All in good faith: where does the law stand on acting in good faith?

Answer

For parties preparing to enter into a joint venture, it may seem obvious that they would each expect the other parties to act ‘in good faith’ in their joint venture dealings. However, English law has traditionally refused to recognise any overriding principle of good faith between contracting parties including where the parties may be co-shareholders.

Background

In Walford v Miles (1992), Lord Ackner stated that “the concept of a duty to carry on negotiations in good faith is inherently repugnant to the adversarial position of the parties when involved in negotiation” and is “unworkable in practice”. Instead, the courts upheld the principles of freedom of contract, the ability for parties to pursue their own self-interest and certainty of contract. It’s thought that a general doctrine of good faith would create obligations that are potentially too vague and subjective.

The rejection of an overarching doctrine of good faith has occasionally been problematic to the courts. This has developed “piecemeal solutions in response to demonstrated problems of unfairness” – and in doing so muddied the waters.

Three issues

There are three issues to be considered for parties entering into contractual relationships including where expressed in a joint venture or shareholders’ agreement:

• Agreeing an express duty of good faith. However, it may be problematic to interpret precisely what obligations arise from this and what the parties must do in practice to make sure they fulfil such a duty.
• Will the English courts imply a duty of good faith? Despite the overarching rejection of the concept of good faith, the courts have shown themselves willing to imply a general duty of good faith into specific contracts, particularly so-called ‘relational’ contracts.
• The duty of rationality is a now well-recognised duty under which a party must exercise a contractual discretion in good faith.

Express duty to act in good faith

In the context of a joint venture, the inclusion of an express obligation on the parties to act in good faith may seem to be an uncontroversial request. Why would anyone want to enter into a contract with a counterparty who wouldn’t agree to act in this way?

However, while the parties to an English law agreement are free to agree to act in good faith, the main issue in including such wording is a practical one. This is because good faith may be an imprecise concept that is impossible to pin down with any degree of certainty.

This is reflected in case law where, in the absence of a general definition of good faith, the courts have been required to interpret the specific words chosen by the parties on a case-by-case basis to ascertain the true intention behind including such a provision. Where an express good faith clause is included in a contract, the court must try to give effect to it, but the actions which it should translate to may not be clear.

The difficulty can be seen from cases that have attempted to establish what is meant by an express duty of good faith. For example, in CPC Group v Qatari Diar (2010), Vos J considered various potential definitions or interpretations of the phrase including that it:

• underwrites the spirit of the contract and supports the integrity of its character;
• is a duty to recognise and to have due regard to the legitimate interests of both parties; and
• emphasises faithfulness to an agreed common purpose and consistency with the justified expectations of the other party.

In Unwin v Bond (2020) the difficulties which may arise if an express duty to act in good faith is added to a shareholders’ agreement were highlighted. Often, the shareholders in a joint venture will not only be a party to the shareholders’ agreement and have rights under the company’s constitutional documents, but they will also be directors and/or employees or have rights deriving from other contractual arrangements. Therefore any good faith obligation arising out of the shareholders’ agreement operates in the same space as the rights and obligations arising out of these other contracts.

Such was the case of this company which was owned by two individual shareholders. Mr Bond was the 80% shareholder and Mr Unwin the 20% shareholder. Mr Unwin was also an employee of the company. Mr Bond dismissed Mr Unwin on the grounds of poor performance. Under the company’s articles of association, Mr Unwin was obliged to sell his shares for a nominal amount in these circumstances as termination of his employment.

The court decided that Mr Bond had breached the good faith obligation in the shareholders’ agreement, even though he had not been dishonest and had been acting in what he considered to be the best interests of the company. He was found to have failed to "deal fairly and openly" with Mr Unwin, which was one of the “minimum standards” in relation to the obligation of good faith.

The conclusion from this decision seems to be that, where there is an express duty of good faith and either of the shareholders holds a position as director and/or employee of the joint venture, this obligation may extend beyond their relationship as shareholders.

When determining the effect of an express good faith clause, the courts will closely examine the wording of the specific agreement and only hold the parties to conduct the expressly stated obligations in good faith, not the whole contractual relationship. As a result, generic or wide ranging obligations of this nature may not be enforced by the courts due to lack of certainty.

It’s also worth noting that an express duty of good faith is unlikely to be placed at odds with defined contractual rights or require a party to give up its commercial interests. On the other hand, the courts do not necessarily require there to be a finding of dishonesty.

Parties should therefore be aware that although an express good faith clause may be intended to fill any gaps in the contractual relationship and encourage both parties to behave in a ‘fair’ way, there is the risk that they will be left without an enforceable right if relationships break down. At worst it may be interpreted in a way that neither party anticipated nor written into their agreement.

Duty of good faith in English law agreements

The English courts have struggled to properly define where a duty of faith may be implied into contracts governed by English law.

In the 2013 High Court case of Yam Seng, it was recognised that the concept of good faith was used to imply two terms into a distribution agreement, in part on the basis that the contract was a long term, ‘relational’ contract. This idea has persisted with certain recent decisions in the courts supporting the concept of implying good faith into this type of contract.

In 2019 the High Court implied a duty of good faith into the Post Office’s contract with its sub-postmasters as this was found to be a ‘relational’ contract. In doing so, the court set out features of a contract that would indicate it was of this type:

• A long-term contract or a contract the parties intend to be long term, even though it lacks a fixed term and allows termination by notice.
• The parties intend their roles to be performed with integrity and fidelity to their bargain.
• The parties will be committed to collaborating.
• The spirits and objectives of the venture cannot be expressed exhaustively in a written contract.
• The parties each repose trust and confidence in one another.
• The contract involves a high degree of communication, cooperation and predictable performance based on mutual trust and confidence, and expectations of loyalty.
• One or both parties have made a significant investment.
• The relationship is exclusive.

Notwithstanding a number of cases willing to imply a duty of good faith into relational contracts, in 2020 the High Court in Russell v Cartwright held that, rather than trying to establish whether a contract is a ‘relational’ one, which therefore includes an obligation of good faith (as was held in Bates v Post Office), the better starting point was the application of conventional tests for the implication of contractual terms. This meant that the question to be asked was whether a reasonable reader would consider that an obligation of good faith was obviously meant, or the obligation was essential to the proper working of the contract since it would otherwise lack commercial or practical coherence.

Potential implications

What are the implications for the parties to a joint venture or shareholders’ agreements?

Well, it’s fairly clear that while the concept of good faith is creeping into English law, the “law has not yet reached a stage of settled clarity”, and this will have implications for the drafting of joint venture agreements or shareholders’ agreements.

Where no express duty is included, it remains unclear from the case law whether parties to ‘relational’ contracts are able to rely on a duty of good faith implied by the law. The willingness of the court to permit this implication is very fact specific, and that inevitably gives rise to a degree of uncertainty around the contractual interpretation.

Final thoughts

Even if a duty of good faith is implied by a court, there may be a lack of clarity on the contractual implications which may follow. While each party to a contract may be entitled to expect that the other parties will not act dishonestly, if they want other protections these should be written into the contract clearly enough for the parties to understand what they can and cannot do.

What does appear to be clear is that an express term of the contract can prevent any duty of good faith being implied, so the parties to a joint venture agreement or shareholders’ agreement could choose to expressly exclude any implied duty of good faith.

Megan Skipper is knowledge of counsel at Norton Rose Fulbright.