Australia: Good faith in commercial contracts: The journey and the destination

The express obligation to act in good faith has long been recognised as a feature of contract law across a number of jurisdictions in Australia and internationally. However debate continues as to its scope and application.

In North East Solutions Pty Ltd v Masters Home Improvement Australia Pty Ltd,1 the Supreme Court of Victoria recognised that an express obligation to act reasonably and in good faith to attempt to resolve differences in relation to the amount of Woolworths' contribution of the cost of developing a Masters store was enforceable.

THE OBLIGATION TO ACT IN GOOD FAITH IN AUSTRALIA

An express obligation to act in good faith is often used in contracts to impose a certain standard of behaviour on the parties in performing their obligations. It is commonly used in long-term supply contracts or joint venture operating agreements (typically seen in the energy and resources sector), teaming agreements, and relational contracts.

As a general proposition, an agreement to negotiate "reasonably" and "in good faith" is sufficiently certain to be enforceable.2 However, there is no clear judicial statement as to the definition or scope of the term in Australia, and what is considered good faith will inevitably turn on the facts of each case.3

This was confirmed in Strzelecki Holdings Pty Ltd v Cable Sands Pty Ltd,4 where Justice Pullin held that the interpretation of the meaning of the words "good faith" is not determined by the parties' subjective understanding, but by the objective meanings of the words which a reasonable person would have understood them to mean.5

Further, Justice Pullin went on to note that in ascertaining the objective meaning, the contract must be considered as a whole,6 and the construction of the contract and interpretation of the words is determined by taking into account the objective background of the transaction or factual matrix of the contract.7 Any such determination though is not to include the subjective intention of the parties.8

In Macquarie International Health Clinic Pty Ltd v Sydney South West Area Health Service,9 President Allsop described the "usual content" of the obligation of good faith as incorporating:

  • Obligations to act honestly and with a fidelity to the bargain;
  • Obligations not to act dishonestly and not to undermine the bargain entered or the substance of the contractual benefit bargained for; and / or
  • Obligations to act reasonably and with fair dealing, having regard to the interests of the parties (which will invariably conflict) and to the provision, aims and purposes of the contract, objectively ascertained.10

Similarly, the duty of good faith is well established in the United States of America where a general implication of the duty is found in the Uniform Commercial Code (UCC) and the Restatement (Second) Contracts. The UCC defines good faith as 'honesty in the conduct or transaction concerned'11 and states that 'every contract or duty within this Act imposes an obligation of good faith in its performance or enforcement.' 12

A number of European civil law jurisdictions also recognise an overriding principle of good faith which encompasses fair dealing. On the other hand, English courts have been more cautious about embracing such a term.

THE NORTH EAST SOLUTIONS CASE AND THE APPLICATION OF "GOOD FAITH" AND "REASONABLENESS" TO AN AGREEMENT TO NEGOTIATE THE VALUATION OF CONSTRUCTION WORKS

In North East Solutions Pty Ltd v Masters Home Improvement Australia Pty Ltd and Woolworths Limited,13 the parties entered into an arrangement whereby North East Solutions Pty Ltd (NES) agreed it would develop a Masters store for Woolworths at a particular site in Bendigo. Once the store had been developed, Woolworths would lease the store for a period of 12 years, with options for a further five terms of six years each.

So as to not to delay the development of the store whilst the suite of technical and design documents was being prepared, Woolworths agreed that NES should commence the development as soon as possible, and that because a precise price could not be ascertained without the suite of technical and design documents, Woolworths would contribute the difference between the estimated cost of building a Bunnings store and a Masters store on the site.

The arrangement also included a provision that allowed either party to terminate the arrangement if the parties, acting reasonably and in good faith, were unable to resolve any disagreement that arose in relation to Woolworths' contribution of the construction costs (being the difference between the estimated cost of building a Bunnings store and a Masters store on the site).

Ultimately a disagreement did arise as to Woolworths' contribution to the construction costs, and Woolworths terminated the agreement on that basis. NES commenced proceedings against Woolworths, arguing that Woolworths did not negotiate "reasonably" and in "good faith". Woolworths countered by arguing that the relevant provision of the arrangement was not sufficiently certain to be enforceable, and was instead, merely an "agreement to negotiate".

Justice Croft found that, in the circumstances and having regard to the express terms of the arrangement entered into by NES and Woolworths, that the parties committed to act reasonably and in good faith in an attempt to resolve differences in relation to a cost estimate. The object of this process and of the clause itself was to enable the parties to quantify the difference in cost as between the development of the site as a Bunnings store and the development of the site as a Masters store, costs which Woolworths had already committed to pay.14

The duty to negotiate reasonably and in good faith was therefore, in this instance, informed by those circumstances. As such, Justice Croft held that the express obligation to negotiate reasonably and in good faith which formed part of the arrangement agreed by NES and Woolworths was sufficiently certain so as to be enforceable.

CONCLUSION

The decision in the North East Solutions case is a timely and important reminder that when considering the application of the obligation of reasonableness and good faith, the interests of various parties in different sectors and industries will likely differ, and that the context in which the commercial relationship is based upon may dictate how the legal principles of reasonableness and good faith are applied.

Despite some continuing debate as to the scope and application of the obligation to act in good faith, what is relatively clear is that where there is an express obligation under a contract to act reasonably and in good faith, all parties to that contract must adhere to the principles outlined above.

Until the High Court finally decides to determine the concept of good faith once and for all, parties to a contract should continue to be mindful of the possible implications when agreeing to take on an obligation to act in good faith. This may well require that party to honour the spirit of the "journey" until the destination is reached.

Note: A follow up article will discuss how the North East Solutions case dealt with the quantification of damages. The authors acknowledge the assistance of Sarah Scully-Leaf, Summer Clerk, in preparing this article.

Footnotes

1 [2016] VSC 1

2 See United Group Rail Services Ltd v Rail Corporation of New South Wales (2009) 74 NSWLR 618

3 See Jobern Pty Ltd v Breakfree Resorts (Victoria) Pty Ltd & Ors [2007] FCA 1066 (23 July 2007) [138]

4 [2010] WASCA 222

5 Ibid [46]; see also Toll (FGCT) Pty Ltd v Alphapharm Pty Ltd (2004) 219 CLR 165

6 Ibid [47]; see also Australian Broadcasting Commission v Australasian Performing Right Association Ltd (1973) 129 CLR 99 at 109

7 Ibid; see also Toll (FGCT) Pty Ltd v Alphapharm Pty Ltd (2004) 219 CLR 165. 179 [40]-[41]

8 Ibid; see also DTR Nominees Pty Ltd v Mona Holmes Pty Ltd (1978) 138 CLR 423 at 429

9 [2010] NSWCA 268

10 Ibid at [10], citing Renard Constructions (ME) Pty Ltd v Minister for Public Works (1992) 26 NSWLR 234; Hughes Bros Pty Ltd v Trustees of the Roman Catholic Church for the Archdiocese of Sydney (1993) 31 NSWLR 91; Burger King Corporation v Hungry Jack's Pty Ltd (2001) 69 NSWLR 558, Alcatel Australia Ltd v Scarcella (1998) 44 NSWLR 349 and United Group Rail Services v Rail Corporation New South Wales (2009) 74 NSWLR 618

11 UCC § 5-102

12 UCC § 1-304

13 [2016] VSC 1

14 Ibid

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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