As procurement professionals know, contractual discretion is a double-edged sword: it leaves you in the driver’s seat, but almost certainly will lead to challenges when that discretion is exercised to the detriment of the other party to the contract. While the Supreme Court of Canada’s decision in Bhasin v Hrynew laid out some organizing principles for what constitutes good faith as a general doctrine of contract law, the same court’s February 5, 2021 decision in Wastech Services Ltd. V Greater Vancouver Sewage and Drainage District examined what constitutes good faith in the context of exercise of a specific contractual discretion clause.
constraints on exercise of contractual discretion
The facts of the case are quite straight forward. Wastech Services Ltd. (“Wastech”) had a long-standing contractual relationship with the District (“Metro Vancouver”) for removal and transportation of waste. The contract gave Metro Vancouver absolute discretion to direct disposal to any of three disposal facilities and provided for a target revenue-to-operating-cost ratio (“Ratio) which had the potential to impact Wastech’s compensation. Metro Vancouver’s facility allocation in 2011 impacted the Ratio, resulting in lower than expected profit to Wastech. Wastech challenged the exercise of that discretion as a violation of the duty to exercise contractual discretion in good faith, claiming $2.8M of damages. There was no allegation that Metro Vancouver had exercised the discretion arbitrarily or capriciously.
The arbitration panel and lower courts found no violation of the duty of good faith by Metro Vancouver, and the matter wound its way to the Supreme Court of Canada for hearing in December 2019. In upholding the decision to dismiss the claim by Wastech, our highest court provided valuable guidance on the constraints that the duty to exercise contractual discretion in good faith imposes on the holder of that discretion. Notably:
- The duty to exercise discretion in good faith is an implied obligation of every contract and cannot be excluded by the parties in their contract.
- This duty does not require subordination of one’s interests to those of the other party to the contract.
- What amounts to reasonable exercise of discretion must be read in the context of what the parties themselves contemplated, as evidenced by the written agreement between them.
- As a corollary to the above, unreasonable exercise of discretion would require exercise in a manner not connected to the underlying purpose of the discretion granted by the contract.
In this case the contract very clearly gave Metro Vancouver the absolute discretion to determine how the waste is to be allocated. In reading the contract as a whole, the SCC found that the purpose of the discretion clause was to allow Metro Vancouver the flexibility necessary to maximize efficiency and minimize costs of the operation. Metro Vancouver’s decision was not unreasonable and was guided by this purpose. The duty to exercise discretion in good faith does not require abandonment of commercial certainty by requiring contracting parties to place their counterparty’s interests ahead of their own. In the words of the court, “the loyalty required of (Metro Vancouver) in the exercise of this discretion was loyalty to the bargain, not loyalty to Wastech.” The claim was dismissed, with costs payable by Wastech.
While each case is dependant on its unique facts, procurement professionals should heed this decision as a signal of the importance of clearly setting out the purpose and intent of contractual discretion to the greatest extent possible. In addition to potentially avoiding protracted litigation such as this, contractual clarity around intent helps to manage expectations and contributes to a better working relationship between contracting parties.
If you would like more tips and valuable guidance on managing contracts and ensuring appropriate exercise of discretion, then consider joining us for PSPP 203 starting soon. Click here to learn more about PSPP 203: Managing and Evaluation.