Article.

The Role of ‘Good Faith’ in an English Law Contract

29/04/2020

At a glance

How does English law currently interpret ‘good faith’ when it is used in a contract, and in what circumstances might there be an implied duty of good faith?

The concept of a party having to act in ‘good faith’ in the performance of a contract has traditionally had no place in English contract law. The traditional approach has been that the words of a contract mean what they say, for better or worse, which brings the great virtue of certainty to the contract, and any additional terms are only to be implied into the contract if they meet stringent requirements.

In more recent times, a concept of good faith has entered the English legal system, introduced primarily by EU laws drafted by lawmakers familiar with the concept from their own continental legal systems; for example, the Unfair Contract Terms Directive from 1993 provided that “contract terms are unfair and, therefore, not binding on consumers if, contrary to the requirements of good faith, they cause significant imbalance in the parties’ rights and obligations to the detriment of the consumer” and caused much head-scratching in the UK where there was at the time no such “requirement of good faith.”

Those cases where one party argues that there is an implied duty of good faith, and even those cases where the contract itself refers to “good faith” in some manner, can therefore still be regarded with some suspicion by Judges in English courts, in much the same way as a English Judge might look askance at a witness who is wearing slip-on shoes.

So how does English law currently interpret ‘good faith’ when it is used in a contract, and in what circumstances might there be an implied duty of good faith?
I have perhaps some shallow spirit of judgement:
But in these nice sharp quillets of the law,
Good faith, I am no wiser than a daw.”  (Henry VI Part 1)

It is more than 400 years since the Earl of Warwick’s declaration of ignorance, but now a flurry of cases in the last few years have helped to provide some reasonably reliable answers to both of these questions.

It is possible, of course, that the parties to a contract might expressly define what they mean by ‘good faith’, although it is not clear that doing so by reference to expressions such as “to adhere to the spirit of the contract, to observe reasonable commercial standards of fair dealing, to be faithful to the agreed common purpose, and to act consistently with the justified expectations of the other party” (CPC Group –v- Qatari Diar [2010]) greatly assist in the interpretation of that expression, and accordingly the meaning of ‘good faith’ tends to be derived mostly from those cases which have considered an implied duty of good faith – because of course if a term is to be implied into a contract then it should be clear as to what that term means.

So what do the cases tell us that ‘good faith’ means when it is used, but not defined, in a contract? The cases tell us that ‘good faith’ remains a slippery customer and that what it means depends on both the circumstances and the commercial context. However, a common theme is that a duty to act in good faith can frequently equally be expressed as an duty not to act in bad faith; for example:

  • It may prevent the party subject to the obligation from acting in a way that frustrates the purpose of the agreement or the reasonable expectations of the other party (Berkeley Community Villages –v- Pullen [2007]).
  • It may prevent the party subject to the obligation from using its position to obtain a financial benefit at the expense of the other party including seeking to do so by entering into covert negotiations without informing the other party (Al Nehayan –v- Kent [2018])
  • It may prevent the party subject to the obligation from knowingly lulling the other party into a false belief (Costain –v- Tarmac [2017]) including by preventing it from knowingly providing false information (Yam Seng –v- ITC [2013]) or by requiring it to disclose information material to the actions or decisions of the other party (Horn –v- Commercial Acceptances [2011]).
  • It may prevent the party subject to the obligation from disputing a matter when it knows that it does not have substantive grounds upon which to do so (Teesside Gas –v- CATS North Sea [2019]).

And then in what circumstances might the Courts imply a duty of good faith? There are a limited number of specific relationships, including those of employer/employee and principal/agent, but leaving those aside, in terms of commercial contracts the Courts have, in recent years, identified that those contracts into which a duty of good faith might (‘might’ not ‘will’) be implied are what are termed ‘relational’ contracts.

What is a relational contract?

A relational contract is a long-term contract, either because it is stated to be for a long fixed term or because it can be shown that the parties intend it to be for long term, even though it is not for a long fixed term and can be terminated by notice, and that contract requires a high degree of cooperation / collaboration / communication / trust /confidence between the parties in order for it to ‘work properly’.

Examples of contracts which have been found to be ‘relational’ contracts include a joint venture agreement (Al Nehayan v Kent [2018]), a joint operating agreement (TAQA Bratani –v- RockRose [2020]), a quasi-franchise agreement (Bates –v- Post Office Ltd [2019]), a distribution agreement (Yam Seng –v- ITC [2013]) and a PFI contract (Amey –v- Birmingham City Council [2018]); whilst long-term contracts which have been found not to be ‘relational’ contracts include a loan agreement (Morley Estates –v- Royal Bank of Scotland [2020]), an aircraft lease (NPATS –v- Windrose Aviation [2016]) and an interim agreement pending the negotiation of a long-term joint venture (Hamsard –v- Boots [2013]).

However, in making this determination the context of the particular contractual relationship is of key importance. To emphasise this point: not every joint venture agreement will be a ‘relational’ contract simply because it was in the Al Nehayan case.

In addition, having a ‘relational’ contract is only the first step. For a duty of good faith to be implied into the contract, a range of other factors must be considered – “the implication of a duty of good faith will only be possible where the language of the contract, viewed against its context, permits it. It is thus not a reflection of a special rule of interpretation for this category of contract” (Globe Motors –v- TRW Lucas [2016]) and “context is everything” (Barthélemy –v- Duet [2019]). In Bates –v- Post Office [2019] the Court first identified a relational contract and then went on to list a number of factors which, in that case, it regarded as relevant to an implied duty of good faith, including:

  • The implication of such a term must not be inconsistent with the express terms of the contract.  As a specific example of the above principle, the contract should not expressly refer to good faith in relation to certain provisions and, if it does, that strongly argues against an implied duty of good faith applying to those provisions where it is not mentioned.
  • The parties intend their roles to be performed with integrity and with fidelity to their bargain.
  • The parties are committed to collaborating with one another.
  • The spirits and objectives of the venture cannot be expressed exhaustively in a written contract.
  • The parties repose trust and confidence in one another.
  • The contract involves a high degree of communication, co-operation and predictable performance based on mutual trust and confidence, and expectations of loyalty.
  • One or both parties have made a significant investment.
  • The relationship is exclusive.

Whilst the principle of ‘good faith’ can therefore be seen to have developed relatively rapidly over the last decade, it should be borne in mind that this also means, in the words of Mr Justice Leggatt, that “This line of authority still has quite shallow roots”.

For completeness, we should also briefly consider the so-called ‘duty of rationality’ (often referred to as the ‘Braganza’ duty from the case of Braganza v BP Shipping [2015]). This is an implied obligation on a party with a decision-making power, in the absence of clear language to the contrary, to exercise its contractual discretion in good faith and not arbitrarily or capriciously so that there is some logical connection between the evidence and the apparent reasons for the decision, meaning that sufficient regard is paid to issues of fairness and due process in that decision making.

Whilst this duty of rationality may at first sight appear to be one example of a form of duty to act in good faith, in fact this duty exists separately from and can be implied in different circumstances from the duty of good faith.  It tends to arise when one party has the contractual right to make a subjective decision on a matter that affects both parties, giving rise to a potential conflict of interest; but, should those circumstances exist, then its application is now “well established” and it will apply in the absence of clear language to the contrary (BT –v- O2 UK [2014]), it is “extremely difficult” to exclude (Mid Essex NHS Trust –v- Compass [2013]) and it does not appear to be subject to the same strict rules that generally apply to implied terms including an implied duty of good faith.

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