Contractual good faith

This section offers a high level overview of the interpretation of express terms of good faith in contracts, the related duty of rationality in cases of contractual discretion (sometimes called the Braganza duty¹), and finishes with a discussion of situations where good faith obligations have been implied into contracts.

Express terms of good faith

As stated, contracting parties can include terms under which they agree to act in good faith or to owe a duty of good faith. It is not easy to discern an overall pattern from the cases interpreting such provisions, except that the more sophisticated and detailed the contract, the less onerous the obligation of good faith is likely to be.   

In Re Compound Photonics Group², the Court of Appeal emphasised that a clause requiring a party to act in good faith must take its meaning from the context in which it is used.  A shareholders’ agreement contained an obligation on each shareholder to “at all times act in good faith in all dealings with the other Shareholders”. The majority shareholders removed two directors (who were also shareholders), who then issued proceedings for unfair prejudice. The Court of Appeal held that the majority shareholders had not acted contrary to the good faith obligation. If the contractual intention had been to prevent them from exercising their powers under company law to remove the directors, this would have been expressed in the shareholders’ agreement. The Court of Appeal placed weight on the fact that the shareholders’ agreement had been professionally drafted. Overall, in the context of the case, the duty of good faith clause imposed a core requirement that the parties should act honestly towards each other and the company, and not to act in bad faith towards each other. The court, however, declined to describe what conduct might fall into the category of bad faith.     

The courts have interpreted good faith obligations narrowly in complex commercial settings, in which it may be expected that contracting parties will have looked after their own interests and to have included all matters that they wish to. In Phones 4u Limited (in administration) v EE Limited and others³, Phones 4u claimed that a notice by EE not to extend or renew a major contract had no legitimate commercial reason, and was designed to cause Phones 4u to go into administration. Phones 4u alleged that EE’s conduct had been in breach of its contractual obligation to “in good faith observe and perform the term and conditions of this Agreement”. The court disagreed, and held that there had been no breach by EE of the provision to act in good faith. The contract was detailed and professionally drafted, and the obligation was limited to fairly narrow aspects of the relevant clause and did not give rise to a general duty. An indication of this was that the contract contained no corresponding good faith obligation on Phones 4u.

Rationality in cases where there is contractual discretion (the Braganza duty)

Contracts often give one party the power to exercise a discretion which will affect the rights of both parties. Generally, such a discretion must be exercised in good faith and not arbitrarily or capriciously. In its modern form, this duty is sometimes called the Braganza duty, after a Supreme Court case relating to an employer’s contractual discretion to pay death in service benefit. 

The duty includes an obligation to take relevant considerations into account, to exclude extraneous considerations, and to be consistent with the purpose of the contract. There are, therefore, similarities with the public law Wednesbury test.   

The duty will not, however, apply to so-called “absolute” contractual rights, such as the right to terminate a contract or to call in a loan. 

Implying a term of good faith

The test for the implication of terms into contracts, focusing on necessity and obviousness, is not easy to satisfy. The area in which good faith obligations have been most readily implied are so-called “relational” contracts. The foundational case of Yam Seng⁴ involved a wholesaler and distributor. The distribution agreement was short and was not drawn up by lawyers. The wholesaler stated that it intended to use another distributor in part of the relevant market, and knowingly gave the distributor false pricing information. The contract did not deal with these issues, and the court considered whether these actions were in breach of an implied duty of good faith. The court found that the contract could be classified as “relational”, by which was meant that a high degree of co-operation based on mutual trust and confidence, and expectations of loyalty, were implicit in the contract, and that the wholesaler had been in breach.   

A further example of the implication of a good faith term is Al Nehayan v Kent⁵. In a long-term joint venture with little contractual detail, the court found there to have been breaches of a duty of good faith where one party had (a) secretly negotiated to sell jointly owned property without informing the other, and (b) used its position as a shareholder to obtain a financial benefit at the other party’s expense.

In summary, an implied term of good faith will likely mean that the parties must avoid conduct that reasonable people would regard as commercially unacceptable and must not act to undermine the benefit of the agreed bargain.   

Conclusion 

Given the uncertainties surrounding good faith in English law, it is legitimate to ask whether including a good faith duty is worthwhile. It may seem desirable to have such an agreement, in particular if a long-term commercial relationship is envisaged, but bear in mind that doubts about what constitutes good faith conduct mean that the problem child status of the concept is likely to continue for some time.