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Business person filling the contract

Larisa Bozhikova/Getty Images/iStockphoto

The common law operates like Christopher Columbus in reverse. Instead of loudly proclaiming the "discovery" of an already populated New World, judges create novel laws from old cases.

This process of finding new rules in old law is useful for understanding the Supreme Court of Canada's unanimous decision in Bhasin v. Hrynew where Justice Cromwell uses both Canadian and American law to carve out a new duty of good faith in contractual performance.

For now, the Supreme Court's decision makes contract law more uncertain. It means that judges will have more discretion, which may mean more litigation and more discomfort on the part of parties wishing to cancel contracts, at least until courts elaborate on the decision and contracts adjust. But despite the risk of more litigation, this uncertainty is the price of making contract law better at what it's supposed to do – determine what the reasonable expectations of contracting parties are.

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One way we could interpret contracts is technically and literally. For example, if a contract fails to specify which party has to obtain a necessary permission for the completion of a sale – say, for the subdivision of a tract of land – and only one party is capable of obtaining that permission but refuses to, we could let that contract fail.

This doesn't square with commercial reality. When the parties signed the contract, they intended to undertake good faith efforts to complete the transaction and the failure by the only party capable of obtaining the permission to do so is a failure of that intention. In other words, a duty of good faith more accurately reflects the reasonable expectations of the contracting parties.

Where contracts give a party discretion, there is an expectation that discretion will be exercised in good faith. As Justice Cromwell says "parties will rarely expect that their contracts permit dishonest performance of their obligations."

The duty that Justice Cromwell finds in Bhasin, implies a duty of good faith in exercising a non-renewal provision beyond reasonable notice. The plaintiff in Bhasin is, unsurprisingly, one Mr. Bhasin, a former enrollment director for Canadian American Financial Corp ("Can-Am", now known as Heritage Education Funds Inc.) who sold education savings plans to investors. Over ten years, Mr. Bhasin built a successful business. Mr. Bhasin's contract with Can-Am provided for automatic renewal every three years with the condition that either party could terminate the contract on six months notice. In 1999, Can-Am hired one Mr. Hrynew, a competitor of Mr. Bhasin, and reached a deal with him that would have forced a merger of Mr. Bhasin's business into Mr. Hrynew's and put Mr. Hrynew in a position to view Mr. Bhasin's books.

Critically, on multiple occasions, Can-Am misled Mr. Bhasin when he asked about their dealings with Mr. Hrynew. In May 2011, when Mr. Bhasin refused Mr. Hrynew access to his books, Can-Am gave Mr. Bhasin his notice of non-renewal. Mr. Hrynew subsequently took over most of Mr. Bhasin's business. It was the exercise of the non-renewal clause that the Court found to be not in good faith.

While Justice Cromell shows that American law has recognized this in both its foundational contractual documents – the Uniform Commercial Code (the UCC) governing the law of commercial transactions and the Restatement (Second) of Contracts – his account doesn't tell the whole story.

Generally, American law treats good faith differently in the context of termination or non-renewal provisions. The UCC requires only that parties give each other reasonable notice when terminating a contract in order to satisfy their duty of good faith. Similarly, recent jurisprudence in New York State – the most influential commercial law jurisdiction in the world – finds that where parties have explicitly negotiated a right to terminate, the law does not require that parties do so for a good faith reason.

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This creates a bit of a puzzle – Can-Am's bad faith towards Mr. Bhasin during the performance of the contract didn't cause Mr. Bhasin's any damages as his contract was not renewed before he was forced into a merger with Mr. Hrynew. However, Mr. Bhasin was awarded damages based on his loss from the failure to renew the contract, an action that, taken on its own, seems to meet most common law standards of good faith.

Though Justice Cromwell offers little guidance in his opinion as to how Can-Am's bad faith towards Mr. Bhasin with respect to the merger negotiations applies to Mr. Bhasin's termination, he clearly views the two as intimately related. This is, I think, because Justice Cromwell – perhaps borrowing a bit from Quebec's civil law – views contracts as relational. Mr. Bhasin had devoted over ten years to Can-Am, his contract had been renewed multiple times, Mr. Bhasin likely developed a set of expectations that Can-Am would communicate with him honestly about the renewal of his contract and the state of his business, especially since the termination was arguably done to appease Mr. Hrynew.

This is a broader and fuzzier conception of good faith than what U.S. jurisprudence offers, but it's also a more honest one. The expectations parties have of one another change over time and that means the duties of good faith change over time. Even if Can-Am would have terminated Mr. Bhasin regardless of their interactions with Mr. Hrynew, ten years, multiple contract renewals and much personal investment by Mr. Bhasin into the business suggest that he was owed better than a lie.

In finding a duty of good faith, Justice Cromwell carefully surveyed both Canadian and international law, in particular American law, and found that a duty of good faith in contractual performance is both an accepted common law principle in other jurisdictions and a lurking assumption in much Canadian jurisprudence. Like the new world, it had always been there; it was just waiting to be discovered.

For the time being, terminating parties will have to be more honest and careful in exercising rights to terminate; but the obligation to exercise one's discretion in good faith will lead to both contracts and case law that better reflect the promises that parties make to one another. If this makes you uncomfortable think about North America's early settlers – brave new worlds can be scary places, but that doesn't mean their "discovery" was a bad idea.

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