Earnout arrangements typically involve post-closing obligations on the part of the buyer, who now owns and likely operates the purchased business or assets. This post, the third in our earnout series, takes a look at how the Supreme Court of Canada's November 2014 decision in Bhasin v Hrynew, a case concerning the role of honesty and good faith in the common law of contract - might affect earnout provisions in future.
Bhasin: Good faith and honest performance in contract law
In Bhasin, the Supreme Court of Canada held that good faith is an "organizing principle" within Canada's common law of contract. What that means, basically, is that good faith is not in itself a general rule of contract law, but rather a principle that underlies and informs a range of narrower common law doctrines that have traditionally required the exercise of good faith in certain limited types of contractual performance. Examples include the good faith obligations that arise in certain relationships, such as "insurer-insured", as well as those that have been held to apply in certain situations, as in the case (for example) of a contract whose central purpose would be frustrated if one side did not endeavour in good faith to obtain a required permit.
One of the key holdings of Bhasin, however, is that, from time to time, the organizing principle of good faith may generate new good faith duties in addition to those that are already recognized. While the court repeatedly emphasized that any new good faith duties would have to evolve by means of gradual and incremental steps, the fact remains that its decision in Bhasin indicates that the range of good faith obligations in Canada can be expected to expand over time.
That gradual expansion began in Bhasin itself, with the court's decision to take the "incremental step" of introducing a duty of "honest performance" into Canadian common law. The duty of honest performance requires that parties not lie or otherwise knowingly mislead their counterparties about matters directly related to the performance of a contract. It creates what the court called a "minimum standard of honesty" - "minimum" because it does not rise to the level of a duty of loyalty or a duty of disclosure. However, while it may not be as onerous as a fiduciary duty, the new duty of honesty, as far as it goes, will be difficult to avoid. There appears to be no way to contract out of it, although the court did state that it can be limited by express...
