The extent and scope of U.S. tariffs applicable to Canada (and the rest of the world) is in flux. Canadian businesses facing this turbulent environment are evaluating current and future contractual obligations and attempting to determine how best to remain on solid footing[1].
One area of concern in this context is contractual discretion: tariffs may prompt contracting parties to consider whether, and how, contractual commitments can be varied. Many contracts confer discretion over how an obligation is to be performed, or whether a party can amend contractual terms. A contract may also permit a party to request certain amendments and provide the counterparty with discretion to refuse.
A party with discretion might believe it simply has the right to exercise that power in any manner it sees fit. But doing so could lead to liability. Contractual discretion must be exercised in good faith, and parties cannot contract out of this requirement.
What the duty of good faith demands in practice will be context-specific and can raise complex issues. Accordingly, parties facing whether and how to exercise contractual discretion in response to tariffs should consult counsel familiar with managing the applicable risks.
Contracts Are Subject to Good Faith Duties — and Parties Cannot Contract Out of Those Duties
All contracts in Canada’s common law jurisdictions are subject to an overarching principle of good faith. The principle manifests in particular duties. The list of good faith duties is developing and continues to expand. For example, in Ontario, four duties are recognized:
- The duty of cooperation between the parties to achieve the objectives of the contract;
- The duty to exercise contractual discretion in good faith;
- The duty to not evade contractual obligations in bad faith; and
- The duty of honest performance.
Contracting parties must keep these duties in mind when considering their contractual rights and obligations, including with respect to contractual discretion.
The Supreme Court of Canada has made clear that parties cannot contract out of good faith contractual duties. Importantly, this prohibition may also preclude parties from contractually excluding or limiting liability for breaching such duties[2]. Parties who may consider themselves protected by a comprehensive limitation of liability provision may not be as protected as hoped.
Although this area of law is developing, it is also likely that these good-faith duties do not apply in pre-contractual negotiations[3].
One Such “Good Faith” Duty Requires That Contractual Discretion Be Exercised Reasonably
Discretionary clauses are common in commercial contracts:
- A party may have discretion as to how an obligation is to be performed;
- A party may have discretion to amend the contract unilaterally; and
- A party may have discretion to refuse amendments proposed by the counterparty.
A party with discretion might believe it has the right to exercise it in any manner it sees fit. However, discretion must always be exercised in good faith. This means that a party must exercise contractual discretion reasonably — even when the contract does not expressly limit the discretionary power.
The Supreme Court of Canada has explained that:
- Parties must exercise their discretion in a manner connected with the purpose for which the discretion was granted;
- Where the contract does not state the purpose for the grant of discretion, the purpose may be ascertained by interpreting the contract as a whole; and
- Parties cannot exercise their discretion arbitrarily or capriciously.
Accordingly, when considering whether and how to exercise contractual discretion, parties must at a minimum think through whether their intended exercise of discretion is consistent with the purpose for which the discretion was granted.
Consider Obtaining Legal Advice Before Exercising Contractual Discretion
Evaluating whether contractual discretion has been exercised in good faith can be highly context-specific. A shifting tariffs landscape is likely to raise complexities in this area, since contracting parties may not have turned their minds to that issue at the outset. Because exposure can be significant, contracting parties should carefully consider their positions. Parties should be particularly cautious when the exercise of discretion will materially change the nature of the contract or otherwise modify the obligations of the parties, and should consider obtaining legal advice specifically directed at potential risk.
For further insights on how tariffs are reshaping contractual obligations, join us at Fasken’s upcoming webinar, “The Impact of Tariffs and Common Contractual Provisions,” where our team will explore key legal considerations for navigating this evolving landscape.
