Canadian M&A Perspectives Private and Public Mergers & Acquisitions | Private Equity

Good Faith in the Shadow of Contractual Rights

Posted in Contractual Matters, Private Equity, Private Transactions, Public M&A, Strategy
Brandon Kain

Most M&A contracts contain provisions that confer discretionary contractual powers on one or both parties to the transaction (e.g., the right to withhold consent to an assignment).  One of the most pressing questions in modern contract law is whether the party in possession of such a power must exercise it in good faith. In Bhasin v. Hrynew, 2013 ABCA 98, the Alberta Court of Appeal recently addressed this issue, and held that parties are not under a duty of good faith in exercising a right of non-renewal when the term of an evergreen contract comes to an end. While Bhasin did not concern an M&A agreement, it is an important cautionary tale for those who would seek to use the duty of good faith to limit any discretionary contractual right, and may well prove important to future M&A litigation.

Background

The facts in Bhasin are discussed in detail in an earlier post on Canadian Appeals Monitor, and may be summarized fairly shortly here. The case involved a claim against CAFC, a company which marketed RESPs to parent-investors through various retail dealers, by one such retail dealer, Mr. Bhasin. Section 3.3 of their dealership agreement – to which Bhasin had agreed after legal advice and negotiations – contained an evergreen clause.  It provided that the contract would automatically renew for successive, periods unless one party notified the other that they desired expiry of the agreement prior to the end of the relevant term. CAFC exercised its right to not renew the agreement, and Bhasin sued, alleging among other things that CAFC’s decision was made in bad faith. According to Bhasin, CAFC declined to renew the contract in retaliation against Bhasin for refusing to submit to an audit by a competitor who CAFC had appointed to monitor its dealers’ compliance with Alberta securities law, and to coerce a merger between Bhasin and that competitor. Bhasin’s action was successful before Moen J. at first instance.

The Bhasin Appeal

The Court of Appeal overturned the trial judgment, rejecting Moen J.’s conclusion that the non-renewal right was subject to implied preconditions. In doing so, the Court produced a lengthy list of legal principles to the delight of defendants everywhere (see para. 27), which emphasize that there is no duty to perform most contracts in good faith, that courts are reluctant to rewrite or imply terms into commercial agreements, and that there are limits upon the judicial power to consider parol evidence. Applying these principles, the Court made four interesting findings.

First, it held that Moen J. erred in relying upon parol evidence of contractual negotiations, oral promises and the expectations of the parties given the existence of an entire agreement clause in the contract. This clause excluded any “terms.. expressed, implied or statutory, other than expressly set out in this Agreement”. As a result, the Court distinguished the Ontario Court of Appeal’s ruling in Civiclife.com Inc. v. Canada (A.G.) (2006), 215 O.A.C. 43, where an entire agreement clause that did not expressly exclude implied terms was found insufficient to preclude the application of the duty of good faith. The Court also noted that, even apart from the entire agreement clause, it was inappropriate to consider this parol evidence since the contract was not ambiguous and the evidence went beyond mere background knowledge.

Second, the Court rejected the submission that the contract was an “employment” agreement, such that CAFC was subject to a duty of good faith by operation of law. It noted that the agreement was “clearly not an employment contract in form or substance”, and that even if it were, employment contracts are not as a general matter contracts of good faith, particularly in “a case of non-renewal (expiry), not of termination”.

Third, the Court also rejected the argument that a duty of good faith arose by implication from the intentions of the parties. It observed that nothing in the contract suggested the parties intended it to be of perpetual duration. Instead, 3.3 plainly stated that the agreement would expire if one party chose to exercise its non-renewal right. To suggest that “the contract will keep renewing itself automatically every three years, if the motive for giving the notice does not meet certain standards… flatly contradicts the clause’s words”.

Finally, the Court held that Moen J. erred in focusing upon inequality in bargaining power or sophistication between the parties. In fact, given Bhasin’s receipt of the legal opinion and the “expressly negotiated” nature of the evergreen clause, the Court found that the existence of such inequality was not “even arguable”.

Significance

The significance of Bhasin lies in the Court’s refusal to impose a duty of good faith upon the exercise of non-renewal rights, even though – as Moen J. emphasized below – they involve the use of a discretionary power. As the Ontario Court of Appeal observed in Civiclife.com, discretionary contractual powers are one of the classic situations in which courts will imply duties of good faith. Indeed, the Alberta Court of Appeal’s own prior judgment in Mesa Operating Ltd. v. Amoco Canada Resources Ltd. (1994), 149 A.R. 187 (C.A.); Lord Sumption made the same point more recently in Hayes v Willoughby [2013] UKSC 17 at para. 14.

By declining to imply such a duty in Bhasin, the Court has signalled that the mere fact a contractual right is discretionary is not itself a sufficient reason for placing good faith constraints upon it. Rather, judges must still ask whether those constraints are consistent with the text, context and purposes of the relevant provision and the contract as a whole. There may be some cases in which an unfettered discretionary right is precisely what a reasonable observer would conclude the parties intended. The non-renewal provision in Bhasin is an example of this phenomenon.

As a practical matter, therefore, Bhasin suggests that parties negotiating clauses in M&A contracts which confer discretionary contractual powers should insist upon express limits to those powers if they are concerned that the powers may be exercised for improper purposes. Absent such express terms or a statute imposing a duty of good faith (e.g., as under the Arthur Wishart Act (Franchise Disclosure), 2000), the strategy of sheltering in the common law duty of good faith at trial may prove difficult, especially where the clause was negotiated between parties of roughly equal bargaining power with the benefit of legal advice, and is located in a contract containing an entire agreement clause. In the end, as Bhasin confirms, “the thoughts or impressions of the parties cannot be used to vary the express terms of a contract”.