Implied Duties of Good Faith in Commercial Contracts Under English Law

Implied Duties of Good Faith in Commercial Contracts Under English Law

December 23, 2022, Covington Alert

English law does not generally impose a duty of good faith on contracting parties, unlike some other legal systems. However, contracting parties should be aware of a growing body of cases in which a duty of good faith has been implied, and the ramifications for their contracts. English law also imposes some restrictions on the exercise of contractual discretion, which may be overlooked by contracting parties.

In this article, we consider recent developments in the circumstances under English law in which duties of good faith can be implied into commercial contracts, the potential impact of this on party obligations, the potential expressly to exclude implied duties of good faith, and the remedies available for breach of an implied duty of good faith.

In What Circumstances Can a Duty of Good Faith Be Implied into a Commercial Contract?

In recent years, a concept has developed in English law that a general duty of good faith is likely to be implied (where there is no express provision) into commercial contracts that are ‘relational’ in nature.

A relational contract is one that is long-term and calls for collaboration and co-operation between contracting parties and a greater regard for each other’s interests than would ordinarily be required between commercial contracting parties dealing with one another at arm’s length.

Just because a relationship between two parties is ‘relational’, it does not follow that any contract entered into in the course of that relationship must be relational. A non-exhaustive list of ‘ingredients’ for a relational contract was set out in a landmark 2019 High Court judgment, Bates v Post Office[1]:

1. There are no specific express terms preventing a duty of good faith being implied.
2. The contract is long-term, with the contracting parties mutually intending a long-term relationship.
3. The contract involves a high degree of communication, co-operation and predictable performance based on mutual trust, confidence, and expectations of loyalty.
4. The contracting parties intend that their respective roles be performed with integrity, and with fidelity to their bargain.
5. The contracting parties are committed to collaborating in the performance of the contract.
6. The spirits and objectives of the venture may not be capable of expression exhaustively in a written contract.
7. The contracting parties intend to place trust and confidence in one another (but of a different kind to that involved in fiduciary relationships).
8. There may be a degree of significant investment/substantial financial commitment by one contracting party (or both) in the venture.
9. The relationship may be exclusive.

It is not necessary for all of the ingredients listed above to be present. However, the more of these factors that are present, the greater the likelihood that the contract will be considered relational. 

It is important to remember that an implied duty of good faith is no different from any other implied term. In order for the duty to be implied, it must:

1. be either:
   1. necessary to give business efficacy to the contract, so that no term will be implied if the contract is effective without it (the ‘Business Efficacy Test’); or
   2. so obvious that "it goes without saying" (the ‘Officious Bystander Test’); and
2. be capable of clear expression and not contradict any express term of the contract (the ‘Cardinal Rule’).

If a contract does include express terms that refer to positive requirements to exercise good faith in relation to specific defined contractual obligations, then this may make it more difficult to argue that other terms, which do not refer to such requirements, ought to be subject to an implied duty of good faith.

Contractual Discretions: The Braganza Duty

Separately, the English courts have found that where a commercial contract requires one party to exercise a contractual discretion, that party is under a duty to exercise that discretion ‘rationally’. In summary, this is a duty to exercise the discretion reasonably and in good faith, and not arbitrarily or capriciously. This is sometimes referred to as the ‘Braganza Duty’[2]. 

The Braganza Duty is now well-established, and will be presumed to apply in the absence of clear language to the contrary.

The Braganza Duty does not amount to a duty to act reasonably in the colloquial sense.  Rather, it is defined by a test with two limbs: first, the court will assess whether the right matters have been taken into account by a party in reaching a decision in the exercise of its discretion, and second, the court will assess whether the result of this exercise of discretion is so outrageous that no reasonable decision-maker could have reached it. If the right matters have been taken into account and the result is not outrageous, the discretion will be deemed to have been exercised rationally.

What Additional Obligations Does a Duty of Good Faith Impose?

There is no single definition of ‘good faith’. In fact, very recent guidance form the Court of Appeal[3] on the interpretation of express good faith provisions warns against a “formulaic” approach that may detract from the court’s ability to examine the context in which a specific good faith provision was introduced and to interpret it accordingly. The Court of Appeal also warned against attempts to interpret references in contracts to parties performing obligations in "the spirit of the contract" as an "open invitation" to interpret the clause as imposing additional substantive obligations or restrictions outside the contract terms, providing that the court should instead seek to identify the shared aims of the parties from the express and implied terms of the agreement.

As such, any analysis of what additional obligations may be imposed by a duty of good faith will necessarily be very fact-dependent. That said, the English Courts have provided some guidance on what it means generally to act in good faith (and in bad faith).

An express contractual requirement to perform obligations in good faith has generally been interpreted as a duty to adhere to the spirit of the contract, to observe reasonable commercial standards of fair dealing and openness, to be faithful to the agreed common purpose, and to act consistently with the justified expectations of the other party. In practice, this has been found to include:

• Providing full and frank disclosure of material facts.
• Acting honestly and not lulling a contractual counterparty into a false belief, or pursuing an ulterior purpose.
• Not engaging in deception or the knowing provision of false information.
• In the context of a joint venture, not participating in undisclosed negotiations with third parties.
• Not knowingly commencing or persisting in a groundless dispute.
• Transparently reporting shortfalls in performance of contractual obligations.
• Co-operative and even-handed investigation of causes of failure to perform obligations.
• Transparency as to problems encountered with performing obligations.
• Having regard to a counterparty's interests (albeit while considering and taking into account one's own interests).

The courts have also provided guidance on what is not included in the concept of good faith.

First, good faith is not a fiduciary duty. Relational contracts, subject to an implied duty of good faith, involve trust and confidence but of a different kind from that involved in fiduciary relationships. Specifically, relational contracts do not require that one party subordinates its own interests to those of another, but rather that each party will act with integrity and in a spirit of cooperation.

Second, good faith is not simply another term for honesty. For example, there may well be acts which breach the requirement of performing the contract in good faith, but which it would be difficult to characterise definitively as dishonest.

When Drafting a Contract, Is It Possible Expressly to Exclude Any Implied Duty of Good Faith?

The answer is: in principle, yes. This is a further consequence of the fact that the duty is based on the contracting parties’ presumed intentions – as such, it is open to the contracting parties to modify the scope of the duty by the express terms of their contract and to exclude it altogether. 

The English courts have held that that there must be very strong, completely unequivocal language to ‘oust’ the Braganza Duty and ensure that a contractual discretion is treated as an absolute contractual right.

In certain factual circumstances, even clear language may not be enough. For example, in recent cases concerning employment/consultancy contracts purporting to provide an employer with an "absolute discretion" whether or not to award a bonus to an employee/consultant, the English courts have consistently held that such wording did not in fact provide an absolute discretion, but rather one that was subject to the Braganza Duty.

In practice, it may be commercially difficult to suggest excluding a duty of good faith at the outset of a contractual relationship. It may be more acceptable to expressly identify those obligations under the contract that are to be subject to a duty of good faith (thereby implicitly evidencing the contracting parties’ intention for other obligations not to be) and/or to state expressly that good faith duties only arise where expressly specified in the contract.

In relation to the Braganza Duty, a party may, in certain circumstances, want to consider including contractual wording to specify the extent to which any contractual rights are discretions, and/or as to exactly how any discretions are to be exercised – e.g. by outlining examples of conduct that will fall in and out of scope, in defined circumstances.

What Are the Remedies for Breach of an Implied Duty of Good Faith?

If the effect of the breach deprives the non-defaulting party of the ‘substantial benefit’ of the contract, they will have the right to terminate the contract and claim damages (including loss of bargain damages[4]), or affirm the contract (i.e. treat it as persisting irrespective of the breach) and claim damages (but excluding loss of bargain damages).

If the effect of the breach does not deprive the non-defaulting party of the ‘substantial benefit’ of the contract, then the non-defaulting party will not have the right to terminate but will be entitled to claim damages (excluding loss of bargain damages).

Damages for breach of an implied duty of good faith are awarded on the same basis as for breach of contract generally, and are subject to the same rules around causation, mitigation, reasonableness and remoteness. 

Equitable remedies may also be available, depending on the circumstances, including specific performance, injunctive relief and an account of profits.

Commentary

Where a commercial contract is classified as relational, it may be considered subject to an implied general duty of good faith. Further, many commercial contracts contain provisions that give the contracting parties discretion with respect to the exercise of contractual rights, which may be subject to the Braganza Duty requiring them to be exercised rationally.

When drafting commercial contracts, contracting parties should consider their intentions and the nature of the contract to evaluate whether it is likely to be considered a relational contract and, if so, whether further steps are required to protect their interests. Where disputes arise, such obligations can be another string to the bow of a claimant.

While there have been developments in other common law jurisdictions, in particular with regard to implying a general duty of good faith into all commercial contracts regardless of their type/the underlying facts, we consider that English law is unlikely to go this far, at least in the short-to-medium term. However, English law in this area is evolving, and contracting parties should continue to monitor developments.

If you have any questions concerning the material discussed in this client alert, please contact the following members of our Commercial Litigation practice.