Businesses behaving badly - Expanding contractual duties of good faith 


November 2011

Litigation Bulletin

Various courts have struggled with the concept of "good faith" between two contracting parties. The struggle arises from the competing principles of the individualistic and adversarial nature of contracting versus the natural inclination to punish people for taking undue advantage of another person. As indicated in a recent decision of the Ontario Court of Appeal in Oz Optics Limited v Timbercon, Inc,1 this struggle continues to challenge many courts. While this case does not resolve the issue, it appears to invite future courts to consider expanding the scope of contractual duties of good faith.

The underlying dispute in this case relates to "attenuators", which are a fiber-optic component used in jet fighter planes. Oz Optics Limited ("Oz"), a manufacturer of attenuators, entered into discussions with Timbercon, Inc. ("Timbercon") to have the attenuators incorporated into a product to be sold to Lockheed Martin. Although Timbercon told Oz that Oz was the sole bidder to supply the attenuators, Timbercon was also in discussions with another attenuator manufacturer. Ultimately, Timbercon presented both attenuator options to Lockheed Martin, but due in part to a substantial markup on the Oz product, Lockheed selected Oz's competitor for the project.

Oz then claimed against Timbercon, alleging that Timbercon had misrepresented the lack of other bidders, and had breached a duty of good faith towards Oz. The trial judge found in favour of Timbercon. The matter was appealed, and the Court of Appeal reversed the trial judge's decision on the misrepresentation, holding that Timbercon was liable to Oz for misleading it as to whether there was any competing bidder. In addition, Justice Armstrong of the Court of Appeal went on to discuss the concept of the duty of good faith in contractual dealings.

After noting that it "is difficult to ascertain in what circumstances [a duty of good faith] will be applied," Justice Armstrong made an attempt to identify where the law stands on the duty of good faith. In essence, the state of the law was described as follows:

1. There is currently no recognized "free standing duty of good faith based in tort." The duty of good faith arises only through contract.

2. The law has not recognized "a general duty to bargain in good faith," although the Court of Appeal has previously left open the possibility that such a duty exists in "special circumstances."2 Those "special circumstances" which could give rise to pre-contractual bargaining obligations, however, require that the parties ultimately enter into a contract.

3. In certain circumstances, a "duty to enforce or perform a contract in good faith has been recognized" (although it has also been criticized by some courts).

4. A specific duty of good faith has been recognized in the termination of employment contracts, as between a franchisor and franchisee, and between a condominium developer and a condominium corporation.

5. A duty of good faith has been recognized in the commercial tendering context, under the Contract A/Contract B framework originally recognized by the Supreme Court of Canada in Ontario v Ron Engineering.3

The present case caused some concern for Justice Armstrong. Justice Armstrong clearly viewed Oz as having been wronged by Timberline. Yet, on one hand, there was no actual contract on which to base a contractual duty of good faith. And on the other hand, the court was bound by prior authority that there is no freestanding duty of good faith in tort. As a result, after considering whether the case could be shoehorned into the Contract A/Contract B tendering paradigm, Justice Armstrong ultimately left the issue unresolved, stating:

However, in light of the reluctance of the courts, in particular the Supreme Court of Canada, to extend the doctrine of good faith beyond the context of a contractual relationship (whether formal or implied) I would be hesitant to invoke the doctrine here given that recovery can be grounded in negligent misrepresentation. This approach is suggested by the Supreme Court in Martel. Therefore, I do not find it necessary to consider this issue further.

Given that it was not necessary to enter into this discussion to decide the case, it is noteworthy that the court even ventured into this area. Was it intended to simply clarify the state of the law on contractual duties of good faith? Or was it perhaps intended to signal, to judges and the bar, the court's interest in finding a future case to finally resolve this longstanding legal question? In either case, Justice Armstrong has perhaps opened the door for future cases to expand the debate on contractual duties of good faith.

by Mark Wifffen

1 2011 ONCA 714.

2 978011 Ontario Ltd v Cornell Engineering Co (2001), 53 OR (3d) 783 (CA).

3 [1981] 1 SCR 111.

a cautionary note

The foregoing provides only an overview and does not constitute legal advice. Readers are cautioned against making any decisions based on this material alone. Rather, specific legal advice should be obtained.

© McMillan LLP 2011