Withdrawal Agreement shows the dangers of good faith clauses

Withdrawal Agreement shows the dangers of good faith clauses

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With the UK due to exit from the EU at the end of the year negotiations between the parties about the terms of Brexit are ongoing. 

However, both the UK and the EU have recently accused each other of breaching good faith clauses in the Withdrawal Agreement. Specifically it has been widely reported the UK Government’s Internal Markets Bill could undermine obligations under the Northern Ireland Protocol and the UK believes the EU is imposing restrictions on it as a pre-requisite to even a basic Free Trade Agreement which it did not require for other countries. This has led to a lot of acrimony and threats to proceed under the dispute resolution procedure under the Withdrawal Agreement. The EU has now issued a letter in respect of the UK’s actions which could lead to formal legal action.

The conflict raises questions about the obligation to act in good faith in commercial agreements and what that duty means in practice. Good faith clauses are increasingly seen in commercial contracts but are they a good idea and what constitutes acting in good faith? Are parties subject to a duty of good faith if the contract is silent on the issue?

What does “acting in good faith” mean?

It means more than just acting honestly. According to the courts it is an obligation to act:

  • Honestly and with fidelity to the bargain or, put another way, not to act dishonestly or undermine the bargain, or the substance of the contractual benefit bargained for.
  • 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 assessed.

The concept of “fair dealing” in this context, particularly when assessed objectively, is not generally considered to be a demanding one. In practice, parties are required to do no more than refrain from conduct which in the relevant context would be regarded as commercially unacceptable by reasonable and honest people. However, the scope of the duty is wide and potentially uncertain. It is easy to envisage circumstances where one party considers it is acting honestly in accordance with its duty whilst the other sees its actions as commercially unacceptable. This leads to disputes as to whether the duty has been satisfied.

When will the courts imply a good faith clause into a contract?

The courts are showing themselves to be increasingly willing to imply good faith clauses into "relational" contracts and has provided guidance on what it considers a relational contract to be. In Yam Seng Pte Ltd v International Trade Corporation Ltd [2013] EWHC 111 (QB) the court said this included contracts which:

“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.”

Furthermore, in Bates & Ors v Post Office Ltd (No 3) [2019] EWHC 606 (QB), the court said that whether a contract was a relational one 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. According to Bates, a number of relevant characteristics should be considered: 

  • There must be no specific express terms in the contract that prevents a duty of good faith being implied into the contract.
  • The contract will be a long-term one, with the mutual intention of the parties being that there will be a long-term relationship.
  • The parties must intend that their respective roles be performed with integrity, and with fidelity to their bargain.
  • The parties will be committed to collaborating with one another in the performance of the contract.
  • The spirits and objectives of their venture may not be capable of being expressed exhaustively in a written contract.
  • They will each repose trust and confidence in one another, but of a different kind to that involved in fiduciary relationships.
  • The contract in question will involve a high degree of communication, co-operation and predictable performance based on mutual trust and confidence, and expectations of loyalty.
  • There may be a degree of significant investment by one party (or both) in the venture. This significant investment may be in some cases, more accurately described as a substantial financial commitment.
  • Exclusivity of the relationship may also be present.

While all or some of these factors may be relevant only the first characteristic is determinative. In short, if you do not want a duty of good faith implied into your contract, you can state this expressly in the contract. 

Even without such a clause in a relational contract, a duty of good faith is not automatically implied. The court will consider whether the language of the contract, viewed against its context, permits such an implication. Where a contract has been negotiated carefully between sophisticated parties who have carefully considered the terms it is unlikely that the courts will imply a duty of good faith.  

When should I include a good faith clause in my contract?

If you want a good faith obligation to bite on the parties (for example where a contract requires a high degree of co-operation and goodwill) it should be expressly drafted in. However, it is worth considering whether to limit its operation to certain clauses or sections of the contract to reduce uncertainty. Litigation based on alleged breaches of good faith clauses are fact specific and likely to be hard fought as a matter of principle. A well-drafted contract can help to stop such disputes before they begin.

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