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What does good faith mean in a commercial contract?

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6 mins read

Updated on 23 June 2023

Our subject expert
Edward Kilner

Senior Solicitor - Commercial

The concept of good faith in commercial contracts can be a source of confusion for businesses operating under English law, which generally does not impose an overarching duty of good faith.

However, it may still arise through express clauses or implied terms in specific contexts such as joint ventures or long-term relational contracts. Failing to understand when and how good faith obligations apply can leave your business vulnerable to misinterpretation or dispute.

Our team of highly experienced commercial contract lawyers can work with you to assess whether a good faith clause is appropriate in your agreements, help draft terms that clearly reflect your commercial intentions, and advise on the legal implications should disputes arise.

What is good faith in English contract law?

Unfortunately, there is no clear, agreed-upon definition; however, in a commercial context, it has been found to encompass ‘honesty and fair dealing’.

However, English law - unlike the US and much of Europe - does not have an overriding principle of good faith.

This is because:

The lack of agreement on exactly what is meant by ‘good faith’ leads to uncertainty in interpreting it in a contract.
The idea that the parties should have ‘freedom of contract’, ie, to agree and arrange business on whatever terms they like. The imposition of specific and pre-ordained obligations would contradict this principle.

Despite this, a duty of good faith can still be incorporated into a contract in certain circumstances. As such, it is important that its position within English law is understood.

Where might you come across good faith clauses?

Good faith clauses can be included in any agreement, but are most commonly found in insurance and employment contracts, as well as in contracts with a long-term element, such as franchise, construction, joint venture, and long-term distributorship agreements.

Usually, you’ll only become aware of the question of ‘good faith’ when one party feels aggrieved at the behaviour of the other party and a dispute arises as to its meaning within that particular contract.

When can the principle of good faith apply?

If there is:

Express agreement in the contract (whether it’s to the whole agreement or only to specified clauses).
The exercise of ‘discretion’ - if one party is exercising discretion during the course of the contract, that discretion must be exercised in good faith and not ‘arbitrarily or capriciously’ (known as a duty of ‘rationality’ or the Braganza duty). ‘Rationality’ is implied in the contract even if it is not mentioned. It can be excluded, but any wording that does this must be particular.
Implied by a court after a dispute over the clause has come before it. However, the law is not consistent in this area, and the existence of an implied duty should not be relied upon as a fallback solution. It will all depend upon the type of contracts and the circumstances of the case.

How can a good-faith clause affect your business?

It all depends on how the contract is interpreted!

It’s unlikely to require one party:

to consider the other’s commercial interests over its own, or
to remind the other of their rights under the contract.
Similarly, it is unlikely to be interpreted as overriding other express obligations in the contract.

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, the courts have held such a duty 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, they 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 requires a party to divulge certain information to the other party.

It has also been held to be implied when the contract is a ‘relational’ contract, as these contracts require collaboration, are long-term, or involve significant investment, and involve an honest and open relationship of mutual trust and confidence. Examples could include employment, insurance or franchise agreements.

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 types of clauses that tend to be called into question when the relationship takes a downturn. 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, including any endeavours clauses that set the level of effort required, to avoid this uncertainty further down the line.

What should your businesses be aware of?

There is no general duty of good faith in English contract law.
The courts may imply a duty of good faith, but only in specific circumstances, and this should by no means be relied upon.
Are negotiations automatically conducted in ‘good faith’? Not automatically, although an express obligation in a contract to negotiate in good faith can be effective.
You are perfectly entitled to use confidentiality agreements or other non-disclosure agreements to protect your commercial interests in a situation where you don’t yet know that anything will actually come of the discussions you are having.
If your contract is detailed and clear and all obligations are fully and carefully set out, including any conditions precedent that must be satisfied before obligations take effect, you won’t need an express catch-all good faith obligation because the parties will understand what is required of them.
If you do want a good faith clause, it has to be drafted carefully. It’s a good idea to include a list of possible actions as examples of what the parties agree amounts to good faith. It must be obvious that you and your counterparty both intend that the obligation will apply.
Be wary of attempting to exclude the concept of good faith expressly. This is likely to raise the question ‘Why?’ by the other party and may make negotiations more difficult.
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.

How to mitigate risk with expert contract advice

Good faith may not be a default requirement under English law, but its inclusion, or omission, can have serious consequences in certain contractual relationships. Our commercial contract lawyers help you assess whether reasonable faith duties are necessary, enforceable or potentially risky in your specific context. We assist with drafting and negotiating clauses that minimise ambiguity, enhance mutual trust, and protect your interests in the event of disagreement or litigation.

About our expert

Edward Kilner

Senior Solicitor - Commercial

Ed is a senior solicitor in Harper James’ commercial team, specialising in IT, technology and intellectual property. He qualified as a solicitor in 2017 and helps growth-focused businesses navigate the contracts and legal issues that underpin their technology, products and commercial relationships.

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