Does Good Faith mean fair play?By: Julia Court

According to the Office of National Statistics, the property market is showing signs of a positive recovery, having risen by 5.3 per cent over the past year. This has resulted in an increase in development and construction contracts being signed. Good faith and co-operation obligations often feature in these agreements, but it’s important that all parties involved understand what agreeing to good faith can mean.

When entering into deals, you might well expect that the other party to your contract is honest, trustworthy and fair – and most people want to see sensible co-operation throughout the contract. But do you have to assess your fairness every step of the way and justify your choices?

Traditionally English law has not recognised an overall duty of good faith. This stands against the tide of good faith recognition across European jurisdictions and countries like Australia, the USA and Canada. Closer to home, Scottish law has also recognised a broad principle of good faith.

Good faith and co-operation clauses are usually aimed at protecting interests and avoiding irrational or unfair operation of clauses such as remuneration. However, could they limit exercise of rights such as the right to terminate?

A case of good faith

Recently, the English courts have considered both express good faith clauses and possible implication of an implied good faith duty – most significantly in the case of Mid Essex Hospital Services Trust v Compass Group UK and Ireland Ltd (Medirest).

The case was concerned with exercise of a right to terminate and operation of a payment mechanism under a long-term facilities management contract that permitted payment deductions for performance failures. The Court considered whether a requirement for the parties to ‘co-operate with each other in good faith’ applied generally across all provisions or was limited to specific instances.

The High Court decided that the specific good faith obligation could apply generally and this led to a finding of implied good faith and breach of that term.

The Court of Appeal disagreed. The Trust had express discretion to deduct payments and terminate the contract at will, so it would be incorrect to add an additional obligation not to act arbitrarily, capriciously or irrationally in doing so. That discretion simply permitted the Trust to decide whether or not to exercise a contractual right.

However, the Court did not wholly dismiss good faith. It said that where there is a range of options that can be taken by a party. which affects the interests of both parties, it is more likely that good faith could be implied to that decision. However, the duty would depend on context. Following previous case law, the duty would be concerned with acting honestly and not in bad faith, which is consistent with dictionary definitions of good faith. The court also commented that exercising a right dishonestly was not the same as exercising it mistakenly.
Although the Court in Medirest did not apply the express good faith provisions generically to the rights exercised, there could have been other specific obligations to which they did apply.

Lessons in good faith
Where does this case leave us? The outcome and approach seem sensible. Most parties particularly those entering into long term arrangements would expect that the other party would not act dishonestly. A clear express right to calculate and deduct liquidated damages on certain conditions being satisfied as appear in agreements for lease and standard construction contracts would not fall foul of good faith challenges based on Medirest. The only discretion is a choice about whether or not to deduct them.

It follows that if a contract has precise rules about how something is to be done then this is likely to militate against triggering a good faith duty. If a clause requires something to be to the ‘reasonable satisfaction’ of a party then this is an objective test and there is no need for a further or different control mechanism.

So, what are we left with? A situation where a contract gives a power or discretion that involves a party making an assessment or choosing between a range of options affecting both parties’ interests. Easy to describe, but difficult to isolate in practice.

This situation could be subject to an express duty or depending upon the context and nature of the contract, could give rise to an implied duty of good faith. However, the courts do not imply terms lightly and in assessing whether to imply good faith, they have not departed from the rules established in past years for determining whether a term should be implied. Whether a term is necessary for business efficacy is therefore a key consideration.

Interpretations of when good faith might be implied are narrow, so it isn’t advisable to amend contracts to include a general exclusion of good faith. But if you are including good faith and co-operation clauses in contracts you need to be careful. How will they fit with other clauses? Do they apply generally or specifically?

A change for good?

The Medirest decision has provided more clarity on good faith, but the door is not closed and it is likely that parties will continue to have a go at pushing the boundaries on good faith as deal activity increases but performance remains key.

In Yam Seng PTE Limited v International Trade Corporation Limited the High Court readily implied a duty of good faith and found there to be ‘no difficulty’ in doing so but Yam Seng is particularly confined to its facts and sits at odds with the Court of Appeal in Medirest.

However, it will be interesting to see future challenges before the courts, most likely in the context of long term and partnering contracts or where one party believes there is a sniff of dishonesty in the operation of a contract, which makes it worth pushing at the legal “crack” in the door.  

About the author

Julia Court is Co-head of Construction at international law firm King & Wood Mallesons SJ Berwin