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What Amounts to Good Faith Conduct or Repudiation on Construction Projects?

Last week we discussed joint ventures in construction projects.  That issue arose from the important recent decision of the Prince Edward Island Court of Appeal in WCI Waste Conversion Inc. v. ADI International In. 

In this article, we will examine two further issues raised by that decision:

One, the duties of good faith and fiduciary duties in a construction project; and

Two, the degree to which conduct must be wrongful before it will amount to repudiation entitling the other party to terminate a construction contract.

The Background

To refresh our memory from my article last week, in June 2000, a PEI Crown Corporation, Island Waste Management Corporation (“IWMC”), issued a Request for Proposals for the design, construction and operation of a central composting facility to serve the province of Prince Edward Island.  WCI approached ADI about making a proposal together.  The ultimate Proposal was submitted in March 2001 by ADI and it stated that it was prepared by both companies.  In July 2001, IWMC awarded the contract to ADI, with WCI shown as a sub-contractor.

In May 2001, ADI and WCI entered into a Memorandum of Understanding (“MOU”).  They entered into a further MOU in August 2001 after the contract had been awarded by IWMC to ADI.  A provision of the August MOU stated that, while ADI would be the prime contractor and WCI the subcontractor, the actual working relationship between them would be based upon the general principles of a joint venture agreement.  The majority of the Court of Appeal held that this provision resulted in the parties being joint venturers, not independent contractors.

Under ADI’s contract with IWMC, ADI was to enter into a five year operating contract with IWMC, and under the MOU, ADI was to enter into a five year subcontract with WCI under which WCI was to be the operator.

In its Substantial Performance letter dated October 7, 2001, IWMC accepted ADI’s application for Substantial Performance effective October 1, 2001.  In accepting Substantial Performance, IWMC stated that its concerns about throughput performance were to be addressed by the date of Total Performance, which was to occur on February 1, 2003.  As a result, both ADI and WCI had until February 1, 2003 to demonstrate throughput performance.  Moreover, the majority of the Court of Appeal concluded that, based upon its conduct leading up to the Substantial Performance letter, ADI effectively viewed WCI’s performance with respect to throughput performance as being a deficiency, and not conduct which repudiated WCI’s obligations under the contract.

On November 26, 2002, ADI gave notice to WCI that it was in default of its obligations and gave a five day “cure” notice to WCI.  By letter dated November 29, 2001, WCI denied that it was in default and restated its commitment to improve the throughput performance of the project.  By letter dated December 4, 2002, ADI terminated the contractual relationship between the parties.

Repudiation and Termination

The trial judge held that, as of the date of ADI’s termination of the contract, WCI had not repudiated the contract, and therefore ADI’s termination was unlawful.  This finding was upheld by the majority of the Court of Appeal.  There are several aspects of its conclusions that are important.

First, the majority of the Court of Appeal held that the “cure” notice could not be given by ADI if WCI was not then in default.  Since WCI had until February 2003 to ensure that throughput performance was met, WCI was not in breach of any obligations as of November 26, 2002 when ADI delivered its “cure” notice, and December 4, 2002 when it terminated the contract. The Court of Appeal stated its affirmation of the trial judge’s conclusion as follows:

“The trial judge was entitled to find, as he did that WCI did not by its words or conduct repudiate; that, in any event, the time for correction of the deficiencies in question was not exhausted; and, in the circumstances of the status of the deficiencies, ADI did not show that WCI was incapable of performing its part of the contract.”

This is a very useful check list for a contractor contemplating termination of a subcontractor, particularly when deciding to give or act upon a “cure” notice.  First, by its words or conduct, has the subcontractor really repudiated its obligations?  Second, has the time for performance of the obligations in question really been exhausted?  And third, is the subcontractor really incapable of performing its contract?   And for good measure, can I prove all these elements at a trial?

The second important aspect of the Court of Appeal’s decision is its affirmation of the principle that “when a contract provides a time within which the contract work must be completed, the contractor is entitled to the whole of that time for doing the work” relying on Goldsmith and Heintzman on Canadian Building Contracts (4th ed) at chapter 5, part 1(d).

Third, the trial judge and majority judgment in the Court of Appeal applied the principle of good faith performance of contractual obligations.  The trial judge held that ADI did not act in good faith in seeking approval of Substantial Completion on the basis of throughput performance being achieved by February 2003 and then turning around and terminating the contract with WCI based upon its deficiencies in relation to throughput performance before February 2003.  The Court of Appeal held that a contract must be performed in good faith, that this obligation involves performance within the reasonable expectations established by the contract, and that the trial judge was entitled to find that ADI’s “tactics and motivations” were inconsistent with a good faith exercise of its obligations and contractual duties to WCI.

Fourth, in examining the conduct and rights of ADI and WCI, the trial judge and Court of Appeal looked to the conduct and rights as between the owner, IWMC, and ADI.  Thus, IWMC had delivered no “cure” notice or termination notice to ADI in relation to throughput performance.  Why was ADI delivering such a notice to WCI?  At ADI’s request, IWMC had agreed that throughput performance would be established by the date of Total Performance.  Why was ADI not agreeing with WCI to the same date for performance?  Clearly, ADI’s inconsistent conduct or attitude was of crucial concern to the trial judge, and the Court of Appeal upheld the trial judge’s findings based on those concerns.

The minority judge agreed with this conclusion but would have directed a new trial related to the entitlement of ADI to terminate the operating contract with WCI at its sole discretion and whether it had done so in good faith.

All the judges of the Court of Appeal were firmly of the view that the issue of whether or not WCI had repudiated the contract and whether or not ADI had the right to terminate the contract based on repudiation, was to be determined on an objective basis.  The majority held that repudiating is “not lightly to be inferred from a party’s conduct”, and that, as the terminating party, ADI had the obligation to prove WCI’s repudiation and its entitlement to terminate.  Accordingly, there was no element of discretion or deference to be accorded to ADI’s decision to terminate.

In all respects, this decision of the PEI Court of Appeal provides a very useful survey of the issues which must be addressed by contractors and subcontractors when termination for repudiation is contemplated under a construction contract, particularly when a “cure” notice is involved.

Good Faith and Fiduciary Duties

The trial judge concluded that, by reason of the joint venture between them, the parties owed fiduciary duties to each other.  Both the majority and the minority of the Court of Appeal disagreed.  The majority held that a joint venture, unlike a partnership, does not necessarily give rise to fiduciary duties.  Without deciding if fiduciary duties did arise in this joint venture, the majority held that the material findings of the trial judge about the conduct of the parties and the legal consequences of that conduct could be supported without reference to fiduciary duties.

The minority judge found that it was unlikely that, in the circumstances of this case, fiduciary duties would arise.  The minority judge then considered whether the parties had an obligation to exercise their rights under the contract in good faith.  He concluded that there was no such obligation in relation to any of the provisions of the contract which did not involve discretion, and that there was in relation to those provisions that did involve discretion.  He then concluded that under the “cure notice” provision of the MOU, if AWI properly followed the notice provisions and WCI did not cure, then the MOU could be terminated without regard to issues of good faith.  However, he held that AWI’s right to terminate the operating agreement was unilateral and could be exercised “in its sole discretion”, provided it gave the required notice and paid the required termination fees.  In this circumstance, the minority judge concluded that AWI was required to act in good faith in giving a notice to terminate the operating agreement.

The concepts of a fiduciary duty and a duty of good faith are very different.  A fiduciary duty is a duty to act in the utmost good faith and in the other party’s best interest.  An obligation of good faith is not a fiduciary duty.  It is not the obligation to act in the utmost good faith and in other party’s best interest.  It is the obligation to act in accordance with the purpose of the contract and not to undermine its performance.

It is highly doubtful that a true fiduciary duty will arise during a construction project unless the parties call themselves partners.  The commercial setting for the project is not consistent with such an obligation.

On the other hand, it is hard to see why an obligation to act in good faith should not arise.  After all, that obligation simply requires a party not to act in bad faith, not to act for an ulterior motive, that is, a motive which is outside the purpose of the contract.

Making an obligation of good faith dependent upon the existence of discretion, as the minority judge did, is highly problematic.  The element of discretion is usually relevant to determining whether the duty is a fiduciary duty, not whether a duty of good faith exists.  If a cure notice is given properly on its face, but is given for an ulterior motive having nothing to do with the proper completion of the construction project, why should that sort of conduct be valid?  Why is the right to terminate the operating contract any more “unilateral” than the right to give a cure notice?  And if a party has a right to terminate “in its sole discretion”, then surely the real issue is whether that right is exercised for bona fide reasons consistent with the purpose of the contract.

In all these circumstances, good faith appears to be applicable to most of the obligations on a construction project.

See Heintzman and Goldsmith on Canadian Building Contracts, 4th ed, Chapter 7, part 1.

Building Contracts   –   Good Faith   –   Fiduciary Duties   –   Repudiation  –  Cure Notice

WCI v. ADI, 2011 PECA 14 (CanLII)

Thomas G. Heintzman O.C., Q.C.                                                                          January 10, 2012