EnerMatix Article

Good Faith and Honest Contracting – Impacts of Bhasin v. Hrynew on Land Agreements
May 24th, 2015 | Categories : Land A&D, Oil & Gas

In 1796, George Washington’s presidential farewell letter included the advice, “that honesty is always the best policy.” Curiously, since Confederation, honesty has never been an established principle of Canadian contract law. As polite as Canadians may be, they reserved the right to be self-serving when it came to contract performance. This has changed.

In November 2014, the Supreme Court of Canada released a landmark decision in the Alberta case, Bhasin v. Hrynew, 2014 SCC 71. It has far reaching implications for the Canadian common law of contract because it expands implied terms, creates a duty of honest contractual performance, and establishes an overarching principle of good faith. The case raises policy and process concerns about how contracts are drafted, maintained, and about how they are terminated when a party experiences an economic loss due to termination. Petroleum land administrators, analysts, and negotiators need to know what this means and how to put it into practice.

A quick thumbnail sketch of the case is that it was about two independent sales reps, Harish Bhasin and Larry Hrynew, working for a common vendor, Can-Am. Bhasin and Hrynew each had their own franchise-like arrangement with Can-Am and each ran their own independent, competitive business marketing education savings plans to investors. Their contracts with Can-Am included clauses that said: (i) the contract was for a 3-year term; (ii) either the sales rep or the vendor could terminate the agreement on 6 months’ notice without cause; and (iii) terms of the agreement were all the terms in the entire agreement. Hrynew wanted to take over Bhasin’s business. He applied pressure on Can-Am to terminate Bhasin’s agreement and put him out of business. Can-Am eventually complied, but along the way lied to Bhasin saying it had no plans to terminate him—until the ax suddenly fell and Bhasin’s business was toast.

When the case went to trial (Bhasin (Bhasin & Associates) v. Hrynew, 2011 ABQB 637) it was unclear how, if at all, lying would translate into legal liability. In earlier decisions, the Alberta Court of Appeal said there is generally no duty to perform most contracts in good faith (Mesa Operating Partnership v. Amoco Canada Resources 1994 ABCA 94, and Klewchuk v. Switzer, 2003 ABCA 187). However, that didn’t stop the Alberta Court of Queen’s Bench. It looked at several causes of action and found that Can-Am was in breach of contract because the agreement included an implied term of good faith performance. It found that Can-Am, (i) “lied,” (ii) exercised its right to terminate the contract, “in a capricious and arbitrary manner,” and (iii) “acted dishonestly” in a “particularly unconscionable” way. Wow. Strong language for a court. From there the court also found Hrynew liable for intentionally inducing breach of contract and both Hrynew and Can-Am liable for civil conspiracy.

This decision was overturned on appeal. Consistent with its previous rulings, the Alberta Court of Appeal (Bhasin v. Hrynew, 2013 ABCA 98) disagreed that there was an implied term of good faith in the context of an unambiguous contract containing an entire agreement clause that, “expressly excludes ‘terms’ which are not express.” The clause would be familiar to many land administrators and negotiators, It said,

11.2 This Agreement expresses the entire and final agreement between the parties hereto and supersedes all previous agreements between the parties. There are no representations, warranties, terms, conditions or collateral agreements, express, implied or statutory, other than expressly set out in this Agreement.

The Court of Appeal also found that Hrynew was not liable, “for conspiracy or deliberate infliction of harm,” as the only alleged illegal act was breach of contract. The other causes of action fell too. But, that still wasn’t the end of it. Bhasin appealed to the Supreme Court of Canada.

Bhasin may have felt disappointed as the Supreme Court agreed with the Court of Appeal that Hrynew was not liable for inducing breach of contract or unlawful conspiracy. It reached this decision because Hrynew was not a party to the contract between Bhasin and Can-Am. However, the Supreme Court wasn’t done and that’s where this case really got interesting.

The Supreme Court disagreed with the Alberta Court of Appeal and found Can-Am liable for breach of the duty of honest performance, “when it failed to act honestly with Mr. Bhasin in exercising the non-renewal clause.” The Supreme Court said that Can-Am did not have appropriate regard for the business interests of its contractual partner, Bhasin. It found Can-Am liable for $87,000 in damages, representing the value of Bhasin’s business at the time of non-renewal explaining that, “if Can-Am had performed the contract honestly, Mr. Bhasin would have been able to retain the value of his business rather than see it, in effect, expropriated and turned over to Mr. Hrynew.”

In reaching its decision the Supreme Court said it was introducing brand new concepts to the common law and contract law in two incremental steps: (i) “good faith”; and (ii) “duty of honesty”. Defining good faith and duty of honesty in the abstract is a bit like trying to pin jelly to the wall. So, to characterize these tricky concepts the Supreme Court said some powerful new stuff.

The first part of the new doctrine is that good faith is now characterized as an, “overarching organizing principle,” of Canadian contract law. It is, “not a freestanding rule, but rather a standard that underpins and is manifested in more specific legal doctrines and may be given different weight in different situations.” As an overarching organizing principle, good faith is not an implied term. It is, “a requirement of justice from which more specific legal doctrines may be derived.” It means parties, “generally must perform their contractual duties honestly and reasonably and not capriciously or arbitrarily.” This includes, “honest, candid, forthright or reasonable contractual performance,” and this list is not closed. Canadian courts may add more characteristics as new cases are heard.

The second part of the new doctrine is that honest contractual performance is now a common law duty applying to all contracts. Acting honestly is a minimum legal expectation that cannot be excluded by contract language. It remains possible that parties may establish their own standards for satisfying this duty as long as the core of the duty is respected. In the Supreme Court’s words, “it is a simple requirement not to lie or mislead the other party about one’s contractual performance.” Since this is now a general doctrine and not an implied term, it cannot be excluded by an, “entire agreement clause.” In the Supreme Court’s own words, “…because the duty of honesty in contractual performance is a general doctrine of contract law that applies to all contracts… the parties are not free to exclude it.” However, the Supreme Court also says that it is, “not a duty of loyalty or of disclosure.” It does not, “require a party to forego advantages flowing from a contract.” It does not impose a, “duty to subordinate [a party’s own] interest to that of the other party.”

The Supreme Court did not specifically address whether this new organizing principle of good faith and duty of honest contractual performance applies to existing contracts. However, it’s reasonable to assume that parties to contracts that are currently in force should apply this doctrine on a go-forward basis. Whether the doctrine can be used in litigation that has already commenced is a more complicated question that requires consultation with legal counsel.

The application of this case to petroleum land law may lead to some litigation due to uncertainty about the extent of the organizing principle and duty. It raises questions about the implications that arise if a party remains silent in response to an inquiry. Silence may be a form of dishonesty by omission that breaches the duty of honest contractual performance. It may also raise disclosure expectations when issuing rights of first refusal particularly in the face of a request for more information when using an exception. Summary judgments may be more difficult as honesty becomes an issue worthy of trial. There may be expansion of the scope of discovery to support closer scrutiny of not only what a party did, but why and how they did it as decision making motives may go to good faith and honesty. If a party is subject to the discretion of another party, asking questions may be an effective defence.

There may be risk in terminating an agreement without consideration for its impact on the other party’s business interests, but this does not mean a party cannot decide to not renew a contract. It does mean that a party cannot deliberately mislead its contracting partner about its intentions and it means that parties should exercise caution vis-à-vis renewal or nonrenewal provisions and maintain appropriate supporting documentation.

Termination of freehold leases may engage application of this principle because it has an impact on the lessee’s business interests especially when relying on subjective grounds such as whether or not a well is capable of production. However, termination that is triggered by objective criteria such as expiry of the primary term without payment or drilling is less likely to raise issues about good faith or honesty.

Surface lease rent review probably triggers a legal duty to act honestly and in good faith. Lessees need to ensure they do not remain silent and are as transparent as reasonably possible in the face of an inquiry even when exercising what might seem to be a clear contractual right. Parties must have regard to the legitimate contractual interests of the contracting partner. Document internal decision making processes to confirm that decisions are not considered capricious or arbitrary. Give careful consideration to how and what is communicated to other contract parties. A misrepresentation anywhere along the line by any employee, contractor, broker, or other agent may incur legal liability.

Use of the CAPL operating procedures is probably impacted by this new legal doctrine. It may re-draw the legal line for an operator choosing to maximize its own benefits or limit its obligations. It probably expands operator obligations despite 2007 CAPL 1.05C saying the operator will not, “have any additional obligation in contract, at law or in equity.” It may broaden an operator’s fiduciary duty to respond to inquiries of joint operators despite the language of 2007 CAPL 1.05A that attempts to narrow the scope of fiduciary duty. As parties cannot completely contract out of the new organizing principle and duty, it may limit the scope of 2007 CAPL 1.05B that expressly recognizes joint operators as competitors and says each party, “is free to conduct its business in such manner as it, in its sole discretion, sees fit.” This is not to say that the doctrine limits competition. The Supreme Court said that, “honest performance will vary with context and the parties should be free in some contexts to relax the requirements of the doctrine so long as they respect its minimum core requirements.” It may mean that operators and joint operators are free to compete as long as their dealings respect good faith and honesty.

It’s unclear how it may impact any tactical business use of independent operations notices designed to influence the business interests of competitors (2007 CAPL Article X). The Supreme Court says that,

The organizing principle of good faith exemplifies the notion that, in carrying out his or her own  performance of the contract, a contracting party should have appropriate regard to the legitimate contractual interests of the contracting partner. While ‘appropriate regard’ for the party’s interest will vary on the context of the contractual relationship, it does not require acting to serve those interests in all cases. It merely requires that a party not seek to undermine those interests inbad faith… Unlike fiduciary duties, good faith performance does not engage duties of loyalty to the other contracting party or a duty to put the interests of the other contracting party first.

However, it’s still unknown what “appropriate regard” means, or what “legitimate interests” are, or what “bad faith” means, or what kind of conduct fills the spectrum between fiduciary obligations and good faith performance. Future case law will help settle these interpretations.

There is also a duty to consider that the timeliness of an operator’s response may have an impact on the business interests of the joint operators. Any response that is incomplete may be a form of dishonesty by omission. An operator giving notice of, “the revised terms and conditions on which it would continue as Operator” (2007 CAPL 2.05) may need to consider impacts on business interests of the joint operators. The forecast of operations (2007 CAPL 5.04) may be subject to greater scrutiny and sensitivity. Although the clause says it is, “for informational purposes only,” this may not be sufficient to overcome the new duty to avoid dishonesty by omission and the duty to consider the impact on the business interests of the joint operators. Some operator accounting practices may be open to review under this new doctrine. It may create a duty on operators to provide timely advice to its joint operators of its financial distress to empower them to take in kind and mitigate risks from commingled funds following, Brookfield Bridge Lending Fund Inc. v. Karl Oil and Gas Ltd., 2009 ABCA 99.

Except in the case of tendering, it appears that the new doctrine does not apply to contractual negotiations. Negligent or fraudulent misrepresentation still applies. It always did. However, the principle of good faith and duty of honest contractual performance is about the performance of contractual obligations after the agreement is in place, not before. It encourages parties to be even more explicit about the language used in negotiated contract terms especially if seeking to contractually “relax” the meaning of honest contractual performance. The generically worded, “entire agreement clause,” in most existing contracts is insufficient.

Time will tell if the new organizing principle of good faith and duty of honest contractual performance makes the wheels of freehold petroleum and natural gas leases, petroleum land contracts, joint venture agreements, and other commercial contracts turn more smoothly, or grind to a halt. A positive outcome is that it tends to better align the Canadian common law of contract with the law in Quebec and the USA, but it is unlikely that case law from these jurisdictions can be applied directly. Interpretation of an “unless lease” shows how different US and Canadian courts can be.

In this new contracting world, petroleum land departments are advised to consult legal counsel for guidance and review of existing precedents, policies, and procedures. This conversation should include how electronic data is maintained in land information systems, document management systems, shared drives, and email as all of it can be producible evidence in court.

 

ABOUT THE AUTHOR:

Tracey Stock is a lawyer, engineer, and landman with extensive experience in corporate and commercial law, energy and mining law, intellectual property, mergers and acquisitions, land negotiations and administration, A&D, joint ventures, midstream, economic evaluation of oil and gas assets, and information systems development and management. He is a CAPLA member and serves as a director, and its vice president and treasurer.

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Tracey Stock, LL.B., M.B.A., P.Eng. practices oil and gas law, land administration, and systems management. He has extensive experience in law, engineering, land, information technology, and has combined his background and experience in all disciplines for several of leading energy companies. His practice has included thousands of transactions throughout Canada and the United States with total value of several billion dollars involving oil and gas mineral acquisitions and divestitures, land title review, management of preferential rights, energy partnerships, joint ventures, economic analysis, and evaluations. He is a notable leader in significantly reducing administrative costs by designing and implementing information and GIS mapping systems that successfully support business processes. Tracey has extensive negotiating experience and has lead data aggregation, mapping, analysis, and interpretation in support of strategic business opportunities in strategic land acquisitions and trend optimization. Tracey has successfully managed corporate departments, project teams, and his own private law practice focusing on oil and gas and land title transactions and has provided legal and business support for successful trade missions to China.

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