Implied good faith obligations under English law

The most recent cases provide some further guidance as to when a good faith obligation may apply, even if not expressly stated in the contract. They also provide some guidance as to what such an implied term might mean in practice. As the cases show, the developing doctrine of good faith under English law may affect a party’s ability to enforce contractual rights in certain circumstances, even if no such restraint is expressed in the contractual drafting. Although the law in this area remains far from certain, these judgments are important for businesses to be aware of, particularly in a year such as 2020 which has seen many companies struggle with the impact of the Covid 19 pandemic on their ability to fulfil contractual obligations.

Recent cases

• In July, the High Court delivered its judgment in Cathay Pacific v Lufthansa Technik AG [2020] EWHC 1789 (Ch), which revolved around a contract for the provision of maintenance and repair services. Cathay Pacific could, according to the contract, “at its option”, remove certain elements from the scope of the services it was to provide to Lufthansa. However, it chose to exercise this option in a manner which Lufthansa had apparently not foreseen, and which ultimately, following the financial reconciliation mechanisms contained in the contract, left Lufthansa out of pocket. In its arguments, Lufthansa claimed that, in exercising the option, Cathay Pacific was: (i) subject to an implied duty of good faith since the contract was a “relational contract”; and (ii) subject to a implied of duty of rationality (the so-called ‘Braganza duty’ following Braganza v BP Shipping [2015] UKSC 17). The judgment contains detailed consideration of the current state of the law on both points, each of which was separately considered in the following two further cases this year.
• Judgment was handed down in June in Essex County Council v UBB Waste (Essex) Limited [2020] EWHC(?) 1581 (TCC), which centred on a 25 year contract to design and maintain a waste treatment facility. UBB Waste, which had been accused of numerous breaches of the agreement, argued in response that the contract was relational and that Essex CC had in fact breached the resulting implied duty of good faith.
• Meanwhile, earlier this year in April, in UK Acorn Finance Ltd v Markel (UK) Ltd [2020] EWHC 922 (Comm), the court was asked to consider whether an insurer was subject to the Braganza duty when deciding whether to accept the insured’s claim that a misrepresentation made prior to entering into the contract of insurance was innocent. The relevant clause stated that the insured had to demonstrate that any non-disclosure or misrepresentation was innocent “to [Markel’s] satisfaction.”

Relational contracts: an implied duty of good faith?

The law on relational contracts was first established in Yam Seng Pte Ltd v International Trade Corporation Ltd [2013] EWHC 111 (QB). A relational contract is one which sets out terms envisaging a long-term collaboration between the parties, as opposed to a single transaction. The court in Yam Seng considered that such contracts might include joint venture agreements, franchise agreements and long-term distribution relationships. In the intervening years, subsequent cases have applied the doctrine to long-term contracts for services (see UBB v Essex below as well as Bates v Post Office) and sponsorship agreements (Liverpool FC v New Balance). Where an agreement is relational, a duty of good faith may be implied by law and/or fact, in the absence of express language to the contrary.

The court set out some helpful indicators in Bates v Post Office Ltd (No 3) [2019] EWHC 606 (QB), noting that other features pointing towards the existence of a relational contract would be significant investment by one or both parties, exclusivity, a relationship of trust or confidence and a commitment to collaboration. The judgment in Bates also referred to a requirement that the spirits and objectives of the collaboration contemplated by the parties should not be able to be expressed completely in a written contract(and this was relevant to the judgment in the Cathay Pacific case – see below). Clearly, something beyond a simple contractual exchange of money for services is required.

Cases in this area have not always agreed that a general duty of good faith automatically follows once an agreement is classed as a relational contract, with some judgments making reference to the usual business efficacy test for the implication of terms. All have agreed, however, that where a contract is relational, it is more likely that the test will be met. This would mean that the parties to a relational contract will be required to avoid conduct that would be considered commercially unacceptable by reasonable and honest people in the specific context. This was expressed alternatively in the UBB v Essex case as “sharp practice.” A duty of good faith does not, however, require a party to put the interests of another party above its own.

The Braganza duty

Also at issue in the Cathay Pacific case was the Braganza duty: a separate minimum standard of good faith which can be imposed on parties seeking to exercise a discretionary right under a contract. Whilst the potential existence of this duty is not restricted to relational contracts, it could potentially apply in addition to, or as an alternative to, a general duty of good faith implied to such a contract. It is an exception to the general principle of English law that parties are free to enforce their contractual rights however they choose.

Where the Braganza duty applies, its effect is to imply a duty of rationality. This means that the party seeking to exercise such a discretion must take the relevant evidence into account (and the decision-making process should be documented) and cannot act capriciously or arbitrarily. However, it is important to note that even in a relational contract, the Braganza duty will not apply to every clause. It only comes into play where a party has the discretion to make a subjective decision which affects both parties.

The duty does not apply to clauses which confer an absolute contractual right. Distinguishing such a right from a genuine discretion is not always easy, but in general the Braganza duty is more likely to be engaged where a party is obliged to make some sort of assessment or consider facts presented to it before making a decision, rather than simply being free to exercise a right at any time. It is also worth noting that unequal bargaining power between the parties will make the existence of a Braganza duty more likely.

What did the courts conclude in the Cathay Pacific, Essex CC and Acorn cases?

• In Cathay Pacific, the court observed that the law on relational contracts had “not yet reached a settled state of clarity.” Having reviewed the factors set out in Bates v Post Office and other recent cases, the court asked whether the relevant tests were met. In this case, although the contract was long-term, it did not require the parties to “collaborate in future in ways that respected the spirit and the objectives of their joint venture but which the parties had not specified or had been unable to specify in detail.” In fact, the contract set out full details of the commercial relationship envisaged by the parties, and it was an ordinary contractual relationship for commercial services. Since it was not a relational contract, a duty of good faith could not be implied as a matter of law. Neither were the requirements met for it be implied as a matter of fact (i.e. it was not “necessary to give coherent effect or business efficacy to the Agreement”).
• The contract at issue in the Essex CC case, meanwhile, was deemed to be relational. Importantly the long term of the agreement was not the only feature present from the Bates The judge in that case pointed to the high degree of communication and co-operation required between the parties, as well as to the trust and confidence the parties required from one another. However, when considering whether Essex CC had breached the resulting implied term of good faith, it was clear that Essex CC’s behaviour had not included anything that would be considered commercially unacceptable in the relevant context by reasonable and honest people.
• Turning to the Braganza duty, the court’s view in Cathay Pacific was that the relevant option was a straightforward option that could be exercised at any time without any qualifications or requirement to conduct any kind of assessment beforehand. It was an absolute contractual right and therefore the Braganza duty was not engaged.
• The conclusion in the Acorn case was more favourable to the party seeking to argue that an implied duty arose, however. In this instance, it was clear that the insurer, Markel, had to consider evidence provided by the insured, Acorn, in making its determination. Whilst there was no qualification in the wording of the clause which stated that the evidence provided by Acorn had to meet Markel’s “satisfaction”, Markel had the ability to make a decision which would impact the rights of both parties. It was therefore subject to the Braganza duty when exercising this decision-making right and could not do so arbitrarily or unreasonably. On the facts, Markel had not taken into account the explanations provided by Acorn and had breached the duty.

What are the takeaways for businesses?

• Firstly, it is important to note that the implied duty of good faith applicable to relational contracts arising from Yam Seng and the subsequent case law is a separate and distinct duty from the duty to act rationally which can be implied to the exercise of specific discretionary rights under commercial agreements following Braganza. Nevertheless, the effect of each can be broadly similar, restraining parties from acting unreasonably or unfairly even in the absence of contractual language fettering their ability to do so.
• The overall takeaway from the recent cases is that, as always, the courts will not intervene to rewrite contracts where well-advised parties with equal bargaining power have simply made a bad bargain. It is not the courts’ job to identify what parties should have agreed, but rather to determine what they actually did agree. The evolving “good faith” principle in English law does not change this. The outcome of the Cathay Pacific case indicates that not every long-term contract will be subject to the good faith doctrine and to some extent represents a return to conventional principles. The contrast between the nature of the collaboration envisaged by the agreement in Cathay Pacific and that in the Essex CC case is clear.
• Perhaps the most important practical point arising from the gradual emergence of the doctrine of implied good faith under English law is that businesses should be careful to document the thought processes and governance procedures behind the exercise of discretionary rights granted to them under commercial agreements. Record-keeping can help to demonstrate that a party took into account the relevant facts and made its decision on reasonable grounds. Evidence of a rational and coherent decision-making process can help to prove that a party discharged any implied duty of good faith or rationality should they be held to apply.
• At the contractual level, if there are particular actions which a party wishes to be able to take unilaterally without being held to the Braganza duty, then it may be possible through drafting to identify these as absolute contractual rights. However, it is likely that simply adding words like “in its sole and absolute discretion” may not suffice where a party has the ability to make a decision which must be based on assessment of certain facts. Parties need to conduct a thorough analysis of contractual terms and ensure that they are aware of any potential restraints on their ability to take certain steps.
• Businesses seeking to agree long-term contracts should be aware of the possibility that such agreements may be classed as relational contracts. It is still not entirely clear from the case law that this will automatically mean a duty of good faith will be implied, but it will certainly make this more likely. Parties could seek to avoid such a duty by, for example, including an express statement that a contract is not relational (which could be a hard point to sell during negotiations), or explicitly stating that a duty to act in good faith attaches to certain clauses and that such a duty shall not apply except where explicitly stated. In the Cathay Pacific case, the presence of good faith wording in clauses other than the relevant option was a factor in dissuading the court from implying the duty to the option itself.