The Supreme Court of Canada has recognized the “there is a general duty of honesty in contractual performance.”

In stating specifically what this means to parties to a contract, the Court explained:

“…parties must not lie or otherwise knowingly mislead each other about matters directly linked to the performance of the contract.”

The Court explained that this duty is not to be treated as an “implied term” of the contract. Rather, it is a “general doctrine of contract law.” This is an important distinction. As the Court explained, the duty of honesty operates “irrespective of the intentions of the parties.”

Because it is a general doctrine, the Court went on to explain that parties cannot disclaim their duty to perform the contract honestly. However, they can expressly include language in their contracts to determine the standards by which the performance of the obligations are to be recovered. The standards though must not be unreasonable.

This development was combined with an overarching statement by the Court of the breadth of the duty of good faith in the performance of contracts in Canada. Prior to this decision, the courts recognized the application of the duty of good faith in particular types of contracts such as employment, insurance and franchise agreements.

The Court explained that the duty of good faith applies generally to contracts. A contracting party “should have appropriate regard to the legitimate contractual interests of the contracting parties. “The court explained that “appropriate regard” will vary depending on the context of the contractual relationship but generally will not permit one party to “undermine” the other’s interests.

The Courts have already identified types of situations and relationships in which the law requires in certain respects, honest, candid, forthright or reasonable contractual performance. This decision does not modify that state of the law in these situations.

In further defining what the duty of honesty means for contracting parties, the Court explained that it operates as “reassurance that if the contract does not work out, they will have a fair opportunity to protect their interests.”

The Court applied its doctrine to the dispute which Mr. Bhasin of Alberta had over the non-renewal of his dealer agreement to sell education funds.

The Court was clear to find that the dealership in question was not a franchise relationship. The dealership agreement allowed one party not to renew it every three years by giving six months’ notice. In this case, however, instead of simply not renewing the agreement, the dealer was treated dishonestly leading up to the exercise of the non-renewal. The dealer was lied to about what was going on at the time.

As a result, the Court found that the lack of honesty was directly connected to the performance of the non-renewal clause. The Court found a breach of the contract when Mr. Bhasin was not treated honestly relating to the exercise of the non-renewal clause.

Mr. Bhasin was awarded the loss of the value of his agency which he would have sought to retain had the dishonesty not occurred.

This decision resolves many of the existing debates surrounding the duty of good faith in contractual relations and introduces the duty of honesty in a clear and reasoned manner. The decision provides long needed guidance to contracting parties and their lawyers which will impact how Canadian contracts are drafted and carried out in the future.

Every party to a commercial contract should review its language and consider how its performance may be impacted by this landmark ruling.