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23 Dec

Viewing the Supreme Court of Canada’s decision in Callow through a compliance lens

Wednesday, December 23, 2020James R.G. Cook, Kenneth Jull, Jonathan James Nehmetallah, Ian SpiegelLitigationContract Law, Supreme Court of Canada, Compliance

The Supreme Court of Canada released its decision in C.M. Callow Inc. v. Zollinger[1] on December 18, 2020. This decision is ground-breaking in the world of contracts, and can have far-reaching repercussions to contracting parties that could easily fall into the trap of acting outside of their duty of honest performance as formulated in Bhasin v Hrynew.[2] Generally, corporate compliance programs focus on government regulation. After the decision in Callow, compliance programs would be wise to focus on the distinction between actively misleading conduct and innocent non-disclosure in contractual performance as well.

Factual Background

The Appellant, C.M. Callow Inc. (“Callow”) signed a two-winter maintenance agreement with the Respondents, a group of 10 condominium corporations that were joined together through a Joint Use Committee (“Baycrest”). The term of the original contract ran from 2010 to 2012, and was subsequently renewed for the period of November 1, 2012 until April 30, 2014. Callow had a separate two-summer contract with Baycrest as well.

The winter contract included a unilateral termination clause (“Clause 9”), which allowed for unilateral termination of the contract by Baycrest if (1) Callow’s services were unsatisfactory, or (2) if Callow’s services were no longer required. Baycrest need only provide 10 days’ notice to Callow when invoking Clause 9.

During the winter of 2012, there were several complaints regarding Callow’s snow removal service from occupants of the condominiums. Mr. Callow, on behalf of Callow, attended a meeting with Baycrest on January 3, 2013 where the service issues were discussed and explained. The meeting was generally positive and the then-property manager wrote that there was “nothing outstanding to report”.[3]

Several weeks later, a new property manager took over for Baycrest, Tammy Zollinger (“Zollinger”). Zollinger decided that the contract with Callow should be terminated due to poor workmanship. Baycrest voted and passed the decision to terminate the contract with Callow in either March or April of 2013, but did not inform Callow of this decision.

Throughout the summer of 2013, Callow continued to perform the summer contract work, even performing additional work that Mr. Callow described as “freebie” work in hopes of securing a renewal of the winter contract. Mr. Callow was under the impression that Baycrest was happy with his work and that a renewal was likely. A board member of Baycrest, Mr. Peixoto, was well aware of this based on multiple dealings with Mr. Callow during that time. He even stated in an email that “he is under the impression we’re keeping him for winter again. I didn’t say a word to him.”[4]

Baycrest did not inform Callow of their decision to terminate the winter contract until September 12, 2013 in an email from Zollinger, whereby she notified Callow that Baycrest would invoke Clause 9.

Callow brought a claim against Baycrest for breach contract based on acting in bad faith; loss of opportunity stemming from not bidding on other winter contracts due to Baycrest’s conduct; and claiming that Baycrest was unjustly enriched by the freebie work provided by Callow.

Lower Court Decisions

Ontario Superior Court of Justice (O’Bonsawin J.)

Justice O’Bonsawin held that the principle of good faith performance and the duty of honest performance of contracts were engaged. She found that Baycrest actively deceived Callow between when the decision to terminate the winter contract was made and when the contract was actually terminated, some five months or so. She found that Baycrest “acted in bad faith by (1) withholding the information to ensure Callow performed the summer maintenance services contract; and (2) continuing to represent that the contract was not in danger despite [Baycrest’s] knowledge that Callow was taking on extra tasks to bolster the chances of renewing the winter maintenance services contract”.[5] The existence of active communication throughout the summer months between Baycrest and Callow without disclosure of any alleged performance issues or Baycrest’s decision to terminate the winter contract evidenced deliberate deception by Baycrest, which was a breach of contract by reason of the duty of honest performance. O’Bonsawin J. awarded damages to Callow in order to put it in the same position it would have been had the breach not occurred, with an additional amount representing a one-year rental of equipment that would not have been leased had Callow known the contract was to be terminated.

O’Bonsawin J. further found that Baycrest was unjustly enriched by the freebie work performed by Callow. However, no damages were awarded because Callow did not properly show the expenses incurred for this work.

Ontario Court of Appeal (Lauwers, Huscroft and Trotter JJ.A.)

The Court of Appeal unanimously overturned the trial judge’s decision. The Court of Appeal had two lines of reasoning. First, Baycrest had no contractual obligation to disclose the decision to terminate the contract prior to the notice period. Second, Callow itself acknowledged that failure to disclose was not in and of itself evidence of bad faith. The trial judge had based her decision on what amounted to a “failure to act honourably”[6], however it did not rise to the level of being a breach of the duty to perform honestly.

The Court of Appeal further noted that any deception was in relation to a potential renewal of the contract, and could not be linked to the existing contract

Supreme Court of Canada Decision by Kasirer J. (Wagner C.J. and Abella, Karakatsanis and Martin JJ. concurring)

Kasirer J., writing for the majority, began by offering a comprehensive analysis of the duty of honest performance as set out in Bhasin. This analysis has two main components.

1. The dishonesty must be directly linked to the performance of the contract.

Kasirer J. is very deliberate in his discussion of this point. There was no dispute that Baycrest was at perfect liberty to exercise Clause 9. However, the manner of the exercising of a contractual right is the main issue:

Stated simply, no contractual right can be exercised in a dishonest manner because, pursuant to Bhasin, that would be contrary to an imperative requirement of good faith, i.e. not to lie or knowingly deceive one’s counterparty in a matter directly linked to the performance of the contract.[7]

Kasirer J. utilizes a comparison from Quebec civil law’s theory of the abuse of contractual rights in service of determining when dishonesty will be considered to be directly linked to a contract.

Dishonesty is directly linked to the performance of a given contract where it can be said that the exercise of a right or the performance of an obligation under that contract has been dishonest.[8]

It should be pointed out that Justices Brown, Moldaver and Rowe, who concur with the decision of the majority of the Court, did not agree with the comparison with Quebec law’s abuse or rights. Brown J., writing for the concurring justices, writes that while they object to utilizing Quebec law in this instance, they use the reasoning from Bhasin to reach a similar position.

The Court disagreed with the Court of Appeal in suggesting that the dishonesty was related to a future contract. Baycrest’s decision was to exercise a right in terminating an existing contract through Clause 9. By leading Callow to believe that there was no danger to the existing contract, Baycrest was acting with a link to the performance of an existing contract.

2. Whether Baycrest’s conduct constitutes dishonesty.

Kasirer J. states that outright lies and half-truths to knowingly mislead are dishonest practices that could constitute breach of contract. He also notes that the duty of honest performance does not reach the level of acting as a fiduciary in disclosing information where there is no contractual obligation.

The main point of contention is what actually constitutes knowingly misleading another party where lies and half-truths are not involved, as in the circumstances at issue Baycrest for the most part remained silent. In Bhasin, the duty of honesty is recognized as a negative obligation, one that places a duty on the actors to not lie rather than a positive obligation to act in good faith. With that in mind, Kasirer J. defines what can constitute knowingly misleading another party in light of the case at hand:

At the end of the day, whether or not a party has “knowingly misled” its counterparty is a highly fact-specific determination, and can include lies, half-truths, omissions, and even silence, depending on the circumstances. I stress that this list is not closed; it merely exemplifies that dishonesty or misleading conduct is not confined to direct lies.[9]

Using this rather broad spectrum, Kasirer J. concurs with the findings of the trial judge that Baycrest knowingly misled Callow. Baycrest remained silent regarding their decision to terminate the contract with Callow despite active communications between Callow and Baycrest after the decision had been made. Mr. Peixoto led Mr. Callow to believe that the services of Callow were to the satisfaction of Baycrest and that the winter contract was likely to be renewed. In emails, Mr. Peixoto even admitted that he understood Mr. Callow’s attempts to curry good favour with freebies and believed that a contract extension was likely, yet he had remained silent. Baycrest knew that Callow was under the false impression that the contract was in good standing and would likely be renewed, despite Baycrest having already decided to terminate the contract, and accepted the freebies willingly. To satisfy the duty to perform honestly, Baycrest ought to have corrected Mr. Callow’s false beliefs. By not doing so Baycrest’s conduct misled Callow.

Damages

Kasirer J. concludes with a discussion about the appropriate quantum of damages for the breach of the duty to perform honestly. He notes that the correct analysis for damages would be expectation interest, the amount that would put Callow into the position it would have been in had the duty been performed. Had Baycrest been upfront with Callow and made Callow aware of its intention to cancel the contract, it would have been able to seek contracts out for at least an equivalent amount for the upcoming winter. By breaching the duty, Baycrest deprived Callow of the lost profits associated with a one-year winter contract.

Further, Kasirer J. agreed with the trial judge’s award representing the rental of a piece of machinery for the next winter. As he explains, the damages award was for lost profit, not lost revenue. Callow was rightly entitled to recover on expenses as well.

Once again, the concurring justices reach the same conclusion through a different approach. While Kasirer J. uses an expectation measure of damages, Brown J. notes that a reliance measure would be more appropriate. “In short, the plaintiff’s complaint is not lost value of performance, but detrimental reliance on dishonest misrepresentations.”[10]

A Strong Dissent

Arguably, a party should not accept “freebie” work provided by a party who may be operating under an unachievable expectation of compensation. However, the law of restitution or unjust enrichment already protects the interests of parties in such circumstances. A person claiming unjust enrichment for providing services must show that the recipient freely accepted the services and that the provider may have reasonably expected to be paid for providing them: e.g. Sharwood Company v. Municipal Financial Corporation, 2001 CanLII 24066 (ON CA). In the case at hand, however, the parties had an existing contract whose terms arguably ought to have framed Callow’s expectations for compensation and the right of renewal (or lack thereof). Whether Baycrest was unjustly enriched as a result of freebie work provided by Callow is a matter of restitution rather than breach of contract, and Callow had failed to provide evidence of the value of the freebie work conferred upon Baycrest.

In a dissenting opinion, Côté J. framed the pertinent questions as follows:

What constitutes actively misleading conduct in the context of a contractual right to terminate without cause? Where should the line be drawn between active dishonesty and permissible non-disclosure of information relevant to termination? Does a party to a contract have an obligation to dissuade his counterparty from entertaining hopes regarding the duration of their business relationship?[11]

Côté J. agreed that there was a duty of honest performance of contractual obligations, pursuant to Bhasin, but disagreed with the conclusion that Baycrest had a freestanding obligation to provide notice to Callow of its intention to exercise the termination provision in the contract.

Baycrest had a contractual right to terminate Callow’s services “at any time” and “for any other reason than unsatisfactory services” upon 10 days’ notice. The litigation arose from Baycrest’s decision to wait before sending the notice of termination to Callow. Had Baycrest advised Callow immediately of the 10 days’ notice there would not have been any issue. But why did Baycrest wait? Baycrest did not want to jeopardize the performance of other ongoing work being done by Callow and so Baycrest did not discourage Callow’s unachievable hopes.

For Côté J., the issue came down to a single question: did Baycrest lie or otherwise knowingly mislead Callow into thinking that there was no risk it would exercise its right to terminate the winter agreement for any other reason than unsatisfactory services? Côté J. disagreed about the evidence as to whether Baycrest had specifically represented to Callow that the contract would be renewed.

The driving concern of the majority was that Baycrest knew that Callow was hoping to renew the contract (even though Baycrest did not specifically do or say anything to contribute to such hope), and then accepted and implicitly encouraged Callow’s continued services with no actual chance of renewing the contract. During this time, Callow conferred benefits onto Baycrest in the form of extra freebie services. Such services may have amounted to “incontrovertible benefits” under the law of unjust enrichment, but Callow had not adduced evidence for the expenses incurred in relation to such work and so the court did not assess whether such a claim could succeed.

Baycrest had bargained for the right to terminate for any reason and at any time upon giving 10 days’ notice. There was nothing in the contract which extended the 10 days’ notice. However, that is the consequence of imputing a “good faith” obligation into the relationship. Going forward, if a party makes a decision to exercise a termination option in a contract they will have to carefully assess whether they have an immediate obligation to give notice of the intention to terminate.

The questions posed by Côté J. will need to be carefully assessed in any situations where two parties are in an ongoing contractual relationship. What constitutes actively misleading conduct in such a context? Where should the line be drawn between active dishonesty and permissible non-disclosure of information relevant to termination? If decisions are made about the potential termination of a relationship, must this be conveyed immediately? The failure to dissuade a counterparty from entertaining hopes regarding the duration of their business relationship may indeed amount to “bad faith.”

Although the Court does not explicitly refer to inequality of bargaining power, there is an underlying David versus Goliath theme in Callow. Perhaps this leads the way to a prescription. A right to terminate with only 10 days’ notice appears harsh and Courts may be tempted to offer relief to the smaller and less experienced party. Commercial actors would be well advised to draft termination clauses that are more flexible and reasonable.

Callow and Moral Incrementalism

The spectrum of lies, half-truths, omissions, and even silence, depending on the circumstances, raises the issue of moral incrementalism. A simple example is the “white lie” that escalates. The idea behind the white lie is that no one really gets hurt by it. And if a person gets away with it, they are more likely to do it again. It may start small, but risks increase as morals are incrementally relaxed.

Eugene Soltes, a Harvard Business Professor, has written a wonderful book entitled Why They Do It: Inside the Mind of the White Collar Criminal[12] (Public Affairs 2016). Soltes gives the example of grey areas in the haggling that occurs when one is buying a car.

When the dealer says “I'm giving you the best price I can”, however, we don't normally think that it's literally the lowest price he could possibly offer. Few would think the seller acted wrongly if he had the authority to lower the price even further—we'd just say that they buyer should have negotiated more aggressively. Few would accuse the dealer of outright fraud since what he said is understood as simply part of the negotiation process.

Soltes gives several real life examples to illustrate his point:

People misstate, misrepresent, and exaggerate all the time in business. Sometimes these practices are tolerated as acceptable—as in negotiations for a new car—and sometimes they are fraudulent and possibly constitute crimes—as in the bond market. The legal ramifications are radically different, but the distinction between these different kinds of deception is not always so clear.[13]

The problem with any lying is that it strays over a pretty hard line, which is the line of truth.

Of interest during the COVID-19 pandemic, studies have shown that dishonesty increases with social distance.[14] It is easier to lie over the internet than it is to lie to a person’s face. The dangers of moral incrementalism become more acute with increasing distance and the resulting temptation to relax moral stances.

A recent 2020 study in the financial industry showed evidence of widespread dishonesty with the statistic that over 92% of subjects lie at least once.[15] Research has found that men are more likely than women to tell lies.[16]

Group dynamics may also enhance lying. There is a stronger inclination to behave immorally in groups than individually.[17] The reason for this is that communication exposes group members frequently to arguments in favor of violating the norm. Group think or behavior reinforces the danger of moral incrementalism.

From the perspective of the person being told a half truth, such as Mr. Callow, it is a fair assumption that strangers are being truthful. It is what Malcolm Gladwell describes as the “default to truth” that permitted fraudsters such as Bernie Madoff to go undetected.[18]

The decision in Callow will enhance the role of behavioral research in the area of truth telling and detection. The decision moves the discussion of moral incrementalism into the commercial world. Compliance programmes should be developed to integrate behavioral research. Techniques such as encouraging peer review and dissonance within a workplace will assist in promoting truth in commercial dealings and good faith.[19]

Conclusion

This case will present corporate compliance program designers with a unique challenge. To this point, corporate compliance programs have been an important element in maintaining compliance with government rules and regulations. This is about to change. Going forward these programs must contain a section focused specifically on contractual relationships. The extremely broad definition of what can constitute “knowingly misleading” a party to a contract can create confusion and difficulty for representatives of a corporation, especially given the particularly resonant dissent of Côté J. The spectrum of “lies, half-truths, omissions, and even silence” is begging for years of litigation, which may one day assist corporations in understanding just what they can and cannot do. In the meantime, making representatives of your corporation aware of the potential pitfalls and repercussions of “knowingly misleading” contractual partners is of the utmost importance.

Kenneth Jull

If you require any assistance, our Compliance Group is available to discuss your specific matter. Please contact Kenneth Jull at 416.865.2964 or kjull@grllp.com.

(This blog is provided for educational purposes only, and does not necessarily reflect the views of Gardiner Roberts LLP).

 


[1] C.M. Callow Inc. v Zollinger, 2020 SCC 45 (“Callow”).

[2] Bhasin v Hrynew, 2014 SCC 71.

[3] Callow, supra note 1, at para 9.

[4] Ibid, at para 13.

[5] Ibid, at para 21.

[6] Ibid, at para 27.

[7] Ibid, at para 54.

[8] Ibid, at para 73.

[9] Ibid, at para 91.

[10] Ibid, at para 142.

[11] Ibid, at para 183.

[12] Why They Do It: Inside the Mind of the White Collar Criminal[12] (Public Affairs 2016),

[13] Soltes at p. 147. See Chapter 10, “Unfortunately, the world is not black and white: Financial Reporting Fraud.”

[14] “Be close to me and I will be honest : How social distance influences honesty” by Daniel Hermann and Andreas Ostermaier (February 2018). The authors observe: “The influence of social distance on honesty is interesting because it relates to most in­teractions that involve honesty. For example, public authorities usually appear as a distant and impersonal interaction partner to people, and honesty is indeed a major concern in tax collec­tion. In this and other areas, people often interact through intermediaries, who increase social distance between the interaction partners. More generally speaking, the wide use of the internet has profoundly simplified but also depersonalized communication.”(at page 4). Participants were less willing to lie at the expense of fellow students than at the expense of the experimenter (at page 14).

[15] WP 1927 – September 2019, revised June 2020 “The Way People Lie in Markets” Chloe Tergiman, Marie Claire Villeval, Electronic copy available at: https://ssrn.com/abstract=3635302. Regarding the nature of lies, absent reputation, up to 97% of subjects who lie make lies that can lead to detection. However, the introduction of reputation leads to a major change: detectable lies become infrequent, and project managers shift towards a “Deniable Lie Strategy” so as to not be detected as liars by the investors with whom they are in fixed relationships.

[16] Judgment and Decision Making, Vol. 13, No. 4, July 2018, pp. 345–355 “Gender differences in lying in sender-receiver games: A meta-analysis” by Valerio Capraro.

[17] “I Lie? We Lie! Why? Experimental Evidence on a Dishonesty Shift in Groups” Martin G. Kocher, Simeon Schudy, Lisa Spantig CESIFO WORKING PAPER NO. 6008 CATEGORY 13: BEHAVIOURAL ECONOMICS JULY 2016 at page 4. The exchange of arguments and talking to people that argue in favor of violating the norm also changes the norm perception. The authors show that the expectation that other people (out-of-sample) lie increases significantly after the group interaction. A detailed analysis of the protocols from the group interaction suggests that groups lie more because communication enables them to justify dishonest behavior in a different way than individuals. Further the authors find that the dishonesty shift in groups is very strong such that the group composition (in terms of the number of initially dishonest group members) only weakly affects the extent of dishonesty in a group.

[18] Malcolm Gladwell, Talking to Strangers (Little Brown and Company New York, 2019).

[19] Profiting from Risk Management and Compliance |Todd L. Archibald and Kenneth E. Jull, Thomson Reuters, Chapter 21. Compliance Systems and Operational Change.

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