Good faith in commercial contracts

6 November, 2013

Under English law there is generally no duty to act in good faith. This article summaries the law in this area and suggests how best to impose an obligation to act in good faith in a contract.

 

1 WHAT IS A DUTY TO ACT IN GOOD FAITH?

This duty can be difficult to define as it will depend on the contractual relationship between the parties, but it has been described as:

1.1 A duty of honesty (Jackson LJ in Mid Essex Hospital Services NHS Trust v Compass Group UK and Ireland Ltd (Trading As Medirest) [2013] EWCA Civ 200).

1.2 “…’playing fair’, ‘coming clean’ or ‘putting one’s cards face upwards on the table.’ It is in essence a principle of fair open dealing…” (Bingham LJ in Interfoto Picture Library Ltd v Stiletto Visual Programmes Ltd [1989] 1 QB 433).

1.3 To observe reasonable commercial standards of fair dealing, to be faithful to the parties’ agreed common purpose and to behave consistently with their justified expectations (Berkeley Community Villages Ltd & Another v Pullen & Ors. [2007] EWHC 1330 (Ch))

 

What constitutes good faith is an objective test and will depend on the nature of the relationship between the parties.  When considering whether a party is acting in good faith, it is necessary to consider whether the conduct would be regarded as commercially acceptable by reasonable and honest people (Legatt J in Yam Seng Pte Ltd v International Trade Corporation Ltd [2013] EWHC 111 (QB)).

 

2 PERFORMANCE OF CONTRACTS

There is no general duty to perform contracts in good faith under English law.  The observations of Bingham LJ in Interfoto Picture Library Ltd v Stiletto Visual Programmes Ltd [1989] 1 QB 433 at 439 are often quoted to describe the English approach to good faith (emphasis added):

“In many civil law systems, and perhaps in most legal systems outside the common law world, the law of obligations recognises and enforces an overriding principle that in making and carrying out contracts parties should act in good faith. This does not simply mean that they should not deceive each other, a principle which any legal system must recognise; its effect is perhaps most aptly conveyed by such metaphorical colloquialisms as ‘playing fair’, ‘coming clean’ or ‘putting one’s cards face upwards on the table.’ It is in essence a principle of fair open dealing… English law has, characteristically, committed itself to no such overriding principle but has developed piecemeal solutions in response to demonstrated problems of unfairness.”

 

The reluctance of the courts to recognise a general principle of good faith is mainly attributed to a desire:

2.1 To avoid uncertainty

As per Lord Hoffman in Union Eagle Ltd v Golden Achievement Ltd [1997] A.C. 514:

“The existence of an undefined discretion to refuse to enforce the contract on the ground that this would be “unconscionable” is sufficient to create uncertainty.”

2.2 To preserve the freedom of the parties


A general principle of English law is that the parties should be free to pursue their self-interest both in negotiations and performance (provided no contractual term is breached) of a contract.

Instead, the courts have preferred to adopt a piecemeal approach, adapting existing legal principles to deal with specific issues when they arise.

 

3 PROBLEMS OF UNFAIRNESS

The piecemeal approach referred to by Bingham LJ includes:

3.1 Contractual interpretation

Where the strict wording of the contract would result in an unreasonable result, the court should consider whether this was intended by the parties at the time the contract was formed.  In such cases, the courts may choose an interpretation of a contract that gives a ‘reasonable’ result, rather than based on the strict wording of the contract:

“The fact that a particular construction leads to a very unreasonable result must be a relevant consideration. The more unreasonable the result the more unlikely it is that the parties can have intended it, and if they do intend it the more necessary it is that they shall make that intention abundantly clear” (AG v Wickman Machine Tool Sales Ltd [1974] AC 235).

3.2 Equitable doctrines

Certain equitable doctrines have been established to address unfairness in a contractual context.  For example, where one party makes it clear that they do not intend to assert all of their legal rights and the other party reasonably relies on this representation then this can amount to promissory estoppel.

3.3 Misrepresentation

The law of misrepresentation can be applied to have an effect analogous to a duty to negotiate in good faith.  For example, where a party makes a statement (that is true when it is made), but before the contract is formed the circumstances change so that the statement is no longer true, the party who made the statement has a duty to tell the other party about the change and failure to do so may amount to a misrepresentation. 

3.4 Implied terms at common law

Generally

A duty of good faith can be implied into a contract, based on the presumed intention of the parties (Leggatt J in Yam Seng Pte Ltd v International Trade Corporation Ltd [2013] EWHC 111 (QB)).  Such a term may be implied into a contract if it can be shown:

3.4.1 It is so obvious that it goes without saying; and

3.4.2 It is necessary to give business efficacy to the contract.

 

This is more likely in ‘relational’ contracts, which involve a high degree of co-operation, consultation and performance based on mutual trust and confidence.  It is also important to note that in the case of Yam Seng the court was asked to consider a ‘simple’ contract that had been prepared without legal representation.  In these circumstances the court is more likely to consider the nature of the business relationship between the parties and imply terms into the contract in order to make it ‘work’.

 

Exercise of discretion

A power conferred by a contract on one party to make decisions which affect both parties must be exercised honestly and in good faith, for the purposes for which it was conferred and must not be exercised arbitrarily, capriciously or irrationally (Abu Dhabi National Tanker Co v Product Star Shipping Ltd [1993] 1 Lloyd’s Rep 397, 404).

 

Specific Contracts

The courts have been willing to imply a duty of good faith in the following contracts:

3.4.3 Employment – implied duty that an employee will conduct themselves with fidelity and good faith (Robb v Green [1895] 2QB 1).

3.4.4 Partnership agreements.

3.4.5 Fiduciary relationships.

3.4.6 Joint venture agreements.

3.4.7 Franchise agreements.

 

AN EXPRESS DUTY TO ACT IN GOOD FAITH

Consistent with the principle that the parties to a contract are free to pursue their self-interest and negotiate as they see fit, the parties to a contract are free to include an express duty of good faith (or other similar provisions), which can be enforced by the courts. 

 

5 A DUTY TO NEGOTIATE IN GOOD FAITH

By contrast, an express obligation to engage in good faith negotiations has been held to be unenforceable due to uncertainty (for example, see Halifax Financial Servies v Intuitive Systems [1999] 1 All ER 303). 

 

6 PRACTICE POINTS

While the courts will, in some circumstances, recognise a contractual requirement of good faith, the fact remains that there is no general duty of good faith in English law.  This approach is intended to remove uncertainty, however, this often has the opposite effect. 

 

If the parties are seeking to impose an obligation to act in good faith then the best advice is to make this an express term of the contract.  To minimise the risk of this obligation being ambiguous, or unenforceable due to uncertainty, this duty should be broken down (where possible) into specific obligations.  For example, an obligation of good faith could be drafted as follows:

“1.  The parties agree to operate with the utmost good faith when performing the [obligations (NB – consider whether ‘obligations’ is wide enough and whether this should also include exercising a right to terminate)] set out in this Agreement.  This duty includes, but shall not be limited to:

1.1 [To observe reasonable standards of commercial fair dealing.]

1.2 [To be faithful to the parties’ agreed common purpose.]

1.3 [To behave consistently with the reasonable expectations of the other party in relation to the performance of their obligations under this Agreement.]

1.4 [To provide any information that may affect the other party’s ability to perform [its] obligations under this Agreement.]

1.5 [Other specific obligations]”

A boilerplate severability clause should also be included in the contract, so that, in the event that any part of this clause is held to be unenforceable, it does not invalidate the rest of the clause, or agreement.  For example, this clause could state:

“1. If any provision of this Agreement shall be found by any court or administrative body of competent jurisdiction to be invalid or unenforceable, such invalidity or unenforceability shall not affect the other provisions of this Agreement which shall remain in full force and effect.

2. If any provision of this Agreement is so found to be invalid or unenforceable but would be valid or enforceable if some part of the provision were deleted, the provision in question shall apply with such modification(s) as may be necessary to make it valid.”

Reviewed in 2015