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Good Faith Clauses

Sep 04, 2018

With the exception of some limited clauses of contracts (e.g. contracts of insurance) English contract law does not incorporate a general obligation to act in good faith towards other parties in a contract.

Nevertheless, many contracts impose a contractual obligation to act in good faith towards each other. What does such an obligation require?

Words Used
Many different phrases are used in good faith clauses: ‘to act with the utmost good faith’, ‘to act in absolute faith’ and even ‘to resolve disputes by friendly discussion’. 

In practice, often nothing rides on these differing terms; they all mean to act in good faith.

It is possible to have good faith obligations only in respect of certain obligations in a contract and no such obligations in respect of the remaining obligations.

Meaning
In one case the judge summarised good faith obligations as being a duty to ‘adhere to the spirit of the contract, to observe reasonable commercial standards of fair dealing, to be faithful to the agreed common purpose and to act consistently with the justified expectations of the other part’.

How this applies to any particular contract depends on the individual circumstance of the case. However, the following examples illustrate some past interpretations:

  • Not to take action that frustrates the purpose of the agreement. In one case a landowner sold its land during the duration of a land promotion agreement affecting the land. The effect of this was to deprive the developer of any commission that might become due. The sale breached the good faith obligation as it frustrated the developer’s reasonable obligations that the contract would be fulfilled.
  • Require the disclosure of material fact. A developer had obtained top-up funding from a lender without disclosing it had borrowed other funds rather than provide them from its own resource. This meant the top lender lost out when the developer was unsuccessful. The top-up lender was able to sue the developer for breach of its good faith as they had effectively been induced into making the top-up loan by the non-disclosure of the other borrower.
  • A duty to act rationally should be based on the information that was available to the decision maker at the time.

Should You Enter Into a Good Faith Obligation?
It is becoming more common to include good faith obligations in commercial contracts. They do help bridge gaps in contractual relationships and encourage both parties to act towards each other in a fair and honest way.

However, as a duty of good faith has no universally accepted meaning and its application will vary accordingly to the specific facts of each specific case, including one may introduce a degree of uncertainty. They risk spurious arguments and could lead to unintended consequences; certainly few people would expect to disclose material facts that might help the other party. Including detailed terms about the substance of the contract (e.g. price, provision of information, controls on termination rights etc.) are probably better than incorporating a good faith obligation.

The Duty of Rationality?
In the absence of clear language to the contrary, a good faith obligation requires a party to exercise a contractual obligation rationality and not arbitrarily. This is often called the ‘Braganza Duty’ after the court decision which set it out. 

A duty to action rationally is a lesser standard than to act reasonably. Reasonableness requires an external objective standard to be applied, rationality is subjective but requires a minimum standard to the relevant parties thought process; there must be some logical connection between the evidence and the apparent reasons for the decision. It is intended to act as a safety value to protect one party authorising its role as a decision maker.

Examples of situations where the courts decided a duty of rationality applied are: 

  • Unilaterally setting or varying interest rates in a contract;
  • Refusing to allow pets to be kept on premises;
  • Carrying out valuations.

On the other hand, simple exercise of termination rights has been deemed not to be subject to such a duty.

To discharge a duty to act rationally the decision made must:

  • Ask the right questions;
  • Take the right matters into account;
  • Have evidence to support the decision;
  • Avoid an irrational outcome (i.e. one that is so absurd no reasonable decision maker could have made it).

In reviewing the decision the review should not be made with hindsight.


Michael Talbot

About the author

Michael Talbot

The Commercial Property team is led by Michael Talbot. Michael qualified as a solicitor in 1982, having graduated from Nottingham Trent University and Lancaster Gate ...

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