Good faith in commercial contracts: recent developments

Introduction

Unlike many jurisdictions, English law does not imply a general duty of good faith into contracts. This is to avoid uncertainty, and preserve the freedom of the parties to pursue their own interests (within their contractual framework). This article explores the situations in which obligations of good faith may arise in commercial contracts, before discussing the recent case of Phones 4U Ltd (In Administration) v EE Ltd and others [2023] EWHC 2826 (Ch), in which the existence or otherwise of good faith obligations were of central importance.

 

Key takeaways for commercial parties

Parties negotiating contracts often agree good faith provisions as a means of concluding a deal. However, parties should beware the law of unintended consequences, giving active consideration to whether good faith duties are needed. If they are, careful drafting is required to ensure the extent of those express good faith obligations is articulated as clearly as possible, so that whether or not the obligation in question has been discharged can be objectively determined.

As a recent decision of the English court shows (see below), relying on a court to imply a good faith duty for your benefit introduces a high degree of risk and uncertainty. Equally, if contractual counterparties wish positively to exclude the implication of a good faith duty into their contract, they can do that by express words, or by saying that obligations of good faith only arise where expressly provided for in the agreement. Giving careful thought to such points at the point of negotiating contracts will help parties to avoid dispute in the future. 

 

Starting position

The starting position is that parties to an English law contract are not under any general duty to act in good faith in the performance of it. That said, a duty to act in good faith can arise in three situations:

1. Where the parties have agreed an express obligation to act in good faith;
2. Where the so-called Braganza duty operates to imply an obligation on a party to exercise its contractual discretion in good faith; and
3. Where the contract is considered to be “relational” in nature such that a general duty of good faith should be implied.   

 

Express obligations of good faith

There is no universally accepted meaning of what a duty of good faith involves and words will be construed in their commercial and contractual context to determine what obligations exist in a given case. Disputes can therefore arise as to the precise scope of a party’s obligations. In a recent judgment – Compound Photonics Group Ltd; Faulkner v. Vollin Holdings Ltd [2022] EWCA Civ 1371 – the Court of Appeal overturned the High Court’s judgment that the express obligation contained in a shareholders agreement to act in good faith required the parties to observe certain minimum standards that apply in every case in which a contractual duty of good faith arises.

The court held that such a broad approach should not be taken, and ordinary principles of contractual interpretation must be applied in each case. There is no automatic “minimum” standard of conduct to be applied to a duty of good faith; beside the point that “the core meaning of an obligation of good faith is an obligation to act honestly”, the duty can be broader, depending on the context and the other terms of the agreement in issue. In the words of Snowden LJ in Compound Photonics: “Depending on the contractual context, a duty of good faith may be breached by conduct taken in bad faith. This could include conduct which would be regarded as commercially unacceptable to reasonable and honest people, albeit that they would not necessarily regard it as dishonest”.

 

Braganza duty

The Braganza duty is beyond the scope of this article, but is a situation in which a duty to act in good faith may arise in connection with a contract. Where discretionary powers are afforded to a party in a contract, the English court may imply a duty on the party benefitting from the discretion to exercise its discretionary powers honestly, in good faith and not in an arbitrary, capricious or irrational way.

 

“Relational” Contracts

Yam Seng PTE Ltd v International Trade Corporation Ltd [2013] EWHC 111 (QB) was widely considered to mark a new era, where the High Court ruled that the hostility of the English courts to a general duty of good faith in contracts was misplaced. And so over the last decade, the English courts have come to recognise the concept of “relational” contracts, into which a general duty of good faith may be implied.

Bates v Post Office (No.3) [2019] EWHC 606 (QB) set out a list of factors which indicated that the following characteristics were relevant when deciding whether a contract was relational or not:

(i)    There must be no specific express terms in the contract that prevent a duty of good faith being implied into the contract;

(ii)   The contract will be a long-term one, with the mutual intention of the parties being that there will be a long-term relationship;

(iii)  The parties must intend that their respective roles be performed with integrity, and with fidelity to their bargain;

(iv)  The parties will be committed to collaborating with one another in the performance of the contract;

(v)   The spirit and objectives of the parties’ venture may not be capable of being expressed exhaustively in a written contract;

(vi)  The parties will each repose trust and confidence in one another, but of a different kind to that involved in fiduciary relationships;

(vii) The contract in question will involve a high degree of communication, co-operation and predictable performance based on mutual trust and confidence, and expectations of loyalty;

(viii) There may be a degree of significant investment by one party (or both) in the venture. This significant investment may be, in some cases, more accurately described as substantial financial commitment; and

(ix)   Exclusivity of the relationship may also be present.  

Where a contract is “relational”, an implied duty of good faith must satisfy the business efficacy or officious bystander tests (as for any implied term). It must also be capable of clear expression so as not to contradict any express term of the contract. Relational contracts which are subject to an implied duty of good faith require the parties to act with integrity and in a spirit of cooperation. Parties may pursue their own interests but in a way which allows them to have trust in the other. It does not only mean that they should behave honestly, but that they should refrain from conduct which would be regarded as commercially unacceptable by reasonable and honest people.

 

No good faith duty implied where parties are sometimes competitors

On 14 November 2023, in Phones 4U Ltd (In Administration) (P4U) v EE Ltd and others (EE) [2023] EWHC 2826 (Ch), the High Court held that an agreement was not a relational contract and EE was not under a general duty to act in good faith.

EE had informed P4U that they would not be extending their trading agreement (through which EE would pay P4U for selling mobile phone contracts to new customers or upgrading existing customers’ contracts). P4U claimed that EE intended to force P4U into administration by terminating the agreement a year before it was due to end, avoiding further payments. P4U argued that the agreement was relational in nature and that, as a consequence, EE was under an implied general duty to act in good faith in relation to the performance of its obligations under the contract (relying on the judgment in Yam Seng).  

The judge (Roth J) expressed the view that the first of the characteristics cited in Bates (listed above) goes less to the question of whether a contract is relational than to the question whether a duty of good faith should be implied “[A]s Leggatt J said in Yam Seng at [149], since implication of the term is based on the presumed intention of the parties, it is open to them to modify the scope of the duty by the express terms of their contract, or to exclude it altogether.” He held that the agreement in question did “address the question of good faith, and expressly defines its scope in the language of clauses 13.1, 13.2 and 13.11”, and that operated to preclude the implication of a more general duty of good faith. 

Although Roth J acknowledged that some features of a relational contract existed, for example it was long term and required the parties to collaborate, he decided that the contract was not relational. In doing so, he made the following observations:

• Whereas exclusivity indicates that a contract is relational, conversely competition between the parties indicates the opposite. “It is a striking feature of the present case that EE was not only enabling P4U to supply connections to its network but was in competition with P4U in seeking to supply such connections to customers directly… exclusivity is a supporting indication, not a necessary condition, for a relational contract, and I consider that being in direct competition is a strong factor pointing the other way.”
• Relational contracts do not tend to describe how the parties are to cooperate in detail and that “here, the details of the parties’ collaboration are spelt out in considerable detail in the written agreement…”The agreement contained an express requirement for EE to act in good faith in relation to activity designed to reduce P4U's revenue. This did not mean that EE must act in good faith generally. The contract had been negotiated between sophisticated parties and their lawyers, and “[I]f [the parties] had intended to impose a general obligation of good faith, I consider that they would have done so.”

Roth J went on to say that, even if the agreement was relational in nature, it would not affect the outcome. This was firstly because of his earlier finding that no general obligation of good faith was to be implied. Second, even if he were to be wrong on that point, there was no breach of good faith by EE on the facts of the case. EE had a right to prioritise its own interests and concerns. EE’s decision to notify P4U that their agreement would not be extended could not be regarded as commercially unacceptable by reasonable and honest people.