Exercise caution when granting discretionary power to business partners

Parties to a contract cannot expect the other party to look out for their interests when exercising discretionary power for purposes granted under the agreement, according to a recent Supreme Court of Canada ruling.

In Wastech Services Ltd. v. Greater Vancouver Sewerage and Drainage District, the nation’s top court considered a waste management company’s complaint that a municipal sewage department had breached its good faith obligations by exercising its contractual discretion in a way that negatively impacted the company’s profits.

Ultimately, the Supreme Court ruled that the municipality acted reasonably and not in bad faith, offering in the process further clarification of the organizing principle of good faith performance in contract law.

The facts

The relationship between Wastech and Metro Vancouver dates all the way back to the mid-90s when the parties signed a 20-year agreement for the removal and transport of waste to three disposal facilities following 18 months of negotiations.

Under the final 1996 agreement, Wastech was to receive different rates of pay depending on which of the three sites the city directed waste to, as well as the distance travelled. The contract also contemplated a target operating profit for Wastech of 11 per cent, although it did not guarantee the company would achieve a certain level of profit in any given year. Critically, the contract specifically granted Metro Vancouver absolute discretion to allocate waste to whichever facility it chose.

In 2011, the parties ran into trouble when Metro Vancouver exercised that discretion, reallocating waste from a further away disposal site to a closer one, in a change that sent the company’s operating profit for the year plunging to around four per cent, well short of the 11-per-cent target.

The arbitral award

Wastech responded to the change by referring the matter to arbitration, seeking $2.9 million in compensatory damages for what it alleged was a breach of the contract denying the company the opportunity to achieve the target operating profit for 2011.

When the arbitrator’s ruling finally arrived in 2015, it came down in favour of Wastech, concluding that the duty of good faith did indeed apply to Metro Vancouver’s discretionary power over waste allocation, and that the city had breached the duty.

After reviewing the existing case law on contractual good faith, the arbitrator found that the long-term, relational nature of this agreement required the city to have “appropriate regard” for Wastech’s legitimate contractual interests when exercising its discretionary power to reallocate waste.

The appeals

Both the Supreme Court of British Columbia and the province’s Court of Appeal agreed with Metro Vancouver that the arbitrator’s ruling could not stand before the case made its way to the nation’s top court.

In their ruling, all nine judges on the Supreme Court of Canada bench also sided with the city, concluding that its reallocation of waste was not unreasonable.

The Supreme Court judges confirmed that parties do have a duty to exercise contractual discretion in good faith that requires them “to exercise their discretion in a manner consistent with the purposes for which it was granted in the contract.

A breach of the duty may occur when the exercise of discretionary power “falls outside the range of choices connected to its power,” they added.

In cases where the purpose of the discretion is not clear, the court must interpret the contract to determine one. Judges may also intervene in cases of discretion power exercised arbitrarily or capriciously, the Supreme Court added, cautioning judges against delving into the wisdom or morality of the decision from a business perspective.

In Wastech’s case, the Supreme Court found that the purpose of the city’s discretionary power was to give it flexibility to maximize efficiency and minimize the cost of the garbage operation, and that Metro Vancouver had been guided by these objectives when it exercised its discretion to reallocate waste sites.

It was clear from the record that the parties were aware of the risk presented by the exercise of discretion and had chosen to leave it in place, the Supreme Court judges wrote, characterizing Wastech’s claim as a request for an advantage is had not bargained.

“Metro is Wastech’s contracting partner, not its fiduciary. The loyalty required of it in the exercise of this discretion was loyalty to the bargain, not loyalty to Wastech,” the decision reads.

Lessons for businesses

It is hard not to have sympathy for Wastech’s predicament, but in my view, the Supreme Court got the decision right.

Both parties had chances to constrain the city’s discretionary power to allocate waste wherever it wanted, and they rejected the opportunity to do so.

This should drive home the importance of assessing risks in a contract’s discretionary power from the very outset. Play out the potential consequences and consider negotiating limits now, because if things turn out badly later, it may be too late to claim you were treated unfairly.

It’s also important to remember that each side bears risk when one party is granted discretionary power under a contract. It is not a licence for the party granted the power to behave as they please, since they must act reasonably and in good faith in exercising discretion. However, clearly defining the reason for the discretionary power in the contract and acting in accordance with that purpose can reduce the room for accusations of bad faith.

If you have questions about good faith and how it could be effecting your business and would like to learn more, please contact one of our lawyers.

*This post is not intended to be legal advice and should not be taken as such. Please contact McConnan Bion O’Connor & Peterson if you have any questions regarding this post or require assistance or legal advice regarding contract law.