ONTARIO – Duty of Good Faith and Honest Performance of Contract – Even where a Court finds a breach of the organizing principle of good faith and honest performance of a contract, the claimant must still prove its damages. Where the claimant failed to tender any evidence that it suffered a loss arising from the defendant’s breach, the Court refused to award any damages. The Court distinguished between evidentiary issues in proving damages, which may allow the Court to draw inferences as to quantum, and a failure to tender any evidence as to damages.

Bhatnagar v. Cresco Labs Inc.
2022 ONSC 1745 (March 21, 2022)
Ontario Superior Court (Kimmel J.) 

Editor’s Note: Even though this decision was released several months ago, we considered it significant to report to our readers.

This was an application under Rules 14.05(3)(d)-(h) of the Rules of Civil Procedure in which the vendors under a share purchase agreement (“the SPA”) sought damages for amounts still owing under the agreement.

The dispute concerned whether:

1. The applicant was entitlement to certain revenue milestone payments (the “Revenue Milestone Payments”) and a license milestone payment (the “License Milestone Payment”) under the SPA totaling $6,166,185.49; ( 117)
2. The Respondent purchaser breached its obligations under the SPA, including its duty of good faith and honest performance of its contractual obligations and/or its duty of good faith and honesty in the exercise of its discretion under the provisions of the SPA, and if so, whether the applicant was entitled to damages; ( 3) and
3. The Applicant was entitled to a price adjustment for certain tax credits. ( 5)

Disposition

After a detailed explanation of the SPA and the transactions, Justice Kimmel held that:

1. The issues raised on this application could be decided based on the evidence filed on the application. A trial was unnecessary because most of the facts were not in dispute.  No credibility findings necessary to determine the alleged breaches and claimed damages, or complex factual determinations were needed. ( 8)
2. The Respondent breached its duty of good faith and honest performance of the SPA by having advised the vendors repeatedly until October 2019 that the Arrangement Agreement would close in 2019 and not correcting or updating that advice when Origin House was informed that the closing date would be delayed to January 2020. ( 75)
3. The Respondent’s obligation was not greater than one of disclosure to correct the misinformation. The duty in this case would not extend to explaining to the vendors the effects and implications for the vendors of the Arrangement Transaction closing in 2020 as opposed to 2019. ( 75)
4. Damages in a claim for breach of contract are compensatory. There must be an evidentiary foundation upon which the court can conclude that there was a credible opportunity that could have resulted in the closing date being changed that resulted in the Applicant’s alleged loss. ( 88)
5. The applicant vendors proved that they were they were wronged but they did not prove that they suffered a loss as result of the Respondents’ breach and, in the circumstances, no damages could be inferred. ( 91) The applicant’s claim for damages for breach of contract was dismissed. (para. 7)
6. However, the respondent was ordered to pay a purchase price adjustment for scientific research tax credits (“SR&ED”) of $142,775.50, essentially based on the agreement between the parties, except as to whether a consulting fee should be deducted. ( 7, 107-111)

Factual Background

The applicant purchased the shares of a vape products company (“180 Smoke”) from the respondent (“Origin House”), a publicly traded cannabis sector U.S. company, and the shares were then transferred to another company, Cresco. (para. 1)

The transaction ultimately closed on February 19, 2020. (para. 9e)  However, the closing was determined by the date when Cresco could close, which  was supposed to be in October 2019. The purchaser failed to promptly notify the vendor of the delay in the closing date. That failure, the vendor submitted, resulted in the substantial damages claimed.  (para. 67)

Under the terms of the SPA there were two ways the vendors could be entitled to receive Revenue Milestone Payments: either (i) by earning them through the achievement of the Minimum and Target Revenue Thresholds for each Earn-Out Period (in 2019, 2020, and 2021) as provided for in s. 2.04 and Exhibit “E” to the SPA; or (ii) in the event of an Indirect Sales Transaction (as occurred when Cresco acquired Origin House through the Arrangement Agreement), through the Indirect Sale Milestone Payment Buyout of any Unearned Milestone Payment Commitment, as provided for in s. 2.04(k) and Exhibit “E” to the SPA. (para. 28)

The dispute turned first on the calculation of the “Unearned Milestone Payment Commitment,” which is set out in Exhibit E to the SPA. (para. 11)

Kimmel J. sets out the terms of the SPA in detail and concluded that “[t]he issues associated with these contractual provisions turn on whether the parties agreed to deduct payments that could not be earned as a result of a ‘pending’ Indirect Sale Transaction, or only a completed and closed Indirect Sale Transaction, and on whether it matters why the Minimum and Target Revenue Thresholds were not achieved in the First Earn-Out Period.” (para. 18) In respect of the License Milestone Payment, Justice Kimmel held that “[t]he issue associated with this contractual provision is whether it matters why the Standard Processing License was not obtained prior to January 8 (or December 31), 2020.” (para. 23)

Kimmel J. further held that if the transaction had closed on January 8, 2020, the applicant vendors would have been eligible to receive $4,166,185.49, representing the Milestone Payment for the First Earn-Out Period, which ended December 31, 2019, if 180 Smoke had achieved the prescribed Minimum or Target Revenue Thresholds for 2019. Under the prescribed SPA formula, that is the sum that is to be deducted from the Milestone Payment Cap to determine the Indirect Milestone Payment Buyout Price. (para. 47)

However, the Court held that, as a matter of strict interpretation of the SPA, the vendors have been found not to be entitled to receive the portion of the Unearned Milestone Payment Commitment for the 2019 Earn-Out Period because the transaction did not close in 2019 or on January 8, 2020. In that circumstance, they would not have been eligible for an Annual Target Payment because it is only calculated at year end, so there would have been no deduction from the Milestone Payment Cap. (para.48)

Analysis 

Breach of the Organizing Principle of Good Faith 

There was no allegation that the delay in the closing of the Arrangement Transaction into 2020 was intentional or the fault of any action or inaction on the part of the purchaser.  If there had been, the analysis of the alleged breach of the duty of good faith in the performance of the purchaser’s obligations and/or in the exercise of its discretion under the SPA would be different. (para. 49)

The Court referred to the organizing duty of good faith in contractual performance, which was affirmed by the Supreme Court of Canada Bhasin v. Hrynew, 2014 SCC 71, that requires that parties “generally must perform their contractual duties honestly and reasonably and not capriciously or arbitrarily.”  A contracting party must have “appropriate regard” for the “legitimate contractual interests” of the contracting partner. (para. 53)

The Court also cited the more recent decisions of the Supreme Court of Canada, which further explain the application of the principle of good faith in contractual performance: C.M. Callow Inc. v. Zollinger, 2020 SCC 45, para. 116; Wastech Services Ltd. v. Greater Vancouver Sewerage and Drainage District, 2021 SCC 7 para. 70. (paras. 52-56)

Justice Kimmel found that the duty of honesty was alleged to have been engaged by the statements made by the purchasers to the vendors up until October 2019 that the Arrangement Agreement was expected to close in 2019.  If this had occurred, the Indirect Sale Milestone Buyout Price would have been the full Milestone Cap, without any deductions, irrespective of whether the Revenue Milestones were achieved. (para. 67)

However, after the purchasers became aware in late October of 2019 that Cresco was moving the target and outside closing dates to January 2020, the vendors argued that the duty of good faith and honest contractual performance required Origin House to disclose this new target closing date to the vendors.  According to the purchaser, as evidenced by its position in this litigation, a delay of the closing, even by just a few weeks into the following year, had a material impact on the vendors’ financial interests and entitlements under the SPA. (para. 68)

Kimmel J. held that the purchaser breached its duty of good faith and honest performance of the SPA by having advised the vendors repeatedly until October 2019 that the Arrangement Agreement would close in 2019 and not correcting or updating that advice when they were advised by Cresco that the closing date would be delayed to January 2020.  The obligation was not greater than one of disclosure to correct the misinformation.  (para. 75)

Failure to Prove Damages 

Causation and damages are an integral part of a breach of contract claim and this does not change even if the breach is of the duty of good faith and honest performance of the contract. (para. 78)

Kimmel J. held that even where the damages arise from the respondent’s breach of the principle of good faith and honest performance, the Court must still consider whether the vendors have met “at least a minimum evidentiary threshold of establishing that there were opportunities or avenues that might have been pursued by the vendors if they had received the undisclosed information about the closing date in October 2019, through which they could have avoided the deduction of the Annual Target Payment for 2019 from the Milestone Payment Cap in the calculation of the Indirect Sale Milestone Payment Buyout Price under s 2.04(k) and Schedule “E” of the SPA.” (para. 83)

The Court distinguished between cases where there are evidentiary difficulties in proving damages, as referred to in the Supreme Court of Canada cases, and the present case, where the applicant vendors offered no evidence to substantiate their loss. (para. 84)

Kimmel J. referred to the kind evidence that would have been acceptable to permit the Court to infer that the applicant suffered a loss, but which was not tendered in the present case. The Court concluded that “[t]his leaves the vendors with a pyrrhic victory, in that they were wronged and should have been told about the move of the closing date, but it has not been established by inference or otherwise that there was any reasonable opportunity that they could have availed themselves of to change the calculation of the Indirect Sale Milestone Payment Buyout Price to include the 2019 Annual Target Payment that they claim to have lost.” (paras. 88-90)