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A line-up of cars waiting to drop off garbage at Wastech in North Vancouver.LAURA LEYSHON/The Globe and Mail

The obligation to show good faith in the performance of a contract stops short of harming one’s own interests, the Supreme Court has ruled.

The ruling came in a dispute between a waste management company and a government board in Vancouver. It is important for businesses, because it puts limits on what good faith requires of each party to a contract. At the same time, the ruling underlines that parties must act reasonably, not just honestly, when contracts allow them discretion in their conduct.

In 2014, the court said that good faith and honesty are central to contract law, barring the parties from lying to or misleading each other. In December, the court said that dishonesty can include misleading through silence, or failing to correct a misimpression.

No dishonesty was alleged in the dispute between Wastech Services Ltd. and the Greater Vancouver Sewerage and Drainage District, a board responsible for overseeing waste disposal. The issue was whether the municipal board had used discretion allowed by the contract to serve its own interests at the expense of the company’s, thus violating its obligation to deal fairly and in good faith with Wastech.

Wastech had a 20-year contract with the city, and was responsible for delivering waste to three sites; the further away the sites, the more money it made. The contract left it to the municipality’s “absolute discretion” to alter the proportion of waste it sent to the three sites. And while Wastech had a target profit written into the contract, it did not have a guarantee that the municipality would meet that target.

The Vancouver board chose, 15 years into the deal, to send more of its waste to a closer site in the name of cost-effectiveness. Wastech accused it of acting unfairly, and sought damages. The two sides had a long-standing relationship based on trust, the company said, and in such a situation, the municipality had broken with the company’s reasonable expectations.

The unfairness, the company told the Supreme Court in a legal filing, was that the city “reduced its waste allocations to reduce its own costs knowing that this would make it impossible” for Wastech to meet its profit target in 2011.

But the Supreme Court unanimously disagreed.

“Wastech is asking for [the municipality’s] discretion to be constrained so that it can achieve a result – an advantage – for which it did not bargain and, in fact, that it might have been said to have bargained away,” Justice Nicholas Kasirer wrote on behalf of himself and five other judges.

The loyalty required of the municipality was “loyalty to the bargain, not loyalty to Wastech.” Courts must look at whether discretion allowed by a contract was “reasonable” – that is, used in a way that is consistent with the purposes of that contract, such as cost-effectiveness. He added that it is unnecessary to “act selflessly.”

Three other judges would have gone further to limit the good-faith requirement when a party uses its discretion in the exercise of a contractual power. Justice Malcolm Rowe, Justice Russell Brown and Justice Suzanne Côté said “loyalty” to the shared business venture or contract had no place in the dispute.

“Such a starting point risks, even invites, undermining freedom of contract and distorting the parties’ bargain by imposing constraints to which they did not agree,” Justice Brown and Justice Rowe wrote for the group of three.

Wastech declined comment.

Irwin Nathanson, a lawyer for the board in the dispute, called the decision “extremely important.”

“My client is pleased with the result … and the clarity provided with respect to the doctrine of contractual good faith performance,” he said.

Jeremy Opolsky, a lawyer in Torys litigation group in Toronto, said the court’s ruling will give comfort to the business community. “What is reasonable and fair is defined foremost by the contract itself and, within that framework, they can make business decisions in their interest,” said Mr. Opolsky, who represented the Canadian Chamber of Commerce, an intervenor in the case.

Brandon Kain, a lawyer with McCarthy Tétrault in Toronto, who was not involved in the case, said the ruling confirms that “good faith requires discretionary contractual powers to be exercised in a manner that is reasonable, not only in a manner that is honest.”

John McCamus, a professor emeritus at Osgoode Hall Law School, said the court had “reaffirmed and strengthened its embrace of an underlying general principle requiring contract parties to perform their contractual obligations in good faith.”

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