Do Duties Of Good Faith Apply To Letters Of Intent?

Overview

In its groundbreaking judgment in Bhasin v. Hrynew, 2014 SCC 71, the Supreme Court of Canada held that there is a general organizing principle of good faith "performance" in the common law of contracts. However, the Court did not address whether or how this principle may apply to contractual negotiations. This has resulted in significant confusion about the existence of any duty to negotiate contracts in good faith, together with the source and content of the duty. The confusion is most acute where negotiations take place under pre-existing or preliminary contracts, as such agreements offer a potential foothold for a contractual duty of good faith to arise.

The recent decision in Dr. Michael Emon Dentistry Professional Corporation v. Alexander Sevo Dentistry Professional Corporation, 2025 ONSC 4961 considers if a duty of good faith can apply to a would-be-purchaser negotiating with the vendor after executing a letter of intent. The decision suggests that a letter of intent may indeed attract such a duty, even if it is only binding in part. However, the Court's reasons may raise additional questions: it did not directly address whether the duty applied, only why the duty was not breached on the facts of the case, whether the duty applied or not.

Background

Duties to negotiate in good faith have received a somewhat chequered reception by Canadian courts, with courts typically rejecting such obligations where no enforceable agreement already exists. At the same time, courts have been prepared to recognize that duties of good faith can apply where negotiations take place pursuant to a binding pre-existing or preliminary agreement, such as negotiations to renew a lease. In such cases, the exercise or performance of negotiation rights and obligations may attract the traditional duties of good faith, such as the duty of honest performance or the duty to exercise contractual discretion reasonably.

Where negotiations take place pursuant to preliminary rather than pre-existing agreements, such as letters of intent, difficult questions may arise on the degree to which the preliminary agreement is binding. It is only where the preliminary agreement is already an enforceable agreement – in that the parties intended it to be binding, and reached agreement on all of its essential terms with sufficient certainty – that it can support a contractual duty to negotiate in good faith. Does this mean that a preliminary agreement can support a duty of good faith if, as is sometimes the case with letters of intent, the parties intended that only some of its provisions would have legal force? The Emon decision suggests that it can.

The Facts of Emon

The Emon case arose from the attempted sale of a clinic between two dentists. Both Dr. Michael Emon, through his Dentistry Professional Corporation ("Emon"), and Alexander Sevo Dentistry Professional Corporation ("Sevo"), provided endodontic services in Ontario. In 2016, the two parties discussed Sevo purchasing Emon's practice with the intention of Sevo continuing to service Emon's patients while Emon transitioned into retirement. The parties executed a Letter of Intent (the "LOI"), stating that it was "not contractual in nature or binding (except as specifically set out herein)," with a mix of non-binding and binding provisions.

The LOI expressed the parties' intention to negotiate a purchase agreement, which was to be signed 20 days after the LOI was signed, with the closing of the transaction to take place the following day or on such other date as the parties agreed. Under the LOI, the closing was subject to the usual conditions in favour of Sevo as the purchaser, which were to be included in the purchase agreement. They included requirements that there have been no material adverse change in the practice, that it had been carried on in the ordinary course, and that Sevo enter into a lease for Emon's clinic, conduct due diligence investigations, and obtain financing in a manner satisfactory to him. Further, the LOI explicitly allowed Sevo to terminate it by written notice if he was "not satisfied with [his] due diligence investigation for any reason," but stated that such termination would not affect the liability of a party for breach of any of the binding provisions (including due diligence and access in order to conduct due diligence). As well, the LOI provided that certain of its provisions would survive termination, such as those relating to confidentiality, public announcements and each party's responsibility for the expenses incurred in connection with the LOI transactions.

The two parties worked toward finalizing the sale. However, negotiations with the landlord over the lease agreement for the clinic stalled, leading to repeated extensions of the closing date from April to August 2017. During this time, Emon's clinic manager resigned and Sevo learned that the bookkeeper would retire after closing. Shortly afterward, Sevo terminated the transaction through his lawyer, and Emon brought an action against him alleging breach of good faith duties in carrying out discretionary provisions of the LOI and in exercising his discretion to terminate it.

The Court's Treatment of the Good Faith Issue

The Honourable Madam Justice Horvat presided over the trial and concluded that there was no breach of any duty of good faith by Sevo. It is important to note that the Court recognized that the LOI did not bind the parties to complete the transaction unless all of the conditions were met, "except as specifically set out herein." The decision, however, did not set out which portions of the LOI, if any, were binding.

The Court focused on three rights under the LOI which attracted good faith duties: (1) negotiating a satisfactory lease agreement; (2) becoming satisfied with the due diligence; and (3) termination of the transaction. In exercising these rights, the duty of (a) honesty; (b) good faith performance; and (c) reasonable use of discretion, were all engaged. In holding that the duties were not breached, the Court highlighted the broad language of the LOI and the steps that Sevo took to close the transaction prior to terminating it.

The Court rejected the argument that Sevo, as the purchaser, delayed the closing by hiring a lease consultant. According to the LOI, Sevo was free to negotiate a lease on terms satisfactory to him, and actively engaged in negotiations for four months to do so. Hiring professional help, at his own expense, supported the conclusion that he met the duty of good faith performance. Having failed to agree on the terms of the lease, it was reasonable for Sevo to terminate the transaction.

Likewise, after learning of the pending departure of two key employees, Sevo was of the view that he would no longer be purchasing a "turnkey" practice as contemplated by the LOI. It was also reasonable for Sevo to terminate the transaction on this basis. The Court found that in either case, Sevo took no steps to actively mislead Emon about his intentions prior to providing the termination notice.

Takeaways

The application of good faith duties to a partially binding letter of intent is a novel issue. Although the Court did not find that any such duty was breached in Emon, its decision to treat the letter of intent as attracting good faith duties leaves the door open to similar claims in the future. Where a letter of intent contains at least some binding provisions, they may enable a duty of good faith to arise during the pre-closing negotiations that take place under the letter, or the termination of the letter.

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