Good Faith

 

English law does not recognise a general duty to act in “good faith” in contracts but in Yam Seng Pte Ltd v International Trade Corporation Ltd [2013] EWHC 11 (QB) (which was not a franchise case but related to the distribution of Manchester United merchandise in the Middle East and elsewhere), the judge, Mr Justice Leggatt, acknowledged that whilst it would be unlikely that a duty of good faith would be implied in every commercial contract, elements may be implied in contracts involving a long term relationship between parties who have made a substantial commitment.  The judge stated that these “relational” contracts:

“… may require a high degree of communication, cooperation and predictable performance based on mutual trust and confidence and involve expectations of loyalty which are not legislated for in express terms of the contract but are implicit in the parties’ understanding and necessary to give business efficacy to the arrangement”.

The judge indicated that, franchise agreements were “relational” contracts.

The extent of this duty of good faith and whether other courts will follow the decision in Yam Seng is unclear.  On 18 October 2016 Mr Justice Leggatt set out his views on good faith in a lecture to the Commercial Bar Association and, in this context, he sought to explain what was meant by “good faith” in common law jurisdictions.

He emphasised the difference between the common law and civil law approach and gave by way of an example Article 1104 of the recently revised French Civil Code which provides that:-

“Contracts should be negotiated, executed and performed in good faith.  This requirement is a matter of public policy”.

He highlighted that there were three important differences between the civil law approach as reflected in Article 1104 and the common law approach reflected in section 1-304 of the American Uniform Commercial Code:-

“Every contract … imposes an obligation of good faith in its performance or enforcement”.

The common law concept of good faith envisages that it is the contract itself that imposes a duty of good faith which has the corollary that the contract can also exclude or limit such duty because the underlying aim is to give effect to the intention of the contracting parties.  The purpose of the common law concept is not to restrict the freedom of contract and it has two elements:-

–      Adherence to reasonable commercial standards of fair dealing; and

–      Faithfulness to the purpose of the contract and to the reasonable expectations of the contracting parties.

Two scenarios need to be distinguished. The first is where the contract contains an express duty of good faith and the second is where it does not.  In addition issues similar to “good faith” arise when a contract gives a contracting party a discretion. The classic example of that in a franchising context is the discretion granted to a franchisor to change contractual terms offered to a franchisee wishing to renew the term of his franchise agreement.

Express Duties of Good Faith

In Berkeley Community Villages Limited v Pullham [2007] EWHC 1330 (Ch) the contract under consideration contained a clause to the effect that “in all matters relating to this agreement the parties will act with the utmost good faith towards one another …”. The contract related to the appointment of a developer to obtain planning permission which, to a large extent, had been done but the land owner decided to sell the land without planning permission.  Even though the contract contained no express prohibition on the land owner from selling the land before planning was granted, the court agreed, in injunction proceedings, that to do so would breach the express good faith clause. This approach has been followed in a number of subsequent cases.  CPC Group Ltd v Qatari Diar Real Estate Investment Co, a decision of Vos J. [2010] EWHC 1535 (Ch), para 246. That case was, in turn, cited with approval by Jackson LJ in Compass Group UK and Ireland Ltd (t/a Medirest) v Mid Essex Hospital Services NHS Trust, [2013] EWCA Civ 200, although the clause was held not to apply on the particular facts.  It appears clear that the courts will give effect to an express good faith provision.

Until recently few franchisors inserted express good faith obligations on themselves although it is common for franchisees to be required to act in good faith.  Increasingly franchisors are inserting specific good faith obligations with which they must comply. This has the effect of making it clear precisely what good faith obligations are being accepted rather than assuming any good faith obligation would be implied leaving it to the court to decide what good faith obligations to imply.

Implied Duty of Good Faith

An implied obligation of good faith and fair dealing was recognised by the House of Lords in Malik v BCCI [1998] AC 20, where there was no express obligation of good faith contained in the contract. The contract related to perhaps the most relational of relational contracts, an employment contract. The question then is the extent to which employment contracts are in a separate and special category to other commercial contracts.  There are grounds for suggesting that they may not be. In Bristol Groundschool Ltd v Intelligent Data Capture Ltd [2014] EWHC 2145 (Ch), the contracting parties collaborated to produce training manuals for pilots.  One of the parties, after the contract was terminated, downloaded material to continue selling the manuals.  The contract contained no prohibition on this but the court held that there was an implied term requiring good faith in its performance which had been breached by the “commercially unacceptable” activities of the party.  In D&G Cars Limited v Essex Police Authority [2015] EWHC 226 (QB) a police authority terminated a contract with a vehicle recovery company that had rebuilt a car that the police authority had required to be destroyed. The court held that the contract was a relational contract and that an obligation of “honesty and integrity” would be implied.

Nevertheless there are a number of cases where no such good faith obligation was implied. In Hamsard 3147 Ltd v Boots UK Ltd [2013] EWHC 3251 (Pat) the parties entered into an interim agreement that applied during the period in which they were negotiating a long term joint venture for the supply of children’s wear to Boots. In that case the judge found that the interim agreement could not be categorised as a relational contract and that, as a result, no good faith obligation would be implied.  The judge indicated that he did not accept that there was a general obligation of good faith in commercial contracts, in the following terms:-

“I readily accept that there will generally be an implied term not to do anything to frustrate the purpose of the contract. But I do not accept that there is to be routinely implied some positive obligation upon a contracting party to subordinate its own commercial interests to those of the other contracting party.”

No English cases have suggested that a duty of good faith should “routinely” be implied into all commercial contracts.  Further, as Mr Justice Leggatt points out in his lecture, the concept of good faith set out in Yam Seng does not, in fact, require such a subordination of commercial interests:-

“It does not require one party to put the other party’s interest before its own. That is the nature of a fiduciary duty. Good faith is different. Good faith demands loyalty, not to the other party, but to the agreement itself – to the bargain the parties have made through which each have sought to advance its own commercial interests by mutual collaboration[1]”.

Nevertheless, in the Carewatch v Focus Caring Services, Anthony J Grace, Elaine Grace [2014] EWHC 2313 (Ch) decision which was clearly a case involving a relational contract – a franchise agreement – the judge, in that case, refused to accept a duty of good faith and quoted with approval the statement set out above from the Hamsard decision.

Further, in a Court of Appeal decision, MSC Mediterranean Shipping Co v Cottonex [2015] EWHC 283 (Comm); [2016] EWCA Civ 789 the Court of Appeal considered a situation where a party to a contract had clearly committed a repudiatory breach but the innocent party refused to accept the repudiatory breach as bringing the contract to an end and its refusal to accept that the contract was at an end meant that the defaulting contracting party had to continue to make payments which far exceeded the innocent party’s loss.  In the High Court Mr Justice Leggatt indicated that the constraint on the innocent party’s power to keep the contract alive “could be seen as analogous to the now well established constraints on the exercise of contractual discretions and as a manifestation of a more general principle of good faith”.  Lord Justice Moore-Blick refused to accept that indicating that:-

“the better course is for the law to develop along established lines rather than to encourage judges to look for what the judge in this case called some “general organising principle” drawn from cases of disparate kinds.”

And he went on to say:-

“There is, in my view, a real danger that if a general principle of good faith were established it would be invoked as often to undermine as to support the terms in which the parties have reached agreement.”

In view of the above, it is clear that the position concerning good faith in franchise agreements continues to be unclear!

Contractual Discretion

The English courts have regulated the exercise of discretion which a contract grants to a contracting party.  In Abu Dhabi National Tanker Co v Product Star Shipping Ltd (the “Product Star”) (No 2)[2] Lord Justice Leggatt, the father of the judge in the Yam Seng case, said:

“Where A and B contract with one another to confer a discretion on A, that does not render B subject to A’s uninhibited whim … [N]ot only must the discretion be exercised honestly and in good faith, but, having regard to the provisions of the contract by which it was conferred, it must not be exercised arbitrarily, capriciously or unreasonably.”

That decision was followed in a number of cases using identical[3] or slightly different formulations[4].

In the Esso Petroleum Co Ltd v David Addison and others[5] case the High Court had to consider the discretion granted in a petrol station licence agreement (which contained many provisions which are similar to those found in franchise agreements) to Esso to vary margins offered to licensees on products supplied to them. The judge held:

“In general people enter into contracts on the understanding that the other party will act honestly and rationally (albeit in his own interests) rather than arbitrarily or capriciously, but whether it is necessary to imply a term to that effect is likely to depend on the nature of the contract and the circumstances in which it is made. Clause 6 gave Esso a wide power to vary the terms of the licensee’s remuneration and to that extent the licensee was at Esso’s mercy. I do  not think it is an answer to say that the licensee could give up his licence if he did not like the new arrangements. …  More importantly, however, the licence was intended to run for three years and provide an opportunity to develop a business over that period.  This requires a degree of mutual co-operation that is inconsistent with one party’s having the right to impose terms on the other in an arbitrary manner.  I am unable to accept, therefore, that if the question had been raised at the time they entered into the agreement either party would have thought for a moment that Esso was entitled to act arbitrarily, capriciously or irrationally in exercising its rights to vary the margin.”

The judge found that Esso’s discretion was subject to two limitations:-

–    It was not entitled to make adjustments arbitrarily, capriciously or irrationally;

–    and it was not entitled to make adjustments the combined effect of which was to render the operation of the service station commercially impossible.

More recently[6] Lord Sumption in the Supreme Court summarised the cases in the following way:

“As a general rule, the scope of a contractual discretion will depend on the nature of the discretion and the construction of the language conferring it. But it is well established that, in the absence of very clear language to the contrary, a contractual discretion must be exercised in good faith and not arbitrarily or capriciously. This will normally mean that it must be exercised consistently with its contractual purpose.”

[1] In National Private Air Transport Services Co v Windrose the judge found that an aircraft lease was not a relational contract but Mr Justice Blair in that case also rejected attempts to cast general doubt on the Yam Seng approach pointing out that it had been cited with approval by the Court of Appeal in Globe Motors v TRW Lucas Varity Electric Steering Limited [2016] EWCA Civ 396, para 67 as well as by the Court of Appeal in Singapore.

[2] [1993] 1 Lloyd’s Rep 397

[3] See for instance Paragon Finance plc v Nash [2002] 1 WLR 685

[4] See for instance Socimer International Bank Ltd v Standard Bank London Ltd [2008] 1 Lloyd’s Rep 558 where “concepts of honesty, good faith and genuineness and the need for the absence of arbitrariness, capriciousness, perversity and rationality” were applied.

[5] [2003] EWHC 1730 (Comm)

[6] British Telecommunications plc v Telefonica O2 UK Ltd [2014] UKSC42.


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