Marshall et al. v. Bernard Place Corporation et al. [Indexed as: Marshall v. Bernard Place Corp.]

58 O.R. (3d) 97

[2002] O.J. No. 463

Docket No. C35104

Court of Appeal for Ontario

Carthy, Sharpe and Cronk JJ.A.

February 13, 2002

Contracts -- Conditions precedent -- Sole discretion clause -- Good faith -- Sale of land -- Whether discretionary condition imposing subjective or objective standard depending upon intention of parties as disclosed by contract -- Discretion must be exercised in good faith -- Agreement of purchase and sale of land conditional upon inspection report satisfactory to purchaser in his sole and absolute discretion -- Purchaser entitled to rely on non-satisfaction of condition as grounds to terminate agreement -- Purchaser entitled to return of deposit.

Sale of land -- Conditions precedent -- Sole discretion clause -- Good faith -- Whether discretionary condition imposing subjective or objective standard depending upon the intention of parties as disclosed by contract -- Discretion must be exercised in good faith -- Agreement of purchase and sale of land conditional upon inspection report satisfactory to purchaser in his sole and absolute discretion -- Purchaser entitled to rely on non-satisfaction of condition as grounds to terminate agreement -- Purchaser entitled to return of deposit.

In August 1998, the Ms signed an agreement to purchase a residential property from BCP for a purchase price of $1,510,000. The Ms paid a deposit of $150,000. The agreement was conditional "upon the inspection of the Property by a home inspector of the Purchaser's choice and receipt of a report satisfactory to him in his sole and absolute discretion". The property was inspected and the inspector's report described the house as "well-built" and "above average", but the report identified various deficiencies relating to the construction, design or condition of the house. With an exception for a leak in one of the washrooms, for which the cost of repair could not be determined pending further inspection, most of the deficiencies could be remedied at minor cost. The inspector also advised the Ms that their renovation plans of creating a rooftop garden area and redesigning the garden patio doors, which plans were not referred to in the agreement of purchase and sale, would be costly. After considering the inspection report, the Ms decided not to waive the condition and requested the return of the deposit. When this was not forthcoming, litigation ensued. After a trial, Keenan J. ordered the return of the deposit. BCP appealed.

Held, the appeal should be dismissed with costs.

Contractual conditions subject to discretionary judgments, sometimes called "sole discretion clauses", must be exercised honestly and in good faith. This good faith requirement applies whether the exercise of the discretion is measured by an objective or subjective standard, and the determination of whether a discretionary condition imposes a subjective or objective standard depends upon the intention of the parties as disclosed by their contract. Absent express contractual language to the contrary, an inspection report which identifies deficiencies in the construction of a house provides an objective basis on which to assess the potential exercise of discretion under a discretionary property inspection condition. The intention of the parties, as reflected in the language of the condition, then determines the scope of the subjective assessment of the materiality of the identified deficiencies. In this case, the subject-matter of the agreement first attracted elements of an objective standard of reasonableness but, second, the inspection condition also imported a significant subjective element. On the facts of this case, in relying on the non-satisfaction of the inspection condition, the Ms met the standard of acting honestly and in good faith. The report identified legitimate uncertainties and inconveniences that they were entitled to take into account. Their decision was not driven by considerations of cost since they had the financial means to remedy the identified deficiencies. There was evidence to support the trial judge's conclusions that the Ms' decision was motivated by subjective considerations of personal compatibility and was based on their judgment pursuant to the authority given to them in the conditional clause and that they had met the requirements of good faith, honesty and reasonableness.

APPEAL from a judgment of Keenan J. (2000), 36 R.P.R. (3d) 153 (S.C.J.) ordering the return of the deposit in an agreement for the purchase and sale of land.

Cases referred to Canadian National Railway Co. v. Inglis Ltd. (1997), 1997 1070 (ON CA), 36 O.R. (3d) 410, 153 D.L.R. (4th) 291, 15 R.P.R. (3d) 1 (C.A.), affg (1992), 1992 8604 (ON SC), 93 D.L.R. (4th) 461 (Ont. Gen. Div.); Greenberg v. Meffert (1985), 1985 1975 (ON CA), 50 O.R. (2d) 755, 18 D.L.R. (4th) 548, 7 C.C.E.L. 152, 37 R.P.R. 74 (C.A.) [Leave to appeal to S.C.C. dismissed (1985), 1985 3114 (SCC), 56 O.R. (2d) 320n, 64 N.R. 156n, 14 O.A.C. 240n, 30 D.L.R. (4th) 768n]

Alan Lenczner, Q.C., and Kirsten Crain, for appellant. Sean Dewart, for respondents.

The judgment of the court was delivered by

[1] CRONK J.A.: -- The issue on this appeal is the entitlement to a deposit of $150,000 paid by the respondents pursuant to an agreement of purchase and sale concerning residential real estate. At trial, Justice Keenan held that the respondents were entitled to the return of the deposit, together with accumulated interest, and costs on a party and party scale to November 3, 1998 and on a solicitor and client scale thereafter following assessment. The appellant, Bernard Place Corporation, appeals from that decision. It also initially sought leave to appeal the costs award, but that request was abandoned before this court. For the reasons that follow, I would dismiss the appeal with costs.

A. Background

[2] On August 9, 1998, the respondents executed an agreement of purchase and sale (the "Agreement") to acquire a residential property situated on Bernard Avenue in Toronto, Ontario (the "Bernard Property") from Bernard Place Corporation ("BPC") for a purchase price of $1,510,000. Following several counter- offers and sign-backs, the Agreement was finalized on August 11, 1998.

[3] The respondents paid a deposit of $150,000 to the listing broker, Chestnut Park Real Estate Limited, which held it for some months. After commencement of this action, the deposit funds were paid into court and the action was dismissed as against the broker, on consent. At the time of this appeal, the funds remained in court accumulating interest.

[4] The Agreement provided for a closing date of January 29, 1999, conditional upon the following:

This Agreement is conditional upon the inspection of the Property by a home inspector of the Purchaser's choice and at the Purchaser's own expense, and receipt of a report satisfactory to him in his sole and absolute discretion. Unless the Purchaser/Co-operating Broker gives notice in writing, delivered to the Vendor/Listing Broker on or before 3:00 p.m. Wednesday, August 19, 1998, that this condition is fulfilled, this Agreement shall be null and void and the deposit shall be returned to the Purchaser in full, without interest or deduction. The Vendor agrees to co-operate in providing access to the Property for the purpose of this inspection at reasonable times upon reasonable notice given by the Purchaser. This condition is included for the sole benefit of the Purchaser and may be waived at his sole option by notice in writing to the Vendor/Listing Broker within the time period stated herein. [See Note 1 at end of document]

[5] Schedule "A" to the Agreement provided, amongst other matters, that the Bernard Property was being offered for lease during the conditional period under the Agreement and confirmed that if BPC elected to rent the property prior to closing, the respondents would have the right to approve the tenant and the rental agreement. The Schedule also set out the work to be done by BPC at the Bernard Property prior to closing.

[6] When they entered into the Agreement, the respondents resided in New York City. It was their plan to return to Toronto in the future and, for this reason, in August 1998 they were considering purchasing real estate in Toronto with a view to renting the property until their return.

[7] The respondents inspected the Bernard Property on two occasions prior to entering into the Agreement. They were considering two renovations to the house, should they acquire it: creation of a rooftop garden area, which would require a feasible water source on the rooftop, and the re-design of existing garden patio doors. No mention of either renovation was made in the Agreement, either as a condition or as part of the work scheduled to be done by BPC prior to closing, the latter as detailed in Schedule "A" to the Agreement.

[8] The respondents promptly arranged for a professional property inspection. The resulting inspection report identified various deficiencies relating to the construction, design or condition of the house. Some of the deficiencies concerned inadequately or uninsulated pipes, ductwork and a crawl space area, giving rise to the potential for the freezing of pipes, increased heating costs and the need for installation of insulation. In addition, amongst other matters, the flat roof on the detached garage did not slope properly, raising drainage concerns; the caulking on the roof and front door was described as "incomplete"; a leak was identified in one of the washrooms in the house; and water damage on the carport ceiling was observed. Most of the deficiencies, according to the inspector, could be remedied at minor cost. The cost to remedy the leak, however, could not be determined pending further investigation.

[9] Overall, the inspector described the Bernard Property as a "well-built house", requiring no major repairs at the time of the inspection. On a rating scale, the inspector assigned the Bernard Property a score of 7, denoting an "above average" property, out of a possible score of 9. He testified that a score of 8 out of 9, which he occasionally assigned, signified a house which was meticulously well built to the highest of standards.

[10] The respondents discussed their renovation plans with the inspector. He informed them that arranging a water source for the proposed rooftop garden would be disruptive and costly, involving extensive repairs. In the inspector's view, the re- design of the existing patio doors would be similarly disruptive and was "not a small job".

[11] After considering the inspection report, the respondents decided to rely on the condition by not waiving it or delivering the required notice that the condition had been fulfilled. Their agent informed the listing agent of this decision on August 17, 1998, two days prior to the expiry of the notice period under the condition. They subsequently requested the return of the deposit. When this was not forthcoming, litigation ensued in which the respondents sought damages for breach of the Agreement by BPC. The action was not framed in misrepresentation or fraud, nor was any contract collateral to the Agreement alleged.

[12] When she learned of the respondents' decision, the listing agent, who had represented BPC in the negotiations concerning the Agreement, sought to be informed of "what elements have been revealed by the inspection report to be unsatisfactory" and to discuss the inspection report directly with the inspector, who declined to do so. She also communicated with the respondents' solicitors, requesting receipt of a copy of the inspection report. Her request was denied, although a copy of the report was subsequently provided to BPC's solicitors. The listing agent's actions were fuelled by her belief that the respondents were seeking to resile from the Agreement over concerns unrelated to the condition of the Bernard Property.

[13] On the same day that the respondents informed the listing agent of their decision to rely on the inspection condition, BPC accepted an offer to lease the Bernard Property. The respondents had approved the form of lease.

[14] One month after terminating the Agreement, the respondents entered into a new agreement of purchase and sale for another, less expensive property located in the same neighbourhood as the Bernard Property. While residing outside Canada, they undertook extensive renovations to this second property, at a cost of approximately $1.6 million.

B. Issues on Appeal

[15] The issues raised by BPC on this appeal concern:

(1) the requisite standard for the exercise of discretion by the respondents under the inspection condition;

(2) the onus for demonstrating compliance or non-compliance with the requisite standard; and

(3) the availability of relief from forfeiture if it is concluded that the respondents did not meet the requisite standard.

C. Analysis

(1) The requisite standard for the exercise of discretion

[16] In Greenberg v. Meffert (1985), 1985 1975 (ON CA), 50 O.R. (2d) 755, 18 D.L.R. (4th) 548 (C.A.), leave to the Supreme Court of Canada refused (1985), 1985 3114 (SCC), 56 O.R. (2d) 320n, 30 D.L.R. (4th) 768n, this court confirmed that discretion under contractual conditions subject to discretionary judgments (sometimes called "sole discretion clauses") must be exercised honestly and in good faith. Both parties acknowledge this requirement, but BPC argues that it was not satisfied by the respondents.

[17] BPC also argues that in exercising their discretion under the inspection condition, the respondents were obliged to act reasonably, according to an objective standard. The respondents argue that "reasonableness" is to be measured by a subjective standard or, alternatively, a blended subjective/ objective standard.

[18] In Greenberg and in Canadian National Railway Co. v. Inglis Ltd. (1997), 1997 1070 (ON CA), 36 O.R. (3d) 410, 153 D.L.R. (4th) 291 (C.A.), it was recognized that discretionary contractual provisions fall into two general categories. In Greenberg, Robins J.A. stated, at pp. 761-62 O.R., p. 554 D.L.R.:

Provisions in agreements making payment or performance subject to "the discretion""the opinion" or "the satisfaction" of a party to the agreement or a third party, broadly speaking, fall into two general categories. In contracts in which the matter to be decided or approved is not readily susceptible of objective measurement -- matters involving taste, sensibility, personal compatibility or judgment of the party for whose benefit the authority was given -- such provisions are more likely construed as imposing only a subjective standard. On the other hand, in contracts relating to such matters as operative fitness, structural completion, mechanical utility or marketability, these provisions are generally construed as imposing an objective standard of reasonableness: see generally, 4 Hals., 4th ed., p. 612, paras. 1198-9; Corbin on Contracts (1960), vol. 3A, ss. 644-48; Williston on Contracts, 3rd ed. (1957), ss. 675A, 675B; Hudson, Building and Engineering Contracts, 10th ed., (1970), chapter 7.

In any given transaction, the category into which such a provision falls will depend upon the intention of the parties as disclosed by their contract. In the absence of explicit language or a clear indication from the tenor of the contract or the nature of the subject-matter, the tendency of the cases is to require the discretion or the dissatisfaction to be reasonable: Minster Trust, Ltd. v. Traps Tractors, Ltd., et al., [1954] 3 All E.R. 136 at p. 145. This construction imposes the least hardship in that it produces a result that cannot be said to be unfair or unjust to either of the parties. Other things being equal, I think it preferable that provisions of this kind be construed as implying the less arbitrary standards of the objective test: American Law Institute, Restatement of the Law, Second: Contracts 2d (1981), s. 228. (sic)

(Emphasis added)

[19] Under the principles articulated in Greenberg, the contract controls the standard to be applied to a sole discretion clause. The determination of whether a discretionary condition imposes a subjective or objective standard depends upon "the intention of the parties as disclosed by their contract".

[20] The requirement of honesty and good faith applies whether the exercise of discretion is measured by an objective or subjective standard (Greenberg, at p. 761 O.R., p. 554 D.L.R.). No contractual discretion is absolute, in the sense of authorizing the capricious or arbitrary exercise of the discretion. Greenberg confirmed that even a broadly stated contractual discretion is not "unbridled" and is subject to established limits. Further, as illustrated in Inglis, even where the operative standard of reasonableness is an objective one, it can only be satisfied if the discretion or opinion at issue was "reasonably formed" in the circumstances (at p. 416 O.R., per Robins J.A.).

[21] In my view, absent express contractual language to the contrary, an inspection report which identifies deficiencies in the construction or integrity of a house provides an objective basis on which to assess the potential exercise of discretion under a discretionary property inspection condition. The intention of the parties, as reflected in the language of the condition, then determines the scope for subjective assessment of the materiality of the identified deficiencies. The language of a contract may afford considerable latitude to a party seeking to rely on a discretionary property inspection condition where an inspection report provides objective evidence on which to base a decision that the deficiencies identified in the report are sufficiently unacceptable as to warrant a decision not to complete the transaction.

[22] In this case, relying on Greenberg, BPC asserts that the respondents were obliged to complete the purchase of the Bernard Property unless the inspection report revealed defects of a nature that went to "operative fitness, structural completion, mechanical utility or marketability". It argues that the deficiencies identified by the report were minor and capable of ready remedy at minimal cost.

[23] The inspection condition, as drafted by the respondents' agent and accepted by the listing agent, provided that the inspection report was to be "satisfactory" to the purchaser; the purchaser's discretion was described as "sole and absolute"; and the condition was for the "sole benefit" of the purchaser and could be waived at the purchaser's "sole option" in a stipulated manner.

[24] It was the trial judge's view [at p. 164 R.P.R.] that:

This Agreement of Purchase and Sale was a contract between experienced business people who stood on equal footing, negotiated on their behalf by professionals who employed and agreed to explicit language which gives a very broad subjective discretion to the purchasers. The intention of the parties as disclosed by their contract was that the purchasers, after receiving the inspection report, could back out of the deal if they were not satisfied that [they] were getting what they bargained for.

(Emphasis added)

[25] I agree that the language of the inspection condition in this case imports a significant subjective element into the exercise of the discretion conferred under the condition. On a plain reading of the condition, subjective factors relating to "sensibility, personal compatibility or judgment" (Greenberg, at p. 761 O.R., p. 554 D.L.R.) are not precluded by words of limitation or exclusion. Had it been the intention of the parties to exclude such factors, it is not unreasonable to assume that suitable qualifying language would have been introduced to the condition.

[26] However, it is also my view that the subject-matter of this Agreement attracts elements of an objective standard of reasonableness. The Agreement relates to the acquisition of a residential property. The integrity of the property and its condition are matters which are capable of objective measurement. As indicated above, this suggests that, in the first instance, objective factors must ground the exercise of discretion under the condition. If such objective factors exist, the language of the condition will then establish what latitude is given to the party seeking to rely on the condition in determining whether the risks associated with the identified deficiencies in the property are acceptable in the circumstances. This determination must be reasonably based, and the discretion must be exercised honestly and in good faith. In the circumstances of this case, therefore, the contract between the parties dictates that a standard of reasonableness containing, first, objective, and second, subjective, elements governs the exercise of discretion under the property inspection condition. It remains, then, to consider whether the respondents met this standard in relying on the inspection condition, acting honestly and in good faith.

[27] The inspection report identified physical deficiencies which could be remedied at minimal cost; however, the true risks associated with some of the deficiencies could not be determined at the time of the inspection. In addition, the report gave rise to the prospect of coping with the deficiencies, and effecting necessary repairs, when a tenant was in possession of the premises. These were legitimate uncertainties and inconveniences which the respondents were entitled to take into account.

[28] The evidence indicates that cost did not drive the respondents' decision to rely on the inspection condition. Neither the purchase price of the Bernard Property, nor the cost of remedying its identified deficiencies, was beyond their financial reach. Any doubt about this is dispelled by the fact that the respondents subsequently purchased and renovated another property, the existence of which was not known to them until after August 1998, at a cost in excess of the entire purchase price of the Bernard Property. There is no basis to conclude, therefore, and BPC does not argue, that in deciding to rely on the inspection condition, the respondents were seeking to avoid the Agreement in order to purchase a preferred, less expensive house, or to escape repairs which they were unable to afford.

[29] In any event, the inspection condition was not tied to the cost of correcting identified deficiencies, nor did it contain language of limitation regarding the number or nature of deficiencies, or the materiality of any associated repairs, that would support reliance on the condition.

[30] The respondents commissioned the inspection report promptly after entering into the Agreement. Further, when it was in hand, they acted speedily, through their agent, to inform the listing agent of their decision.

[31] The trial judge held that the respondents' decision to rely on the inspection condition was "motivated by subjective considerations of personal compatibility and was based on their judgment pursuant to the authority given to them in the condition clause". In my view, there was evidence to support this conclusion. He further concluded that the respondents met the requirements of good faith, honesty and reasonableness. I agree, for several reasons.

[32] First, the deficiencies revealed by the inspection report related to the construction, design or condition of the Bernard Property. The report thus identified objective, physical factors concerning the structural integrity of the Bernard Property. While the evidence suggests that in deciding whether to proceed with the transaction, the respondents also took the uncertainties associated with their proposed renovations to the Bernard Property into account, the inspection report detailed objective facts on which they were entitled to and did base the exercise of their discretion under the inspection condition.

[33] Second, there is no evidence that the respondents engaged in the type of collusive conduct at issue in Greenberg, as to establish dishonesty or bad faith. In Greenberg, unlike this case, the respondents were held to have devised a scheme to divide a listing agent's commission in order to defeat his entitlement to commission after his employment had been terminated. There is no evidence whatsoever of similar improper conduct in this case. Further, on the record before this court, the respondents were serious purchasers who, prior to the inspection, did not have any intention to resile from the Agreement or to invoke the inspection condition to avoid completion of the transaction.

[34] Third, the inspection condition did not contain language which tied it to the "operative fitness, structural completion, mechanical utility or marketability" of the Bernard Property, as might warrant imposition of an exclusively objective standard of reasonableness. No concept of materiality was embodied in the condition, either in relation to the cost of repairs or the overall significance of the deficiencies. Accordingly, once the inspection report identified objective facts relating to deficiencies in the property, the expansive language of the inspection condition agreed to by the parties permitted the respondents to assess whether the risks, uncertainties and inconveniences associated with the deficiencies outlined in the report were acceptable, according to their own subjective circumstances and perspectives.

(2) The onus of proof

[35] BPC also argues that the trial judge improperly shifted the onus of proof to BPC to demonstrate that the respondents had acted dishonestly and in bad faith in deciding to rely on the inspection condition. It suggests that the failure of the respondents to afford BPC an opportunity to view the inspection report, and to correct the identified deficiencies, renders holding BPC to such an onus illogical. These arguments, in my view, must fail.

[36] The trial judge found, rightly in my view, that the onus was on the respondents to prove the Agreement, the inspection condition in the Agreement and their right, in light of the condition, to call for the return of the deposit. In its Statement of Defence and Counterclaim, BPC raised the issues of reasonableness and good faith as a basis to disentitle the respondents to the return of their deposit. BPC also specifically pleaded the bad faith of the respondents in seeking to rely on the inspection condition. In these circumstances, there is no affirmative obligation on the respondents to disprove an exception or a suggested ground of disentitlement to the relief claimed. As noted by the trial judge, when grounds of disentitlement are raised,

. . . it is for the Court to examine all the evidence to discover whether it discloses that the plaintiffs did not act reasonably, honestly and in good faith and were thereby disentitled to the relief sought by them.

BPC was obliged, if it wished to assert that the respondents had not met the requirements necessary to support their exercise of discretion, to ensure that all evidence upon which it sought to rely for this defence was proffered at trial.

[37] While the respondents declined to provide the listing agent with a copy of the inspection report upon demand, it is acknowledged that a copy was subsequently provided to BPC's solicitors. The clear language of the inspection condition did not provide for the participation by BPC, as vendor, in the inspection of the property or in the decision whether the inspection report was satisfactory, nor did it confer a right on BPC to remedy any deficiencies identified in the inspection report to avoid reliance by the purchaser on the inspection condition. Had the parties envisaged such rights for the vendor, or its agent, the language of the condition should have so stated.

(3) Relief from forfeiture

[38] In their Reply and Defence to Counterclaim, the respondents sought relief from forfeiture as an alternative ground of relief. BPC argues that such relief is not available in the circumstances. For the reasons set out above, however, it is unnecessary to consider this issue in this case.

D. Conclusion

[39] I would therefore dismiss the appeal, with costs.

Appeal dismissed with costs.

Notes

Note 1: Although both of the respondents executed the Agreement, it referred throughout to "purchaser" in the singular.