Ransford braham good faith in business relations

GOOD FAITH IN BUSINESS RELATIONS

Ransford Braham, QC.

Page |1

GOOD FAITH IN BUSINESS RELATIONS1

To the extent that people engage in business activities there is an expectation by each party that there is a benefit to be derived from the relationship. Trust and honesty are vital ingredients to the business process. Let’s face it no one would enter into an agreement with another if there was doubt as to the integrity or trustworthiness of the other.

Contracts are drafted in anticipation of a number of things going wrong and will set out the terms and conditions to guide the actions of the parties in the event of a dispute. These express terms often guide the Courts in their effort to resolve the dispute. However, unless one can see into the future not every wrong or potential breach can be anticipated and the sheer size of a contract that could possibly cover all things is enough to cause pause to the negotiations. Nevertheless, there is legislation in place to regulate the contractual rights and discretions of the parties and where there is no legislation there is the common law or the equitable doctrines. Perhaps one reason that not all things are expressly stated in a contract is because the parties have to come to the table with some ‘good intention’ to carry out their end of the bargain. Where there is discord and one party alleges the other has breached his end of the bargain because he acted in a manner contrary to the

1This

paper is limited to considering ‘good faith’ in the context of business relations/contract law. It is acknowledged that good faith has been present in equity in the duties of fiduciaries, contracts of insurance, and the law merchant. This paper will not consider those areas.

Page |2

spirit of the agreement the Court will ordinarily refer to the terms of the contract as a guide because of the premise that parties to a contract are free to negotiate their terms and those terms excluded were not intended to form part of the agreement.

This begs the following questions: 1. Does a duty of good faith exist in the performance of business or commercial relations? If so, does the duty arise by implication by law or as a matter of construction?

2. To what extent can the duty be negatived by an express provision or necessary implication?

What is meant by business relations2: “a connection/interaction between individuals / companies involving commercial endeavour designed to achieve some commercial end. In general these relationships or endeavours include contracts but not necessarily so, but for the purpose of this paper the aspect of the business relationship being focused on will be contracts�.

2Investopedia

defines Business relations as the connections formed between various stakeholders in a business or commercial settings, including but not limited to relations between employers and employees, business partners, and all the companies with which a company is associated as well as individuals pursuing such business or commercial objectives.�

Page |3

What is meant by good faith: Black’s Law Dictionary Eighth Edition defines good faith as “a state of mind consisting in 1) honesty in belief or purpose, 2) faithfulness to one’s duty or obligation, 3) observance of reasonable commercial standards of fair dealing in a given trade or business, or 4) absence of intent to defraud or to seek unconscionable advantage”.

To date however, there is no generally accepted definition of good faith in a contractual context. It is not an independent concept and takes its meaning from the context in which the Courts have chosen to consider it and thus its meaning and effect vary considerably depending on its use and in which jurisdiction it is being considered. The varying interpretations for good faith in contracts are: honesty3 in all dealings4; loyalty to the contract5; parties are to act reasonably in the performance of their obligations6; fair dealing7 and, fidelity to the parties’ bargain8.

In the Oxford Dictionary honest means “free of deceit; truthful and sincere” – genuine—interacting in a way absent fraud and fidelity means “continuing loyalty to a person, cause, or belief” 4 Fujitsu Services Limited v IBM UK Ltd. [2014] EWHC 752 (TCC). In Bluewater Energy Services BV v Mercon Steel Structures BV [2014] EWHC 2132 (TCC) the Court considered that ‘[h]onesty, fairness and integrity shall be paramount principles in the dealings between the parties’.

5 Strzelecki Holdings Pty Ltd v Cable Sands Pty Ltd [2010] WASCA 222 6 Renard Constructions v (ME) Pty Ltd v Minister for Public Works (1992) 26 NSWLR 234 and Vodafone Pacific Ltd v Mobile Innovations Ltd [2004] NSWCA 15 7 Yam Seng Pte Ltd. v International Trade Corporation [2013] EWHC 111 QB and RPR Maintenance Pty Ltd v Marmax Investments Pty Ltd [2014] FCA 409 8 Yam Seng Pte Ltd. v International Trade Corporation [2013] EWHC 111 QB 3

Page |4

Good faith is a concept that continues to evolve and due to its malleability and uncertainty as to meaning the result is an obscure area of law often discussed in the Courts, but it remains devoid of a precise legal meaning.

In Australia each party is required to ‘exercise the powers conferred upon it by the agreement in good faith and reasonably, and not capriciously or for some extraneous purpose’9 it is considered a general standard of fair dealing between parties and is synonymous with notions of reasonableness.

The Canadian Supreme Court in Bhasin v Hrynew10

recognizes a general

organizing principle of good faith which “exemplifies the notion that, in carrying out his or her own performance of the contract, a contracting party should have appropriate regard to the legitimate contractual interests of the contracting partner… [and] requires in certain, respects honest, candid, forthright or reasonable contractual performance”11.

Far Horizons Pty Ltd v McDonald’s Australia Ltd [2000] VSC 310. – The court accepted the principle in Renard Constructions (ME) Pty Ltd v Minister for Public Works that there was an implied term of good faith and fair dealing which obligates parties to exercise the powers conferred on them under the contract in good faith and reasonably, not capriciously or for an extraneous purpose.

In Brogden v Investec Bank plc [2014] EWHC 2785 (Comm) - Leggatt J considered the discretion exercised in calculating an employee’s bonus scheme and concluded: ‘where a contract gives responsibility to one party for making an assessment or exercising a judgement on a matter which materially affects the other party’s interests and about which there is ample scope for reasonable differences of view, the decision is properly regarded as a discretion which is subject to the implied constraints that it must be taken in good faith, for proper purposes and not in an arbitrary, capricious or irrational manner […] where the decision is final and binding on the other party.’

9

Bhasin v Hrynew [2014] 3 SCR 494 at 528-529 (a similar view was expressed by Finn J. in the Australian case of Hughes Aircraft Systems International v Airservices Australia (1997) 76 FCR 151 at 192.

11 Ibid page 529 paragraphs 65 and 66 10

Page |5

In English law ‘good faith’ has been “most aptly conveyed by such metaphorical colloquialisms as ‘playing fair’, ‘coming clean’ or ‘putting one’s cards face upwards on the table’. It is in essence a principle of fair open dealing.12

In the United States § 1- 201(b)(20) the Uniform Commercial Code (UCC) (amended 2003) defines good faith as “honesty in fact and the observance of reasonable commercial standards of fair dealing”13

Despite the difficulty in arriving at a precise definition for “good faith” the characterization of the term remains closely associated with the notion of honesty, reasonableness, fair dealing and mutual trust.

England

Interfoto Picture Library v Stiletto Visual Programmes Ltd [1989] 1 All ER page 352, paragraph J. See also Berkeley Community Villages Ltd and another v Pullen and others [2007] EWHC 1330 (Ch) paragraphs 95 and 96.

13 § 205 of the Restatement (Second) of Contracts (1981) provides for a general duty of good faith in all contracts and states “Every contract imposes upon each party a duty of good faith and fair dealing in its performance and its enforcement”. Comment d to § 205 states: “Good faith performance. Subterfuges and evasions violate the obligation of good faith in performance even though the actor believes his conduct to be justified. But the obligation goes further: bad faith may be overt or may consist of inaction, and fair dealing may require more than honesty. A complete catalogue of types of bad faith is impossible… ” 12

Page |6

Traditionally the English Courts avoid implying a duty of good faith in contracts but have considered the good faith concept to be implied generally in certain categories of contracts 14.

The decision of the Court of Appeal in Mid-Essex Hospital Services NHS Trust v Compass Group UK and Ireland Ltd15reaffirmed the traditional view that whilst English law will respect and enforce an express obligation to act in good faith, it will do this restrictively, looking to the context of the particular contract as a whole and will not imply a general duty of good faith 16.

In Mid-Essex, the Court of Appeal overturned the decision of the High Court wherein the pertinent good faith clause being relied on was deemed to be imposing on the Trust an obligation to cooperate in good faith and the High Court found that the Trust had failed to do so.

There is a generally accepted implied duty of good faith in certain categories of contracts, namely those involving employment (Horkulak v Cantor Fitzgerald International [2004]EWCA Civ 1287) insurance, agency and partnership generally where there is a fiduciary relationship (Socimer International Bank Ltd. v Standard Bank London Ltd. [2008] EWCA Civ.116). The Courts have not yet included franchising agreements as a part of this category known as ‘relational contracts’.

15 [2013] EWCA Civ 200. This case concerned a catering and service contract between the Trust (for a hospital) and the caterer (Medirest). When the performance of certain services did not meet the specifics in the contract the Trust relied on the discretion given to it under the contract to terminate the contract. Medirest commenced proceedings against the Trust claiming substantial damages for breach of contract and the Trust counterclaimed. In the first instance Cranston J held that the Trust breached the obligation to co-operate in good faith (clause 3.5); that the Trust’s discretion to terminate was subject to an implied term not to act in an arbitrary, capricious and irrational manner and that the Trust had breached this implied term. The Trust appealed.

16 Jackson LJ at paragraph 109; Beatson LJ at paragraph 151 14

Page |7

The contract in question contained a clause (clause 3.5) which provided: “The trust and the contractor will cooperate with each other in good faith and will take all reasonable action as is necessary for the efficient transmission of information and instructions and to enable the trust or, as the case may be, any beneficiary to derive the full benefit of the contract.”

Although the clause was an express clause requiring good faith in the conduct of the parties, the Court of Appeal formed the view that the clause did not imply a general obligation on the parties to cooperate in good faith. On its interpretation of the clause requiring a duty of good faith, the Court considered the contract in its entirety and Jackson LJ concluded that “[T]he obligation to co-operate in good faith is not a general one which qualifies or reinforces all of the obligations on the parties in all situations in which they interact. The obligation to co-operate in good faith is specifically focused upon the two purposes stated in the second half of that sentence” 17. Jackson LJ was of the view that “it was clear that the content of a duty of good faith is heavily conditioned by its context”.

17

Paragraph 106

Page |8

Beatson LJ in his contribution referred to the case of Yam Seng Pte Ltd. v International Trade Corp Ltd 18, and agreed with Legatt J’s emphasis that “what good faith requires is sensitive to context”.19

Beatson LJ went on to

express that “[T]he scope of the obligation to co-operate in good faith in clause 3.5 must be assessed in the light of the provisions of that clause, the other provisions of the contract, and its overall context” 20. He concluded that when looked at in context the scope of the expressed duty to co-operate in good faith takes its content from “the circumstances and the nature of the contract concerned.”

The Lord Justices in Mid Essex accepted the express reference to good faith but in keeping with the traditional view it would not expand the scope of its use by implying it applied beyond the express reference.

In Yam Seng Pte Ltd. v International Trade Corporation Ltd. 21 Leggatt J gave consideration as to whether good faith could as a general rule be implied into commercial contracts.

The case involved a distribution agreement between International Trade Corporation ("ITC") the supplier and Yam Seng the distributor for the distribution of branded toiletries and perfumes in duty free outlets. There [2013] EWHC 111 (which dealt with an implied obligation of good faith rather than an express obligation as in Mid Essex) 19 Yam Seng Pte Ltd. v International Trade Corporation Ltd, [2013] EWHC 111 (QB) Legatt J at paragraph 141 20 Ibid at Paragraph 151 21 [2013] EWHC 111 (QB) 18

Page |9

were a series of disputes between the parties and Yam Seng terminated the contract and alleged that ITC breached the implied term to work together in good faith. The contract however, made no mention of a duty of good faith.

Consistent with the position that there is no overriding principle of good faith the Court in Yam Seng formed the view that English law was not yet at the stage to recognize the requirement of good faith as a duty implied by law into all commercial contracts. 22

However, Legatt J’s deliberation demonstrates a

willingness of the English Courts to imply good faith terms into commercial contracts in certain circumstances. He was of the view that a duty of good faith can be implied “in an ordinary commercial contract based on the presumed intention of the parties” 23. That is, if the courts consider that the parties intended the term to form part of their contract, “the term must be so obvious that it goes without saying that the term is necessary to give business efficacy to the contract”24. The Courts’ analysis of the implication is part of the exercise in the construction of the contract as a whole and against a background of unstated shared understandings which inform their meaning 25.

This was the principle established in Interfoto Picture Library Ltd v Stiletto Visual Programmes Ltd [1989] Q.B. 433 23 Yam Seng Pte Ltd. v International Trade Corporation Ltd, at paragraph 131 24 Yam Seng Pte Ltd. v International Trade Corporation Ltd, referencing the Privy Council case of Attorney General for Belize v Belize Telecom Ltd. [2009] 1 WLR 1988 at 1993-5 25 Yam Seng Pte Ltd. v International Trade Corporation Ltd, paragraph 132 22

P a g e | 10

The Judge was of the view that some of the terms which Yam Seng argued ought to be implied on the basis of good faith and could be implied on the construction of the parties’ intention. 26

The Court assessed the parties’ background in relation to good faith and was of the view that "A paradigm example of a general norm which underlies almost all contractual relationships is an expectation of honesty….As a matter of construction, it is hard to envisage any contract which would not reasonably be understood as requiring honesty in its performance” 27.

Leggatt J. was of the view that “in some contractual contexts the relevant background expectations may extend further to an expectation that the parties will share information relevant to the performance of the contract such that a deliberate omission to disclose such information may amount to bad faith … English law has traditionally drawn a sharp distinction between certain relationships –such as partnership, trusteeship and other fiduciary relationships – on the one hand, in which the parties owe onerous obligations of disclosure to each other, and other contractual relationships in which no disclosure is supposed to operate. …many contracts do not

While a contractual duty of good faith could be implied the Court noted that where there was going to be construction based on the parties’ intention it would be done based on the merits and particular facts of each case. There was no underlying implied duty of good faith.

27 Yam Seng Pte Ltd. v International Trade Corporation Ltd, at paragraphs 135 (see also paragraphs 138 -142).

26

P a g e | 11

fit this model and involve a longer term relationship between the parties which they make a substantial commitment. Such “relational” contracts, as they are sometimes called, 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 the express terms of the contract but are implicit in the parties’ understanding and necessary to give business efficacy to the arrangements.

Examples of such relational contracts might include some joint venture agreements, franchise agreements and long term distributorship agreements. The Agreement in this case was a distributorship agreement which required the parties to communicate effectively and cooperate with each other in its performance”.28

Yam Seng Pte Ltd. v International Trade Corporation Ltd, at paragraph 142-143. In summary Leggatt J recognized that i) a duty of good faith is implied by law in some categories of contract (employment contracts, partnership agreements and agreements involving fiduciary relationships) but English law has not gone so far as to imply by law a duty of good faith into all commercial contracts. ii) a duty of good faith could, nonetheless, be implied in fact into an ordinary commercial contract based on the presumed intention of the parties. In this regard, one of two criteria must be satisfied: the term must be so obvious that it goes without saying or it is necessary to give business efficacy to the contract. iii) as contracts are interpreted contextually, norms of behaviour (whether generally accepted socially or more specifically in the context of a trade, commercial activity or contractual relationship) are relevant factors, even if such norms are not expressly drafted into an agreement. He gave the example of such a ‘norm’ in contractual relationships, the expectation of honesty which is both obvious and necessary to give business efficacy to commercial transactions. iv) there are ‘relational contracts’ which require a high degree of communication, co-operation and predictable performance based on mutual trust and confidence and which involve expectations of loyalty which (if not legislated for expressly) are implicit in the parties’ understanding and necessary to give business efficacy to the arrangements. v) the test of good faith is objective in that it depends not on either party’s perception of whether particular conduct is improper but on whether, in the particular context, conduct would be regarded as “commercially unacceptable by reasonable and honest people”. In other words, an objective analysis of the parties’ presumed intention and the relevant context in which the contract was made could justify implying a duty of good faith.

28

P a g e | 12

Leggatt J explained that contracts can never expressly provide for every event that may occur and in unforeseen circumstances contractual language must promote the "values and purposes expressed or implicit in the contract" 29.

Leggatt J considered that failure to imply good faith would be “swimming against the tide” given that the principle is well established in other jurisdictions, including most civil law systems and some common law systems.

He went on to say that “there is in my view nothing novel or foreign to English law in recognizing an implied duty of good faith in the performance of contracts. It is consonant with the theme identified by Lord Steyn as running through our law of contract that reasonable expectations must be protected…” 30

The English Courts will enforce express contractual terms requiring parties to act in good faith, but it comes down to a question of construction. The clause in question will be interpreted in the context of the agreement as a whole and on the facts of each case.

When Leggatt J coined the new term ‘relational contracts’ he opened the door to a new category of cases where good faith could be implied by law. He however provided no clear definition on what could be a relational contract

29 30

Yam Seng Pte Ltd. v International Trade Corporation Ltd, at paragraph 137 Ibid at paragraph 145

P a g e | 13

that is, is it defined by years of the relationship? Or by evidence of a substantial obligation?

In Bristol Groundschool Limited v Intelligent Data Capture Limited 31, the High Court implied a duty of good faith into a contract pursuant to which the parties had collaborated on producing training manuals for commercial airline pilots. In this case one party had behaved in a commercially ‘unacceptable’ manner when it accessed the other party’s computer and downloaded information. On the facts, the Court found that the unauthorised downloading of material by Bristol was commercially unacceptable and in breach of the implied duty of good faith.

In reaching its decision, the Court in Bristol found that the agreement in question was a ‘relational’ contract (a term coined by Leggatt J in Yam Seng). Spearman J said: “Although the Court of Appeal in the Mid Essex case made only passing reference to the judgment of Leggatt J in the YSP case, and, moreover, did not focus on the implication of the duty of good faith in contracts outside the categories mentioned by Leggatt J, I detect no element of disapproval of that judgment in the judgments of the

31

[2014] EWHC Civ. 200

P a g e | 14

Court of Appeal. Moreover, I respectfully agree with Leggatt J’s analysis” 32 and that “good faith extends beyond, but at the very least includes, the requirement of honesty”.

Spearman J placed trust at the heart of any commercial relationship so, subject to the context, an implied term as to trust may be read into the contract. He considered that breach of an implied good faith term was to “strike at the heart of the trust which is vital to any long-term commercial relationship” 33.

Although the extent to which “good faith” can be implied into commercial contracts remains vague, the courts appear to be prepared to imply such a duty where it is possible to do so based upon the presumed intention of the parties and a ‘test’ for good faith appears well established. The relevant test is whether the conduct in question would be regarded as “commercially unacceptable” by reasonable and honest people in the particular context involved.

In Mid Essex, Beatson LJ applied an objective test to determine the existence of a duty of good faith in the contract, “the test of good faith is objective in the sense that it depends on whether, in the particular context, the conduct would be regarded as commercially unacceptable by reasonable and honest people” 34 This

Ibid at 196 Ibid at paragraph 196 (xiii) 34 Mid Essex at paragraph 150 32 33

P a g e | 15

approach mirrors that of Leggatt J in Yam Seng and Spearman J in Bristol Groundschool.

The High Court has also implied a duty of “honesty and integrity� in the case of D&G Cars Ltd v Essex Police Authority.35 Here the claimant had a contract with the police to collect and crush vehicles. A vehicle was meant to have been crushed but instead the claimant used it in its own fleet. The defendant terminated the contract and excluded the claimant from the tendering process. The claimant brought an action alleging bad faith on the part of the defendant. The Queen's Bench Division dismissed the claim on the basis that there was evidence to show that a reasonable person in the defendant's position, and in possession of the facts which the defendant had, would have done precisely what the defendant had done and would have treated that which had been discovered (dealing with a

[2015] EWHC 226 (QB) D&G Cars, a vehicle recovery business, had a longstanding commercial relationship dating back to 1998 with the Essex Police Authority to collect and dispose of motor vehicles that had been damaged in road traffic accidents or used unlawfully. In March 2006 D&G entered into a new five-year contract to undertake vehicle recovery in particular areas of Essex. In 2008 another contractor withdrew from its contract and the police authority put this contract out to tender. D&G was invited to participate in the tender, which was governed by the Public Contracts Regulations 2006. Just before the contract was awarded, the police authority received an anonymous letter alleging that D&G had acted contrary to its obligations under its existing 2006 contract. The police authority carried out a preliminary investigation and suspended the 2006 contract pending the outcome of a full investigation. The results of the full investigation appeared to support the allegations and, while D&G's directors denied any knowledge or involvement, the police authority terminated the 2006 contract in August 2008 and notified D&G that it had been excluded from the tender competition for the new 2008 contract. D&G argued that this exclusion was in breach of the regulations and invited the police authority to delay the award of contracts pending the determination of the lawfulness of that exclusion. The police authority refused to do so and awarded the contracts to two other tenderers.

D&G commenced the following proceedings: In relation to the 2006 contract, it claimed damages for breach of contract on the grounds that the notice of suspension was a breach, as were the purported termination and removal of vehicles stored by D&G. In relation to the 2008 contract, D&G claimed that the police authority had acted in breach of the regulations in refusing to consider D&G in the tender process. D&G claimed that it had been discriminated against.

35

P a g e | 16

vehicle without the defendant's consent) as a repudiatory breach and also grave misconduct so as to lead to the termination of the contract and the removal of the claimant from the tender process.

Dove J held that the police had been entitled to terminate for material breach.

Significantly, the court also found that there was “a relational contract par excellence” giving rise to an implied term to act with integrity that had been breached despite the absence of a finding of dishonesty. Dove J said: “By the use of the term ‘integrity’, rather as Leggatt J uses the term ‘good faith’, the intention is to capture the requirements of fair dealing and transparency which are no doubt required (and would, to the parties, go without saying) in a contract which creates a long-standing relationship.”36

Bingham LJ in Interfoto Picture Library 37 was of the view that the English law had produced piecemeal solutions as needed in response to issues of unfairness. He expressed based on the facts of the case “[T]he tendency of the English authorities has, I think, been to look at the nature of the transaction in question and the character of the parties to it; to consider what notice the party alleged to be bound was given of the particular condition said to bind him; and to resolve whether in all the circumstances it is fair to hold him bound by the condition in question…”.38

Ibid.

[1989] QB 433 38 Interfoto Picture Library Ltd. v Stiletto Visual Programmes Ltd.0 [1989] QB at 445 36 37

P a g e | 17

Nonetheless his view of good faith was “in essence a principle of fair and open dealing.” “[It] does not simply mean that [the parties] should not deceive each other, a principle which any legal system must recognise; its effect is perhaps most aptly conveyed by such metaphorical colloquialisms as “playing fair,” “coming clean” or “putting one’s cards face upwards on the table.”

It is clear that in considering the duty of good faith whether implied or as an express term in the contract the English (through the Court of Appeal in Mid Essex) have decided to retain the firm traditional position, there is no general implied duty of good faith by law. However, the lower courts continue to make decisions based on a ‘new’ category of contracts, the ‘relational contracts’. These decisions are seen as an incremental process necessary to give piecemeal solutions to particular problems rather than embracing a broad overarching principle of a duty of good faith.

In Renard Constructions (ME) Pty Ltd v Minister for Public Works39, the New South Wales Court of Appeal held that the principal had a duty to act reasonably

(1992) 26 NSWLR 234 The Minister for Public Works (“the Principal”) entered into two NPWC contracts with Renard Constructions (ME) Pty Ltd (“the Contractor”) for the construction of pumping stations as part of a sewerage project in the Gosford/Wyong area. After the Contractor commenced work, delays occurred and the Principal gave notice to the Contractor under Clause 44.1 of the contract calling on it to show cause as to why the Principal should not take over the work or cancel the contract. The Contractor responded indicating that the Principal had not yet supplied materials which under the contract it was required to supply and the work would be completed soon after its supply. The Contractor was instructed to proceed and further delays occurred. After concerns that the delays were due to poor workmanship the Superintendent 39

P a g e | 18

and honestly when exercising powers under a standard form government contract. Priestley JA considered that the law should imply an obligation of reasonableness, in the sense of a duty of good faith and fair dealing in contractual performance40.

Priestley JA examined implication by fact and implication by law in deciding whether a term of reasonableness was implied in the contract. On the objective construction of the contract, he stated: “it seems to me relatively obvious that an objective and reasonable outsider to this contract upon reading subcl 44.1 would assume without serious question that the principal would have to give reasonable consideration to the question whether the contractor had failed to show cause and then, if the principal had reasonably concluded that the contractor had failed, that reasonable consideration must be given to whether any power and if any which power should be exercised41.

recommended the Contractor be called upon to show cause under Clause 44.1 in respect of both contracts.

Clause 44.1 conferred power to take over the whole or any part of the work or to cancel the contract. The Contractor indicated that it was willing and able to complete the contracts with a reasonable time and that it considered the action a repudiation of the contracts. The Superintendent, who was not fully informed of the relevant circumstances by the Principal, recommended cancellation of both contracts and the Principal took over the remaining works. The matter was referred to arbitration, the Supreme Court and appealed in the Court of Appeal on the grounds that the Principal was unreasonable in exercising its power to take over the work and exclude the Contractor from the site, in breach of an implied condition of the contracts. The issue was whether the Principal was under a duty to act reasonably. The Court of Appeal held that Clause 44.1 should be construed as requiring the Principal to act reasonably as well as honestly in forming the opinion that the Contractor had failed to show cause to his satisfaction and thereafter in deciding whether or not to exercise the powers conferred; this derived from the ordinary implication of reasonableness, the provision for the Contractor to be given an opportunity to show cause against the exercise of the power and the provision enabling disputes to be referred to arbitration. The Court of Appeal also considered that the duty of good faith and equitable interference in the exercise of legal rights is relative to considerations of reasonableness.

40 Ibid at 268 (Priestly JA, held the view that the notion of good faith was best expressed as a standard) 41 Ibid at paragraph 257

P a g e | 19

Priestley JA considered whether the term was required for business efficacy and concluded that a contract which allowed termination upon any default would make the contract as a matter of business quite unworkable. He said: “One way of explaining this view is to say that no contractor in his senses would enter into a contract under which such a thing could happen. The reasonable contractor, the reasonable principal and the reasonable looker-on would all assume that such a result could not come about except with good reason�.42

As to whether such a term satisfied the requirements of necessity, Priestly JA considered that necessity should not be used in the absolute sense: In regard to classes of contract to which particular implications have been recognised as attaching, it is not possible to say that the implication was always necessary, in the sense that the contracts could not have worked without the implied term43.

The approach of Renard was applied in Burger King Corp v Hungry Jacks Pty Ltd44, a franchising agreement where it was stated that a duty of good faith and reasonableness ensures powers under a contract are only exercised to the extent necessary to achieve the parties' legitimate contractual interest.

Ibid at paragraph 258 Ibid at paragraph 261 44 (2001) 69 NSWLR 558 42 43

P a g e | 20

In this case Hungry Jacks was to develop four new restaurants each year. It was to pay Burger King a fee for every restaurant not opened, unless the obligation to open a new restaurant was made good the following year. Burger King could terminate the franchise agreement if Hungry Jacks did not comply with any of its terms. Burger King terminated the agreement when Hungry Jacks failed to open four restaurants in a year.

The Court of Appeal of New South Wales accepted Hungry Jack’s claim that Burger King was acting for a purpose external to a franchise development agreement by exercising its power to terminate the agreement because Hungry Jacks failed to develop four restaurants per year in certain States as required by the agreement.

Despite the suggestion that all franchise agreements contain an implied duty of good faith this case established that this duty will only apply in circumstances where: 

It must be reasonable and equitable to imply the duty;



It must be necessary to imply the duty to give efficacy to the contract, so that no term will be implied if the contract is effective without it;



The duty must be capable of clear expression and so obvious that it ‘goes without saying;

P a g e | 21



The duty must not contradict an express term of the agreement.45

The Court of Appeal felt it necessary to imply the duty of good faith to give business efficacy to the agreement in Burger King Corp because the agreement gave Burger King a discretionary power to terminate the agreement on the basis of operational and financial grounds that involved subjective considerations. The discretionary power meant that Burger King could terminate the agreement for the slightest breach if it were not obliged to act in good faith.

The Court said that Burger King wanted to engineer a default of the agreement so that it could control the number of new Hungry Jacks’ branded outlets and ultimately ‘take back’ the Australian market, which was a purpose that was extraneous to the agreement46.

BP Refinery (Westernport) Pty Ltd v Shire of Hastings (1977) 180 CLR 266.

The Court found that Burger King had taken a number of steps that impeded Hungry Jack’s ability to comply with this requirement. For example, Burger King imposed a ‘freeze’ on Hungry Jack’s ability to recruit new third party franchisees by telling Hungry Jack’s that it must not send information to prospective franchisees because some of the information was out of date. The freeze was to remain in place until Burger King resolved the issue, but Burger King did nothing to assist in this process. Burger King also refused to allow Hungry Jacks to open new company-owned stores on the basis that Hungry Jacks did not meet Burger King’s financial or operational requirements at that time, despite the fact that there was no real basis on which to form this view and Burger King failed to specify how Hungry Jacks could meet the operational requirements.

45 46

P a g e | 22

Neither Renard nor Burger King Corp has been approved by the High Court, and dicta from the High Court suggests that a general duty of good faith may be problematic and should not be implied. Contractual obligations clearly arise from express terms of a contract, but may also be implied.47

However, where a term is not expressly provided in a contract, it may be implied only if such term is not inconsistent with the express terms of the contract.

In the absence of an express term, the High Court has not recognized a general duty on parties to act in good faith while negotiating and performing obligations under contract.

The New South Wales Court of Appeal revisited good faith in the case Vodafone Pacific Limited v Mobile Innovations Limited48.

Vodafone was a carrier, and

Mobile innovations resold Vodafone services. Pursuant to the Agent Service Provider contract, Vodafone was required to determine the number of new subscribers it would provide to Mobile to manage. The pertinent clause (18.4) read:- Vodafone will have the sole discretion to determine, from time to time, the target level in respect of the number of connections of New Subscribers. The target level will be

But as seen in the Australian Burger King franchise case an express term can be ‘amended’ to imply good faith in order to give business efficacy to the contract in particular where there is a discretionary power given to one party –a similar position was taken in the English Mid-Essex case that is, where a contract confers on one party considerable power over the other, courts have ruled to remove the capricious and arbitrary edge of those powers.

48 [2004] NSWCA 15 47

P a g e | 23

determined by Vodafone in conjunction with the determination of the Business Plan referred to in Clause 21.

One of the questions before the Court was whether there was a duty of good faith implied in the contract, and whether Vodafone breached its duty of good faith by setting the target level too low for Mobile to avoid stagnation and failure.

Giles JA noted that “an obligation of good faith and reasonableness in the performance of a contractual obligation or the exercise of a contractual power may be implied as a matter of law as a legal incident of a commercial contract” 49

He was prepared to consider in this case that unless excluded by express provision or because it was inconsistent with the terms of the contract, Vodafone was under an implied obligation to act in good faith and reasonably exercise it powers under the Agreement. He said, “I do not think the law has yet gone so far as to say that commercial contracts are a class of contracts carrying the implied terms as a legal incident, and the width and indeterminancy of the class of contracts would make it a large step”.50

Giles JA considered that because the power in the Agreement was expressed in terms of being a “sole discretion” of Vodafone, it was more unlikely to be subject

49 50

Ibid at paragraph 189 Ibid at 191

P a g e | 24

to a constraint of good faith. He advanced that with the further emphasis in the Agreement that, "Vodafone's decision will be conclusive and binding on the parties" and the emphasis again that it could be “exercised in any manner Vodafone saw fit” that these words cannot be passed over, and they weigh against the implied obligation of good faith and reasonableness in the exercise of the power51. He concluded “Without more, in my opinion, the implication of the obligation to act in good faith and reasonably in exercising the power of determining target levels …was excluded”52.

The Court recognized the general rule that good faith is not implied by law but even if it was it would be overcome by express terms to the contrary. It was of the view the implication of good faith can be a matter of construction and in this case it was not implied because it had been excluded.

In Esso Australia Resources Pty Ltd. v Southern Pacific Petroleum NL 53 the Victorian Supreme Court accepted the position that a duty of good faith could be implied into some contracts. Buchanan JA however, was reluctant to conclude that this duty should be implied as a matter of law so as to apply to all rights and powers under a commercial contract.

Ibid at paragraph 195 Ibid at paragraph 198 53 [2005] VSCA 228 at paragraph 25 51 52

P a g e | 25

The Supreme Court of Southern Australia held in Alstom Ltd v Yokogawa Australia Pty Ltd (No.7)54 that a duty of good faith is implied into every commercial contract. Bleby J said ”I consider that it is a term to be implied in every commercial contract, despite doubt expressed by some earlier cases that it was not to be implied unequivocally as a universal term. …however even if the term were not to be implied universally, this contract is one example of the type of contract where it must be implied”.55 He relied on ‘the three principles of "good faith" in commercial contracts, being an obligation on the parties to: 

cooperate in achieving the contractual objects (loyalty to the promise itself)



comply with honest standards of conduct, and



comply with standards of conduct that are reasonable having regard to the interests of the parties’56.

[2012]SASC 49 Yokogawa argued that Alstom breached an implied obligation of good faith by not doing everything necessary to ensure that Yokogawa could perform its obligations under the subcontract, particularly by failing to provide information and preventing Yokogawa from creating and updating an effective project work program. Yokogawa asserted that, as a result, it was unable to comply with the terms of the subcontract. Justice Bleby held that Alstom had breached the implied terms by not providing the information to Yokogawa, resulting in Yokogawa being unable to properly plan its works under the subcontract and to comply with its provisions. Accordingly, Alstom could not rely on the subcontract's liquidated damages regime.

55 This was based on the complexity and interdependencies of the project demanding a high degree of cooperation and reliance upon the good faith of each party. Bleby J also found there were implied terms imposing a duty to cooperate and not hinder the other party's performance.

56 Sir Anthony Mason, ‘Contract and its Relationship with Equitable Standards and the Doctrine of Good Faith’, The Cambridge Lectures, 1993 (8 July 1993), which was the basis of his later article, ‘Contract, Good Faith and Equitable Standards in Fair Dealing’ (2000) 116 LQR 66. As referenced by Elizabeth Peden in “Contractual Good Faith: Can Australia Benefit from the American Experience?” Bond Law Review, 2003 Volume 15 Issue 2.

Article 12.

54

P a g e | 26

The Western Australia Court of Appeal in Trans Petroleum (Australia) Pty Ltd. v White Gum Petroleum Pty Ltd57 relied on the New South Wales Court of Appeal case law authority for the proposition that a duty of good faith may be implied both in performing obligations and exercising rights may be imposed on parties to a contract.

In Auto Masters Australia Pty Ltd. v Bruness Pty Ltd.58 the Western Australia Supreme Court found that a breach of the express term of good faith in the franchise agreement had occurred on the basis that the franchisor had doubtful foundations for exercising a right to terminate, acted capriciously and unreasonably and also failed to have due regard to the legitimate interests of both parties.

Hasluck J said “[I]t follows from earlier discussion that, in my view, the good faith term in the Franchise Agreement was sufficiently certain to be enforceable. The content of the term is to be established by reference to the contract as a whole and the nature of the franchise arrangements. That being so, it was not open to the franchisor to exercise its rights and powers unreasonably or capriciously, although it was entitled to have regard to its own commercial self-interest.59

[2012] WASCA 165 [2002] WASC 286 59 Ibid at paragraph 150 57 58

P a g e | 27

He went on to say, “from my review of the decided cases that there is often thought to be a link between the obligation to act in good faith and the obligation to act fairly and reasonably. The notion of unconscionable conduct may not be coextensive with conduct conforming to the requirement to act in good faith but conduct which is held to be unconscionable within the meaning of s 51AC of the Trade Practices Act will probably be sufficient to constitute a breach of an express term providing for absolute good faith between the parties. The decided cases indicate that a party will not be acting in good faith if it acts capriciously or in an oppressive, unfair or intimidatory manner. The Court will have regard to the reasonableness of the conduct in question. The term "good faith" imports a duty to have due regard to the legitimate interests of both parties in the enjoyment of the fruits of the contract. In some circumstances a cynical resort to the black letter or literal meaning of a contractual provision may be taken into account in determining whether there has been a lack of good faith”60.

What is obvious in Australian jurisprudence is the approach taken by each State in formulating a definition for the duty of good faith and in establishing exactly what it entails. The decisions in each State highlights the conceptual difficulties with applying the ‘doctrine’ as an overarching principle. McDougall J of the New South Wales Supreme Court made the following observations61

60 61

Ibid at paragraph 148 Justice Robert McDougall, ‘The Implied Duty of Good Faith in Australian Contract Law’ on 21 February 2006.

P a g e | 28

Thus, I do not think that it is fruitful to enquire, in some a priori way, as to the content of the concept of “good faith� in a contractual context. It is necessary to look at the particular contract, to see what might be comprehended as a particular expression of the general concept of good faith, and then to enquire whether that particular term, or a term having that particular content, should be implied, or whether is excluded by express terms or necessary implication from them.

The majority of lower courts in some Australian states appear to be prepared to accept that all contracts contain an implied duty to cooperate and parties to a contract are obliged to enable each other to have the benefit of the contract. This implied duty of good faith however, is not above the express promises made by the parties to the contract or where the implied duty contradicts expressed contract terms. Where a contractual right or power advances only the interests of the party on whom it is conferred, good faith may be implied in order to bring about business efficacy in order to remove the capricious and arbitrary edge. An express term in a contract may exclude any implied obligations of good faith or reasonableness. If no express exclusion clause is made in the contract, then the courts will determine the existence of good faith with reference to all other clauses to the contract.

P a g e | 29

While the Australian state courts grapple with the doctrine of implied good faith the High Court has not definitely ruled on the issue. However in Royal Botanic Gardens and Domain Trust v South Sydney City Council62 the issue was raised but the court declined to determine it.

Nonetheless Justice Kirby expressed the view that to imply into a contract an obligation to act in good faith may be inconsistent with the notion of caveat emptor (buyer beware) and other common law principles outlining the circumstances in which a term may be implied into a contract. He said, “In Australia such an implied term appears to conflict with fundamental notions of caveat emptor that are inherent in common law conceptions of economic freedom. It also appears inconsistent with the law as it has developed in this country in respect of the introduction of implied terms63.

Canada Canadian law did not recognize a duty of good faith in contractual performance and there is no set of coherent guiding principles as to how and when a duty of good faith would exist.

(2002) 240 CLR 45 The Royal Botanic Gardens and Domain Trust (“the Trustees”) entered into a lease with the Council of the City of Sydney (“the Council”) in relation to an area of land called the Domain, which included a parking station and footway. The term of the lease was 50 years. Clause 1 of the lease provided that the yearly rent for the first three years was $2000. Clause 4(b) provided that the yearly rent payable subsequent to the first three years was to be determined by the Trustees having regard to “additional costs and expenses” arising out of construction, operation and maintenance of the parking station. The Council instituted proceedings claiming that the Trustees had regard to other additional costs and expenses not contained with clause 4(b). The Trustees contended that it was implied in the lease that the rent payable must be fair and reasonable. The issue was whether there was an implied term of good faith and reasonableness in the lease.

62

63

Ibid at 87

P a g e | 30

In Transamerica Life Canada Inc. v. ING Canada Inc.64 the Court did not recognize a “standalone duty of good faith that is independent from the terms expressed in a contract or from the objectives that emerge from those provisions. The implication of a duty of good faith has not gone so far as to create new, unbargained-for, rights and obligations. Nor has it been used to alter the express terms of the contract reached by the parties. Rather, courts have implied a duty of good faith with a view to securing the performance and enforcement of the contract made by the parties, or as it is sometimes put, to ensure that parties do not act in a way that eviscerates or defeats the objectives of the agreement that they have entered into�.65

Transamerica claimed for damages for misrepresentation and breach of warranties and covenants contained in a share purchase agreement. In its defence, among other things, ING pleaded that Transamerica breached certain implied duties of good faith and fair dealing and was precluded from asserting certain claims.

The basic facts are that on a pleadings motion, the motion judge struck the allegations relating to the duty of good faith. The Judge held that a duty to bargain in good faith was not recognized in Canadian commercial settings and would have the effect of adding to the obligations contained in the agreement contrary to the

64 65

(2003), 68 O.R. (3d) 457 (C.A.) Ibid Justice O’Connor at paragraph 53

P a g e | 31

“entire agreement” and “no rights in addition” clauses in the agreement. The judge struck out the plea that the agreement should be construed in accordance with the intentions and expectations of the parties and also struck out pleas of certain factual matters which were determined at Appeal to be possibly relevant to the pleas of a duty of good faith. The Judge concluded that ING’s pleas that Transamerica owed it implied duties of good faith were not tenable at law. The Court of Appeal reversed the decision and allowed the pleading to stand.

The Court’s analysis tied the duty of good faith to the terms of the contract. The Court in Transamerica was of the view that: 1- The terms of the contract are key both to a determination of the existence and scope of any duty of good faith, and to whether there has been a breach of the duty. A party claiming the existence (and breach) of a duty of good faith must be able to point to a specific term of the contract that it says has not been performed in good faith.

2- The terms of the contract can be supplemented by the “objectives that emerge” from those terms. Similar to a contractual interpretation that gives business efficacy to the agreement - by examining the purpose/objectives to determine whether a party’s conduct in relation to a term of the contract is in breach of those objectives.

P a g e | 32

3 - The duty of good faith does not create “new, unbargained-for, rights and obligations.” The duty of good faith does not stretch to impose an obligation on a party that is not expressed in the terms of the contract.

The Court noted that ING in its defence provided no specifics about what is entailed in the general duty, that the pleading “is vague and is not tied to the performance or enforcement of the provisions in the agreement” and that the pleading was not “linked to any alleged actions by Transamerica that would defeat any of the contractual objectives.”66 These findings reinforce the principles of law set out in the decision that establish the boundaries of the good faith principle.67

In Canada, the concept of a duty of good faith has been generally confined to particular types of contracts based on the obligations and the relationship (the ‘relational contracts’).

While the Supreme Court recognized the current Canadian common law regarding the duty of good faith in the performance and enforcement of contracts as: (i) uncertain; (ii) lacking coherence; and (iii) being out of step with Quebec and the U.S., it chose to impose an incremental step moving it closer to entrenching the principle of good faith.

Ibid at paragraph 64 This was followed in National Logistics v American Eagle Outfitters Canada 2012 ONSC 384 (Hourigan J at paragraph 52.

66 67

P a g e | 33

In the case Bhasin v Hrynew68 the seven justice panel of the Supreme Court of Canada released a unanimous decision that contract law implies a duty of good faith that requires parties to perform their contractual obligations honestly.

Cromwell J recognized that Canadian courts reached different conclusions on the issue of whether there was a general duty of good faith in contractual performance with some courts: 

of the view that a general duty of good faith as an implied terms in all contracts that establishes minimum standards of acceptable commercial behaviour: Gateway Realty Ltd v Arton Holdings Limited (1991), 106 N.S.R. (2d) 180 (S.C. (T.D.));



of the view that there exists no general duty in all contracts with good faith playing a limited role in certain types of contracts (dependent on the type of contractual relationship): Transamerica Life Canada Inc. v. ING Canada Inc. (2003), 68 O.R. (3d) 457 (C.A.).69

Cromwell J took the position “that it is time to take two incremental steps in order to make the common law less unsettled and piecemeal, more coherent and more just. The first step is to acknowledge that good faith contractual performance is a general organizing

68 69

[2014] 3 SCR 494 Ibid at paragraphs 38 and 39

P a g e | 34

principle of the common law of contract which underpins and informs the various rules in which the common law, in various situations and types of relationships, recognizes obligations of good faith contractual performance. The second is to recognize, as a further manifestation of this organizing principle of good faith, that there is a common law duty which applies to all contracts to act honestly in the performance of contractual obligations”.70

He described good faith as an ‘organizing principle’ -- not as law but as a standard that underpins and is manifested in more specific legal doctrines and may be given different weight in different situations; and that parties to a contract have a duty of honesty with each other.

“The organizing principle of good faith exemplifies the notion that, in carrying out his or her own performance of the contract, a contracting party should have appropriate regard to the legitimate contractual interests of the contracting partner. While “appropriate regard” for the other party’s interests will vary depending on the context of the contractual relationship, it does not require acting to serve those interests in all cases. It merely requires that a party not seek to undermine those interests in bad faith. This general principle has strong conceptual differences from the much higher obligations of a fiduciary. Unlike

70

Ibid at paragraph 33

P a g e | 35

fiduciary duties, good faith performance does not engage duties of loyalty to the other contracting party or a duty to put the interests of the other contracting party first.� 71

This organizing principle of good faith manifests itself through the existing doctrines about the types of situations and relationships in which the law requires, in certain respects, honest, candid, forthright or reasonable contractual performance. Generally, claims of good faith will not succeed if they do not fall within these existing doctrines. But we should also recognize that this list is not closed. The application of the organizing principle of good faith to particular situations should be developed where the existing law is found to be wanting and where the development may occur incrementally in a way that is consistent with the structure of the common law of contract and gives due weight to the importance of private ordering and certainty in commercial affairs.72

While the Supreme Court of Canada now recognizes a general duty of good faith in the performance of contracts which requires honest, candid, forthright or reasonable contractual performance, by recognizing this list is not closed it has left a gap and therefore recommends using existing law as the primary guide to future development.

71 72

Ibid at paragraph 65 Ibid at paragraph 66

P a g e | 36

The approach of recognizing an overarching organizing principle but accepting the existing law as the primary guide to future development is appropriate in the development of the doctrine of good faith. Good faith may be invoked in widely varying contexts and this calls for a highly context-specific understanding of what honesty and reasonableness in performance require so as to give appropriate consideration to the legitimate interests of both contracting parties. For example, the general organizing principle of good faith would likely have different implications in the context of a long-term contract of mutual cooperation than it would in a more transactional exchange: Swan and Adamski, at § 1.24; B. Dixon, “Common law obligations of good faith in Australian commercial contracts — a relational recipe” (2005), 33 A.B.L.R. 87.73

Cromwell J was of the view that: The principle of good faith must be applied in a manner that is consistent with the fundamental commitments of the common law of contract which generally places great weight on the freedom of contracting parties to pursue their individual self-interest. In commerce, a party may sometimes cause loss to another — even intentionally — in the legitimate pursuit of economic selfinterest … Doing so is not necessarily contrary to good faith and in some cases has actually been encouraged by the courts on the basis of economic efficiency

73

Ibid at paragraph 69

P a g e | 37

… The development of the principle of good faith must be clear not to veer into a form of ad hoc judicial moralism or “palm treeˮ justice. In particular, the organizing principle of good faith should not be used as a pretext for scrutinizing the motives of contracting parties.

Tying the organizing principle to the existing law mitigates the concern that any general notion of good faith in contract law will undermine certainty in commercial contracts. In my view, this approach strikes the correct balance between predictability and flexibility.

From the rhetoric of Cromwell J it appears likely that the recognition of the duty of good faith in the performance of contracts will be on a case by case basis.

The United States of America In the USA the doctrine of good faith has been codified in the Uniform Commercial Code (UCC) and the Restatement (Second) of Contracts. However, prior to the codification the duty of good faith and fair dealing began as an unstated provision that made an agreement enforceable.

In Wood v. Lucy,74 the plaintiff and defendant agreed that the plaintiff would have the exclusive right to place the defendant’s endorsements on others’ fashion

74

222 N.Y. 88 (1917)

P a g e | 38

designs and sell or license the defendant’s designs. In exchange, the defendant would receive half of all of the profits and revenues. The Plaintiff claimed the Defendant broke the contract by placing endorsements without his knowledge and keeping all the profits to herself.

The Plaintiff sued for damages. The

Defendant objected on the ground that the agreement lacked mutuality: the Plaintiff hadn't promised to do anything.

The Supreme Court of New York, Appellate Division, dismissed the complaint for a lack of mutuality. The promise was "'instinct with an obligation,' imperfectly expressed"-Wood's promise was implied. It stated:

“the defendant insists, however, that it lacks the elements of a contract. She says that the plaintiff does not bind himself to anything. It is true that he does not promise in so many words that he will use reasonable efforts to place the defendant’s indorsements and mark other designs. We think, however, that such a promise is fairly to be implied. The law has outgrown its primitive stage of formalism when the precise word was the sovereign talisman, and every slip was fatal. It takes a broader view today. A promise may be lacking, and yet the whole writing may be “instinct with an obligation,” imperfectly expressed. If that is so, there is a contract”.

The decision reflected a period in which contract law was changing. Justice Cardozo explained that "[w]ithout an implied promise, the transaction cannot

P a g e | 39

have such business efficacy as both parties must have intended that at all events it should have." Parties were required to use best or reasonable efforts to further the parties’ intention in a contract even when it was not expressly stated. The comments to section 204 of the Restatement (Second) of Contracts which provides for the supplying of "omitted essential terms," portray gap-filling of omitted terms as a post-interpretive step. Comment C states that "[i]nterpretation may be necessary to determine that the parties have not agreed with respect to a particular term, but the supplying of an omitted term is not within the definition of interpretation."75.

Subsequent cases began to rely on the implied duty to use best or reasonable efforts to further the parties’ intention in a contract even when it was not expressly stated and this implied duty was transposed into the gap filling implied duty of good faith.

In the US the view is that every contract imposes upon each party a duty of good faith and fair dealing in its performance and enforcement. Courts possess a considerable amount of discretion when applying the implied covenant there is no bright line rule or single definition, “Although the Covenant is a generally acknowledged principle, its precise contours are not fixed.” 76. That despite an

75 76

Restatement (Second) of Contracts § 204 (1981).

E.I. DuPont de Nemours & Co. v. Pressman, 679 A.2d 436, 443 (Del. 1996) (en banc)

P a g e | 40

existence spanning “at least three centuries of American legal thought . . . the term ‘good faith’ has no set meaning”77 and a definition of good faith and fair dealing for all cases has not been developed 78.

The Court in Baker v. Lafayette College79 noted that the meaning of good faith varies with the context of the contract and in applying the implied duty the courts form the view that it should be ‘fact intensive and should turn on the issues of compelling fairness’. 80

In the Restatement (Second) of Contracts/Uniform Commercial Code − Good faith is defined in the Uniform Commercial Code as “honesty in fact in the conduct or transaction concerned.” Fair dealing requires more than honesty that is, you cannot act in a way that is contrary to the spirit of the bargain, even if you give the opposing party notice of your actions.

It emphasizes faithfulness to an agreed

common purpose and consistency with the justified expectations of the other party.

It is the view that subterfuges and evasions violate the obligation of good faith in performance even if the actor believes his conduct to be justified. Bad faith defines what is

Dunlap v. State Farm Fire & Cas. Co., 878 A.2d 434, 440-41 (Del. 2005) (en banc) Wade v. Kessler Institute, 778 A.2d 580 (N.J.Super. A.D. 2001) 79 504 A.2d 247 (Pa. Super 1986) 80 In Cincinnati SMSA LP v. Cincinnati Bell Cellular Sys. Co., 708 A.2d 989, 992 (Del. 1998) 77 78

P a g e | 41

not good faith and may be overt or may consist of inaction. While a complete catalogue of bad faith is impossible, judicial decisions have recognized the following: evasion of the spirit of the bargain, lack of diligence and slacking off, willful rendering of imperfect performance, abuse of a power to specify terms, and interference with or failure to cooperate in the other party’s performance.81

The doctrine requires a party in a contractual relationship to refrain from conduct that prevents the other party from receiving the fruits of the bargain82 and a party who’s conduct frustrates the overarching purpose of the contract can be liable for a breach of good faith.

In Pennsylvania, the doctrine of necessary implication dictates that, absent an express provision, the law will imply a contract between the parties to “perform those things that according to reason and justice they should do in order to carry out the purpose for which the contract was made and to refrain from doing

81

§205 of the Restatement (Second) of Contracts (1981) Comment D Nemec v. Shrader, 2009 WL 1204346, at *5 (Del.Ch. Apr.30, 2009) This case involved two retired Booz Allen partners who, throughout their tenure, received annual grants of stock pursuant to an “Officer Rights Stock Plan.” Under that plan, Booz Allen had a right to redeem the retired officers stock at book value; book value was approximately $120/share. The Company negotiated to sell a part of its business at a price that translated to a total venture value of more than $700 per share. Despite prior assurance to the retired shareholders that it would not do so, the Company exercised the call prior to the sale. The retired shareholders then sued. The retirees claimed that had the transaction occurred earlier, they would have been able to participate in the $60 million purchase price. The plaintiffs claimed that, despite the express terms of the stock option plan at issue in the case, the defendant's decision to exercise its call option on the plaintiffs' shares just weeks before a lucrative merger was arbitrary and unreasonable because it advanced no legitimate interest of the defendant, yet denied the plaintiffs the right to participate in the merger consideration. The Court was unmoved by these claims from the two wealthy retired executives and ruled in favor of the Company.

82

P a g e | 42

anything that would destroy or injure the other party's right to receive the fruits of the contract.”83

In John B. Conomos, Inc. v. Sun Co., Inc84 the Court held that the “implied covenant of good faith and the doctrine of necessary implication are principles for courts to harmonize the reasonable expectations of the parties with the intent of the contractors and the terms in their contract.”.

The Courts in Delaware, Pennsylvania and New Jersey have stated that the covenant cannot be invoked to imply terms that would contradict, override or circumvent the express terms of an agreement. In Winshall v. Viacom Intern., Inc.85. the Delaware Court held that the implied covenant of good faith and fair dealing cannot properly be applied to give the plaintiffs contractual protections that “they failed to secure for themselves at the bargaining table.” In New Jersey the Court held that the principles of fair dealing cannot and will not alter the terms of a written agreement86.

Nonetheless the Courts in Delaware, Pennsylvania and New Jersey courts hold the view that the doctrine “[R]equires more than just literal compliance” with the

Somers v. Somers, 613 A.2d 1211, 1215 (Pa. Super. 1992) 831 A.2d 696, 707 (Pa.Super. 2003) 85 76 A.3d 808 at 816 (Del.2013) 86 Rudbart v. N. Jersey Dist. Water Supply Com'n, 605 A.2d 681, 700 (N.J. 1992) 83 84

P a g e | 43

express terms of the agreement it also requires the parties to “preserve the spirit of the bargain.”87 The doctrine of necessary implication will be employed to imply an obligation where it is clear that an obligation is within the contemplation of the parties at the time of contracting or is necessary to carry out their intentions, even without an ambiguity in the agreement. In other words, when fairness dictates, the covenant may be invoked, despite the express terms of a contract, to protect a party’s reasonable expectations.88

In Somers v. Somers,89 an Uncle and nephew entered into an employment agreement for uncle to act as a consultant. The agreement specified no term, but provided for a monthly consulting fee, and 50% of net profits from the project, which involved the construction of a correctional facility in New York. During negotiations for the project, the uncle and the nephew disagreed about the

Dunlap, 878 A.2d at 444 See Nemnec case at 88 above and compare with facts from Dunlap v. State Farm Fire & Cas. Co., 878 A.2d 434 (Del. 2005). Anne Dunlap was a passenger in Mark Cardillo’s vehicle and was severely injured upon collision with a Delaware Transit Corp. bus. She sued Cardillo, DART and the bus driver. Cardillo’s insurance company paid the policy limit of $500,000, yet DART offered to settle for $175,000 of its $300,000 policy limit.

Dunlap sought underinsured motorist (UIM) benefits and was informed by State Farm that she must exhaust all applicable tortfeasor policies before pursuing a UIM claim. The jury ultimately found Cardillo solely liable for the accident. State Farm paid the UIM coverage limit to Dunlap, and then State Farm was sued for bad faith. The trial court granted State Farm’s motion to dismiss with prejudice as State Farm had not unreasonably delayed or refused payment of its UIM coverage limits. The Supreme Court of Delaware upheld most of the trial court’s judgment; however, it ruled that State Farm’s refusal to cooperate with the Dunlaps’ request could be considered a breach of the implied covenant of good faith and fair dealing. The plaintiff claimed that, despite the express terms of the insurance policy at issue in the case, the defendant's insistence on the exhaustion requirement of the policy was arbitrary and unreasonable because it advanced no legitimate interest of the defendant, yet resulted in the plaintiff risking and ultimately losing monetary recovery ($125,000) in a separate lawsuit. Dunlap, 878 A.2d at 444-45. Here, the Court sympathized with Dunlap, who was catastrophically injured through no fault of her own. They also noted that insurance companies typically possess very unequal bargaining power with their policyholders. o The same five Supreme Court justices heard both cases.

89 613 A.2d 1211(Pa. Super. 1992) 87 88

P a g e | 44

handling of the claim and nephew terminated uncle’s employment. The Uncle sued alleging the nephew and company breached duties implied in the agreement.

The Court held, that the Uncle’s stated claim for relief for breach of employment contract is based on the implied duty of good faith and is therefore entitled to a trial to attempt to prove nephew and company breached their duty of good faith.

The courts expanded on the duty of good faith by describing it in various ways.

In Pennsylvania, the doctrine of necessary implication dictates that, absent an express provision, the law will imply a contract between the parties to “perform those things that according to reason and justice they should do in order to carry out the purpose for which the contract was made and to refrain from doing anything that would destroy or injure the other party's right to receive the fruits of the contract.” Although a complete list of types of bad faith is impossible to define, “it is possible to recognize certain strains of bad faith which include: evasion of the spirit of the bargain, lack of diligence and slacking off, willful rendering of imperfect performance, abuse of a power to specify terms, and interference with or failure to cooperate in the other party's performance.” The court found that this duty applied to at-will employment contracts.

P a g e | 45

In Sons of Thunder, Inc. v. Borden, Inc.,90 a Clam supplier sued a purchaser after the purchaser terminated a minimum supply contract. The contract contained an express provision that either party could cancel without reason. However, before termination, the buyer continuously breached other express provisions of the contract by not buying the required amount of clams from the supplier. Further, the buyer knew that the supplier depended on income from the contract to pay loans on his boats. The supplier alleged breach of contract and implied covenant of good faith and fair dealing, while the purchaser argued that the implied covenant of good faith and fair dealing cannot override an express and unambiguous termination clause in a contract.

The New Jersey Supreme Court held that an implied covenant of good faith and fair dealing cannot override express terms of the contract, including the termination clause in contract. However, the court found that an obligation to perform in good faith exists in every contract, including those contracts that contain express and unambiguous provisions permitting either party to terminate the contract without cause. The court emphasized the parties’ unequal bargaining power as one factor in its decision.

90

690 A.2d 575 (N.J. 1997).

P a g e | 46

The evolution of the concept of implied good faith and fair dealing in the USA shows an effort primarily aimed at ensuring parties to a contract do not interfere with or destroy the other party’s reasonable expectations with respect to the benefits to be derived under the contract. It is felt that the duty protects the ability of the parties to rely on their contracts, promises and the risks undertaken.

CONCLUSION Every jurisdiction is prepared at the very least to determine whether the doctrine of good faith applies and if it is implied whether it is to be based on a construction of the contract. Other jurisdictions are prepared to go further and to imply good faith as a matter of law.

Traditionally, some courts have been reluctant to accept a general doctrine of good faith for fear that it would lead to uncertainty in the interpretation of contracts and more importantly undermine the parties’ right to determine their contractual obligations.

It is left to be seen whether the doctrine may become generally applicable while addressing the issues of concern.

P a g e | 47

The discourse on the doctrine of good faith has presented an environment that is still uncertain, primarily due to the lack of a standard definition of good faith. Instead there is reliance on behavioural terms to guide the process in reliance on the term. The expectations of parties and the reliance on the Court to construct and gap fill also add to the uncertainty.

It has therefore become necessary for Attorneys in drafting agreements to either expressly exclude all potential implied duties of good faith or expressly include it and then detail with precision the context in which it will apply.

RANSFORD BRAHAM, QC OCTOBER 11, 2016