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Commercial Contracts and the Implied Duty of Good Faith and Fair Dealing

  • Ireland
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A practical quandary has arisen in recent years whether there is a general principle of good faith and fair dealing in Irish commercial contract law, in particular, in respect of parties to a Shareholders’ Agreement.

Resolution of this Quandary in Flynn

Clarity was provided to this question by Finlay Geoghegan J in the Court of Appeal decision of Flynn & anor v Breccia & anor1  (“Flynn”). Although, the Court of Appeal acknowledged that there are certain categories of agreements, such as partnership agreements and insurance contracts, where an implied duty of good faith and fair dealing may be implied, however, such terms will generally not be implied into commercial contracts, in particular, Shareholder Agreements. Therefore, Finlay Geoghegan J has considerably dampened any expectation that a mutual duty of good faith and fair dealing could be implied in commercial contracts generally. This decision makes it clear that where a party to a Shareholders’ Agreement wants to rely on a good faith or fair dealing provision, they must ensure that it is expressly included in the Shareholders’ Agreement.

Notably, however, the Court of Appeal did not expressly rule out the application of the UK decision of Yam Seng Pte Limited v International Trade Corporation2 in future cases, which suggested that an implied duty of good faith could be implied into a commercial contract where that contract fell within a particular class of agreement classified as a “relational contract”.

Background to the Flynn Decision
In Flynn the parties were both shareholders in Blackrock Hospital Limited (“BHL”), the company which owns and controls Blackrock Clinic. Benray Ltd (“Benray”) had taken out a loan with Anglo Irish Bank in order to fund its purchase of shares in BHL, and those loans were secured on its shareholding in BHL. All of the shareholders in BHL had provided cross security for Benray’s loans, and in the event that Benray was unable to pay the loan the lender could cause a forced sale of all the shareholders’ respective holdings in BHL. 

Benray’s loan was subsequently acquired from NAMA by Breccia, who was also a shareholder in BHL; Breccia then proceeded to demand repayment, and when Benray failed to discharge the sums demanded, Breccia appointed a receiver over Benray’s shareholding in BHL. Benray sought to restrain Breccia and the receiver from selling its shareholding on a number of grounds, including, that:

(i) each of the shareholders owed each other a duty of good faith and fair dealing; and/or,
(ii) they would not take any step which would cause another shareholders’ shares to be sold other than in accordance with the Shareholders’ Agreement.

The High Court’s Decision
In 2015, the High Court initially decided that the Shareholders’ Agreement (and the context in which it came to be executed) demonstrated the elements of a relational contract as contemplated in the Yam Seng decision in the UK and that therefore, it should be interpreted to include implied terms of good faith and fair dealing. The High Court granted a permanent injunction restraining the defendant from calling in the loans or appointing a receiver over the plaintiff’s shareholding.

The Court of Appeal’s Decision
In March 2017, the Court of Appeal overturned this decision and found that the trial judge was incorrect in respect of his interpretation of the Shareholders’ Agreement and that there was no implied duty of good faith and fair dealing between the parties. Further, there were no valid grounds for restraining a shareholder from calling in outstanding loans secured against another shareholding. The approach taken by the Court of Appeal is notable when compared to the trend seen in other common law jurisdictions such as the UK, in particular, but also Australia where implied obligations of good faith are more prevalent and Canada where a common law duty of honest performance has been found to exist. 

Similarly, the civil codes in France and Germany also incorporate notions of good faith in commercial dealings.

Implied Contractual Terms under Irish Contract Law
In relation to implied terms, the Court of Appeal referred to the well-established rules for implying terms into a contract, namely, that a term must be:

(i) necessary in order to give business efficacy to the Shareholders’ Agreement;
(ii) so obvious that it goes without saying (also known as the “officious bystander” test); and
(iii) certain and gives effect to the parties’ intentions.

The latter of these can occasionally be implied by reason of the conduct of the parties or on the grounds of it being a trade or professional custom. In Flynn, the Court of Appeal observed that there was a presumption against importing terms into a contract that is not in writing. The more detailed the written terms agreed, the stronger the presumption against the implication of additional terms. Finlay Geoghegan J also pointed to the fact that the Shareholders’ Agreement contained a single specific
clause requiring the parties to “negotiate in good faith” in the event that any provision of the Shareholders’ Agreement was found to be void or unenforceable, but did not contain any further general provisions on good faith. For this reason, it is essential that commercial contracts are drafted by experienced legal counsel so as to avoid uncertainty.

The Court of Appeal noted that Irish contract law does not recognise a general principle of good faith and fair dealing, although there are certain limited categories of contractual relationships which imply such duties, such as partnership contracts. This principle is in stark contrast to contract law in the UK.

The UK Position

In Yam Seng Pte, International Trade Corporation (“ITC”) granted Yam Seng the exclusive right to distribute Manchester United branded fragrances and toiletries across 42 duty free centres in Asia. The plaintiff terminated the distribution agreement on the basis of persistent breaches by defendant. The plaintiff then sought to argue that an obligation of good faith should be implied into the agreement on the basis that the defendant provided false information that it knew the plaintiff would rely on, and it authorised sales of the products by third parties in the markets covered by the distribution agreement at a lower retail price than the agreed duty free price. Legatt J held an obligation of good faith could be implied into the contract. The contract was a long term distributorship agreement which, the court noted, required the parties to communicate effectively and cooperate with each other. Legatt J classed this type of agreement as a “relational contract”. He cited examples of cases that would fall into the definition of a relational contract including joint venture agreements, franchise agreements and the type of long term distributorship that was the subject of the dispute.

The court in Yam Seng Pte stated that one of the reasons a relationship of good faith could be implied into the contract was that the agreement was skeletal and had not been drafted by lawyers, and in view of the court it would be more difficult to imply such a term into a detailed and professionally drafted document.

Yam Seng Pte could be described as a high water mark for the English Court of Appeal in terms of implying a duty of care into such contracts. Subsequently, the court has taken a more narrow and restrictive approach which has arguably helped delay the opening of the floodgates. In Mid Essex Hospital Services NHS Trust v Compass Group UK & Ireland Limited3, for example, the UK Court of Appeal stated that the obligation to act in good faith under a specific contractual provision did not extend to the entirety of the contract. The respondent provided catering services to the appellant under a contract. The contract provided that if the respondent failed to meet certain specified performance levels the appellant was entitled to levy those deductions and terminate the contract. One particular clause of the contract contained an express duty to cooperate in good faith (to transmit information and provide full benefit of the contract to the customer). The respondent, relying on the decision in Yam Seng, sought to argue this good faith obligation should be construed widely so as to apply to the contractual provisions relating to performance, or to imply a general duty of good faith. The Court of Appeal found the obligation to act in good faith was limited to the purposes identified in the clause ie, to transmit information etc. The court stated that commercial common sense did not favour creating an overarching duty to cooperate in good faith in circumstances where it had been provided for in the contract in such a precise way: “if the parties want to impose a duty they must do so expressly.”4

A similar fact was present in the Irish Flynn decision where the Shareholders’ Agreement (the “Agreement”) also incorporated one specific reference to “good faith” in the document. The Shareholders’ Agreement contained a clause that required the parties to negotiate in good faith in order to agree mutually satisfactory terms in the event that any provision of the Agreement was found to be void, invalid or unenforceable. The court did not find that this requirement to act in good faith had any application beyond this specific clause and it is submitted that if parties to a contract wished to include a requirement to act in good faith they would have to include a clause that applied generally to the contract.

Practical Implications of Recent Case Law

The court in the Flynn decision confirmed that there is no general principle of good faith and fair dealing in Irish contract law. The court, however, fell short of stating that the Yam Seng Pte principles would not be applied in Ireland if a different set of facts had been presented. Indeed, the court acknowledged that there are certain types of agreements and contracts to which a duty of good faith applies, such as in a partnership agreement or the principle of uberrima fides (utmost good faith) in insurance contracts. It was clear, however, that the shareholders agreement in Flynn was not the type of contract that attracted a general duty of good faith. This was first and foremost because of its clear commercial nature and the fact that it had specifically included a “no partnership” clause.

While it is perhaps unlikely that the Irish courts will recognise an implied duty of good faith and fair dealing in commercial contracts (save where it is perhaps necessary to give business efficacy to the contract), any risk of the courts enthusiastically rowing in behind the approach seen in Yam Seng Pte and in jurisdictions such as Australia, Canada, France and Germany (to name but a few) can be mitigated by parties addressing the issue of good faith expressly, if that is the intention. It should also be made clear whether any good faith obligations will apply to specific obligations in the contract or if it is to have wider application to the contract as a whole, in which case a stand-alone clause may be advisable. Where appropriate, the parties may also wish to specify the precise actions required by the parties in order to meet that good faith requirement. In certain cases, it may even be appropriate to expressly exclude any good faith obligations (express or implied) however in doing so it will clearly be important not to jeopardise the personal relationship between the parties before the terms of the contract have been signed.

The one thing that is for certain is that parties will require contractual certainty when they enter into commercial agreements. The best way to achieve this is to have commercial contracts prepared and reviewed by professional, experienced solicitors. As stated by Mr. Justice Legatt in the context of the Yam Seng Pte decision, “the agreement is a skeletal document which does not attempt to specify the parties’ obligations in any detail. In relation to such a document it is easier than in the case of a detailed and professionally drafted contract to suppose that a part of the bargain has not been expressly stated.”

1. [2017] ICEA 74
2.[2013] EWHC 111 (QB)
3. [2013] EWHC 111 (QB)
4. See also MSC Mediterranean Shipping SA v Cottonex Asphalt [2015] EWHC 283 (comm) where the UK court held that if a general principle of good faith were established it would be invoked as often to undermine as to support the terms in which the parties have reached agreement.

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