UK: Good Faith Implied As A Term In A "Relational" Contract

Last Updated: 2 April 2013
Article by Mark Alsop

ITC (an English company) approached Yam Seng (a Singapore company) in January 2009 about entering into a distributorship agreement, saying it had recently signed an exclusive licence agreement to manufacture and sell "Manchester United" fragrances and toiletries. In May 2009, a distribution agreement was signed, granting Yam Seng exclusive rights to distribute the products in a number of territories for 30 months.

Yam Seng ended up terminating after 15 months due to consistent breaches by ITC, including failing to ship orders promptly, refusing to supply certain products after Yam Seng had marketed them, undercutting agreed prices and attempting to claw back certain distribution rights.

Yam Seng sought damages for breach of contract, with part of its argument being that there was an implied term that the parties would deal with each other in good faith. It also sought damages for misrepresentation on the basis it had been induced to enter into the agreement by ITC's assertion in January 2009 that it was had a licence to manufacture and sell, when it transpired that the licence was only granted in May 2009.

The High Court (Mr Justice Leggatt) gave judgment was given for Yam Seng. On the facts, there were specific repudiatory breaches of the distribution agreement which justified termination by Yam Seng. Yam Seng was also entitled to damages for misrepresentation (the fact the licence had been signed by the time the distribution agreement was signed was of no consequence). The most interesting part of the judgment for lawyers is the judge's consideration of the doctrine of good faith.

He acknowledged that English law has not, historically, recognised a general duty of good faith. However, it has long been recognised in the US and was increasingly being recognised in European countries and other common law jurisdictions. With a duty of good faith and fair dealing infiltrating from Europe, the pressures towards a more unified European law of contract would continue to increase. In refusing to recognise any general obligation of good faith, the English jurisdiction would appear to be "swimming against the tide".

Whilst a duty of good faith was implied under English law in certain categories of contract, principally where there was a fiduciary relationship, such as employment contracts or partnership agreements, it was not implied by default into all commercial contracts. That said, it could be implied based on the presumed intention of the parties and the relevant background against which the contract was made.

Relevant background included not only matters of fact known to the parties but also shared values and norms of behaviour. Such norms included an expectation of honesty, which was naturally taken for granted when making any contract without being specifically spelt out in the agreement.

English law had traditionally drawn a sharp distinction between certain relationships where the parties owed onerous obligations of fidelity to each other (such as partnership, trusteeship and other fiduciary relationships) and other contractual relationships, in which no such obligations were supposed to operate. That dichotomy was too simplistic. Whilst a "simple exchange contract" may not require an implied duty to disclose information, that was not the case with "relational contracts" which involved a longer term relationship and a substantial commitment by the parties. They generally required a high degree of communication, cooperation and predictable performance based on mutual trust and confidence. Examples of such relational contracts were joint venture, franchise and long term distributorship agreements. [And presumably outsourcing agreements]

The test of good faith was objective, depending not on either party's perception of whether particular conduct was improper but on whether in the particular context the conduct would be regarded as commercially unacceptable by reasonable and honest people.

Leggatt J said, in his view, there was nothing novel or foreign to English law in recognising an implied duty of good faith in the performance of contracts, or in describing it as a duty of good faith "and fair dealing". The advantage of including a reference to "fair dealing" was that it drew attention to the fact that the standard was objective and distinguished the relevant concept of good faith from other senses in which the expression "good faith" was used. He concluded by suggesting that the traditional English hostility towards a doctrine of good faith in the performance of contracts, to the extent that it still persisted, was misplaced.

Comment. We have seen the courts recognise a duty of good faith between parties to a joint venture in the past (Ross River Ltd v Waverley Commercial Ltd reported in the Jan 2012 bulletin). This judgment gives further weight to the argument that such a general duty will often exist and that English law should recognise it in the relational agreements outlined. Note that good faith in this context equates with fair dealing rather than fiduciary duty.

The fact that the duty of good faith is implied by law means, of course, that it can be excluded by agreement (subject to UCTA). This contrasts with civil law jurisdictions where the duty cannot be excluded.

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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