Conduct Matters in Contracts: The Duty to Be Reasonable (3/4)
This is the third in a series of posts that unpacks the Supreme Court of Canada’s 2014 decision in Bhasin v. Hrynew and looks at how conduct matters in commercial contracts, sometimes more than the words of the contract.
Long before Bhasin, there was a general recognition that parties must exercise their contractual rights and discretions reasonably and to not do so arbitrarily or capriciously. The seminal decision on this duty is the 1958 Supreme Court of Canada decision in Mason v. Freedman[i]. In Mason, the Supreme Court of Canada held that “a vendor who seeks to take advantage of [a] clause must exercise his right reasonably and in good faith and not in a capricious or arbitrary manner”[ii].
Key cases that have considered this duty to exercise one’s contractual rights reasonably have this to say:
- Courts will apply an objective standard or a subjective standard when evaluating the reasonableness of a party’s exercise of a contractual discretion. Where a court uses a subjective standard, the freedom of the party possessing the discretionary power is significant and only good faith and honesty is required. The court will not consider whether the conduct was objectively reasonable. [iii]
- Whether reasonableness is measured against a subjective or objective standard will depend on the words of the contract.[iv]
- When an objective standard of reasonableness is applied, acting reasonably entails some subordination of a party’s interests in the sense that its rights or its conduct will be tested with reference to an external objective standard.[v]
- The use of “sole discretion” has been subject to an objective standard of reasonableness.[vi]
- “Sole opinion” cannot be exercised in an arbitrary or fickle manner. The opinion must be reasonable and must be an opinion held in good faith.[vii]
- Where a party reserves the right to exercise a discretion “unreasonably”, it merely excludes the obligation of the party exercising the power to give reasons for its action. It does not allow a party to exercise its right unreasonably.[viii]
- Even where the expression “in its sole and absolute discretion” is used, a party’s exercise of discretion must be reasonable. No contractual discretion is absolute.[ix]
Parties who wish to reserve greater freedom of decision-making when exercising their contractual rights and discretions must use language that clearly demonstrates that intention.
Regardless of the language, when exercising a contractual right, parties exercising a contractual right or discretion should always be prepared to justify their actions in the event of a challenge as they will be called upon to show that the right was exercised in good faith and not capriciously or arbitrarily.
Parties who are unable to justify their actions may be held to have breached their contractual obligations.
When exercising a contractual right, think before you act, especially if acting could negatively impact your business counterpart. Try to avoid acting arbitrarily when exercising your contractual rights. Understand your business rationale to taking a specific action and, if possible, try to do what you can to minimize the impact on the other contracting party.
In my final post, I’ll wrap up this series of “Conduct Matters in Contract” posts with some final take aways.
[i] Mason v. Freedman 1958 CanLII 7 (SCC).
[ii] Mason, supra, page 487.
[iii] G. Hall, supra, p.313.
[iv] Partec, supra and G. Hall, supra, p.314.
[v] Partec, supra, para 15-17. See also: A. Swan, supra, p.727.
[vi] Greenberg, supra.
[vii] 869125 Ontario Inc. v. Angeli in para. 30 quoting from Greenburg v. Meffert.
[viii] Marshall v. Bernard Place Corp, 2002 CanLII 24835 (ONCA) para. 31.
[ix] Marshall, supra, at para. 20.