B.C. – court identifies limits to duty of good faith to meet party’s contractual expectations – #062

In allowing an appeal on a question of law, Mr. Justice Mark T. MacEwan in Greater Vancouver Sewerage and Drainage District v. Wastech Services Ltd., 2018 BCSC 605,  ruled that the doctrine of good faith cannot fill gaps left by parties in their contracts.  One party’s exercise of its contractual rights can deny the other party’s contractual expectations but will not breach the duty of good faith if their contract contains no express or implied terms to safeguard those expectations.   MacEwan J. held that sophisticated parties do leave gaps in their agreements which either might regret even if the situation is “highly unlikely”.

Wastech Services Ltd. (“Wastech”) and Greater Vancouver Sewerage and Drainage District (“Metro”) entered into a December 20, 1996 contract for the operation and management of the Greater Vancouver Regional District’s waste disposal system entitled “Comprehensive Agreement” (“CA”).  Wastech and Metro negotiated the CA over the course of eighteen (18) months producing what MacEwan J. as a “unique, complex and long-term” agreement.

The CA provided that solid municipal waste would first be delivered to a number of transfer stations around the lower mainland and then transported by Wastech to the Cache Creek Landfill (“CCLF”), the Vancouver Landfill (“VLF”) or the Burnaby Waste to Energy Facility (“Burnaby Incinerator”).

The CA provided that compensation for Wastech’s transfer, transport and disposal services to CCLF would be calculated by payment of a ‘Long Haul Rate’ (“LHR”) and its transfer and transport services to VLF and Burnaby Incinerator by way of a ‘Short Haul Rate’ (“SHR”).  The costs of running the different transfer stations were apportioned to the LHR and SHR based on the tonnes of waste long-hauled to CCLF as opposed to those short-hauled to VLF and Burnaby Incinerator.  Distance matters.

In their CA, Wastech and Metro agreed that Wastech’s compensation would be based on an 89% ‘target operating ratio’ (“Target OR”) which sought to cap operating costs at 89%, leaving Wastech to realize the balance as an operating profit.  Wastech and Metro established that Target OR based on financial performance generated from their prior dealings.

The volume of waste allocated to each of the three disposal sites served as a critical variable in calculating revenues and costs and Wastech’s ability to reach its Target OR.  MacEwan J. noted a key fact: “When the CA was made, both parties knew that if the Target OR was to be achieved, rates, costs, and total volumes allocated to each disposal site all had to be in an appropriate balance”.

The CA gave Metro the discretion to annually allocate waste between the three disposal sites but also the obligation to provide Wastech each August 15 a detailed forecast for the following operating year. That detailed forecast allowed Wastech and Metro to formulate an Annual Waste Allocation Plan.  The Annual Waste Allocation Plan also allowed Metro to plan its future operations and manage its costs.

In 2010, Metro took the decision to significantly redirect the volume of waste from CCLF to VLF.  Doing so resulted in a 2011 Annual Waste Allocation Plan in which it was impossible for Wastech to achieve its Target OR.  That year, its Target OR was 96%.

Despite Wastech’s proven contractual expectations, the CA included no provision to compensate Wastech for lost profits occasioned by a negative impact on the Target OR caused by Metro’s decision to significantly reallocate waste volumes.  MacEwan J. noted : “The CA did not expressly deal with a re-distribution of waste from the CCLF (such as occurred in 2011) because, when the CA was under negotiation, the parties’ representatives considered that it was not realistically possible that Metro would do this.

The facts demonstrated that the parties had drafted their CA based on what they believed would be realistic and not radical redistributions of waste volumes.

The parties jointly decided to not provide a specific remedy for what occurred in 2011 because their common expectations of performance considered it unnecessary. The Arbitrator found that the parties did not deal with a radical redistribution of waste from the CCLF (as occurred only in 2011) because when the CA was under negotiation, the parties’ representatives considered that it was not realistically possible that Metro would do this, in large measure because the express premise that the CCLF would be used to its maximum annual capacity during the term of the CA, that is recital C(6).

The arbitrator had determined the CA contained no express term which would provide a contractual basis on which Wastech could apply for compensation.  The arbitrator also determined that he could not imply a rate-reset provision.  The arbitrator held that Metro did not exercise its discretion in a capricious or arbitrary manner, that Metro’s exercise of its discretion was to further Metro’s own objectives and that Metro’s conduct was honest and reasonable, at least from Metro’s own perspective.  That said, the arbitrator held that Metro’s behaviour lacked “appropriate regard” for Wastech and was in effect “dishonest”.

Excerpts from the arbitrator’s reasoning contained in the award appear in MacEwan J.’s reasons.  A key excerpt of the arbitrator’s reasoning, and which supported in part the arbitrator’s decision to grant Wastech’s claim, focused on the doctrine of good faith articulated by the Supreme Court of Canada in Bhasin v. Hrynew, [2014] 3 SCR 494, 2014 SCC 71 and the impact that doctrine had on the exercise of express contractual rights.

Inherent in the concept of an obligation to perform contracts in good faith is the proposition that the mere fact that the impugned act is expressly authorized by, or not prohibited by, the contract is not determinative. The circumstances in which the contractual right is exercised and the impact of its exercise on the other contracting party may be such as to preclude or limit the exercise of the right. The focus of the organizing principle stated in Bhasin is on conduct that does not show “appropriate regard” for the “legitimate expectations” of the other party as to how the contract will be performed. It seems to me that the good faith doctrine, characterizes the exercise of even an acknowledged, bargained-for contractual right as “dishonest” where it is wholly at odds with the legitimate contractual expectations of the other party. No additional form of dishonesty is required to be shown.

One of the questions raised in the appeal to the court was whether the arbitrator erred in law by holding that the denial of one party’s expectations under the contract could be a basis for a breach of the duty of good faith.  In other words, did the arbitrator err in law by equating the ‘organizing principle’ set out in Bhasin to a free-standing obligation of contractual good faith.

The issue of an implied term for a rate re-set was distinct from the issue of the breach of good faith.

MacEwan J.’s reasons include extensive excerpts from cases exploring the limits of good faith’s impact on contracts.  The excerpts demonstrate the courts’ own difficulty articulating not only the concept of good faith and upholding contractual bargains but what to do when those two intersect.

Those excerpts provide stirring statements which explain the duty of good faith and set limits to its application.  On one hand, the duty of good faith is described by Mr. Justice Edward P. Belobaba in Data & Scientific Inc. v. Oracle Corp., 2015 ONSC 4178 as a “broader organizing principle” by which the courts expected parties “to perform their contractual duties honestly and not capriciously or arbitrarily” and be subject to a “general duty of honesty”.   On the other, others caution against creating what Mr. Justice Frederick L. Meyers described in Empire Communities Ltd. et al. v H.M.Q. et al., 2015 ONSC 4355 as being “a free-standing, ill-defined, and potentially arbitrary duty of good faith against which to measure all aspects of contractual performance.”

MacEwan J. concluded that a denial of a party’s contractual expectations cannot be the basis of a breach of duty of good faith unless that breach is based on the terms of the contract itself.   MacEwan J. observed that the appeal presented him with a particular situation.  “This was a case of sophisticated parties leaving aside a term that might have addressed the problem. It is not a situation in which the parties overlooked or failed to consider a provision; it was a situation in which they could not agree.

In allowing the appeal, MacEwan J. recognized the efforts of the arbitrator to resolve the dispute according to the expectations which Wastech and Metro accepted as having been established.  Both knew of Wastech’s legitimate expectations and that any rate adjustment by Metro which thwarted Wastech’s ability to meet that expectation was “highly unlikely”.  As the arbitrator wrote, “by a mutual desire to simplify the CA, both parties agreed that no provision dealing with that eventuality should be included in the CA.”

[63] In the circumstances of this case the Arbitrator attempted to do what is fair, not as grounded in the CA but in a more general sense. Bhasin is not authority for the proposition that contracts may be adjusted to accommodate situations where one party regrets the contract in hindsight.

Despite the proven fact that one party’s contractual expectations had not been met and the efforts of the arbitrator to navigate the undertow created by the competing streams of case law set out in Data & Scientific Inc. and Empire Communities Ltd. cited above, MacEwan J. concluded that what is clearly fair is not always clearly reflected in the parties’ contracts.

urbitral note: leave to appeal Greater Vancouver Sewerage and Drainage District v. Wastech Services Ltd., 2019 BCCA 66 to Supreme Court of Canada granted July 18, 2019 in file no. 38601.