Publication
E-business and Communications (ITEC) Team
Many common types of contracts contain provisions that purport to provide one party with the exclusive and unfettered right to determine whether an important condition has been satisfied, and therefore whether or not certain remedies may ensue, including the contract's possible termination. A familiar example occurs in agreements of residential real estate purchase and sale, which often provide that the purchaser's obligation to complete the transaction is conditional upon its obtaining an inspection report satisfactory to it, in its "sole discretion". However, such clauses are common in a wide variety of commercial agreements, including licence agreements and agreements for services.
There are different formulations of such "sole discretion" clauses (for example, "in the discretion of ...", "in the sole discretion of ...", "in the sole and absolute discretion of ...", "as such party may determine") but they share the characteristic of purporting to provide one party with an unfettered right to make the relevant determination. In the mind of the party benefiting from the discretion clause, there is undoubtedly good reason for having this unfettered discretion - for example, how, one might ask in a real estate setting, could one possibly list in advance with any certainty the variety and severity of problems that a home inspector might identify, or identify the significance to the particular purchaser of every potential problem that might be found?
It would therefore be of particular interest to know that such "sole discretion" provisions may actually provide something short of absolute power of determination, and may be subject to considerable judicial scrutiny. Ontario courts have on several occasions stated that "sole discretion" provisions subject the exercise of such discretion to:
- an obligation to act honestly,
- an obligation to act in good faith, and
- an obligation to act reasonably, in accordance with either an objective standard or a subjective standard, or both, depending on the facts of the case.
Canadian courts (and the courts of other jurisdictions) have in recent years increasingly acknowledged the role of good faith and reasonableness in the interpretation and performance of contracts, and it is therefore prudent to expect that this interpretation of "sole discretion" clauses will find footing in other Canadian provinces.
A recent decision of the Ontario Court of Appeal illustrates the principle. In Marshall v. Bernard Place Corp.1 , the parties had agreed to the purchase and sale of certain residential real estate. The purchaser's obligation to complete the purchase was conditional on an inspection that was to be "satisfactory" to the purchaser in its "sole and absolute discretion". The inspection report identified various deficiencies in the property that were of reasonable interest to the purchaser. The purchaser then notified the vendor that it intended to rely on the inspection condition and exercise its subjective discretion not to complete the purchase. The vendor then sued, arguing in essence that the purchaser was required to complete the purchase unless the inspection report identified defects that met certain objective standards, such as those addressing operative fitness, structural completion, mechanical utility or marketability of the property.
The Court disagreed and found for the purchaser, and in its decision provided a useful restatement of the law concerning the exercise of discretion under such provisions. Essentially, the Court determined the following:
- Sole discretion clauses must be exercised honestly and in good faith - for example, they cannot be exercised capriciously or arbitrarily;
- The opinion that results from the exercise of the discretion must be reasonably formed. The standard of reasonableness that applies depends on the intention of the parties as disclosed in the contract:
- Contracts in which the matter to be decided or approved is not readily susceptible of objective measurement - for example, matters involving taste, sensibility, personal compatibility or judgment - will generally be determined on a subjective standard of reasonableness.
- Contracts relating to matters that are readily susceptible of objective measurement - such as operative fitness, structural completion, mechanical utility or marketability - will generally be determined on an objective standard of reasonableness.
The Court was clearly responding to the concern that a clause that states that a party has "sole discretion" and provides no other guidance as to the scope of that discretion would often, if interpreted literally, effectively give one party the right to terminate the contract unilaterally, for little or no reason, in a manner that would defeat the reasonable reliance and reasonable expectations of the other party to the contract as to the future benefit of the bargain struck. In essence, the courts are saying that one must do more than just use words such as "sole discretion" in an attempt to secure the right to act out of pure self interest and without regard for the interests of other parties.
Contracting parties should also understand that in their review of whether parties have acted honestly, in good faith and reasonably in the exercise of a "sole discretion" right, courts will consider the context of the relationship, the terms of the contract and all other relevant circumstances, and will be influenced by general considerations of fair play. Accordingly, courts may consider factors such as:
- the relative bargaining power of the parties,
- which party drafted the clause, and
- whether the party relying on the clause has made reasonable efforts to complete its part of the bargain.
Where the purpose of the sole discretion clause is to secure an important right for a party, careful drafting will be required and consideration will have to be given as to whether the factors that are to govern the exercise of the discretion, if any, should be expressly set out in the contract. Where a party is of the view that its "sole discretion" right ought not to be subject to good faith or reasonableness requirements, it will be appropriate to consider expressly stating as much in the contract.
- 58 O.R. (3d) 97.
The purpose of this document is to provide information as to developments in the law. It does not contain a full analysis of the law nor does it constitute an opinion of Ogilvy Renault or any member of the Firm on the points of law discussed.
For further information, please contact one of the lawyers of the Information Technology,
E-business and Communications (ITEC) Team mentioned below:
Duncan C. Card (Co-Chair)
(416) 216-2349
dcard@ogilvyrenault.com
Daniel J. Paul (Co-Chair)
(514) 847-4879
dpaul@ogilvyrenault.com
Mark S. Hayes
(416) 216-4094
mhayes@ogilvyrenault.com
Rob Hyndman
(416) 216-3966
rhyndman@ogilvyrenault.com
Grant A. Jameson
(613) 780-1530
gjameson@ogilvyrenault.com
Pierre Lajoie
(514) 847-4491
plajoie@ogilvyrenault.com
Brian A. Ludmer
(416) 216-4001
bludmer@ogilvyrenault.com
Peter S. Newell
(416) 340-6019
pnewell@ogilvyrenault.com
Robert L. Percival
(416) 216-4075
rpercival@ogilvyrenault.com
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