Wednesday, October 9, 2013

"Can you imply good faith into contracts under English law?"

Can you imply good faith into contracts under English law?

In last year’s Review, Richard Smellie wrote about the importance of the decision of the Supreme Court in Rainy Sky S.A. and others v Kookmin Bank1 when it came to considering ambiguities in contract documents. Richard explained that where the language is clear, the rights and obligations will be clear, but language is often susceptible to more than one possible meaning, particularly when arguments arise or the unexpected occurs. Commercial contracts are often complex, and ascertaining the true nature of the parties’ agreement on a particular point can be challenging. The starting point is, of course, the words on the page, but where there is conflict or ambiguity, this must be interpreted. It is at this point that the law of the contract steps in, with rules on how the contact is to be interpreted. In the Kookmin case, the Supreme Court confirmed the particular importance of giving weight to “business common sense” in ascertaining what the parties meant by the language they used, when ambiguity arises.

The Kookmin decision, arguably, reflects an emphasis on the perceived commercial realities that many Dispute Adjudication Boards and arbitrators have been quietly giving precedence to for many years. It does, however, place business common sense at the heart of contract interpretation when ambiguity arises, and so has important ramifications for all commercial contracts, not least construction contracts. It is also a decision which is now routinely to be found in disputes over what a contract actually means. It may also be the reason why the past 12 months or so have seen a resurgence in attempts by parties to rely on the principles of good faith in determining what a contract might mean.

Yam Seng Pte Ltd (a company registered in Singapore) v International Trade Corporation Ltd2

Traditionally under English contract law there is no legal principle of good faith. There are two reasons for this, the general principle of freedom of contract whereby parties are free to pursue their own goals in both negotiating but also in performing contracts provided they do not act in breach of a term of the contract. Second, there is concern that the concept of good faith is too vague and subjective and therefore uncertain.

Mr Justice Leggatt noted that this approach, in refusing to recognise any general obligation of good faith, would appear to be an example of “swimming against the tide” of both civil and common law jurisdictions. Good faith appears in most civil codes and in Australia, for example, the existence of a contractual duty of good faith is reasonably well established.3 The Judge concluded that he doubted that English law had reached the stage where it was ready to recognise a requirement of good faith as a duty implied by law, in all commercial contracts. That said, there seemed to be no difficulty in adopting the established principles of the implication of such terms.

Under English law, the two basic and principal criteria used to identify terms to be implied are that the term is so obvious that it goes without saying and that the term is necessary to give business efficacy to the contract. What would the contract, read as a whole against the relevant background, reasonably be understood to mean? In the case here, the Judge noted that the relevant background was important, not only in terms of matters of fact known to the parties but also in terms of shared values and norms of behaviour. These may include norms that command general social acceptance or that may be specific to a particular trade, commercial activity or even the particular contractual relationship in question.

The Judge stressed that commerce takes place against a background expectation of honesty. Such an expectation is essential to commerce, which depends critically on trust. However, such an expectation is seldom, if ever, made the subject of an express contractual obligation. To seek to do so might actually damage the parties’ relationship by the lack of trust that this would signify. The Judge concluded that as a matter of construction, it would be hard to envisage any contract which would not reasonably be understood as requiring honesty in its performance.

Mr Justice Leggatt stressed that what good faith requires is sensitive to context. That includes the core value of honesty. Some contracts, including joint venture agreements, may require a high degree of communication, cooperation and predictable performance based on mutual trust and confidence, which are not legislated for in the express terms of the contract but are implicit in the parties’ understanding and necessary to give business efficacy to the arrangements. He also referred to the body of cases in which duties of cooperation in the performance of the contract have been implied and the authorities which show that a power conferred by a contract on one party to make decisions that affect them both must be exercised honestly and in good faith for the purpose for which it was conferred, and not arbitrarily or unreasonably. Mr Justice Leggatt concluded:

“In the light of these points, I respectfully suggest that the traditional English hostility towards a doctrine of good faith in the performance of contracts, to the extent that it still persists, is misplaced.”

Now, of course, Mr Justice Leggatt clearly is not saying that you would be able to imply good faith into each and every agreement. It all depends on the context of the contractual arrangements made between the parties. However, the Judge has potentially opened a pathway which others (perhaps coincidentally) have tried to follow. And indeed there have been two further cases in the English courts. Both confirm that everything does indeed depend on the context, and both confirm that the ability to imply good faith into agreements made under English Law remains a difficult matter.

TSG Building Services Plc v South Anglia Housing Ltd4

Here, TSG and SAH entered into a contract for the provision by TSG of a gas servicing and associated works programme relating to SAH’s housing stock. This contract was based on the ACA Standard Form of Contract for Term Partnering (TPC 2005, amended 2008). Mr Justice Akenhead identified two key contract terms:

“1.1 The Partnering Team members shall work together and individually in the spirit of trust, fairness and mutual co-operation for the benefit of the Term Programme,5 within the scope of their agreed roles, expertise and responsibilities as stated in the Partnering Documents, and all their respective obligations under the Partnering Contract shall be construed within the scope of such roles, expertise and responsibilities, and in all matters governed by the Partnering Contract they shall act reasonably and without delay.”

“13.3 If stated in the Term Partnering Agreement that this clause 13.3 applies, the Client may terminate the appointment of all other Partnering Team members, and any other Partnering Team member stated in the Term Partnering Agreement may terminate its own appointment, at any time during the Term or as otherwise stated by the period(s) of notice to all other Partnering Team members stated in the Term Partnering Agreement.”

A question arose as to whether or not termination under sub-clause 13.3 of the Contract needed to have been effected in good faith or at least reasonably. Did sub-clause 1.1 as a matter of construction provide for any constraint, condition or qualification on the apparently unfettered right of either party to terminate in effect for convenience (or without any already given reason) under sub-clause 13.3? In broad terms, the Judge said that this meant that one needed to determine objectively what a reasonable person with all the background knowledge reasonably available to the parties at the time of the contract would have understood the parties to have meant. In doing this, he was saying that he was looking to adopt a more rather than less commercial construction.

The first part of sub-clause 1.1 was clearly primarily calling upon the parties to “work together” and in that context to do so, jointly and separately, “in the spirit of trust, fairness and mutual co-operation”, the object being towards “the benefit of the Term Programme”. The Term Programme had as its object the efficient and good quality performance of the gas-related works in some 5,500 dwellings. This was all to be “within the scope” of the “roles, expertise and responsibilities” called for in the Partnering Documents. This both on its face and as a matter of commercial common sense did not obviously or at all impinge upon either party’s right to terminate at will under sub-clause 13.3. Termination at will was not a “responsibility”. It did not give rise to a “role” and/or was not dependent upon any “expertise”.

It was therefore necessary to consider the scope of sub-clause 1.1 in the context of the preamble confirming that the parties had agreed to work “in mutual co-operation to fulfil their agreed roles and responsibilities and apply their agreed expertise in relation to the Term Programme, in accordance with and subject to the Partnering Documents” and the bespoke part of sub-clause 1.1 which spelt out that the “roles, expertise and responsibilities” of the parties were further described in the Term Brief and Term Proposals. The clause was primarily directed to the way in which the parties shall work together (and individually).

The Judge concluded that sub-clause 1.1 did not require SAH to act reasonably as such in terminating under clause 13.3. Sub-clause 13.3 entitled either party to terminate for any reason or even no reason. It was clear that the four-year term is subject to clause 13. Clause 13 provided for automatic termination for insolvency, termination for breach, and an unqualified and unconditional right to terminate. There could be no doubt that if either party had applied their mind to this prior to the contract being signed it was clear that there was such an unqualified right available to either party; it was obvious to each that the other could terminate at any time. Sub-clause 1.1 was primarily concerned with the assumption, deployment and performance of roles, expertise and responsibilities set out in the Partnering Documents and the parties in so doing must “work together and individually in the spirit of trust, fairness and mutual co-operation for the benefit of the Term Programme” and act reasonably and without delay in so doing.

However, was there an implied term of good faith? The Judge referred to the review carried out by Mr Justice Leggatt in the Yam Seng case. He noted the need to be “sensitive to context” and also the Judge’s comments on what he described as the “core value of honesty”. Mr Justice Akenhead did not consider that the case here was one involving implied obligations of fidelity. There was no suggestion or hint that there had or might have been any dishonesty in the decision to terminate. The Judge concluded that:

“I do not consider that there was as such an implied term of good faith in the Contract. The parties had gone as far as they wanted in expressing terms in Clause 1.1 about how they were to work together in a spirit of ‘trust fairness and mutual co-operation’ and to act reasonably. Even if there was some implied term of good faith, it would not and could not circumscribe or restrict what the parties had expressly agreed in Clause 13.3, which was in effect that either of them for no, good or bad reason could terminate at any time before the term of four years was completed. That is the risk that each voluntarily undertook when it entered into the Contract, even though, doubtless, initially each may have thought, hoped and assumed that the Contract would run its full term…”

Mid-Essex Hospital Services NHS Trust v Compass Group UK and Ireland Ltd6

The Court of Appeal also referred to the Yam Seng case in considering whether or not Compass had been entitled to terminate their long-term facilities contract, the court had to consider the meaning of clause 3.5 which imposed a duty to co-operate in good faith:

“3.5 The Trust and the Contractor will co-operate with each other in good faith and will take all reasonable action as is necessary for the efficient transmission of information and instructions and to enable the Trust or ... any Beneficiary to derive the full benefit of the Contract.”

At first instance Mr Justice Cranston had noted that the Trust and Compass had entered into a long-term contract for the delivery of food and other services within a hospital. The performance of this contract would require continuous and detailed co-operation. He considered that it accorded with commercial common sense for there to be a general obligation on both parties to co-operate in good faith.

The Trust said that if the parties had intended to impose a general duty to co-operate with one another in good faith, they would have stated this in a stand-alone sentence with a full stop at the end. They did the opposite of that in clause 3.5. This was a very detailed contract, where the obligations of the parties and the consequences of any failings were spelt out in great detail. Commercial common sense therefore did not favour the addition of a general overarching duty to co-operate in good faith.

On appeal, LJ Jackson began his judgment by noting that there is no general doctrine of “good faith” in English contract law. If the parties wish to impose such a duty they must do so expressly. He then held that he agreed with the Trust. The content of a duty of good faith is heavily conditioned by its context. The obligation to co-operate in good faith was not a general one that qualified or reinforced all of the obligations on the parties in all situations where they interacted. The obligation to co-operate in good faith was specifically focused upon the two purposes stated in clause 3.5. In the context of clause 3.5, the obligation to co-operate in good faith simply meant that the parties would work together, honestly endeavouring to achieve the stated purposes. The obligation to co-operate in good faith was limited to those stated purposes stated, i.e. the efficient transmission of information and instructions and the enabling of the Trust to derive the full benefit of the Contract.

Compass could not rely upon breaches of the implied term to support their arguments that there had been a breach of good faith. In any event, absent any dishonesty, the Trust’s miscalculation of the amount of service failure points would not have amounted to a breach of a general obligation of good faith.

Conclusion

It should be noted that Lord Justice Beatson specifically commented upon the Yam Seng case, noting that Mr Justice Leggatt had emphasised that “what good faith requires is sensitive to context”,

“that the test of good faith is objective in the sense that it depends on whether, in the particular context, the conduct would be regarded as commercially unacceptable by reasonable and honest people, and that its content ‘is established through a process of construction of the contract’ … Those considerations are also relevant to the interpretation of an express obligation to act in good faith.”

He therefore agreed that the scope of the obligation to co-operate in good faith in clause 3.5 must be assessed in the light of the provisions of that clause, the other provisions of the contract and its overall context. In other words, the content of the obligations to co-operate in good faith was to be determined by reference to the two purposes specified in the clause. Put another way, one should take a narrow interpretation of any clause that suggests that parties must exercise the duty of good faith. He said:

“In a situation where a contract makes such specific provision, in my judgment care must be taken not to construe a general and potentially open-ended obligation such as an obligation to ‘co-operate’ or ‘to act in good faith’ as covering the same ground as other, more specific, provisions, lest it cut across those more specific provisions and any limitations in them.”

That both Mr Justice Akenhead in the TCC and the appellate judges in the Court of Appeal laid stress on Mr Justice Leggatt’s view that “what good faith requires is sensitive to context” rather suggests that we are still a long way off from the English and Welsh courts accepting that there is a wide-ranging duty of good faith, such as to be found in the majority of other jurisdictions around the world.

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  • 1. [2011] UKSC 50
  • 2. [2013] EWHC 111 (QB)
  • 3. The Judge’s judgment provides a useful summary of the position worldwide.
  • 4. [2013] EWHC 1151 (TCC)
  • 5. This is not so far away from the NEC clause 10.1 which requires all those operating the contract to act “in the spirit of mutual trust and co-operation”.
  • 6. [2013] EWCA 200 Civ