March 16, 2021

Wastech and the Franchising Context

By John Sotos, Michelle Logasov, and Lauren Huxtable

Overview

The Supreme Court of Canada’s recent decision in Wastech Services Ltd v. Greater Vancouver Sewerage District, 2021 SCC 7 (“Wastech”) provides guidance on the nature and scope of the duty of good faith when exercising discretionary contractual powers. The Court re-affirmed what many franchise law practitioners have been telling their clients for years; that this discretion must be exercised reasonably within the purpose for which it is granted.

Wastech builds on  the 2014 Supreme Court case of Bhasin v Hrynew, 2014 SCC 71 (“Bhasin”), in which the Court recognised the duty of good faith in contractual relations as an organizing principle in Canadian common law. In Bhasin, the Court declared that in performing a contract, a party must have “appropriate regard to the legitimate contractual interests of the contracting partner.”

In Wastech, the Court further held that good faith requires a party to exercise discretionary powers under a contract reasonably, and in a manner connected with the purpose for which the discretion was granted. This duty exists even when the contract on its face provides for unfettered discretion. Where the text of the discretionary provision does not explicitly state the purpose for which the discretion is granted, such purpose may be ascertained from the contract, interpreted as a whole.

Accordingly, an unreasonable exercise of discretionary power will be one that falls outside of the range of choices connected to the underlying contractual purpose and will constitute a breach of the duty of good faith. In contrast, an exercise of discretion, even one that substantially nullifies the other party’s expected benefits under a contract, will be reasonable, provided that it is consistent with the purpose underlying the discretionary grant.

The contextual nature of the exercise lines up with earlier decisions such as Mayotte v Ontario, 2016 ONSC 1233 (“Mayotte”), a franchise specific case addressing contractual discretionary power. In that case, the trial judge concluded that the duty of good faith did not require franchisors to ensure franchisees earn a reasonable financial return. However, a proper application of Wastech will require future courts to first analyze the discretionary power to ascertain its contextual purpose.

Summary of Facts and Procedural History 

The appellant in Wastech contracted to provide waste transportation and disposal services to Metro, a statutory corporation responsible for the administration of waste disposal for the Greater Vancouver Sewerage and Drainage District.

Under the terms of the contract, the appellant  was responsible for removing and transporting the waste to three disposal facilities: Vancouver, Burnaby, and Cache Creek. It earned a differing rate depending on which disposal facility the waste was directed to: lower, short-haul rates for transport to Vancouver and Burnaby, and a greater long-haul rate for transport to Cache Creek. The contract contained a target revenue-to-operating-cost ratio (the “Target”) with adjustments to its compensation if the Target was not met in a given year.

The contract granted Metro “absolute discretion” to allocate waste among the facilities and did not guarantee that the disposal company would achieve the Target in any given year. Importantly, in negotiating the contract, both parties were aware of a scenario in which the Target might not be achieved due to reallocation of the waste, but both parties believed such a scenario to be highly unlikely. They agreed not to include an adjustment provision to that effect.

In 2011, Metro changed the allocation of waste, sending more waste to Vancouver and Burnaby and much less to Cache Creek. This change lowered the haulage fees and resulted in the provider achieving an operating profit that was well under Target.

A arbitration claim followed. The claim was made that Metro breached the parties’ contract by allocating waste among the facilities in a manner that deprived the provider of the possibility of achieving the Target. This conduct was said to have violated Metro’s duty of good faith.

The arbitrator applied Bhasin to find that discretionary powers under a contract must be exercised in good faith and with “appropriate regard for the legitimate contractual interests” of the counterparty.  Consequently, he held that although Metro’s decision to change the allocation of waste was in furtherance of its own honest and reasonable business objectives, it breached its duty of good faith.

Both the British Columbia Supreme Court and the Court of Appeal set aside the arbitrator’s decision. An appeal was then taken to the Supreme Court of Canada.

The Supreme Court of Canada Decision

A six-justice majority of the Supreme Court dismissed the appeal, with a three-justice minority concurring in the result.

The majority of the Court held that Metro’s decision to change the allocation of waste did not breach Metro’s duty to exercise its contractual discretion in good faith because it was connected to the purpose in the contract for which the discretion was created.

The contract gave Metro unfettered discretion to determine how waste could be allocated. The purpose of this discretion was to allow Metro the flexibility necessary to maximize efficiency and minimize costs of the operation. The contracting parties foresaw the risks of allowing Metro to exercise absolute discretion but specifically elected against including a term in the contract to limit this discretion or to otherwise guarantee that the Target would be achieved.

Accordingly, the majority concluded that Metro’s decision to reallocate the waste was reasonable and fell within the proper bounds for the exercise of discretion contemplated by the contract. As such, there was no breach of the duty of good faith.

The minority concurred with the result but would have held that contracting parties could exclude the duty of good faith in contractual discretion with clear language to that effect.

Significantly, both the majority and concurring decisions held that the duty of good faith is offended where a discretionary power is exercised in a manner that is unconnected to the purpose for which it was granted.

Key Principles and Takeaways for Franchising

Wastech adds to the expanding caselaw illuminating the common law duty of good faith in contracts which is also an express element of the statutory duty of fair dealing in provincial franchise legislation in the six provinces with franchise-specific legislation. The decision confirms that good faith in exercising contractual discretion applies to all contracts, irrespective of the intentions of the parties. However, determining whether or not a particular exercise of discretion breaches this duty is a highly fact-specific determination.

The Court’s comments on the duty of good faith generally and how it influences the use of contractual discretion are especially important to the franchising industry. Franchise agreements typically give franchisors wide discretion in relation to such things as operating requirements, renovation requirements,  use of trademarks and marketing programs.

Franchisors are well-advised not to take clauses giving them unlimited and unfettered discretion literally when exercising their discretionary powers, regardless of the language used. Wastech confirms that good faith requires a party to exercise discretionary powers under a contract reasonably, and in a manner connected with the purpose for which the discretion was granted.

In assessing the purpose of the contract, it can be expected that the courts will distinguish the purpose in a purely transactional contract such as in Wastech where the parties negotiated the Target and considered the possibility where it would not be met from franchise agreements which are contracts of adhesion and are what have been termed “relational contracts”. Relational contracts are long-term, complex agreements that can be fulfilled only if the parties co-operate with each other to achieve the contractual objectives. The underlying purpose of a relational contract is therefore much more nuanced and context dependent compared to a transactional contract. Many franchise agreements address their underlying purpose explicitly by speaking to the success of the system and the need for trust; commitments that must be squared against blanket discretionary powers.

Franchisors which are looking to have broad discretionary powers because they need them legitimately to achieve the purpose of the contract are well advised to include language in their contracts that identifies this purpose if such purpose is not determinable as it already should have been in a well-drafted agreement.  Franchisors are not advised here to rush out to revise one or two provisions to expand their discretionary powers on the basis of  Wastech. They are, however, advised to consider whether there is sufficient clarity in their contracts to identify the rational purpose of the broad discretion they say they need.

John Sotos, Sotos LLP

John Sotos is the founding partner of Sotos LLP and a dean of the franchising, licensing and distribution bar. John has been recognized by Chambers CanadaCanadian Legal LEXPERT DirectoryWho’s Who Legal, and Best Lawyers in Canada as a leading Canadian franchise law practitioner. John can be reached directly at 416.977.9806 or jsotos@sotosllp.com.

Michelle Logasov, Sotos LLP

Michelle Logasov is an associate at Sotos LLP. Her practice focuses on general commercial litigation and class actions. Michelle can be reached directly at 416.572.7306 or mlogasov@sotos.ca.

Lauren Huxtable, Sotos LLP

Lauren Huxtable is an articling student at Sotos LLP. Lauren joined Sotos after graduating from the Queen’s University Faculty of Law in 2020. Lauren can be reached at 416.977.5333 ext. 358 or lhuxtable@sotos.ca