Lessons learnt from the UK-EU stand-off: the risks of good faith clauses

Lessons learnt from the UK-EU stand-off: the risks of good faith clauses

Beneficial variations to an employment contract held to be void where the principal reason is a TUPE

With the EU and UK accusing each other of breaching duties of good faith enshrined in the Withdrawal Agreement, good faith clauses have hit the headlines recently, especially as the EU has since started legal proceedings against the UK. However, whilst the Withdrawal Agreement expressly requires each party to act in good faith, what this actually means is unclear.

Unlike in other jurisdictions, there is no implied duty of good faith between parties to a contract, and the English courts have traditionally been reluctant to erode this position; although, this may be starting to change.

Businesses across sectors should therefore take stock of this political saga and consider what a duty of good faith actually entails. Could you find that there has been one in your contract all along without you knowing about it?

Obligation to act in good faith

Before parties can decide whether a good faith clause has been breached, they first have to know what it requires. In most clauses, the wording is similar and requires the parties to act in good faith, usually adding words such as "utmost" or "absolute". However, in some cases, different words may be used, like requiring parties to act "in the spirit of trust, fairness and mutual cooperation".

However, the way in which the clause is worded could charitably be described as rather vague. To give an example, the courts recently held good faith to be “an obligation to act honestly and with fidelity to the bargain… and an obligation to act reasonably and with fair dealing having regard to the interests of the parties (which will, inevitably, at times conflict) and to the provisions, aims and purposes of the contract, objectively ascertained”. However, this was caveated with the understanding that the obligation of fair dealing was not a demanding one amounting to requiring a party to refrain from conduct, which would be regarded as commercially unacceptable by reasonable and honest people. Therefore, whilst clear examples of bad faith will fall foul of a good faith obligation, because the duty is vague and case specific, it can be hard to predict in advance what behaviour would be a breach of that duty.

In addition to considering the wording of the clause, the courts will also look at commercial context. This makes each case fact specific; although, some general principles do emerge. Specifically, a duty of good faith will not cut across other contractual provisions, which means parties can still exercise termination or other contractual rights, and it will not create new obligations that would otherwise need to be the subject of a new express term. In addition, it is not a duty to prefer the interests of the other contracting party, but rather to recognise and have due regard to the legitimate interests of both the parties. 

Implied duty of good faith

Given the uncertainty around express good faith clauses, parties may legitimately decide to steer clear of them altogether. However, this does not necessarily allow them to avoid them entirely. In some circumstances, the courts will imply a duty of good faith into a contract; broadly when they consider it to be a "relational" contract. According to Lord Justice Leggatt, this is where, “the parties are committed to collaborating with each other, typically on a long term basis, in ways which respect the spirit and objectives of their venture but which they have not tried to specify, and which it may be impossible to specify, exhaustively in a written contract”, giving examples such as joint venture agreements, franchise agreements and long-term distributorship agreements.

Importantly, further clarity on relational contracts was also given by Mr Justice Fraser last year, who said that it depended on the circumstances of the relationship, defined by the terms of the agreement, set in its commercial context, at the time the contract was entered into. He listed a number of relevant characteristics to be considered, such as whether the contract envisaged a long-term relationship, possibly exclusive, and involving a high degree of communication, co-operation and predictable performance based on mutual trust, and whether the contract was to be performed with integrity and fidelity to the bargain, and with commitment to collaboration.The possibility to express the spirits and objectives of the venture exhaustively in the contract was also to be considered and, if so, meant a duty of good faith is less likely to be implied.

Importantly, if a contract is relational, a court will only consider implying a duty of good faith where it is essential to grant effect to the parties’ reasonable expectations and business efficacy to the contract. Such a duty will only be implied where the language of the contract, viewed against its context, permits it. Therefore, a contract that expressly excludes the duty of good faith cannot have the duty implied into it, and a contract negotiated between sophisticated parties who have carefully considered what terms they want to be bound by should be unaffected.

Approach with caution

As always, the key to this issue is careful drafting. Unless you are comfortable with a good faith clause either expressly or implicitly included in your contract, you should expressly exclude it. This may cause your counterparty some consternation, which can be helped by including a duty of good faith but limiting its effect to particular clauses. It is also worth ensuring that, if possible, any duty of good faith is reciprocal.

This chapter of the EU-UK fallout should remind us all of the complexity of good faith clauses. Once properly understood, and then paired with careful and considered drafting, parties can move forward with greater confidence that they are acting in "good" faith.

First published by Business Matters. Reproduced with permission.

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