Commercial Contracts, and the implied duty of good faith: A guide for Businesses

by Faareen Ali

In todays’ commercial climate, most of you will have entered into a contract with an individual or a business; either for a job, to buy a mobile phone, car, or even when acquiring a mortgage. The four basic components required to form a contract include; a party making an offer to another (offer), followed by acceptance of that offer (acceptance), with a form of payment being required, whether monetary or other (consideration), and an intention by both parties to create legally binding relations.

A contract can be written or oral, and its’ terms divided into different classifications, which in turn affects the remedy that an innocent party can seek, following a breach. Terms or duties can be implied into a contract by way of statute (Acts of Parliament) such as Consumer Rights Act 2015, Sale of Goods and Services Act 1982, or very hesitantly through common law (judge made law). Implied duty of good faith is an example of a duty at Common Law. The Common European Sales Law includes a definition of good faith and fair dealing as a “standard of conduct characterized by honesty, openness, and consideration for the interests of the other party to the transaction or relationship in question.”.

The duty of good faith has been widely considered a futile provision in Contract Law, as English Courts have been exceptionally particular in applying it. This could perhaps be due to the level of uncertainty it would cause, as deciding what a certain obligation means can be vague and subjective, and affect the freedom of contract where the parties have freely negotiated the terms between them. There are countries which have embodied the concept of civil code, such that they have been incorporated in their contracts,such as France, Germany and USA.  In comparison, as our English Legal System is partly formed of common law (judge made law), any interpretation of duties will be decided on precedent, and therefore the meaning of the duties will always remain unclear.

Following the case of Yam Seng Pte Ltd v International Trade Corp Ltd [2013] EWHC 111QB (Yam Seng) implied duty of “good faith” can be applied in a contract, as a term in fact, based on the presumed intentions of the parties by using the two main elements; (1) It is so obvious that it goes without saying (officious bystander test); and (2) it is necessary to give the business efficacy to the contract (business efficacy test).

Since the judgement in Yam Seng, it is clear that English Courts have been more accepting towards the incorporation of an  implied duty of good faith into relational contracts, which is a significant change from the approach before, and means that a finding  by a court that a contract is relational can make a substantial difference to the way in which it is interpreted.

Bates; a long-running Saga:

The case of Alan Bates and Others v Post Office Limited (No. 3) [2019] EWHC 606 QB (Bates) or better known as the ‘Post Office Litigation’ was a long-running Saga where courts faced some indispensable questions; (a) whether the contract between both parties was relational? and if so, (b) does implied duty of good faith apply to it?(c) what the scope of that duty would be? To all the questions, HHJ Fraser who presided in this matter, was in favour, and went onto defining the scope of this newly founded position.

Bates was a group litigation in which approximately 550 sub-postmasters (‘SPM’) brought claims relating to the Post Office’s IT system, known as Horizon, an accounting system rolled out in 1999/2000. All the Claimants’, at the material times, were responsible for running branch post offices. Due to the discrepancies in their accounts, some of the sub-postmasters were accused of theft, fraud, and were fined, sacked, made bankrupt, and even convicted and imprisoned. The SPM claimed that the Horizon system included flaws that resulted in accounting discrepancies. The claim brought was based upon the breach of duty of good faith, and 21 other terms said  to have been implied into the contracts as a consequence of that duty.

HHJ Mr.  Justice Fraser recognised that the contract held between the SPM and Post Office was relational in nature,  duty of good faith was implied, and breached. This was then followed by an application to the Court of Appeal by the Post Office to appeal the damning ruling handed down by the High Court, but was dismissed, with Post Office now paying out up to £57.75 million in damages.

What is a relational contract?

An agreement to purchase something outright is unlikely to be identified as a relational contract, as it is conclusive once the sale has been finalised. This compared to a joint venture, franchise arrangements or complex outsourcing deals, which are expected to last for some time, require a contribution of financial investment, time, resources and experience from both sides, as well as a working relationship, are  likely to be defined as relational. As such the mining and metals, oil and gas, and technology sectors are affected by this.

In Bates, according to the Judge, the determination of whether a contract was relational or not was ‘inherently a fact-specific exercise defined by the terms of the agreement, in its’ commercial context’.

What are the characteristics of a relational contract?

HHJ Mr Justice Fraser also defined a non-exhaustive list of nine characteristics to help determine whether a contract is relational?

  1. An intention on part of the parties “that their respective roles are performed with integrity and fidelity to their bargain”
  2. There is no specific express term that prevents the duty of good faith being implied
  3. The contract is intended to exist over a long period of time, or forms a long-term relationship between them
  4. There is a relationship involving collaboration with one another while performing their contractual obligations
  5. The spirits and objectives of the parties to a contract are such that they are incapable of being ‘expressed exhaustively’ in a written contract
  6. Parties repose trust and confidence in one another, but it’s different to trust and confidence in fiduciary relationships
  7. A contract with a ‘high degree of communication, co-operation, and mutual trust and loyalty
  8. A significant financial commitment or investment by at least one party
  9. The relationship between parties is exclusive.
What is the scope of the duty?

The scope of the duty of good faith required is “one where parties must refrain from conduct which in the relevant context would be regarded as commercially unacceptable by reasonable and honest people”. The issue that could arise from this definition is that it’s too subjective, as what I deem ‘commercially unacceptable’ may differ to you, and there’s still a sense of uncertainty of how this will be implemented in practice. Parties to a relational contract should always err on the side of caution, by factoring into their contracts an agreed framework of practices and protocols, which should always be adhered to, before taking steps where any party is adversely impacted as the SPM’s in this case.

There are many critics who argue that the types of companies entering into relational contracts are well-advised, with teams of lawyers supporting them carefully throughout the process of enshrining their relationship into a detailed contract, running in to thousands and thousands of pages. It doesn’t appear fair then for common law to step in, with additional set of obligations? It can be argued that the characteristics highlighted by HHJ Mr Justice Fraser are found even in  contracts which are not ‘relational’, due to the sheer nature of the transaction agreed between parties. However, there is an escape for the equivalent transactional contracts, as the identification process is fact-specific, and companies are able to include specific express terms to prevent  duty of good faith from being implied into their contract.

Some of the contract types that could be affected include Joint venture contracts, long-term gas supply contracts, technology collaborations, outsourcing agreements, and long-term sub-contracting arrangements. Parties will need to be careful that they don’t exceed their end of the bargain, beyond one which they foresee. They should also consider how the contract either excludes the duty of good faith very specifically, or makes it subject to them by defining and agreeing a clear framework of practices and protocols, from the start to the end of the contract.

If you are a business who has been adversely affected by the Coronavirus Outbreak, please do have a look at our articles focusing on the different types of economic relief you could apply for.

Disclaimer: This is a blogging forum tasked with the responsibility of simplifying law, it does not intend for its content to constitute or be used as legal advice

You may also like

Leave a Comment