In the 2014 decision in Bhasin v. Hrynew, the Supreme Court of Canada recognized a general organizing principle of good faith and the duty of honest performance in contract law. Recognizing the duty, however, was only the first step. Subsequent caselaw has delineated the scope of the duty.
The recent decision of the Ontario Court of Appeal in Bhatnagar v. Cresco Labs Inc. 2023 ONCA 401 clarifies how a court should normally assess damages for breach of the duty. The Court of Appeal confirmed that damages for breach of the duty of honest performance will not ordinarily be merely presumed. Instead, aside from exceptional circumstances, the plaintiff must show that the alleged breach actually caused damages and must lead evidence to prove what those damages are. This is in keeping with the normal approach of expectation damages for contractual breach.
Shareholders (the “Shareholders“) of 180 Smoke, a retailer, wholesaler, and manufacturer of vape products entered into a share purchase agreement with Origin House under which the Shareholders sold their interest for $25 million. The Shareholders remained as directors of 180 Smoke.
In addition to the purchase price for the shares, the share purchase agreement dictated that Origin House would make additional payments to the Shareholders if 180 Smoke met specified annual milestone revenue targets for the three years after the sale. These annual milestone payments totalled approximately $12.5 million and were to be made in 2019, 2020, and 2021.
Because there were rumours that Origin House might be sold, the share purchase agreement explicitly contemplated a change of control. Specifically, on a change of control, all “unearned” milestone payments would be due and payable.
The rumours were true. Cresco Labs Inc. purchased Origin House. The parties originally contemplated that this transaction would close before the end of 2019, which would mean that the 2019 milestone payment would be “unearned” and thus due. Origin House told the Shareholders that it had no reason to believe the sale to Cresco would not close in 2019.
Two important things then occurred. First, the Shareholders resigned from their positions at 180 Smoke. At that time, it was clear that 180 Smoke had very little chance of meeting the 2019 revenue numbers that would entitle it to the 2019 milestone payment. Second, because of weakness in the mergers and acquisition market, Cresco proposed a new closing date in early 2020. Origin House did not directly communicate this closing date change to the Shareholders.
Ultimately, the transaction closed in January 2020. This entitled the Shareholders to the accelerated milestone payments for 2020 and 2021, but disentitled them to the significant 2019 milestone payment because the 2019 payment was not accelerated and 180 Smoke did not meet the required 2019 revenue targets.
The Shareholders brought an application to direct Cresco to pay the 2019 milestone payment. Cresco was the defendant because, as the successor corporation, it stepped into the shoes of Origin House.
The application judge found that Origin House had breached its duty of honest performance of the share purchase agreement when it failed to advise the Shareholders of the new closing date.
The application judge, however, also found that there was no evidence that this breach caused any damage to the Shareholders because, at the time of the breach, there was very little chance that 180 Smoke would or could achieve the required revenue numbers for 2019. The judge found that the Shareholders had achieved a “pyrrhic victory;” although Origin House should have told them about the new closing date, it would have made no difference. The judge found that, in the circumstances, damages for the breach of the duty of honest performance could not be presumed. This is one of the first decisions to find that, although there was a breach of the duty of honest performance, no damages flowed from the result.
The Shareholders appealed this decision and Cresco cross-appealed the finding that Origin House breached its duty of honest performance in the first place.
The Court upheld the application judge’s finding that damages could not be presumed. The Court analysed the Supreme Court of Canada’s decision in C.M. Callow Inc. v. Zollinger and, specifically, the Supreme Court’s comments on when it would be appropriate to presume damages for breach of the contractual duty of good faith. The Court of Appeal cited the Supreme Court’s finding that the normal measure of damages would be expectation damages (i.e., the damages that would return the aggrieved party to the position it would have been in had the duty been performed). Here, the Shareholders would and could have done nothing differently if they were informed about the change in closing date. The Court of Appeal essentially found that there was no harm and thus no foul.
The Court also commented about when a different measure of damages might be appropriate. It noted that these circumstances would be “exceptional” and would at a minimum require that other remedies be inadequate. It cited situations in which the losses were “impossible to calculate” or the plaintiff’s interest was not purely economic. The Court found that neither of these situations applied. The breach of the duty did not make it impossible to prove the loss of opportunity because there was “little or no chance” that 180 Smoke was going to achieve the 2019 revenue targets and there was nothing that the Shareholders could have done to alter the closing date. The Court found there was no evidentiary foundation for a claim for loss of opportunity. The decision was a complete loss for the Shareholders.
To make matters worse, in addition to denying the Shareholders’ appeal, the Court of Appeal allowed Cresco’s cross appeal and overturned the finding that there was a breach of the duty of honest performance. The Court found that although Origin House had not told the Shareholders of the new closing date, correspondence from the Shareholders’ lawyer made it clear that the Shareholders knew of the possibility that the closing date might be moved to January 2020. The Court found that, because the Shareholders knew of this possibility, the application judge had made a palpable and overriding error in finding that the Shareholders were unaware of the possibility of a delay in closing. As such, there was no basis for the finding that Origin House had breached its duty of honesty and good faith.
The Court of Appeal’s decision confirms that, in most circumstances, the normal approach to contractual damages applies to breach of the contractual duty of honest performance. While this principle had already been stated by the Supreme Court in C.M. Callow Inc. v. Zollinger, the Court applied Callow and required proof. The Court made it clear that plaintiffs need to prove that they have suffered damages; ultimately, the breach must have made a difference.
Image courtesy of Mohamed_hassan.
Written by Tim Morgan, a litigator with a focus on commercial matters. He has appeared before all levels of Ontario Courts and has represented businesses of all sizes, from Canada’s largest corporations to privately held, family-run businesses.