01 May 2020

KWM Full English: Implied duties of good faith in the UK - when do they apply?

This article was written by Barri Mendelsohn, Jenny Willcock and Cassandra Ditzel.

Executive Summary

There have been several rulings in 2019 and 2020 in the UK Courts relating to implied duties of good faith under English law, and the Courts appear to be sending a consistent message in their findings. Whilst it is accepted law that there is no general duty of good faith in commercial contracts, a duty can be implied where it is in accordance with the presumed intention of the parties and their contractual relationship.  

Context and the circumstances of the relationship determine whether a contract is a “relation contract”, which may be identified by nine key characteristics, such as there is no specific express term to exclude good faith, the contract is of a long term nature,  there is an expectation of performance with integrity and a spirit of collaboration, whilst at the same time specific spirits and objectives are not easily able to be expressed in writing. 

For a relation contract there should be an element of trust and confidence and the contract in question will involve a high degree of communication, co-operation and predictable performance. There should also be a degree of significant investment by one party (or both) and exclusivity of the relationship.

If the Courts are able to find that a relation contract exists, they are more likely to be able to imply a duty of good faith between the parties, subject to the facts.

Additionally, in considering whether terms should be implied into an agreement, the UK Courts would only imply terms of good faith as a matter of fact to give a contract commercial or practical coherence – if an agreement did not need anything further implied to make it function and/or for it to achieve business efficacy, terms would not be implied. 

It is clear that the UK Courts are entertaining implied duties of good faith under English law but they are taking a more critical approach. In order to avoid any ambiguity, parties are recommended to expressly exclude implied duties of good faith, if the intention is for such duties not to apply or if they are to apply, to be more express as to what the parties intend as specific “good faith” obligations for each other to carry out.

Introduction 

A common theme in UK Court cases heard in 2019 was implied terms within commercial contracts and whether a duty of good faith could be implied into contracts. We consider the key rulings from 2019 below and show how there have been followed in cases in early 2020. 

March 2019

Bates v Post Office (No 3: Common Issues) [2019] EWHC 606 (QB)

Facts

The Post Office historically worked with sub-postmasters and, in around 1999/2000, introduced a new computerised system called Horizon for the accounting function both in the branches and between the branches and the Post Office. When using Horizon, the sub-postmasters experienced shortfalls and, when the Post Office became aware of these shortfalls, the Post Office held the sub-postmasters responsible and demanded that each sub-postmaster pay the shortfall in question. 

The sub-postmasters argued that the contract with the Post Office was relational, and that therefore the Post Office was subject to implied duties of good faith, fair dealing, transparency, co-operation and trust and confidence when dealing with the issues arising out of Horizon. 

Judgment

The Court held that, whilst there is no general duty of good faith in all commercial contracts, such duty may be implied where it is in accordance with the presumed intention of the parties. Whether any contract is relational is dependent on context, as well as the terms of any contracts in place. Circumstances of a relationship, defined by the terms of the agreement and the commercial context, determine whether a contract is relational or not. The High Court identified nine key characteristics to be taken into account when determining whether an agreement is relational:

  1. There must be no specific express terms in the contract that prevents a duty of good faith being implied into the contract.

  2. The contract will be a long-term contract, with the mutual intention of the parties being that there will be a long-term relationship.

  3. The parties must intend that their respective roles be performed with integrity, and with fidelity to their bargain.

  4. The parties will be committed to collaborating with one another in the performance of the contract.

  5. The spirits and objectives of their venture may not be capable of being expressed exhaustively in a written contract.

  6. They will each repose trust and confidence in one another, but of a different kind to that involved in fiduciary relationships.

  7. 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.

  8. 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 substantial financial commitment.

  9. Exclusivity of the relationship may also be present.

If the Courts are able to find that a relation contract exists, they are more likely to be able to imply a duty of good faith between the parties.

May 2019

Teesside Gas Transportation Ltd v CATS North Sea Ltd [2019] EWHC 1220 (Comm)

Facts

There was a capacity reservation and transportation agreement in place between Teesside Gas Transportation Ltd (“Teesside”) and CATS North Sea Ltd (“CATS”) which established the amount owed by Teesside to CATS in respect of the pre-determined capacity of gas pipeline allocated to Teesside. The fee payable by Teesside was calculated pursuant to a contractual formula. Under this agreement, Teesside had the right to “dispute, in good faith, any amount specified in an invoice”. In 2013, Teesside disputed certain amounts in an invoice and subsequently, over a period of five years, withheld the payment of £31.7 million to CATS. Under the agreement, the consequence of withholding any sums which were not the subject of a bona fide dispute bore an additional rate of interest of 2% above the normal contractual rate of interest.

Judgment

The Chancery Division found that, even if a case of bad faith was determined, the relevant enhanced rate of interest could only apply to such sums as were withheld in bad faith, from the moment at which their withholding was in bad faith. The questions to be considered were therefore (i) in which cases of withholding there was bad faith; and (ii) from what point such withholding was in bad faith.

Key to determining whether Teesside had withheld sums in good faith was the identification of what sums had been withheld, and why. The judge identified certain matters in respect of which Teesside withheld sums in good faith; where sums were withheld otherwise than in respect of those matters, they were not withheld in good faith. 

Boilerplate provisions in the agreement which made references to good faith indicated the parties’ intentions to define good faith obligations. The High Court found that these inclusions meant that no wider duty of good faith should be implied.

In this instance, the timeline for which Teesside withheld certain sums is also central to answering the question of good faith. In the first instance when Teesside received certain invoices and disputed some of the figures in the invoices, such disputes were in good faith because the figures were not presented with all information required in order to assess whether the fees were accurately stated. The judge accepted that Teesside would require an audit process in order to obtain additional detailed information to assist in determining whether the figures were accurately stated. 

When Teesside continued to withhold sums pending the production of the audit report which took three months, there was still no bad faith because, given the size of the exercise involved in the audit, three months was a reasonable amount of time for Teesside to take in order to obtain more information. However, after the production of the audit report, the judge determined that there was more of a case that Teesside had no bona fide grounds for withholding certain amounts because, at that point, Teesside had been provided with a reasonable explanation regarding the amounts from CATS. Consequently, the High Court declined to imply a general duty of good faith.

In August 2019, the Court held in Zedra Trust Co (Jersey) Ltd v Hut Group Ltd [2019] EWHC 2191 (reaffirming the position set out in both cases above) that terms could be implied into contracts only to the extent that it is necessary in order to give an agreement business efficacy.

September 2019

UTB LLC v Sheffield United Ltd & others [2019] EWHC 2322 (Ch)

Facts

UTB LLC (“UTB”) and Sheffield United Ltd (“SUL”) were shareholders of Blades Leisure Ltd (“Blades”), a company that owned and operated Sheffield United Football Club (“SUFC”). Blades, SUFC, UTB and SUL entered into an investment and shareholder agreement (“ISA”) and, when disagreements arose, SUL sought to dissolve the joint venture and exercised its call option set out in the ISA to purchase UTB’s shareholding by serving a notice to UTB. In response, UTB issued a counter-notice exercising the same in respect of SUL’s shareholding.

SUL claimed that UTB acted unlawfully in its attempts to acquire SUL’s shareholding, contrary to the ISA and contrary to a duty to act in good faith, and its obligation to work fairly and openly with SUL.

Judgment

There was no express obligation to act in good faith contained in the ISA or the articles of association of either SUFC or Blades. However, SUL argued that such duties and obligations of good faith were implied through the existence of (i) a quasi-partnership; and (ii) a relational contract, under both of which duties of good faith arise. 

The Court reviewed the articles of association of Blades and the ISA and ultimately determined that there was no quasi-partnership or a relational contract because of the detail and negotiation that had gone into the articles of association and ISA. The articles of association clearly set out the circumstances in which shares could be transferred or assigned to any party, as well as the rules under which Blades would be governed and UTB had followed the required procedures. The ISA was a carefully drafted and detailed contract between two sophisticated and professionally advised parties and went into great detail regarding the rights and obligations of each shareholder and the rules under which the business should be run. 

Clause 26 of the ISA was an entire agreement clause which, although claimed by SUL to be a boilerplate clause which should not be given weight, the judge found that it was effective and ruled out any other understanding between the parties relating to the affairs of Blades and the rights and obligations of the shareholders between themselves. 

In considering whether terms should be implied into the agreement, the Court determined that good faith would only be implied as a matter of fact to give the contract commercial or practical coherence and that the agreement did not need anything further implied into it in order to make it function and to achieve business efficacy.

In addition to the above comments, the Court considered that the ISA contained two express requirements on the parties to act in good faith in relation to certain dealings (neither of which were relevant on the facts), thus suggesting that a wider or general duty to act in good faith had not been assumed between the parties

2020

Recent decisions show that the High Court have looked at implication of good faith into contracts as a matter of fact rather than law.

At the beginning of 2020, the Chancery Court in Russell v Cartwright [2020] EWHC 41 (Ch) considered whether there was duty of good faith in a joint venture agreement between two parties. Whilst obligations of good faith were included in the agreement in certain places, these were limited to specific matters, not generally, and no party had breached these matters. 

Similarly to UTB LLC v Sheffield United Ltd a duty of good faith could also not be implied and, whilst the joint venture agreement was relational, it did not automatically create an implied duty of good faith. The parties had clearly considered duties of good faith and imposed these in certain limited circumstances.

Additionally, earlier this year the High Court ruled that a lender was not under an implied obligation to act in good faith when calling in a loan, requiring a valuation of a property portfolio and subsequently enforcing security. In Morley v Royal Bank of Scotland plc [2020] EWHC 88, the Court rules that the loan agreement was not a “relational contract” and, having breach the loan to value covenant, the bank had an absolute right to call in the loan, without any obligation to act in good faith. A more detailed review of this case from a banking perspective may be found here.

Conclusion

Whilst the High Court has established the concept of “relational” contracts”, these recent cases 2019 and 2020 suggest that the Courts take a more critical approach when implying duties of good faith, even where a relational contract exists. However, it is clear that the UK courts are entertaining duties of good faith in English law further than they have done so in the past, and look at both the contract and particular facts, before reaching a determination. 

To avoid any ambiguity, when drafting long-term contracts, always consider whether the contract may be considered “relational” by taking into account the key characteristic of such contracts. 

If implied duties of good faith are not intended to be included within the contact, then parties should expressly exclude these in the contract by stating that there is no duty of good faith toward each other.  However, if a duty of good faith is intended in certain circumstances or generally, then this should equally be expressly stated in the contract.


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