastech”), is a British Columbia waste transportation and disposal company that was party to a long-term service contract with the Respondent, the Greater Vancouver Sewerage and Drainage District (“Metro”).  Metro is a statutory corporation responsible for administering waste disposal throughout the Metro Vancouver Regional District. [4]

The contract between Wastech and Metro concerned the allocation, transportation and disposal of waste in the Vancouver region to three disposal facilities: the Vancouver Landfill, the Burnaby Waste to Energy Facility, and the Cache Creek Landfill. [5] Wastech earned a rate premium on transport to Cache Creek, as it was relatively further away; [6] however, Metro was conferred “absolute discretion” to determine the amount of waste disposed at the Cache Creek site each year. [7]  Wastech’s annual compensation was “structured around” a target operating ratio of 0.89, which target meant that Wastech’s operating costs represented 89% of its total revenues, equating to an 11% operating profit. [8] Although achievement of Wastech’s target operating ratio was not guaranteed under the contract, if Wastech’s actual operating ratio deviated from its target, the contract provided for an adjustment payment to be made from one party to another so as to equalize the financial consequences of the variable that caused such deviation. [9]  One such change that could affect achievement of Wastech’s target operating ratio was Metro’s decision to reduce waste disposal at the Cache Creek facility, and this circumstance was contemplated by the parties during negotiation. [10]

In 2011, Metro re-allocated waste from the Cache Creek Landfill to the Vancouver Landfill, making it impossible for Wastech to achieve its target operating ratio, reducing Wastech’s revenue for that year, and causing it to operate at a loss before the adjustment payments were made. [11] Wastech commenced arbitration proceedings against Metro under the contract, claiming $2.8 million in damages for the profits it lost as a result of Metro’s discretionary re-allocation decision. [12] Wastech argued that Metro’s exercise of contractual discretion in this respect breached its duty of good faith under the contract.

Procedural History

Wastech was successful before the arbitrator, [13] but Metro was similarly successful at seeking leave to appeal the arbitral award to the British Columbia Supreme Court [14] pursuant to Section 31 of British Columbia’s Arbitration Act. [15] Accordingly, the arbitral award was appealed to the Supreme Court of British Columbia, [16] then to the British Columbia Court of Appeal, [17] and finally to the Supreme Court of Canada. [18] The arbitral award was set aside on appeal to the British Columbia Supreme Court, which result was upheld by the British Columbia Court of Appeal (albeit for differing reasons than those of the chambers judge). Wastech then secured leave to appeal to the Supreme Court of Canada, seeking to restore the arbitral award in its favor.

The Supreme Court’s Analysis & Key Takeaways

The Supreme Court unanimously dismissed Wastech’s appeal and the arbitral award remained overturned; however, its reasons for doing so were split six Justices to three. Justice Kasirer authored the majority’s reasons and Justice Brown authored concurring reasons.

The Majority of the Supreme Court enunciated the following key principles:

1. Contracting parties have a duty to exercise contractual discretion honestly [19] and in good faith. [20] This duty, like the duty of honest performance, is a “general doctrine of contract law” that “operates in every contract irrespective of the intentions of the parties.” [21]
2. The duty to exercise discretion in good faith obligates contracting parties to exercise said discretion reasonably, [22] which means “connected to the purpose for which the contract granted the discretion.” [23] Generally speaking, there will often be a range of legitimate, reasonable choices or exercises of discretion (and corresponding outcomes flowing therefrom) “in light of the purposes identified by the contract.” [24] Thus, “good faith does not eliminate the discretion-exercising party’s power of choice … it simply limits the range of legitimate ways in which a discretionary power may be exercised in light of the relevant purposes.” [25]
3. The “touchstone” or standard that courts use to measure and evaluate whether a party has exercised their discretion reasonably and in good faith is the purpose for which the discretion was created and conferred according “to the bargain the parties had chosen to put in place,” which is the “first source of justice between the parties.” [26] Where the purpose or intentions of the parties with respect to the conferred discretion is not explicitly discernible from the text of the contract, the court must engage in contractual interpretation to ascertain same. [27] In this way, judicial review of the reasonableness of a contracting party’s discretion remains grounded in the parties’ own contract and intentions, and it will be inappropriate for a court to evaluate a party’s choices based on its own view of whether the discretion was exercised fairly, morally or wisely (in a commercial sense, or otherwise). [28] This approach avoids “ad hoc judicial moralism.” [29]
4. A party will be in breach of the duty where they exercise contractual discretion in a manner that is not consonant with its underlying purposes, an example of which is “where the exercise of discretion is capricious or arbitrary.” [30] Further, a party will be in breach of the duty where their exercise of discretion “falls outside of the range of choices connected to its underlying purpose – outside the purpose for which the agreement the parties themselves crafted provides discretion.” [31] Discretionary power capable of “objective measurement” will have a “relatively smaller” range of reasonable outcomes, whereas powers not “readily susceptible to objective measurement” will have a relatively larger range of reasonable outcomes. [32] Ultimately, a court’s evaluation of exercises of discretion is “highly context-specific,” and ultimately dependent on the “intention of the parties as disclosed by their contract.” [33]
5. That a party’s exercise of discretion causes its contracting partner to “lose some or even all of its anticipated benefit under the contract,” or causes a “’substantial nullification’ or ‘evisceration’ of the benefit of a contract,” is not determinative or a “necessary prerequisite” to finding a breach of the duty to exercise contractual discretion in good faith.” [34] Rather, such an outcome may be a relevant factor in the analysis of whether the choice leading to that outcome was connected to the animating contractual purposes.
6. The duty does not require the party exercising discretion to “subordinate its interests” to those of its contracting partner, or to confer a benefit on its contracting partner “that was not contemplated under the contract.” [35] This limitation ensures that the duty does not confer an advantage or benefit on a party that was not provided for in the agreement. [36]

Practically speaking, the Wastech Decision makes clear that parties that “provide for discretionary power cannot contract out of the implied undertaking that the power will be exercised in good faith, i.e., in light of the purposes for which it was conferred.” [37] Therefore, parties ought to consider expressly providing for, or identifying, their purposes and intentions behind the creation and conferral of all discretionary powers included in their contract in order to mitigate potential litigation.

What remains unclear in the wake of the Wastech Decision is the applicable standard of review framework for appeals of commercial arbitral awards under provincial arbitration legislation. Pursuant to prior Supreme Court precedents of Sattva Capital Corp v Creston Moly Corp, [38] and Teal Cedar Products Ltd. v British Columbia, [39] arbitral awards appealed under arbitration statutes are reviewed on the deferential standard of reasonableness, unless the questions raised are constitutional ones, or those of central importance to the legal system as a whole and outside the arbitrator’s expertise. [40] However, the Supreme Court recently released its decision in Canada (Minister of Citizenship and Immigration) v Vavilov, [41] (“Vavilov”) which established a revised framework for determining the applicable standard of review from administrative decisions. According to the majority in the Wastech Decision, since Vavilov did not “advert to” those prior Supreme Court precedents on the standard of review applicable to appeals of commercial arbitral awards, this question was most appropriately left to another day. [42] In contrast, the three minority justices in concurrence concluded that, post-Vavilov, the appellate standard of review framework (i.e. the correctness standard) should now apply to appeals of arbitral awards, given that these awards are appealed pursuant to a statutory appeal mechanism and only on questions of law. [43] However, these comments are obiter and the impact of Vavilov on the applicable standard of review for appeals of arbitral awards remains to be resolved by a majority of the Supreme Court.

The Outcome for Wastech

The Supreme Court unanimously concluded that Metro’s exercise of discretion to reduce the waste allocated to the Cache Creek Landfill, which had the effect of reducing Wastech’s profitability for the year and making it impossible for Wastech to achieve the target operating ratio, was not exercised in bad faith.  Since the contract gave Metro absolute discretion to determine the amount of waste disposed at Cache Creek each year, the court engaged in contractual interpretation to discern the parties’ specific intention and purpose behind conferring this discretion on Metro in order to evaluate whether it was exercised reasonably, i.e., consonant with, and within the reasonable range of choices connected to, that purpose. Reading the contract as a whole, and particularly focusing on the recitals to the contract and the adjustable compensation structure in Wastech’s favor, the majority of the Court concluded that the purpose of the discretion was to enable Metro to allocate waste in a way that maximized efficiency and minimized costs, not to guarantee Wastech a certain level of profit. As such, Metro was found not to have breached its duty, as it exercised its discretion reasonably and consistent with the underlying purposes for which it was granted by allocating waste away from Cache Creek Landfill. Wastech’s appeal was ultimately dismissed with costs.

Implications of the Wastech Decision on the Construction Industry, Contributed by Nicholas Willis

In light of the Wastech Decision, stakeholders in the construction industry should remain mindful of all instances in which construction contracts confer discretionary powers to the parties, and ensure their actions are consistent with the purpose of the grant of discretion.

For example, if a contract confers discretion to an owner to accept or reject a contractor’s work (such as in a design-bid-build scenario), the owner must exercise that discretion in good faith such that approval is not unreasonably withheld if the contractor’s work product is consistent with the project specifications.

Conversely, if a contract provides broad design discretion to the contractor (such as in a design-build scenario), the contractor must ensure that it exercises its discretion in good faith, and design the project in a manner consistent with the intentions of the parties in light of the overall contract. However, provided that it does so, the owner’s ability to dictate particular design outcomes may be severely circumscribed.

Finally, the applicable standard of review for appeals of arbitral awards post-Vavilov will be closely monitored as this will impact those construction contracts with binding arbitration clauses.

Miller Thomson is Here to Assist

Miller Thomson LLP is here to help with all of your business needs. If you have further questions about the implications of the Wastech Decision, or other matters of contract drafting, advice or litigation, please contact our Construction Litigation team.

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[1] Wastech Services Ltd v Greater Vancouver Sewerage and Drainage District, 2021 SCC 7, 454 DLR (4^th) 1 [Wastech].

[2] C.M. Callow Inc v Zollinger, 2020 SCC 45, 452 DLR (4^th) 44.

[3] Bhasin v Hrynew, 2014 SCC 71, [2014] 3 SCR 494 [Bhasin].

[4] Wastech, supra note 1 at paras 8-9.

[5] Wastech, ibid at para 10.

[6] Wastech, ibid.

[7] Wastech, ibid at para 13.

[8] Wastech, ibid at para 11.

[9] Wastech, ibid at paras 11-12.

[10] Wastech, ibid at para 14.

[11] Wastech, ibid at paras 15-17.

[12] Wastech, ibid at para 17-18.

[13] BCICAC Case No. DCA-1560, February 13, 2015 (Gerald W. Ghikas, Q.C.).

[14] 2018 BCSC 605.

[15] Arbitration Act, RSBC 1996, c 55.

[16] 2018 BCSC 605.

[17] 2019 BCCA 66.

[18] Wastech, supra note 1.

[19] Wastech, ibid at para 54.

[20] Wastech, ibid at para 58.

[21] Wastech, ibid at para 91.

[22] Wastech, ibid at paras 64-68.

[23] Wastech, ibid at para 69.

[24] Wastech, ibid at para 71, 75.

[25] Wastech, ibid at para 75.

[26] Wastech, ibid at paras 70, 75.

[27] Wastech, ibid at para 72.

[28] Wastech, ibid at paras 71-73.

[29] Wastech, ibid at para 73.

[30] Wastech, ibid at para 4.

[31] Wastech, ibid at para 71.

[32] Wastech, ibid at para 77.

[33] Wastech, ibid at para 76.

[34] Wastech, ibid at paras 83-84.

[35] Wastech, ibid at para 6.

[36] Wastech, ibid at para 7.

[37] Wastech, ibid at para 94.

[38] Sattva Capital Corp v Creston Moly Corp, 2014 SCC 53, [2014] 2 SCR 633.

[39] Teal Cedar Products ltd. v British Columbia, 2017 SCC 32, [2017] 1 SCR 688.

[40] Wastech, supra note 1 at para 45.

[41] Canada (Minister of Citizenship and Immigration) v Vavilov, 2019 SCC 65, 441 DLR (4^th) 1 [Vavilov].

[42] Wastech, supra note 1 at paras 45-46.

[43] Wastech, ibid at para 121.