top of page
  • Writer's pictureLaura J. McPhee

Navigating the Gray Area: Good Faith and Its Implications in Contractual Disputes

By Laura J. McPhee and Thomas O'Leary K.C.

In the world of contract law, there exists a concept that often dwells in the shadows—a principle that can be as elusive as it is vital. This principle is known as "good faith". We think of it as the “dark knight” of contract law, bringing justice when the words of a contract might otherwise leave a loophole for skullduggery.

Good faith has been labeled not as a duty of parties under a contract, but a “general organizing principle” from which specific doctrines governing contractual performance are derived. It involves concepts of fairness, honesty, and upholding the reasonable expectations of the parties. These concepts are both highly contextual and involving significant subjectivity, making their application challenging in many circumstances.

The Supreme Court of Canada has provided an analytical structure in which to apply the organizing principle of good faith in light of its subjective and contextual elements, based on the following:

  1. There is no obligation of good faith during negotiation of a contract, only in relation to its performance[1];

  2. The application of the good faith principle, and its result, in particular contexts is based on the reasonable expectations of the contracting parties[2];

  3. All parties owe a basic duty of honesty which means they must not lie or knowingly mislead counterparties about matters directly linked to the performance of the contract[3];

  4. Higher level good faith-based duties of fairness, candidness, forthrightness and reasonableness attach to contracts governing certain relationships and situations characterized by vulnerability, a need for ongoing trust and cooperation, or imbalances of power. The specifically identified good faith relationships are employment, insurance, landlord-tenant, and tendering. Higher-level good faith duties are also triggered when discretionary powers are granted in a contract, where cooperation to achieve contractual objectives is required, and where a party actively seeks to evade contractual duties [4];

  5. Beyond the relationships and situations already established as requiring these higher-level good faith duties, claims of bad faith beyond active dishonesty should fail unless the existing law is found to be inadequate or “wanting” in relationship to that type of relationship or situation[5];

  6. While some aspects of good faith may be excluded by contract, the basic duty of honest performance may not be excluded by the parties.[6]

This analytical structure serves to guide the application of the good faith concept but leaves significant flexibility for judicial findings on the content of good faith-based duties. As a result, there remains significant uncertainty as to what the good faith principle might require of the contracting parties in specific situations and contractual relationships. Navigating this uncertainty when drafting contracts and in the context of contractual disputes can be tricky, but can be assisted by paying attention to the following guiding principles:

  1. Reasonable Expectations: The key to understanding good faith is often in evaluating the reasonable expectations of the parties involved. What would a reasonable person, in the same circumstances, expect from the contract? This can vary significantly from one case to another, making each dispute unique.

  2. Open Communication: In contractual relationships, open and honest communication is crucial. If disputes arise, parties should try to resolve them through negotiation, rather than resorting to legal action immediately. Open communication and an earnest willingness to resolve issues can support a defense that a party has acted in good faith.

  3. Balancing Interests: Good faith doesn't mean that one party must sacrifice its own interests to accommodate the other. It does import a requirement that one party must respect the “legitimate” interests of counterparties based on the contract itself when pursuing it’s own interests.

  4. Documentation: Keeping thorough records and documenting all communications and agreements is invaluable once a contractual dispute arises, particularly when issues of honesty and good faith may be involved. A clear trail of evidence will be critical to help demonstrate whether a party has acted honestly in good faith.

Example - Directors and Officers Good Faith Obligations

Imagine this: the directors of a business purchase the shares of the majority shareholder. They later sell these shares at a significant profit to a third-party. Do the directors have to account to the former majority shareholder? What if the directors knew of the potential third-party interest in buying the shares when acquiring them from the majority shareholder?

A recent Supreme Court of Canada decision[7] considered this scenario in depth. Two directors of a group of private companies learned that a third-party was interested in acquiring the group of companies. However, rather than informing the current shareholders of the companies, the directors approached and bought out the other shareholders without telling them about the interested third-party. Then, roughly 6 months after they had bought out the shareholders, the directors sold all shares in the companies to the third-party buyer at a large profit. The original shareholders sued the directors for the breach of their duty to act in good faith by keeping the third-party interest from them and claiming the increased value of their shareholdings in the sale to the third-party as damages.

Typically, directors need only act in the best interests of the company, and they do not have good faith or other obligations directly to shareholders. However, in this case, as is common in closely held businesses, the original shareholders had a contract with the directors. It afforded the directors an ability to share in the profits of the company and a right to purchase the company if the shareholders decided to sell. The shareholders argued that an implicit term of that contract was that the directors had to perform the contract in good faith, and the only way they could discharge their good faith obligations under the contract was to be transparent about the potential third-party buyer when the directors sought to buy out the original shareholders.

The Supreme Court agreed, finding that the contract incorporated not only a duty of honesty but higher,-level good faith obligations of “probity” (integrity) that required the directors to be transparent and forthright about the third-party interest. This was material information to the shareholders in selling to the directors under their contract and undermined their reasonable expectations that all parties were working together to maximize the value of the companies.

The directors’ failure to share with the original shareholders the details of the third-party interest in purchasing shares constituted a failure to act in good faith. The directors were ordered to account to the original shareholders for all profits from the third-party sale.

What this case means is that, in appropriate circumstances, an obligation of corporate directors and officers to act in good faith may extend beyond the company itself to the shareholders. Directors beware!


Navigating the gray area within the concept of good faith in contractual performance is a delicate process. It's a concept that hinges on honesty, fairness, reasonableness, and mutual respect between parties. While it can be challenging to define precisely what constitutes good faith in every circumstance, understanding these general principles can provide a strong foundation for resolving disputes and upholding the integrity of contracts.

In complex contractual disputes, seeking legal advice is always a prudent step. The experienced Blue Rock Law contract lawyers can help you understand the legal standards of good faith and how they apply to your situation, allowing you to realistically manage the opportunities and risks in play.

[1] Ko v. Hillview Homes Ltd., 2012 ABCA 245 paras 129-134. [2] Bhasin v. Hrynew, 2014 SCC 7 paras 60-62, [Bhasin]. [3] Bhasin para 73. [4] Bhasin paras 45-47, 53-56. [5] Bhasin para 66. [6] Bhasin paras 74-78. [7] Ponce v Societie d' investissements Rheaume ltee, 2023 SCC 25.


bottom of page