Does good faith apply in commercial contracts? Exploring English law and recent cases
English law does not recognise an overarching duty of good faith in contract law. However, there are certain situations whereby a duty of good faith may exist.
Commercial parties should always be aware of when and where the duty of good faith applies to their contract.
This article explains when the duty may apply and sets out the most recent legal developments in this area of contract law.
Does the duty of good faith apply?
The starting point is that there is no general duty of good faith under English law. The English courts have traditionally been at pains to uphold the principle that parties should be free, within certain limits, to agree the terms of their own contracts and it is not the role of the courts to police those contracts so as to ensure that the parties act in good faith.
The concept of freedom of contract is a core principle that underpins English contract law. However, there are three ways in which obligations of good faith may be incorporated into a contract:
1. Express duty
The drafting of a contract includes an express term that parties will act in good faith. The wording used for this clause can be a useful tool, if used to your advantage, but also a sword if unfavourable to you.
It’s important that you understand the terms of your contract and seek legal advice to ensure the contract is worded in accordance with your intentions.
2. Implied duty
The courts might imply a general duty of good faith into a contract. However, the application of a general duty is rare and restricted to a limited class of contracts.
This type of contract is often referred to as a “relational” contract. An example of a relational contract is the Post Office’s contract with its sub-postmasters.
Certain facts generally indicate a relational contract, such as the length of the contract/relationship, the parties’ intended roles, whether the parties intend to collaborate, the spirit and venture behind the contract, the exclusivity of the contract, and the expectation of loyalty.
3. Braganza duty
Coined from the case of Braganza v BP Shipping Ltd [2015] UKSC 17. This Supreme Court decision created a “duty of rationality.” This typically arises when one party is the decision-maker, and makes a choice that affects both parties, leading to the prospect of a conflict of interest.
The legal precedent imposes a duty to ensure the decision-making party does not abuse its role.
Legal uncertainty
English law generally favours a strict interpretation of a contract designed for commercial purposes. However, public law notions of good faith are creeping into the interpretations of such contracts.
There is significant legal commentary surrounding the implied duty of good faith and the Braganza duty. The law has not yet reached a definitive position, often leading to substantial litigation.
Implied duty
The conventional approach to interpreting contacts is strict, focusing on the true meaning of each word and clause. The potential of an implied duty diminishes the certainty of a contract and potentially limits the exercise of contractual rights.
Contracts are generally formed for private purposes and therefore the public moral notion of good faith is less likely to be a focus of a commercial entity.
Parties may be reluctant for a duty to be implied, when if this was the true intention of the parties, it should have been negotiated and expressly incorporated to the terms of a contract.
The ability to imply a term of good faith into a contract creates an unpredictable and wide ambit.
领英推荐
Braganza duty
Generally, the Braganza duty arises where there is a significant imbalance of power between parties. It is therefore less likely to be applied for sophisticated commercial parties who have the benefit of legal advice.
The precedent stemmed from very specific facts. The case focused on whether the employer of Ms. Braganza’s late husband, had properly exercised its discretion under his employment contract when denying his widow death in service benefits.
The employment contract allowed BP Shipping Ltd (“BP”) to refuse to pay out such benefits if it determined that the death was the result of suicide.
BP’s internal investigation concluded that Mr Braganza had committed suicide, leading BP to decline payment. Ms. Braganza challenged that decision, arguing that BP had failed to exercise its contractual discretion reasonably.
Generally, where a contract grants one party a discretionary which, if exercised, will affect the rights of both parties under the contract, that right must be exercised fairly and in good faith, and “not arbitrarily, capriciously or irrationally or for an improper purpose.”
The Supreme Court agreed with Ms. Braganza, holding that BP’s decision was unreasonable. The Court emphasised that a decision-maker exercising discretion under a contract must act reasonably, avoid arbitrary decisions, and take into account all relevant factors.
BP had failed to properly consider alternative explanations for the death and did not base its decision on solid evidence. The Court therefore found that BP had breached its duty in exercising contractual discretion.
To ensure compliance with the Braganza duty, a decision-maker should:
Given the nature of the duty, it is hard to expressly exclude the Braganza duty and therefore always needs to be considered.
Recent legal commentary
There are concerns and suggestions that the implied nature of good faith should be depreciated/downgraded.
Lord Sales (a Justice of the Supreme Court) and Professor Davies (a leading academic on English contract law), have both suggested that it would be preferable for the normal techniques of interpretation and implication to be used when considering a contract and the duty of good faith (i.e. to consider what is the “proper purpose”) of the clause.
However, those who focus on the public law notions, believe the duty should be possible of being broadly applied as needed.
Tesco Stores Ltd v Union of Shop, Distributive and Allied Workers and others [2024] UKSC 28
The Braganza duty has recently been cited in the above Supreme Court judgment of 12 September 2024. In summary, the supermarket chain was precluded by an implied term from exercising the right to dismiss employees on notice, for the purpose of diminishing their right to receive retained repay.
The judgment states that “there is now a substantial body of case law holding that, where a contract confers on one party a discretionary power, then in the absence of a clear contrary intention the exercise of the power will be subject to an implied restriction that the power must be exercised in good faith and not arbitrarily, capriciously or irrationally or for an improper purpose.”
Tesco submitted that the right of termination is not a discretionary power, but a contractual right. This was rejected by the Supreme Court.
The Court held that a contractual power (i.e. in this case the power to dismiss an employee) can be subject to the Braganza duty/duty of good faith. Rights should not be used “arbitrarily, capriciously or irrationally or for an improper purpose”.
Competing interpretation
The black letter law of interpretation and certainty within a contract is being challenged by the moral compass of the duty of good faith.
It is important that commercial parties consider their role in a contract, whether they are the party holding the decision-making power and whether the contract is considered “relational”.
How can Morr & Co help?
Morr & Co’s Dispute Resolution team is well-equipped to handle duty of good faith issues and can provide clear, strategic advice and representation, helping to resolve disputes related to contracts, business relationships and partnerships.
If you need any assistance drafting a contract or a dispute arises on the interpretation of a contract, please do not hesitate to reach out by calling our Dispute Resolution team on 01737 854500 or email [email protected]