Good Faith in English Contracts

On 7 May 2020, the UK Cabinet Office published guidance that parties to contracts should act responsibly and fairly, support the response to Covid-19 and protect jobs and the economy. Being non-statutory it is unclear how the courts might apply this message. Such expectations call to mind the concept of good faith. The government is encouraging businesses to act in the interest of public health, the job market and other businesses rather than just their own. In contract law this roughly translates as a duty of good faith to the other party of a contract.

History of good faith

The concept of good faith can be introduced in a number of ways. For example, it can be a legal principle that would apply to all the commercial activity in a certain country or it could be written into a contract. Importantly, the way it operates is dependent on the legal system of the country in which it is raised. One thing that is universal about good faith is that it is subjective which creates this scope for different interpretations.

English law has traditionally been averse to subjective clauses and has repeatedly rejected the adoption of good faith as a core concept of private law. There are several reasons for this hostility. English law embodies an ethos of individualism, so that parties are free to pursue their own self-interest. A general doctrine of good faith would also create too much uncertainty by creating obligations that are potentially vague and subjective. This could undermine the goal of contractual certainty, on which English law places great weight.Over the past thirty years, EU law has introduced the notion of “good faith” into confined areas of English private law. The majority of these interventions have concerned the protection of consumers in their interactions with businesses.

Good faith today

There is no general principle of good faith in English law unlike in other European legal systems (France and Germany significantly) and some US states. Therefore including a duty of good faith clause is the best way for a party operating under English law to make sure that the duty applies.

It was stated in a judgement in January 2020 by HHJ Pelling QC that ‘the circumstances in which… [good faith] can be implied into commercial agreements is an incrementally developing area of law’. Although there is no general doctrine of good faith in English contract law it can still affect commercial contracts in three ways:

• Express duty The parties can expressly agree that they will act in good faith. The question is whether the words chosen actually impose this duty and what it means in practice.
• There is a well-recognised duty of rationality under which a party must exercise a contractual discretion in good faith and not arbitrarily or capriciously. This is often referred to as the “Braganza duty”.
• Implied duty The courts might imply a general duty of good faith in a contract, or use the concept of good faith to imply other fact-specific duties. However, these duties are only likely to arise under a limited class of “relational” contracts.

Below is a more detailed look at these three avenues by which good faith is introduced into English law contracts.

Express obligations to act in good faith

Express duties of good faith, i.e. a clause stating that the parties should act in good faith, act with the utmost good faith, act in absolute faith, resolve disputes by friendly discussions, may achieve the following:

• Prevent action that frustrates the purpose of the agreement.
• Require the disclosure of material facts to the other party.
• Prohibit knowingly lulling the other party into a false belief.
• Prohibit asking for information under a pretence.
• Prohibit knowingly providing false information on which the other party will rely.
• Prohibit negotiating behind the other party’s back.
• Prohibit knowingly sustaining a groundless dispute.

The duty of rationality (the Braganza duty)

Another way to introduce good faith is through the principle known as the ‘duty of rationality’. This is an implied obligation in English contract law, in the absence of clear language to the contrary, to exercise a contractual discretion in good faith and not arbitrarily or capriciously (as stated in the case British Telecommunications plc v Telefónica O2 UK Ltd [2014] UKSC 42.). This is often referred to as the “Braganza duty” after the leading case, Braganza v BP Shipping Ltd [2015] UKSC 17.

The duty of rationality is limited in scope. It is only likely to arise when one party, acting as decision-maker, makes a subjective decision on a matter that affects both parties giving rise to a potential conflict of interest between the parties. Any potential conflict of interest will be heightened where there is a significant imbalance of power between the parties. To simplify, the duty exists to stop the more powerful party to a contract from abusing that power.

The duty has been applied in a broad range of situations. Below are some examples:

• Unilaterally setting or varying the charges or interest rate in a contract.
• Valuing a portfolio of securities after the default of a counterparty.
• Deciding whether to award an option to a service provider.
• Deciding whether to award discretionary bonuses to employees.
• Placing an employee on gardening leave.
• Refusing to allow a tenant to keep a dog.
• Deciding to carry out a valuation of premises.
• Assessing and reclaiming overpayments.
• Avoiding an insurance policy.

Implied obligations requiring good faith

It is well recognised that broad concepts of fair dealing may be reflected in the court’s response to questions of construction and implication of terms: “A thread runs through our contract law that effect must be given to the reasonable expectations of honest men” (Lord Steyn, LQR 1997, 133 (Jul)). Almost all contracts would reasonably be understood as requiring honesty in their performance, reflecting the common assumption by the parties to this effect. For example, one of the principles of contract law is that no person may benefit from his or her own wrongdoing, which encourages honest performance. The court may also imply terms in fact that:

• The parties will co-operate in the performance of a contract.
• A party cannot insist on the performance of an obligation it has prevented the other from performing.

Although these obligations exist it would be incorrect to imply that they constitute the concept of good faith as defined in courts around the world. The concept of good faith should not be seen as a “general organising principle”. To do so would risk undermining the express terms agreed between the parties in that, in English Law, the terms of a contract are the most important thing to assess before any subjective principles such as good faith (as stated in the case MSC Mediterranean Shipping Company SA v Cottonex Anstalt [2016] EWCA Civ 789.) However, where the contract is “relational”, it may be possible to use the concept of good faith as an aid when interpreting a contract. This concept was first advocated by the High Court in Yam Seng. Some recent decisions support the concept of a relational contract and give a sense of ‘relational’ is defined:

• The Court of Appeal commented, obiter, that a 25-year PFI contract could be classified as a relational contract. Given the “massive length” of the contract, the parties should not latch onto “infelicities and oddities” to disrupt the project and maximise their own gain.
  (Amey Birmingham v Birmingham City Council [2018] EWCA Civ 264)
• Similarly, the High Court decided that a different 25-year PFI contract was a “paradigm example of a relational contract in which the law implies a duty of good faith”. (Essex County Council v UBB Waste (Essex) Ltd [2020] EWHC 1581 (TCC))
• In the High Court, Leggatt LJ decided that a long-term joint venture to develop hotels and an associated travel business was a relational contract subject to an implied duty of good faith. (Al Nehayan v Kent)

Length can be seen as the main factor in recent statements when considering whether or not a contract is ‘relational’. As stated in the 2019 case Bates v Post Office, broadly speaking a relational contract exists when there is:

• A long-term contract or a contract the parties intend to be long term, even if it lacks a fixed term and allows termination by notice.
• The parties intend their roles to be performed with integrity and with fidelity to their bargain.
• The parties will be committed to collaborating with one another.
• The spirits and objectives of the venture cannot be expressed exhaustively in a written contract.
• The parties each 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.

However, the law remains in flux and the circumstances in which a contract will be considered “relational” are limited.

Summary

Understanding the way the concept of good faith is constituted and used in the jurisdiction under which a contract is governed is the first step when considering to rely upon it. As has been mentioned, its subjective nature causes a wide variety of interpretations and not always the clearest picture of how it is used in practice. Taking the UK as our prime example (and specialism), the English courts have an austere, some would say draconian, approach to interpreting good faith into contracts because the written terms of a contract are seen as being precedent and therefore able to overrule any such principles. Therefore the surest way to make sure the obligation exists in English law (or does not) is by considering the inclusion (or non-inclusion) of a good faith clause.

Relying on the duty of rationality or the concept of a ‘relational’ contract, i.e. not an express clause, is ill-advised. In a recent case, TAQA v RockRose [2020], the court decided that just because a contract could be defined as a ‘relational contract’, it would not automatically lead to the conclusion that the parties owe each other a good faith obligation. It would depend on the terms of the particular contract. This is further indication that the UK courts are unlikely to imply a duty of good faith and even within the context of Covid-19 it is doubtful that its scope will increase.

If you have any questions about good faith clauses or about contract law more generally please contact Neil Williamson.