UK: Probably The Most Expensive Ketchup In The World…

Last Updated: 20 August 2012
Article by Scott McKinnell and Maxwell Fox Leonard

And the chocolate mousse wasn't cheap either!

It is increasingly common to see duties of good faith imposed in contracts yet the concept itself has been unclear in English law and its effect has remained uncertain until now.

The High Court has recently shed some interesting light on the meaning of "Good Faith" in commercial contracts finding that a service provider was entitled to terminate its contract with an NHS Trust for material breach, on grounds that the Trust breached its contractual duty to act in good faith.

In the recent decision in Compass Group UK and Ireland Limited (trading as Medirest) v Mid Essex Hospital Services NHS Trust the court construed and applied a clause requiring co-operation and good faith on the part of the parties after Medirest the defendant NHS Trust brought cross claims for post termination losses following the termination of a contract between them.

 On 1 April 2008, the parties entered into a long term outsourcing agreement for the provision of catering services by Medirest to the NHS Trust in a seven year contract. As with many service contracts in PFI projects, the contract required Medirest to comply with minimum service levels, performance due dates and also contained a mechanism whereby the trust could make deductions from its payments to Medirest in the event of performance failures. Essentially, the trust could award "service failure points" from which it could calculate the appropriate deductions.

The agreement also contained a provision requiring the parties to co-operate with each other in good faith and to 'take all reasonable action as is necessary for the efficient transmission of information and instructions to enable the derive full benefit of the contract.'

The Trust began to identify a number of service failures and went about awarding service failure points. They included the discovery of one box of out of date ketchup sachets and chocolate mousse in a kitchen. Despite apparent improvements to the service and high levels of patient-satisfaction, the Trust stated in December 2008 that Medirest had accrued 52,000 service points resulting in deductions totalling £587,207.67, more than 50% of the service fees payable during the period in question. The deduction for the ketchup sachets was £46,320 and for the mousse one day over its use date the deduction totalled £84,450!

Medirest contested the Trust claims strongly. It calculated that it had only accrued 18,000 service points and the service credits were only £37,665. Despite attempts to resolve the dispute the relationship deteriorated and the Trust started to withhold significant amounts from payments to Medirest. Medirest responded with a notice of termination to the Trust alleging that it was in material breach having failed to comply with its duty to act in good faith. The Trust also gave notice terminating the contract.

The court held that the agreement contained a general contractual duty to act in good faith and that the Trust had breached this obligation and abused its contractual powers by awarding itself excessive service credits. The judge described the calculation of service credits due under the contract as "patently absurd" and "produced in the most cavalier fashion". The deductions had been exercised in an "arbitrary, capricious and irrational manner".

Not only were the service level calculations, in the Trust's own admission, "in many respects indefensible" but the Trust had sought to withhold payment on the basis of these calculations and failed to respond positively to Medirest's attempts to resolve the dispute. This was not only a breach but also a material breach and Medirest was therefore entitled to exercise its contractual right to terminate.

The clause obliged the parties to co-operate with each other in good faith and it was held that this should be read as imposing both a general obligation to co-operate in good faith, but also a more limited obligation to take all reasonable action as necessary for the two purposes contained in the clause (i.e. the efficient transmission of information and to enable to the trust to derive the contract's full benefit. The contract in question was a long term one which would require continuous and detailed co-operation and the Trust, in exercising its discretion with regards to the service credit regime had gone too far and its behaviour was sufficiently unreasonable to be in breach of the good faith obligation.

This case demonstrates that "good faith" does mean something and can allow a party to take legal action. Whilst it is an extreme case which turned on specific facts, it serves as a reminder that, whilst a challenging approach to managing a contract is acceptable and there is nothing wrong with being tough, common sense is always required. If you are seeking to create a collaborative relationship in a contract, using a specific 'good faith' obligation might be part of the solution, however this case also emphasises the importance of co-operation and dialogue to resolve problems which will inevitably occur in a long term contract of this nature. This is particularly relevant to the users of NEC contracts for construction and services which contain an obligation to act in a spirit of mutual trust and cooperation.

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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