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When does a duty of good faith arise in commercial contracts?

  • United Kingdom
  • Commercial agreements

29-04-2019

Introduction

The recent case of Alan Bates and Others v Post Office Limited revisits the issue of when a duty of good faith can be implied into a contract and thereby potentially limit the actions that one or more parties may wish to take.  There have been earlier cases prepared to imply a duty to act in good faith into certain contracts but equally there have been others that demonstrated a reluctance to imply such a term into commercially negotiated arrangements.   This latest judgment appears to confirm the concept of a general duty of good faith but only in contracts that can be categorised as “relational”.

Factual background

This case arose out of a long running dispute between the Post Office and various postmasters who had been sacked, financially ruined or imprisoned for what they believed were errors within the Post Office’s computer system which they were obliged to use: the Post Office in turn alleges that accounting errors were those of the postmasters and not of the system and that the terms of its contracts allow it to recover all losses from the postmasters as well as to terminate their contracts for convenience or for minor breaches.  

This decision will not be the end of the story of this dispute and deals only with the legal construction of the contracts between the Post Office and postmasters.

Legal background

Although some other jurisdictions recognise a concept of good faith that will apply to businesses in their commercial dealings, English law traditionally does not. Instead the position has been that under English law there is no general duty on contracting parties to act in good faith except under certain specific types of contract, such as employment contracts and others where a fiduciary relationship exists. However, since 2013 the position has been slightly unclear when a court decision introduced the idea of a category of “relational” contracts as examples of contracts where a duty of good faith may be implied.

Later cases seemed to rein back on this concept (or reined back from the idea that there is a general principle of implied duties of good faith in English law). However, the judge in the Post Office case interpreted these later cases not as cases which refused to recognise a separate category of “relational” contracts (this separate category being subject to a different approach in terms of the parties’ expected behaviour), rather that they did not recognise that the contracts in front of them were “relational” on the facts.

The decision in the Bates v Post Office case: identifying a “relational” contract

The judge in this latest case, having decided that the concept of relational contracts was an established one in English law, next looked at how to identify one, emphasising the categorisation was heavily dependent upon context as well as on what the actual contract terms say. 

Interestingly, he said that any imbalance of power should have no effect on whether a contract is relational or not (even although in this particular case, the Post Office was in what the judge described as “an extraordinarily powerful position” and the contracts were neither negotiated nor allowed by the Post Office to be negotiated or amended at all), nor should the unfairness of some terms or the length or detail of its terms be taken into account in making this categorisation – effectively saying that parties should not be allowed to argue a “relational” contract simply as a means to avoid the unfairness of particular terms.  

The judgment went on to identify relational contracts as having the following characteristics (as a non-exhaustive list with no single item on the below list being determinative other than the first one):

  • there are no express terms in the contract preventing the implication of good faith;
  • the contract is long term and there is a mutual intention of the parties 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 are committed to collaborating with one another in the performance of the contract;
  • the spirit and objective of their venture may not be capable of being expressed exhaustively in a  written contract (for example in this particular case there was an element of public service to the arrangement);
  • the contract will involve a high degree of communication, co-operation and predictable performance based on mutual trust and confidence;
  • there may be a degree of significant investment by one party or both;
  • exclusivity of the relationship may also be present.

It appears at first sight that many long term services agreements could be said to have some of these characteristics and the fear is that many long term arrangements could now be at risk of being categorised as relational and therefore involve the parties being subject to duties to act in good faith, whether or not they had expressly agreed to this.  However, the judge did point out that “very specific characteristics are necessary in order that a commercial contract is categorised as a relational one”.

The implied duty of good faith

The issue then is, if your contract is likely to be categorised as “relational”, what amounts to good faith.  The judge rejected the idea that good faith means only honesty but what else could be involved?  The judge said that good faith meant that “both parties must refrain from conduct which in the relevant context would be regarded as commercially unacceptable by reasonable and honest people. Transparency, co-operation and trust and confidence are, in my judgment, implicit within the implied obligation of good faith”. 

However, even with this statement of what good faith involves, it does not necessarily follow that it will be clear when a party has met its obligation to act in good faith, what else it is entitled to do and there may also be room for argument as to whether express terms of the contract which cover the same or similar ground are effective to exclude any implied duty to act in good faith.

Conclusion

This is just one of four trials on this issue, with the fourth trial scheduled for early 2020 and it may be that the Post Office will challenge some of these findings.  That leaves us in a position of being aware of the potential risk that a particular commercial transactions may fall to be categorised as “relational” as, if this is the case, it would involve an analysis of what would then be the best approach: relying on an implied duty of good faith, trying to exclude it or trying to delineate what it would entail, including working out whether it has the potential to curtail certain freedoms to exercise rights in a particular way.   

 

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