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Contracts: good faith

In English law, there is no overriding principle of good faith. This is primarily due to the need for certainty in contract law and the concept of freedom of contract. That said, good faith can, in certain circumstances, still be a factor to consider under contract law and should not be ignored. Here we consider when the principle of good faith may apply to commercial contracts under English law and the practical implications of this.

Is there a doctrine of good faith in English contract law?

No, except for specific contract types, such as employment contracts and insurance-related contracts, English contract law does not include a doctrine of good faith. This is mainly because of the:

  • need for certainty in contract law; and
  • principle of freedom of contract.

The concept of good faith is inherently subjective and uncertain. There is no tried and tested definition and as such, the term ‘good faith’ can raise more questions than it solves. In the eyes of English law, this is not beneficial to contracting parties who require certainty and unequivocal contract terms.

In addition, English law takes the view that parties should be free to agree and contract between themselves as they choose and not be tied down to specific, pre-ordained obligations; insisting on a duty of good faith, or any other duty, would be contrary to this principle.

Notwithstanding the above, a duty of good faith can, in certain circumstances, still be incorporated into a contract and as such, it is important that its position within English law is understood. So:

  • the contracting parties can agree between themselves to act in good faith and explicitly state this in the contract;
  • the Braganza duty or duty of rationality provides that where a party has discretion under a contract, they must exercise that discretion in good faith and not arbitrarily or capriciously; and
  • a duty of good faith may be implied into certain contracts by the courts.

Can a duty of good faith be expressly agreed?

Yes, contracting parties can agree expressly in the contract to act in good faith but it is crucial that the wording is clear. Although it appears from case law that the wording used for such a duty can vary and need not follow a certain form, it must still be obvious that the parties intended that a duty of good faith would apply. For example, the courts held in one case that the parties had not expressly agreed to a duty of good faith where the wording provided that they were to ‘have regard’ to various ‘partnering principles’ because ‘having regard’ did not go far enough (Fujitsu Services Ltd v IBM United Kingdom Ltd [2014] EWHC 752).

In addition, the language used must be specific about whether the duty applies to the contract in general or to certain obligations within it. The courts tend to interpret good faith clauses restrictively, and so an overarching duty of good faith needs to be clearly expressed.

The meaning of ‘good faith’ and the obligations it imposes on the parties will, in the absence of clear, express wording, depend on the circumstances and context of the relevant case and are highly unlikely to negate other terms expressly set out in the contract. To ensure certainty, it is advisable to set out in the contract the actions required by the parties or at least include a list giving examples of what the parties had in mind. For examples of what ‘good faith’ has been held to mean by the courts, see How can a good faith clause affect business? below.

Including a good faith requirement in the contract can be helpful in focusing the parties’ minds on their actions and relationship with each other but given that the phrase ‘good faith’ has no accepted legal meaning in English law, the inclusion of it, even expressly, could cause uncertainty. Well-drafted, detailed contracts are key to avoiding such uncertainty. If obligations are fully and carefully set out in the contract, an express good faith obligation may not be required as the parties will understand what is required of them.

The duty of rationality

If a party is given some discretion in a contract, that discretion must be exercised in good faith and not arbitrarily or capriciously. This is the duty of rationality, otherwise known as the Braganza duty, and is an implied duty; it still applies even if not expressly mentioned in the contract. If they wish, the parties can exclude the duty of rationality but to do so the exclusion wording in the contract must be extremely clear and there is no guarantee that it will be effective.

To fall within the duty of rationality, the discretion must be exercisable by one party but relate to a point that affects both contracting parties and which, as a result, could lead to a conflict of interest. For example, the duty of rationality is likely to apply if a lender exercises its discretion to increase the interest rate on a borrower’s loan. If, in this case, the lender increased the interest rate by a ludicrous amount, they would not be acting in good faith and so would fall foul of the duty of rationality. However, the duty will not arise if a contracting party simply decides to exercise a contractual right, for example, terminating a contract in accordance with the agreement’s termination provisions.

To satisfy the duty of rationality, the decision maker must have considered the various options and have sound reasons for making the decision they did. If there is no chance that another person would have made the same decision, then the party will not be considered to have acted rationally. It is advisable to keep evidence of the reasons for making the decision. The type of evidence will vary depending on the decision and the situation but board minutes, correspondence, research documents, and so on might be helpful.

If a court finds that the decision-maker has acted irrationally, it will replace the irrational decision with one that it thinks should have been made.

Is there an implied duty of good faith?

Yes, in extremely limited circumstances the courts may imply a duty of good faith into a contract, but this should not be relied upon as the law in this area is not consistent.

The implication of terms into contracts is a complex topic and depends on the type of contract and the circumstances of the case (see Contracts: Express and Implied Clauses). Generally, the courts are reluctant to imply terms into contracts and this reluctance also applies to implying a duty of good faith. It appears that they will only do so if it is required to make the contract practically or commercially coherent (Monde Petroleum SA v Westernzagros Ltd [2016] EWHC 1472). Cases have shown, for example, that a party does not need to consider the other party’s commercial interests over and above their own and there is no requirement to tell or remind the other contracting party of their rights under the contract. In particular, the express terms of the contract will not be overridden by an implied duty of good faith; the courts are firmly of the view that parties are free to contract as they wish and will not interfere with this unless strictly necessary.

That said, the courts have found that a duty of good faith may exist where the contract is deemed a ‘relational’ or long-term contract, on the basis that these contracts require an honest and open relationship or mutual trust and confidence between the parties. Such contracts include franchise agreements, construction contracts, joint venture agreements and long-term distribution agreements, but it is important to remember that a duty of good faith will not necessarily be implied into a relational contract simply because it is a relational contract; it will depend on the facts and circumstances in each case.

Given the fluidity of the law in this area, any reliance on the implication of a duty of good faith is not advisable. Instead, clear and precise wording should be used in the contract itself to avoid uncertainty and to ensure that all parties are on the same wavelength in terms of what is required from them.

Can there be a requirement to negotiate in good faith?

Yes, in certain circumstances. A contractual obligation to negotiate in good faith can be effective, provided that it is an express obligation. If there is no contract in place, the courts are unlikely to find that good faith applies to negotiations on the basis that such a concept is ‘inherently repugnant to the adversarial position of the parties when involved in negotiations’ (Walford v Miles [1992] 2 AC 128).

How can a good faith clause affect business?

An express requirement to act in good faith can materially affect a business and its relationships and if called into question may result in a business being prohibited from certain actions which the parties may not have considered to be a breach of the good faith requirement.

Although an express duty of good faith is unlikely to require a party to consider the other party’s commercial interests over and above its own or to override other contractual obligations, such a duty has been held by the courts to:

  • prevent a party from acting in a way which would negate the purpose of the contract;
  • stop one party from misleading the other as to why certain information was required; and
  • prohibit a party from purposely giving incorrect information to the other.

All of these things may seem fairly obvious at first glance but in reality, may be difficult to determine. For example, the line between a party acting in a way which negates the purpose of a contract and acting in its own commercial interests, may not be clear-cut. And what about inaction? The courts have considered that a party’s failure to act may be a breach of a good faith duty and have held that a duty of good faith required a party to divulge certain information to the other party. This may come as some surprise to both business owners and lawyers alike.

Ideally, all contractual relationships will include some element of good faith, but care must be taken if it is to be expressly stated. It is easy to assume that the parties can work out what was meant at a later date, but these are the type of clauses that tend to be called into question when the relationship takes a downturn and at this point, a relaxed, amicable chat about how to move forward is unlikely to happen. The contract should be as clear as possible about what is required from each party to fulfil its obligations to avoid this uncertainty further down the line.

When should you include a good faith clause into a contract?

A good faith clause can essentially be inserted into any contract if the parties so wish but it should only be done with care and requires attention to detail. Arguably, if the parties’ obligations can be clearly set out in the contract, then this is preferable to having a general catch-all good faith requirement, which by its very nature, results in some uncertainty.

Can you expressly exclude a duty of good faith?

Yes, it is possible to expressly exclude a duty of good faith in a contract. However, before doing so, or even suggesting it to the other party, consider the implications of doing so. Suggesting that you may not wish to act in good faith is unlikely to reassure the other party to the contract and could turn the relationship sour before it has even properly begun. Similarly, if the other party to the contract suggests such wording to you, think about whether you wish to do business or enter into a relationship with them on this basis.

Points to note

  1. There is no general duty of good faith in English contract law.
  2. A duty of good faith may be implied by the courts but only in specific circumstances and this should by no means be relied upon.
  3. If the wording of the contract is clear and detailed in terms of the parties’ obligations, there may be no need to include good faith wording.
  4. If you do wish to include express good faith wording into a contract, ensure that the wording is carefully considered, thorough and extremely clear. It is a good idea to include a list of possible actions by way of example.
  5. Be wary of attempting to expressly exclude the concept of good faith. This is likely to cause concern and could ruin the relationship with your counterparty.
  6. If you are exercising a contractual discretion on behalf of both parties, keep notes and any other evidence of the decision-making process and the reasons for the decision which was made.

What next?

Our commercial contracts solicitors have plenty of experience in contract disputes and can provide you with commercial and practical advice at all stages of the contractual process. Call us on 0800 689 1700 or fill out the short form below with your enquiry.

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