14 June, 2012
Increasingly, contracting parties are including an express duty of “good faith” in their contracts. The purpose of this update is to make clients aware of the rights and obligations that inclusion of this duty may entail, with a particular focus on joint ventures.
– On the law as it stands, English courts will not generally imply a duty of good faith, but will give effect to an express duty of good faith in the contract.
– Because there is no common law duty of good faith, care must be taken as to how the duty is expressed to operate in the particular contract to avoid unwanted surprises.
– The manner in which the duty will operate will depend on the particular contractual
circumstances. No hard and fast rules can be provided.
– Nevertheless, some recent judicial comment indicates that parties bound by an obligation of good faith may be obliged to (depending on the circumstances, and amongst other things):
(a) Observe reasonable commercial standards of fair dealing;
(b) Disclose facts which would be material to the other party; and
(c) Adhere to the spirit of the contract, and/or the agreed common purpose, rather than relying on a strict interpretation of rights and obligations.
– Parties should be aware that the inclusion of a duty of good faith
may result in ambiguity, and make it more difficult for parties to rely
on the strict wording of a contract. Depending on the circumstances,
potentially this may have the effect that a party could be prevented
from relying on a technical breach to terminate the contract.
The “common law” is a term used to refer to the unwritten English law. The concept of good faith is not generally recognised in the common law relating to contracts. It is recognised in English legislation in specific cases, such as insurance, consumer protection, and property law. Nevertheless, if the parties agree to include the duty of good faith in the contractual documentation, the courts will seek to give effect to it.
In very general terms, the duty is a standard of fair dealing. The inclusion of the duty in contractual documentation can give a party comfort in that the “spirit” of the cooperative relationship relating to the particular undertaking (the business purpose or objective) may be reflected in the contractual documentation. This may therefore be attractive to joint venture participants (“Joint Venturers”) who do not know what the future will hold, but have a relationship of mutual trust and dependence. It is not necessary to spell out how the duty of good faith will operate in the relevant circumstances (although the parties could do so if they wished, thereby limiting the application of the duty). This may be contrasted to the usual position under English law where a party’s rights and obligations tend to be strictly interpreted in accordance with the wording of the contract. The “black letter of the law” will restrict a party’s duties and entitlements. Generally, if a party has not expressly provided for a particular protection in the contractual terms, that party will not be afforded such a protection.
The inclusion of the duty of good faith is not always helpful. First, the duty has been subject to only limited English judicial consideration, so the nature and extent of the duty remains unclear. Great care should therefore be taken with drafting to ensure the parties do not get other than what they bargained for. Secondly, the duty is often expressed to mutually bind the parties. This means that both parties must abide by the provision, which “cuts both ways”. In the circumstances, this may prove to be onerous, and restrict a party from rigorously pursuing its own commercial interests at the potential expense of the other party.
Good Faith in English Law
The English courts have been traditionally hostile to finding that a general duty of good faith exists in the common law. The reasons for this may be broadly summarised by the following two principles:
(a) Parties should be entitled to pursue their own self interest; and
(b) Parties should have freedom to contract as they desire. In other words, they should be entitled to expressly provide for their own rights and remedies, without interference from the courts.
Nevertheless, where the contract binds the parties by an express duty, the English court will give effect to the intentions of the parties and seek to enforce that duty. The necessity to anticipate what the duty of good faith will entail in practice then arises.
A duty of good faith is one well recognised in a number of broadly similar guises in continental European jurisdictions. It is also recognised in limited circumstances in US and Australian law. The nature and scope of the duty in English law, although containing some commonalities with these, will be strongly influenced by the particular contractual circumstances. On the law as it stands, no precise definition can be formulated. However, judicial comment in a number of cases can throw some light on the usual nature of the duty.
In Horn & Others  a loan agreement included a clause that; “…each party shall act in absolute faith towards each other”. In the particular circumstances it was not necessary to decide the meaning of contractual good faith in order to make an award for the Plaintiff. Nevertheless the judge, Smith J, set out his conclusions on the issue in the event it became relevant on appeal. These comments are not binding on future judges, but may have persuasive value (i.e. it is “obiter” commentary).
Smith J said that if the meaning of good faith had been required to be interpreted, he would have held that the obligation imports a duty to disclose facts which could be material to the other party. Such facts would include those which would influence whether the other party would enter into the relevant transaction. It is not necessary or relevant to ask whether full disclosure would have changed the particular Claimant’s decision to proceed with the transaction.
It has previously been held that good faith is consistent with acting honestly (see Central Estates ). However, Smith J found that dishonesty is not a prerequisite to establishing a breach of the duty of good faith. A person may act honestly, but yet still be in breach of the duty.
Smith J also found that where a commercial contract contains an express duty of good faith, it is not necessary to find an overriding fiduciary duty. A fiduciary relationship is one that arises where one party, Party A and the other, Party B, agree that Party A will act on behalf of or for the benefit of Party B in circumstances where Party B relies on Party A in a relationship of trust and confidence. One example would be the duties owed by a Director to his company. Where the courts can find that such a relationship exists, they will imply that Party B is afforded certain protections against Party A’s breach of such trust. The implication of Smith J’s decision is that it will not be necessary to imply a fiduciary relationship and associated protections where an express obligation of good faith requires the parties to act fairly in relation to one another.
In CPC Group Limited  the judge, Vos J, helpfully made the following obiter comments: “..the content of the obligation of upmost good faith…was to adhere to the spirit of the contract….and to observe reasonable commercial standards of fair dealing, and to be faithful to the agreed common purpose, and to act consistently with the justified expectations of the parties”.
Vos J also referred to the persuasive Australian case of Overlook v Foxtel  in which it was stated; “…the party subject to the [obligation of good faith] is not required to subordinate [its] own interests, so long as the pursuit of those interest does not entail unreasonable interference with the enjoyment of the benefit conferred by the express contractual terms so that the enjoyment [could become]…
”nugatory, worthless or perhaps seriously undermined””.
Joint Venturers should also note the case of Elliot v Wheeldon (1992). In that case the contractual documentation did not include an express duty of good faith. The Court of Appeal held that although it is well established that a director owes important duties (including fiduciary duties) to his company, he may also owe an implied duty of good faith to his co-Joint Venturers or co-directors.
This decision was only obiter, but may indicate that there is a general duty of good faith in English law between Joint Venturers or directors of small companies. This may particularly be the case where an individual is exposed due to guaranteeing the liabilities of the joint venture. This is clearly a restricted application of the duty of good faith, but nevertheless significant.
For further information, please contact:
Brian Nash, Partner, Clyde & Co
Sophie Drake, Clyde & Co