WeirTalking Leasing / Season 1 / Episode 7

Good Faith in Leasing Law

Lawyers David Thompson and Karsten Lee set you on the right track with respect to the duty of good faith in commercial leasing.

Transcript

Narrator: You’re listening to WeirTalking Leasing, an eight-episode podcast series from WeirFoulds LLP’s Commercial Leasing Group. Educating landlords, tenants and property managers on today’s commercial leasing landscape in Ontario. Our legal specialists, will be discussing everything new and interesting from lease terminations, office sharing, unattractive properties, cannabis and so much more.

David Thompson: Hi, David Thompson, partner in the leasing group at WeirFoulds. I’m here with my partner Karsten Lee is also in the group.

Karsten Lee: Good day.

David Thompson: So today we’ll be talking about good faith, something that a lot of people get wrong and there’s a recent Supreme Court case about it and we’re going to try and set you on the right track so that you can talk about it and understand it a bit better.

Karsten Lee: Yeah, so that conversation with the client really jives very well with our topic today and how the duty of good faith applies to commercial leasing. So this client of mine recently spent about half an hour venting to me and she’s been stuck spending the past three months or so negotiating with the landlord. And the problem is she’s feeling that the landlord is constantly trying to pressure her to get the deal, the offer to lease signed. And the landlord keeps telling her that there’s so many other tenants circling around waiting for the premises too. So she keeps feeling pressured to do the deal that she’s not quite comfortable doing with. So the issue is, my client is just feeling that the landlord is not being completely truthful with her. She’s thinking that, well, if there’s so many other tenants interested in the space, then why haven’t anyone else pulled the trigger and offered and given the landlord an offer, right?

Karsten Lee: So she’s really feeling like, is the landlord being truthful to her? Is the landlord trying to strong arm her to signing this deal? Is the landlord stretching the truth about having other tenants being seriously interested in the space? So now that’s she’s questioning whether or not everything else the landlord is
saying is actually truthful. Like for example, the landlord keeps saying to her, “oh no, we can’t accept a rent under $30 a foot.” But she’s thinking, well, the market rent for it is actually fine. Thirty’s in the range, but it’s in the upper end of the range. But if they’re demanding a rent that’s $30 or nothing or $30 or higher and nothing less, is that the truth? Will the landlord actually be willing to accept the rent that is lower than that? She’s now wondering if the landlord’s being even truthful about everything else on top of the rent, like the estimates, the landlord’s telling her, “Oh, this is the additional rent estimates, so don’t worry about it.”

Karsten Lee: So now she’s saying, well, is he stretching that truth? What’s the landlord’s future plans for lead development? He’s saying, “oh, don’t worry, we have no plans to redevelop.” But now she’s feeling, “can I trust the landlord on their word that they have no plans to redevelop?” So she’s kind of on that verge of feeling cheated and she was asking me, is there anything that she can do, within the legal context. Is there anything she can do to compel the landlord to at least tell the truth at this stage of the game?

David Thompson: So my question to you is during negotiations, is that different than later in the process?

Karsten Lee: So, the short answer to it is absolutely. And that’s one of the things why this was a good story to start this topic about good faith. There’s definitely a difference between anything said during the negotiation phase of a contract and as compared to that stage of the contract when the contract is already signed and the parties are now performing the terms that are in the
contract.

David Thompson: Wait, I just want to clarify. The duty of good faith only comes in after the contract is signed.

Karsten Lee: Correct. The duty of good faith only applies during the performance of the contract and not the negotiation of the contract. So that’s one of the things that we’re going to be exploring a little bit more during our podcast today.

David Thompson: So can you talk about the leading case that just came out from the Supreme Court?

Karsten Lee: Well, the case has been recent in legal terms, but it was fairly recent legal terms, but it was actually five years ago and the case name is called Bhasin and Hrynew.

Karsten Lee: Now I’m going to call it the Bhasin case going forward just to make it easier to refer to, but what the Bhasin case stands for is the general proposition that contracting party. So parties that are entering into a contract now have a duty of good faith to each other. Right? But only in the performance of the contract, which we’ll again, we’ll touch upon. Before we get into exactly what the duty of good faith means to today. Just wanted to just quickly talk about what the Bhasin case came out with. They came out with three principles. So the first thing is, over the past five years, there’s been a general principle of good faith that underlies many facets of contract law. Okay, so that’s number one. Number two is, how is this general broad principle of the duty of good faith is applied to specific cases will be determined exactly based on the facts of that particular case.

Karsten Lee: So each case will be different based on its facts. And number three, as part of this principle of good faith, who we need to recognize a new common law duty that is a duty of honest performance. Now what is the duty of honest performance? This requires the parties to be honest with each other in relation to their performance of the contract. Now I’m going to expand a little bit on this duty of honest performance. What the Supreme Court said is that this duty of honest performance simply means that the parties must not lie or otherwise knowingly mislead each other about matters directly linked to the performance of the contract. So again, I’m just going to talk a little bit more about this duty of honest performance. Because I think it really gets down to the key points of the duty of good faith.

Karsten Lee: So this duty of honest performance, it won’t force a party to give up on the advantages that it comes from a contract. So if a party has spent a lot of time negotiating a very good term, for example in a lease, if one party is able to negotiate a very strong redevelopment clause, right? Simply performing the contract based on the words or the clause that it has already painstakingly negotiated for, even though it is to their benefit and to the detriment of the other party that is still within the realm of duty of honest performance.

David Thompson: Right, so you get to whatever your deal is, you get to go through with that deal and say those are my rights.

Karsten Lee: So this duty of honest performance doesn’t rely on the intention of the parties, right? It doesn’t go back and look at, oh what exactly is the thought process of the party? It really comes down to what has been negotiated and what’s being said. This duty of honest performance, again, like I mentioned earlier, will vary with the specific facts of each case and it does not mean that one party has a fiduciary duty to the other.

David Thompson: Right. For listeners, you may not know a fiduciary duty is a special legal responsibility to someone. So for example, an executor of a will has to do things a certain way. A franchisor has to act a certain way to franchisees. They’re constrained by the law that they have to, they have a responsibility to act in a certain way. So Karsten’s talking about that, that higher level of duty.

Karsten Lee: Thank you for clarifying that. And at the end of the day, this duty of honest performers merely requires that one party not seek to undermine the other party’s interests in bad faith.

David Thompson: Right. Okay. So you have to be honest in the performance of the contract, you can’t lie in performing the contract, but then what did the case other than those three main points, what else came out of the case that you want to talk about?
Okay, so the Bhasin case came out five years ago and obviously there’s been a lot of cases that have come up in the past five years that have developed this idea of the duty of good faith and what I can talk about today are the seven points about good faith that we can take away with us today. And these seven points have been developing in case law over the past five years. And these are kind of my thoughts on where the duty of good faith stands today. So, as I was mentioning earlier, there is no duty of good faith during the negotiations of the contracts.

Karsten Lee: So this goes back to my original story where my tenant is feeling very frustrated while she’s negotiating her offer to lease with a landlord, but the landlord just doesn’t have that duty of good faith to her at that point in time. The contract’s not signed, the duty of good faith still doesn’t apply.

David Thompson: So too bad, you can just be as aggressive as you want.

Karsten Lee: Now there is that line that you can’t be extremely deceitful because at the end of the day you might open yourself to lawsuits for negligent misrepresentation or intentional misrepresentation and that sort of thing. And you get into issues of undue influence and party signing under duress. But that goes beyond the scope of what we’re trying to talk about today. But in terms of shall we, for lack of a better term, little white lies, there really isn’t any obligation for one party to not have these little white lies during the negotiation process.

Karsten Lee: Right? So simply put with the Bhasin case came out with again was only recognizing a duty of good faith only within the performance of the contract after it’s signed and it did not recognize the duty of good faith in the context of negotiations before the contract is entered into. Now, some people, some lawyers might argue that there have been cases that have come up with a duty of good faith during the negotiation of the contract. But I would say that those one or two cases out there are exceptions to the rule. And were decided solely due to the very specific narrow facts within each case. So the overarching idea is, again, the duty of good faith only applies during the performance of the contract once it’s signed. So that’s kind of the first point that I wanted to talk about.
The second point is entire agreement clauses. So a lot of people say, “well, I’ve entered into this lease, it has an entire agreement clause, so I’m not subject to the duty of good faith because everything that governs the relationship between you and I, is within the four corners of this contract. That’s why we have the entire agreement clause.” Well, unfortunately for them, the courts have confirmed that the duty of good faith still operates even though the contract contains an entire agreement clause. So parties definitely can’t wiggle their way out of the duty of good faith by relying on the fact that their contract has an entire agreement clause. Okay? So number three, the duty of good faith only applies to the express terms of a contract. So, when a party is performing a contract based on the express terms that are already in it, then the duty of good faith applies.

Karsten Lee: But what the duty of good faith does not do is actually imply new provisions into the contract that the parties didn’t originally negotiate.

David Thompson: So Karsten, that’s very important because a lot of people will try to amend a contract or vary a contract orally with the parties and their lawyers are always saying to them, get it in writing, get it in writing. And this is a great example of it’s got to be in writing for you to be able to enforce it and this duty of good faith to apply to it.

Karsten Lee: Absolutely. If it’s already been negotiated in the contract, the other party can’t now say, it’s so unfair to me. So, that definitely has to be a breach of the duty of good faith. That just doesn’t work. If it’s been negotiated in the contract, the other party can trigger that right that they’ve negotiated for. Okay?

Karsten Lee: The fourth point that I wanted to talk about was this duty of good faith does not allow a court to second guess the final terms of the contract. Again, when two parties negotiate the terms of a contract, one of the parties can’t now turn around and say, oh, this is unfair. I’m going to go to court to try to get them to agree with me. What a court does not do is take a look at the clause and say, oh, this clause is actually unfair to one party. The clause is a clause. The parties negotiated it. It is what it is. The only thing that the court can quote unquote “second guess” is how that clause is carried out by one party. When the party was performing its rights or obligations pursuant to that clause. Did they act in good faith or did they act in bad faith?

David Thompson: Right, so the black and white words said something and did they perform in good faith based on those words? They’re not going to reinvent those words.

Karsten Lee: Absolutely not. Yeah.

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Karsten Lee: Now, the fifth point that I wanted to make was the duty of good faith does not mean that it is bad faith if a party performs a contract in accordance with the terms. So exactly what we’re talking about. If one party is able to negotiate a clause that is very, very favourable to it and it goes now, two years down the road it goes to exercise its rights under that clause. It is well within its rights to do it even though it is detrimental to the other party. So just to clarify, if a party is acting in its best interests based on the words of the contract, if they say, okay, the words say this and it’s good for business for me to act in this way and trigger my rights in this clause. Just doing that, even though it’s harming, so to speak, financially harming the other party does not mean that the party who is acting on it, is acting in bad faith.

David Thompson: Right. So if you made a good deal for you, you can enforce your good deal even though it’s not such a good deal for the other side.

Karsten Lee: Yeah. So, at the end of the day you have to have freedom to pursue your own self interests, right? What the Bhasin case is not doing is saying, oh, you have to be fair to everyone. You still can act to your benefit. Right? And if acting in your own self interest causes the other party to lose money, well that’s not in contravention of the duty of good faith. You’re just acting in your own self interest.

David Thompson: As long as the words say that.

Karsten Lee: As long as the words say that. Correct. So the sixth point that I wanted to make was the duty of good faith is generally speaking a duty of honest performance and nothing more, and I already touched upon this earlier, but a duty of good faith does not impose something more than that.

Karsten Lee:  It’s not a duty of loyalty, it’s not a fiduciary duty, which we already chatted about earlier and it is definitely not a duty to put the interests of the other party ahead of yours. Again, you can act in your own self interest. And the last point I wanted to make, my seventh point is that the law is still developing. We’ve only had this concept in common law for the past five years. A
lot of courts are still grappling with how to deal with it. It’s evolving. It may well change from now as compared to five years from now. But that’s part of the arguments that the courts have been dealing with is how this duty of good faith is going to evolve over time.

David Thompson: Thanks for that background. So to summarize a little bit, you can negotiate aggressively. Hard bargaining still exists. The words of the contract that are agreed upon between the two parties will not be amended by the court.

David Thompson: But the court will look at how someone is performing the black and white words to see if they’ve acted in an honest way in performing what the words say.

Karsten Lee: Correct.

David Thompson: Okay. So can you give us some examples? I mean this is pretty theoretical, right? Can you give us some examples to kind of give an idea of how this would work in a leasing company?

Karsten Lee: You know what, David, let’s try to do that. Let’s try to do that. We’ll try to think about what’s the most likely outcome given the state of affairs today. But just as a warning to our listeners, you should take what we say with a little bit of a grain of salt because these issues have not been litigated. They haven’t been considered by the court yet. So, and like I mentioned, the duty of good faith is still evolving. So what we say now might change tomorrow, but yes, let’s try to come up with some examples. Why don’t you come up with an example and I’ll see if I can answer it in the context of the duty of good faith.

David Thompson: Okay. I’ll give you an example. If a landlord has a demolition clause where they can terminate the lease, if they decide to knock the building down and build something else, can the landlord invoke that clause and kick the tenant out?

Karsten Lee: So in our example, this was a clause that was specifically negotiated in the lease?

David Thompson: Correct.

Karsten Lee: And it’s in there in black and white?

David Thompson: Yeah.

Karsten Lee: So in my mind, that is not a breach of the duty of good faith. Again, it was negotiated by the parties. It’s in the contract in black and white. Even if it is perceived by the tenant to be completely unfair to it that their lease gets terminated because of the landlord wanting to redevelop the property. As long as that clause is specifically said on the lease, the landlord can trigger it and it would not be a breach of duty of good faith.

David Thompson: Wait a minute. If the landlord knew it was going to demolish for two years, but it only had to give let’s say a one year notice, are you telling me they could withhold that information for that year until they had to give the notice?

Karsten Lee: That’s a very good question. Now, withholding information is very different than outright lying. Right? So in my view, if a landlord withholds information, so going back to your example, it knew that it was going to redevelop the property for the past two years, but it only had the obligation to provide three months’ notice or six months’ notice. And that’s what the
landlord did is provide the three or six months’ notice. Then that would not be a breach of the duty of good faith because they didn’t lie. They just withheld information. Now the problem is if the tenant was to come to the landlord, two years’ prior and say to them, clearly, “are you planning on redeveloping the property and kicking me out?” And the landlord says blatant lie, “no. Oh, there’s absolutely zero chance for redeveloping the property. And we’re definitely not kicking you out,” then that’s where the landlord can get into some problems.

David Thompson: Oh, right. So there are some grey areas that if you can wait until a certain period to give some information, fine. But if somebody asks you a question and then you lie-

Karsten Lee: Yes, that’s the problem. Yeah.

David Thompson: In leasing and agreements of purchase and sale, they’re often conditions that have to be satisfied or waived by either party. So if one party has conditions, do they have to act honestly when they’re trying to fulfill those conditions or satisfying them?

Karsten Lee:  In my view, I definitely think they do, right? At that point in time, the contract’s already been signed and now you’re performing the terms that are set out in a contract. So for example, if your condition says this deal is conditional on obtaining site plan approval, right? So this is a landlord’s condition that says it’s conditional upon them obtaining site plan approval. And for some reason the landlord gets cold feet, cold feet for any reason. Let’s say they didn’t get the financing at the terms that they wanted. The landlord cannot then turn around and sabotage the site plan approval process in order to kill the deal. If the condition was clearly set out to be a site plan approval, they need to apply and try to obtain the site plan approval in an honest and diligent manner.

David Thompson: Let’s shift gears a bit. Let’s talk about a nonbinding letter of intent, which people do from time to time, especially without our advice. So they’ll do a little one page or two page agreement. It sketches out the general terms of the agreement, the business issues, but it does say often at the end, this is a nonbinding letter. So what if your client’s been negotiating that for eight months and at the end of the eight months the landlord just pulls the rug out from under and just says, you know what? I’m finished. I’m done. I’m going to stop negotiating.

Karsten Lee: Yeah. So that’s a really interesting question. Is that a breach of the duty of good faith? Now, in my view, not at all. There’s no breach there. At the end of the day they’re still negotiating the terms of the contract and as the courts have said, there is no duty to negotiate in good faith. So since they’re negotiating the lease at that point, it’s still in the negotiation phase. There’s no duty of good faith at that point in time. And one party can walk away from the other at any time.

David Thompson: But how about if you had a binding offer signed so there were no conditions and if the conditions at all been waived, now you’ve got a binding offer to lease. It’s got all the terms in it. So you get your draft lease from the landlord and it’s got the business terms, fine. But there’s a lot of, you know how a lease is quite a bit heavier and thicker than an offer. It’s got all these other terms in it. Is that still negotiation? Can the landlord really be aggressive on those sort of grey areas that weren’t covered in the offer?

Karsten Lee: You know, in my view, yes. Whatever was negotiated in the offer as we know, it just has to make its way into the lease. But all those other terms that were not addressed in the offer when
the landlord and tenant are negotiating those terms within the formal lease, hard bargaining rules still apply to those clauses. So still no duty of good faith in those circumstances.

David Thompson: Okay. But that can’t apply to renewal rent. If you had an extension term, option to extend at fair market rent and you said to the landlord, “Hey, you can’t just bargain extremely hard, now you’ve got to act in good faith.” Would that maybe be an exception to that rule?

Karsten Lee: So that’s a very good question. And I think this is one of the more grey areas and I really love to see this exact issue be litigated and I’d love to see what a court would decide, but in my view, the landlord should be acting in good faith in those circumstances. In my view, it is part of the performance of the contract. The option to extend was clearly set out in the lease. The tenant has exercised it and now they’re negotiating rent and that’s clearly been set out in the contract. So when they perform those obligations, in my view at least there has to be some sort of good faith going on during those negotiations. But again, I’d love to see it litigated and I’d love to see how a court would decide that case.

David Thompson: Yes. So for you it’s not clear, what’s negotiation and what’s not? Because it kind of seems to vary with each deal.

Karsten Lee: Well, no, I think the issue with the negotiation of renewal rent is that it’s part of the performance of the contract. The original lease was already signed and now we’re performing the terms that are set out in the contract. So, which is a little bit different than pre-contractual negotiations in a sense no lease has ever been signed. We’re negotiating a new deal.

David Thompson: So does this Supreme Court case make it more unclear or do you think it makes it easier for parties now that they know before the contract they can still be hard and as you put it, little white lies are okay, but now during the contract there’s a new sheriff in town and they’ve got to be fair to some extent.

Karsten Lee: I think so. I think that’s how the legal industry in Canada has been operating since this case has come out. So at the end of the day, any parties who already have a contract or are thinking of negotiating a contract or a lease, will really have to keep in the back of their minds. This duty of good faith. Now like we mentioned, it is still evolving. There’s still going to be changes coming up. There are nuances in this duty, but at the end of the day you’ll have to think about this duty while you are carrying out the performance of your contracts and if you have any questions then definitely a lawyer can help you out navigate those issues.

David Thompson: So stay tuned to more developments. Maybe we’ll have an update in a future podcast. Karsten Lee, thanks very much for joining me today.

Karsten Lee: Thank you.

David Thompson: David Thompson, thanking the listeners for tuning in, and if you enjoyed the podcast, look for our future podcasts and you can always subscribe, review, and rate.

Narrator: Thanks for joining us for this episode of WeirTalking Leasing by WeirFoulds LLP. Please take a moment to rate, review and subscribe, and if you’d like to hear from our lawyers on another topic, send us an email at publications@weirfoulds.com