Karl Taylor
Posted on 3 Mar 2015

Good faith in contracts

Background

English contract law has not historically recognised the general duty to perform contracts in good faith.  The concept of good faith and fair dealing are quite common in various European countries (and other countries, for example Japan), and implied into commercial dealings between parties under the law of the relevant country – for example in France the Civil Code relating to contract implementation includes good faith provisions.  Because of this, the area surrounding the duty to negotiate in good faith and otherwise act in an honourable manner is often a common misconception when English parties deal with counterparts to a contract in Europe.  This is particularly so when negotiating documents such as Heads of Terms or Non-Disclosure Agreements.

Recent trend

There have been a number of cases in the English Courts over the last couple of years which have implied a duty to act in good faith (and not to act in bad faith) into ordinary commercial contracts based on the presumed intention of the parties and the relevant background against which the contract was made.

The English Courts have gone as far as to say that the relevant background included not only facts known to the parties but also shared values and normal behaviour.    In some contractual contexts in Europe and increasingly so in the United Kingdom (UK), the relevant background may extend to the expectation the parties will share information relevant to the performance of the contract. On this basis a deliberate omission to disclose such information may amount to bad faith, which the English Courts have also noted may include dishonest, improper, commercially unacceptable and unconscionable conduct.

With the above developments in mind, there is no set interpretation of good faith.  It has been suggested that good faith means "being honest and playing fair".  This could extend to not only untrue statements that are made dishonestly but also  to keeping silent after discovering that a statement is untrue.  The avoidance of giving answers or being evasive may also be considered to be a breach of a duty of good faith.

The key in many of the English cases driving these developments seems  to revolve around long term relationships with substantial commitments between the parties.  These 'relational' type contracts may require a higher degree of communication, cooperation and predictable performance.  This is often based on mutual trust and confidence and involves the expectation of loyalty.  This expectation may not be legislated for in the terms of the contract itself, but implicit in the parties' understanding and necessary to give business efficacy to the arrangement.  The sort of contracts to which this concept relates are usually matters such as joint venture agreements, franchise agreements and long term distributorship agreements.

As noted above, the English Courts have held that a test of good faith is objective. This means that that the test depends not on either party's perception of whether a particular course of conduct is improper, but on whether, in the particular context, the conduct would be regarded as commercially unacceptable by reasonable and honest people.

Can parties to English law contracts rely on an implied duty to act in good faith?

Due to the fact that the 'concept of good faith' historically derives from the common law system, and the fact that English law seeks to protect freedom of contract for fear that the vagueness and subjectivity of obligations such as good faith would create too much uncertainty, the safer approach is to include an obligation expressly in the contract to provide a duty of good faith.  However, there are limitations to this type of provision.  For example, an English Court may not interpret, as it currently stands, an express good faith obligation in a way that would require a party to give up a freely negotiated right or financial advantage that is clearly established in the contract.

Recent examples of cases in the English Court on good faith obligations

The High Court has tested English law's traditional reluctance to imply good faith obligations into the performance of contracts in a number of recent cases.

In 2013, the High Court implied a duty of good faith into a Distribution Agreement (the Yam Seng case 1).  In this particular case the Judge found that this implied duty of good faith would prevent a party from:

  • 'knowingly providing false information to the other; or
  • undercutting prices of products which were also sold under the Distribution Agreement'.

The judge in this particular case was not prepared to suggest that a duty of good faith would be implied into all contracts of a commercial nature, but there was a readiness to imply such terms into longer term agreements (such as distribution agreements).  In a case known as the Bristol Grammar School case (2) the Judge endorsed the approach of the High Court in Yam Seng and held that the contract in question was a 'relational' agreement which did contain an implied duty of good faith.

Based on these cases, an implied duty of good faith would be likely to encompass a duty to act honestly; and an objective test based on whether in the context of a particular contract the conduct would be regarded as commercially acceptable by a reasonable person.

Is a general duty to act in good faith always favourable to the parties? 

There are potential downsides if the parties do decide to include an express good faith type clause in the contract.  For example, if you consider an Investment Agreement or a Shareholders' Agreement where, for example, the investors/shareholder consent is required before the company carries out any particular matter or refrains from carrying out any particular matter, it is important that that investor/shareholder should be able to withhold or provide that consent as it sees fit without having to debate whether or not they are acting in good faith.  The inclusion therefore of express contractual terms whereby the parties will act in all respects with each other in good faith could be prohibitive under those circumstances.

Summary

Whilst English law does not generally imply a general obligation on the parties to perform contractual obligations in good faith, good faith concepts are becoming more readily implied into contracts.  In addition, the concept of good faith is already recognised in some aspects of English law. Notions of good faith are implied into contracts of employment, agency and contracts between partners and other relationships categorise as fiduciary.  In addition, obligations of good faith are found in legislation based on EU Regulations such as the Unfair Terms in Consumer Contracts Regulations and the new proposed Common European Sales Laws (these are a new set of contract laws across border contracts and they do include the general good faith duty).

The key points to note are that on balance, it is likely that express good faith obligations, whilst enforceable, will continue to be interpreted very narrowly and implications of good faith terms will only be in particular circumstances.

Parties involved in long term 'relational contracts' such as joint ventures, franchise agreements and long term distribution agreements should be aware of the recent trend of a shift towards more of the European understanding and application of good faith, and therefore the possibility of broader duties of good faith being implied into contracts.  It would appear that the English Courts are more likely to be willing to apply good faith obligation to dishonest behaviour by a party. If a good faith provision (express or implied) is breached, it could amount to a repudiatory breach of contract entitling the innocent party to terminate the agreement and claim damages. 

In terms of contractual provisions, a specific contractual provision to act in good faith in relation to certain specific clauses would probably be more likely to be enforceable than a general duty to act in all respects in good faith, for example, when exercising a termination right.  The Compass Group case (3) (Court of Appeal) reinforced this concept where an express undertaking to use good faith in relation to a specific set of matters was not extended by implication to be an overarching duty of good faith (the Court said that if the parties has wanted to do so, then they should have expressly provided for it in the contract). If the parties do not wish to be subject to good faith obligations the parties may instead wish to avoid any possible implied restraints on their ability to act freely in their sole interest by expressly stating this in the contract.

Parties who wish to lower the risk of an allegation of bad faith should ensure that at the very least their conduct towards their counterparties is loyal, reliable and honest, and that they deal with the questions and requests for information promptly and accurately, and that they ensure that all information relevant to their arrangements that they all become aware of is promptly and accurately communicated.  This may, however, be easier to provide in general terms but actually more difficult to implement in practice, especially given the necessity for parties to protect their own commercial positions.

For more information please contact Karl Taylor, Associate on karl.taylor@michelmores.com or 01392 687730.


1.  Yam Seng Pte Limited v International Trade Corporation Limited [2013] EWHC 111 (QB)
2.  Bristol Groundschool Limited v Intelligent Data Capture Limited [2014] EWHC 2145 (Ch)
3. Compass Group UK and Ireland Ltd v Mid Essex Hospital Services NHS Trust 2013 EWCA Civ 200