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Towards a General Duty of Good Faith Performance of Contractual Obligations – Maybe

Posted in Case Comments
Geoff R. Hall

The duty of good faith in contract law: the cautious and inconsistent approach of Canadian courts

Courts in common law Canadian jurisdictions have been reluctant to recognize any general duty to perform contractual obligations in good faith. Such a duty is a central tenet of American law under the Uniform Commercial Code and is a central tenet of Québec civil law, which recognizes a duty of good faith throughout the contracting process. But common law courts in Canada, like their counterparts in England, have been loath to recognize any general duty. They have also been very inconsistent, finding a host of ad hoc circumstances in which a duty of good faith performance exists, but without ever articulating a coherent theory of when the duty arises and when it does not.

Barclays Bank plc v Devonshire Trust, a recent decision of the Ontario Court of Appeal arising out of the asset backed commercial paper (“ABCP”) debacle, appears to edge Canadian common law slightly closer to a general duty of good faith performance of contractual obligations. With the decision, it appears that the law is moving, slowly, towards a rationalization of an erratic and confusing area of the law.

But maybe not. The Ontario Court of Appeal’s decision stands in stark contrast to other authorities, in particular a recent bold pronouncement of the Alberta Court of Appeal that a general duty of good faith performance does not exist. So wither Canadian law? Is there a general duty to perform contractual obligations in good faith or not? Only time and more decisions will tell.

The Decision

Barclays Bank plc v Devonshire Trust involves very complicated facts and a multitude of legal issues. The following very simplified summary focuses only on what is necessary to understand the good faith issue.

Barclays is a global investment bank and was the “asset provider” in an ABCP transaction entered into with Devonshire Trust in 2006. The transaction was based on two credit default swaps. Devonshire was the “conduit” in the transaction and issued short-term notes to investors. Barclays agreed to provide liquidity to Devonshire when certain of the investors’ notes matured if a “Market Disruption Event” or “MDE” occurred. Such protection was required because the maturity of the underlying assets was much longer than the short-term notes, requiring Devonshire to “roll” the notes to new investors on a regular basis. An MDE would disrupt the ability to roll over the notes, in which case Barclays would step in and provide funding to allow repayment of matured notes.

In a highly publicized event, the Canadian ABCP market froze in August 2007 when concerns about holdings of U.S. subprime mortgage assets by ABCP conduits made it impossible for the conduits to roll over ABCP notes. Devonshire claimed that the market freeze was an MDE and that Barclays had breached its contract with Devonshire by failing to provide the required liquidity upon the MDE. Barclays disputed that there had been an MDE. On August 14, 2007, Devonshire delivered a default notice. Under the contract, Barclays had three days to cure its default (if indeed there was one).

On August 16, 2007, the major participants in the Canadian ABCP market entered into the “Montreal Accord”, a standstill arrangement that allowed time for negotiations to restructure the ABCP market. That process eventually led to a well-publicized restructuring that closed in January 2009 after proceedings under the Companies’ Creditors Arrangement Act. Devonshire was ultimately excluded from the overall restructuring, but it and Barclays were parties to the Montreal Accord. The Montreal Accord included a covenant that the parties would “work together in good faith with the other participants in the discussions to bring about the timely implementation of these arrangements”. The effect of the standstill was that the three day cure period was suspended before it had completely run.

Barclays and Devonshire negotiated for a number of months, extending the standstill (and consequently, the cure period) as between them until January 12, 2009. For the last nine months of the negotiations, the parties extended the standstill on a day-to-day basis, with an identical e-mail sent daily by Barclays to extend for another day.

In January 2009, Barclays executed a carefully planned series of events. It delivered an ultimatum to the Caisse de dépôt et placement du Québec, a major player in the negotiations to restructure Devonshire. On Friday, January 9, 2009, Barclays delivered the usual e-mail extending the standstill with Devonshire to the close of business on Monday, January 12, 2009. However, Barclays did not disclose to Devonshire the ultimatum it had delivered to the Caisse, nor the fact that the Caisse was very unlikely to agree to the ultimatum. At the open of business on January 13, 2009, without warning to Devonshire that it would be doing so, Barclays wired the liquidity payment ($71 million plus interest) to Devonshire’s bank account. Before the funds were credited to the bank account, Barclays delivered a notice to Devonshire purporting to terminate the contract between them on the basis that Devonshire was insolvent, which was an event of default under the contract. Barclays then asserted a security interest over the funds held in Devonshire’s bank account, including the funds Barclays had itself just wired. Within hours, Barclays sued, seeking a declaration that its payment of the liquidity amount cured its default before the cure period expired, allowing it then to terminate the contract with Devonshire on the basis of Devonshire’s insolvency.

The trial judge and the Ontario Court of Appeal found Barclay’s actions to be too cute by half and held them to be ineffective. Both courts concluded that Barclays had engaged in misrepresentation by extending the standstill period without disclosing to Devonshire its ultimatum to the Caisse and its knowledge that the ultimatum would be refused. As such, the last two daily extensions of the standstill were set aside and the cure period was found to have expired before Barclays made the liquidity payment. Both courts also concluded that Barclays had breached its duty of good faith.

The treatment of the duty of good faith

The Ontario Court of Appeal started its analysis of the good faith issue by observing, as it has repeatedly in the past, that there is no standalone duty of good faith and that a party to a commercial agreement is entitled to enforce the agreement to its own advantage according to its terms, including by exercising a right of termination. But the court found that two circumstances supported a duty of good faith in the circumstances of the case.

First, Barclays had expressly agreed in the Montreal Accord to engage in good faith negotiations. The court quickly dismissed Barclays’ contention that the provision in question was an unenforceable agreement to agree. This is a somewhat surprising holding, as cases considering such provisions have been split on whether they are enforceable or are unenforceable agreements to agree.

Second, and more importantly for the development of the law, the Ontario Court of Appeal held that there is “an established principle that a duty of good faith arises when necessary to ensure that the parties do not act in a way that defeats the objects of the very contract the parties have entered”. Thus while Barclays was entitled to act in its own self-interest, it was not entitled to act in a way that would defeat or eviscerate its contract with Devonshire, and it had a duty to be honest and candid with Devonshire. Barclays’ liquidity payment was not made for the stated purpose of curing Barclays’ default, but rather was in furtherance of a strategy to grab collateral from Devonshire:

“The purpose of the Liquidity Facility was to provide Devonshire with the funds it required to pay the noteholders in the event of a market disruption. The manner in which Barclays made the payment is entirely inconsistent with that purpose. The payment was combined with a refusal to admit responsibility to make the payment, an assertion of security over the payment, a demand in the form of a lawsuit for their immediate return, and a notice terminating the Agreements on the basis of the very insolvency the payment was supposed to cure. To accept Barclays’ payment as a cure in these circumstances would gut a fundamental part of the Agreements of its meaning and purpose.”

Significance

Barclays Bank plc v Devonshire Trust appears to accept two heretofore dubious propositions, namely that a duty to negotiate in good faith can arise by contract and is not an unenforceable agreement to agree, and that there exists a general duty to perform contractual obligations in good faith so as not to defeat or eviscerate the purpose of a contract. Such a duty, if it has in fact been endorsed, is a narrow one because there are several possible definitions of good faith, of which the narrowest is the formulation accepted by the court. Broader definitions require a standard of behaviour that comports with commercial morality, a somewhat elastic and nebulous concept.

But is there in fact a general duty to perform contractual obligations in good faith? Barclays Bank plc v Devonshire Trust appears to say yes, at least in a narrow form. Yet other cases, and other courts, are sending other messages. Most notably, in March 2013 the Alberta Court of Appeal asserted unequivocally that “[t]here is no duty to perform most contracts in good faith” (Bhasin v Hrynew, 2013 ABCA 98). Only more time, and more court decisions, will tell whether the general duty apparently endorsed in Barclays Bank plc v Devonshire Trust is here to stay.

Case information

Barclays Bank plc v Devonshire Trust, 2013 ONCA 494

Court File: C54400

Date of Decision: July 26, 2013