good faith obligations and contract renewals

good faith represented by person putting block of wood down in puzzle space with trust printed on the edge

In the last issue of The Legal Edge, we reported on the pivotal Supreme Court of Canada decision in Bhasin v. Hrynew, 2014 SCC 71, which expanded the organizing principle of the duty of good faith to include a “duty to act honestly” in general contractual dealings. While acting honestly and making sure that you meet your contractual obligations of course makes good business sense, Bhasin is the first time the courts have acknowledged this general duty under contract law.

In 0856464 B.C. Ltd. v. TimberWest Forest Corp., 2014 BCSC 2433, one of the first cases to apply the Bhasin judgment, the B.C. Supreme Court awarded damages of $2.75 million under a remarkably similar fact pattern – allegations of improper motives during negotiations over contract renewals. In addition to the implied obligation to act honestly imposed by Bhasin, this case also involved a contractual duty of good faith related to negotiation of the renewals. In other words, TimberWest was contractually obligated to negotiate the renewal rates in good faith, and the Court found that it had failed to do so. The Court focused on the express contractual obligation rather than the implied obligation arising from Bhasin, but did consider that case at some length.

Background

The facts are reasonably straightforward. TimberWest is a B.C. timber and land management company that contracts out logging operations to various independent operators. Under an existing collective agreement, TimberWest contracted out its woodland operations on a “stump-to-dump” basis, but it was not permitted to subdivide contracts into smaller volumes without the consent of the union.

After a bidding process in 2004, TimberWest entered into two, five-year timber harvesting agreements with a company that subsequently assigned its cause of action to 0856464 B.C. Ltd. (the plaintiff numbered company) under a bankruptcy proceeding. The agreements, which required “good faith negotiations” over the rates for each subsequent year of the contract, were terminated by TimberWest in early 2008 because of a failure to agree on rates.
0856464 B.C. Ltd. asserted that TimberWest failed to negotiate the 2008 rates in good faith, with the intent to orchestrate the termination of the contracts as part of a plan to pursue subdivision of its logging contracts into smaller, less-expensive contracts. According to this strategy, if the contracts with 0856464 B.C. Ltd. failed, either by the plaintiff’s own hand, or as a result of inability to reach an agreement on rates, it would put pressure on the union to allow TimberWest to further subdivide the contract work.

The Case

0856464 B.C. Ltd. claimed damages for loss of revenue, along with other offset and payment claims against TimberWest, alleging fraudulent misrepresentation in addition to failure to negotiate in good faith. According to 0856464 B.C. Ltd., TimberWest had had this subdivision strategy in mind even before entering into the 2004 contracts, thereby misleading 0856464 B.C. Ltd. into investing in the long-term contracts as negotiated.
The fraudulent misrepresentation claim failed, because 0856464 B.C. Ltd. could not establish that TimberWest had had this strategy in mind when initially negotiating the contracts. The evidence did, however, show that, by the time of the negotiation for the 2008 rates, TimberWest was keen on achieving the right to subdivide, and it was in the context of the subdivision strategy that 0856464 B.C. Ltd. said that TimberWest failed to negotiate in good faith over the rates for the 2008 logging period.
The Court reviewed several cases related to breach of good faith, concluding that such cases very much depend on their particular facts. The issue in this case really came down to whether 0856464 B.C. Ltd. had proven that TimberWest’s “dominant motive” was to terminate the contract over a rate dispute, and if so, whether in the circumstances that was a breach of the contractual obligation of good faith.
According to the Court, an honest and reasonable approach to TimberWest’s obligation to perform the contract and negotiate the rates in good faith would “require that the defendant not put a strategy to terminate an agreement for a collateral benefit ahead of a good faith attempt to fulfill the agreement.”
When reviewing the conduct of the parties related to the rate negotiation for 2008, the Court found that the “firm and inflexible stance” taken by TimberWest, along with the “unprecedented rapidity” of the negotiations, suggested different underlying goals on the part of TimberWest from earlier years, when the discussions were more protracted, but agreement on rates was eventually reached. Taking all of the evidence into account, the B.C. Supreme Court found that TimberWest had breached its contractual obligation to negotiate in good faith, and that 0856464 B.C. Ltd. was entitled to damages for unlawful termination of the contracts.
“I find that it is likely,” Justice Sigurdson remarked, “that in the absence of the strategy that the defendant developed to pursue subdivision, the parties, even at reduced volumes, would nevertheless have been able to reach an agreement on rates as contemplated by the contracts.”

The Award

After an in-depth of examination of the very different positions of the parties on damages, the Court assessed $2.75 million and allowed an offset of $1.01 million, for a net award to the plaintiff of $1.7 million.

Editor’s Note: This case is worthy of note. Coupled with the Bhasin case, it signals a willingness by the courts to examine the “dominant motives” of the parties when exercising or negotiating contract renewal options. We really have not seen much judicial intervention in this area of practice, so it is interesting that these two cases emerged at roughly the same time. It is difficult to say whether the outcome would be the same in the TimberWest case if there had been no contractual obligation to act in good faith. Was the conduct, as described, a breach of the implied obligation to act honestly, as imposed by the Bhasin case? The answer is “likely, but we don’t know for sure,” because every case turns on its specific facts, and no two scenarios are exactly alike. That is what makes the law so interesting and seemingly unpredictable. Stay tuned to The Legal Edge, as we expect more challenges and push back against the exercise (or not) of contractual renewal rights, now that we have some clear judicial guidance on the topic. In particular, we expect that more courts will rely on Bhasin in supporting a close examination of both the motives and the conduct of the parties when it comes to exercising contractual renewal options, in the absence of any contractual good-faith obligation.

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