On February 5, 2021, the Supreme Court of Canada released its decision in Wastech Services Ltd. v. Greater Vancouver Sewerage and Drainage District1 ("Wastech v. Metro"), where it clarified the duty of contracting parties to exercise discretion in good faith. In Wastech v. Metro, the Court affirmed what Canadian lenders have known and practiced for some time, which is that the exercise of their discretion set out in their loan and security documents must be exercised (a) reasonably (notwithstanding any wording in an agreement to the contrary) and (b) in accordance with the stated purposes for which the discretion was granted under an agreement. The decision provides commercial certainty by providing parties with a practical framework to exercise their discretion in a way that will be considered "reasonable" and does not offend the duty to exercise discretion in good faith.
Wastech Services Ltd. ("Wastech") had a long-term business relationship with the Greater Vancouver Sewerage and Drainage District ("Metro") and entered into an agreement with respect to the removal and transportation of waste to designated disposal facilities. The contract purported to give Metro "absolute discretion" in directing waste to the disposal facility of its choosing at any given time. While Wastech's rate of return was directly impacted by the disposal site chosen by Metro from time to time, the contract did not guarantee any specific profit levels to Wastech.
Wastech alleged that it was unreasonable for Metro to exercise its discretion under the contract in a way that limited the profit levels that Wastech would otherwise have achieved, and that, by doing so, Metro breached its duty to exercise discretion in good faith. The Court reviewed the specific discretionary contractual terms and analyzed these terms with a view to their purpose and the scope of the contract between Wastech and Metro.
The Court held that Metro acted reasonably in exercising its discretion as its choice of disposal facilities fell within the discretionary purpose and scope contemplated by the contract and that, therefore, Metro did not breach its duty to exercise discretion in good faith.
Where a Contract Imposes a Discretionary Standard
The Court affirmed that the duty to exercise discretion in good faith is a general contractual doctrine that will arise wherever a discretionary clause exists and that this duty must be adhered to when a contracting party is exercising its discretion under a contract. In other words, parties are not able to contract out of this duty. However, the Court confirmed that exercising this discretion in a manner which is self-interested or merely benefits one party's business at the expense of the other party is not enough to constitute a breach of the duty of good faith.
The duty to exercise discretion in good faith is breached (i.e. made in bad faith) where it is found that such exercise of discretion was unreasonable (i.e. not connected with its underlying purposes), arbitrary or capricious, or is made for purposes extraneous to the contract. This reasonability analysis is context specific, based on the parties' intentions, and will depend on the purposes for which such discretion was granted. The Court held that it will not be considered a breach of the duty to exercise discretion in good faith where a party exercises such discretion in a "morally opportune or wise fashion from a business perspective." Therefore, it is reasonable to conclude that lenders can exercise their discretion to protect their interests and secured position even though it may not benefit their borrowers provided such exercise is done reasonably and within the scope and purpose of the agreement.
Significance of this Decision for Lenders
The discretionary standard imposed on a lender under a loan agreement will depend on the context and underlying reasoning for the exercise of its discretion. Qualifiers such as "unfettered", "absolute" or "sole" discretion will not enable lenders to escape the duty of good faith when exercising contractual discretion. Given the guidance from the Court in Wastech v. Metro, it is evident that adding an element of discretion in favour of a lender under a loan agreement, including one whereby a lender may benefit at the expense of a borrower, is not inherently improper, but will, in all instances, give rise to the lender's duty to exercise its discretion in good faith.
Lenders can get some comfort from this decision that the exercise of their contractual discretionary powers during the course of their business/financing relationship will be considered reasonable if such discretion is exercised in a commercially reasonable manner and fits within the express purpose and scope of the discretion, being to protect its agreed upon secured priority position.
1 2021 SCC 7.
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