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Good faith clauses in commercial contracts

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.

‘Good faith’ clauses can be complicated and, before including or agreeing to a clause, you must ensure its properly drafted and understand its implications. Our team of highly experienced commercial lawyers will be very happy to advise you; please don’t hesitate to get in touch.

What is good faith in English contract law?

Unfortunately, there is no clear agreed definition but, in a commercial context, it has been found to cover ‘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’, which 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, in certain circumstances, still be incorporated into a contract and as such, it is important that its position within English law is understood.

Where might I come across good faith clauses?

Good faith clauses can be included in any agreement, but most especially within insurance and employment contracts, as well as in contracts with a long-term elementsuch 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 into the contract even if it is not mentioned. It can be excluded but any wording to do this has to be very specific.
  • 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.

See our article for more information on express and implied terms.

How can a good faith clause affect my 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, 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.

It has also been held to be implied when the contract is a ‘relational’ contract, because these contracts require collaboration, are long-term or involve significant investment and 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 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.

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. Are negotiations automatically conducted in ‘good faith’? Not automatically, although an express obligation in a contract to negotiate in good faith can be effective.
  4. 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.
  5. If your contract is detailed and clear and all obligations are fully and carefully set out, you won’t need an express catch-all good faith obligation because the parties will understand what is required of them.
  6. 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.
  7. Be wary of attempting to expressly exclude the concept of good faith. This is likely to raise the question ‘Why?’ by the other party and may make negotiations more difficult.
  8. 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.

About our expert

Edward Kilner

Edward Kilner

IP, Commercial & Technology Associate
Ed specialises in IT, IP and general technology-related contracts, but he also advises more broadly on commercial matters.  After completing his studies at the University of Birmingham, Ed trained at Harrison Clark Rickerbys, qualifying into the IP and technology team in 2017.  He joined the commercial team at Harper James in 2019.

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