The lesson for risk managers in this breach-of-contract lawsuit

A recent Supreme Court of Canada ruling in a breach-of-contract lawsuit means risk managers need to be careful about drafting agreements that give parties discretionary powers, a Toronto-based litigation lawyer warns.

Wastech Services Ltd. v. Greater Vancouver Sewerage and Drainage District arose from a decision made in 2010 by the regional board in charge of waste disposal in the Vancouver area. In its decision released Feb. 5, Canada’s highest court ultimately ruled in favour of the Greater Vancouver Sewerage and Drainage District, also known as Metro. The Supreme Court upheld a B.C. Court of Appeal ruling, which overturned an earlier arbitrator’s decision in favour of waste management contractor Wastech.

The case was not about insurance and the defendant won, but it still has key liability risk take-aways, Winston Gee, a lawyer for Torys LLP, told Canadian Underwriter in an interview Friday.

“From a risk management perspective, it is important to make sure contracts are clear about the purpose of business arrangements, and the purpose of a discretionary power in a contract,” Gee said. “If it is not clear about those things, it just leaves more room for a court to interpret the purpose based on the arguments put forth by the parties in litigation.”

In 1996, Wastech Services entered into a solid waste disposal agreement with Metro. One of the stated aims of the contract is to give Wastech a “target operating ratio” of 89%, essentially meaning a profit margin of 11%. The contract also gives Metro the power to choose how much solid waste Wastech would take to three Vancouver area sites: Cache Creek Landfill, the Vancouver Landfill, or the Burnaby Waste to Energy Facility.

In 2010, Metro decided to reduce the amount of waste sent to Cache Creek Landfill by 31% and increase by 36% the amount sent to the Vancouver landfill. This resulted in less revenue, and therefore a lower profit margin, for Wastech in 2011.

The contract essentially required Metro to compensate Wastech by paying 50% of its lost profit if the actual operating ratio were to be worse than the target operating ratio of 89%.  Metro paid Wastech an additional $2.8 million for 2011 but Wastech argued before an arbitrator that an “implied term” in the contract essentially required Metro to pay $5.6 million – or enough to bring its operating ratio down to 89% from 96%. So Wastech wanted an additional $2.8 million from Metro.

Initially an arbitrator found that Metro had breached its duty of good faith, but that decision was reversed in court.

In a breach of contract lawsuit involving one of the party’s discretionary powers, the court needs to determine whether or not a party exercised discretionary power in bad faith, Justice Nicholas Kasirer wrote for the Supreme Court of Canada in Wastech. One central question to ask is: Was the exercise of contractual discretion unconnected to the purpose for which the contract granted discretion? If the answer to that is yes, then the party has not acted in good faith, Justice Kasirer wrote.

In the Wastech case, Justice Kasirer found that Metro was given the discretion to select how much waste went to each site so that Metro could dispose of waste cost-effectively. One purpose of Metro’s 2010 decision was to preserve remaining site capacity at the Cache Creek Landfill. This was one reason the court found that Metro was exercising the discretion it had under the contract for a purpose for which the contract granted discretion [i.e. Metro acted in good faith].

“From a risk management perspective, you want to be making sure that when you enter into contracts, and when you are reviewing your contracts, you are paying close attention to how discretionary rights under the contract are drafted and crafted,” Gee told Canadian Underwriter Friday after Wastech was released. Gee’s areas of expertise include litigation and insurance law.

Gee represents the Canadian Chamber of commerce, which had intervenor status in Wastech. One of the chamber’s arguments is that in Canada, there is no free-standing, common-law obligation for parties to have an appropriate regard for the contractual interests of their counter-party.

In Wastech, the court clarified there is no such free-standing obligation, said Gee. In its ruling, the court was careful to preserve the principle of commercial certainty in contracts, suggested Gee.

“A discretionary power, even if unfettered, is constrained by good faith,” Justice Kasirer wrote in Wastech. “To exercise it, for example, capriciously or arbitrarily, is wrongful and constitutes a breach of contract. Even unfettered, the discretionary power will have purposes that reflects the parties’ shared interests and expectations, which purposes help identify when an exercise is capricious or arbitrary.”

Feature image via iStock.com/alexsl