What you need to know
- When parties enter into so-called 'agreements to agree', which contemplate that particular terms or issues will be agreed at a later date, difficulties can arise when the parties actually come to resolve those terms.
- It is common for contracts to oblige the parties to 'act in good faith' when resolving incomplete contractual terms, but good faith can be a troublesome term.
- We explore some practical steps that parties can take to protect themselves when faced with a good faith obligation.
Agreements to agree always present problems.
This was demonstrated recently in North East Solution Pty Ltd v Masters Home Improvement Australia Pty Ltd  VSC1 (28 January 2016), which concerned the enforceability of an express obligation on the parties to act reasonably and in good faith to agree incomplete contractual terms.
The North East Solution case and the obligation to act in good faith
North East Solution and Masters entered into an agreement for lease (agreement) for the construction and grant of a lease of a Masters hardware store. The agreement required North East Solution to determine the construction costs and the amount Masters would contribute towards those costs. Neither the construction costs nor the proportion to be paid by Masters had been agreed before the parties entered into the agreement.
Crucially, the agreement expressly required the parties to act reasonably and in good faith when attempting to resolve any differences regarding North East Solution's assessment of the construction costs and the Masters contribution. The agreement also provided that if the parties failed to resolve any differences that did arise, either party could terminate. Ultimately, Masters relied on this right and terminated the agreement.
North East Solution challenged Masters' right to terminate the agreement on the basis that there was no genuine disagreement, and if one did exist, Masters had not acted reasonably or in good faith to resolve it.
The court in this instance found in favour of North East Solution stating that on the evidence, Masters' actions constituted a breach of its obligation to act reasonably and in good faith.
What does this mean for landlords and tenants?
The North East Solution case puts a spotlight on two questions:
- What does it really mean to act in good faith?
- What steps can parties take to protect themselves where a contract obliges them to act in good faith?
The meaning of good faith
The definition of good faith in Australian contract law is unsettled. In the absence of an accepted definition, conceptual terms such as cooperation, acting in the commercial interest of the parties, reasonableness and honesty are often used to imply a duty of good faith.
From a practical perspective, the duty to act in good faith might also include such actions as communicating openly and effectively, cooperating with the other party and considering their interests.
Importantly, acting in good faith does not necessarily mean that a party must act contrary to its own best interests. However, a party must act in a manner that is true to the deal.
What is clear and consistent from the current case law, it is that an obligation to act in good faith is dependent on the context of the contract and will vary according to the relevant circumstances.
Steps to protect parties where there is a duty to act in good faith
Be clear on what the obligations to act in good faith actually mean
Where a contractual term is incomplete and to be determined in good faith at a later date, landlords and tenants need to be very clear about the parameters of how that term will be determined when the 'later date' arrives. In particular, the parties should consider:
- what is being negotiated
- what criteria are to be taken into account
- what might or might not be considered reasonable conduct
- what efforts need to be undertaken
- what are the consequences where agreement cannot be reached.
This list of considerations is not exhaustive and should be carefully assessed and adapted for each individual transaction. Clearly setting out the mechanisms for determining any incomplete terms ensures that the fidelity of the contract will be upheld.1
The North East Solution case demonstrates that an incomplete contractual term will not cause a contract to be unenforceable where the objective of the parties is clear.
In light of this, and in the absence of an accepted definition of good faith, a contract should be prescriptive as to the steps a party must take in order to satisfy an obligation to act reasonably and in good faith.
Consider the entire agreements clause
Where a contract fails to properly set out the parties' intentions and a dispute ensues, courts may look to the evidence of surrounding circumstances to assist in interpreting the contract.2 This can have the unintended consequence of bringing extraneous material into evidence.
An entire agreement clause can be a useful tool in confining a contract to the written terms of the document. Often, these clauses are included as part of the boilerplate provisions of a contract and contain statements to the effect that the contract represents the entire agreement between the parties with respect to its subject matter.
Landlords and tenants should be aware that entire agreement clauses will not necessary prevent a court from implying terms into a contract if the clause does not expressly prevent it.3 Similarly, entire agreement clauses will not provide protection where a party has engaged in misleading and deceptive conduct.4
As a practical measure, parties should ensure that entire agreement clauses:
- are tailored to limit the contract to the terms within the document (and other documents, if appropriate)
- expressly exclude terms that may otherwise be implied into the contract
- exclude any pre-contractual conduct or negotiations.
Key takeaways for landlords and tenants
- Where possible, parties should finalise all contractual terms before entering into a legally binding agreement.
- Where it is commercially necessary to enter into a legally binding agreement with incomplete contractual terms, the legal consequences need to be carefully considered.
- The definition of good faith is still unclear in Australian contract law. As a result, the expected conduct of a party subject to a good faith obligation remains uncertain.
- In the absence of a definition of good faith, parties should seek to prescribe the mechanisms for satisfying an obligation to act reasonably or in good faith. In particular, parties should consider placing clear limits on what is required to satisfy any obligation to act reasonably or in good faith. For example, limits on the amount or type of expenditure or expressly stating that a party is not required to adversely impact its own commercial or professional interests, reputation or position.
- Alternatively, the contract should expressly provide that either party may act in its absolute discretion in its own commercial interest and that there is no obligation to act reasonably or in good faith.
- Parties should also carefully consider the entire agreement clauses typically found in the boilerplate provisions of contracts. These clauses do not provide complete protection, but can be adopted as a useful tool for excluding any factors outside the written terms of the contract and confining the contract to the fidelity of the deal.
Macquarie International Health Clinic Pty Ltd v Sydney South West
Area Health Service  NSWCA 268
2 Codelfa Construction Pty Ltd v State Rail Authority (NSW)  HCA 24
3 Hart v MacDonald  HCA 13
4 Campbell v Backoffice Investments Pty Ltd  HCA 25; Competition and Consumer Act 2010 (Cth) Schedule 2, Part 2-1, s 18
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.