UK: Ketchup Case Squashed!

In March of last year, the courts held that a hospital trust's conduct to its contractor was so unreasonable that it was in breach of the express duty to act in good faith in their contract, and this amounted to a repudiation of the contract. While the case turned on its own facts, a number of long term contracts, particularly in PFI/PPP do include such an obligation of good faith, and the decision had served as a warning that extreme behaviour (in this case by the NHS Trust) could be interpreted as a repudiatory breach.

However, the decision has recently been overturned, with the Court of Appeal finding that the original judge had taken the wrong approach to the good faith obligation contained within the contract (Compass Group UK and Ireland Ltd (trading as Medirest) v Mid Essex Hospital Services NHS Trust [2013] EWCA Civ 200).

By way of reminder, the contract in question concerned provision of catering and cleaning services by Medirest to the Trust. Under clause 3.5 of the contract the parties were obliged to co-operate in good faith:

"3.5 The Trust and the Contractor will co-operate with each other in good faith and will take all reasonable action as is necessary for the efficient transmission of information and instructions and to enable the Trust or, as the case may be, any Beneficiary to derive the full benefit of the Contract."

The contract included mechanisms for Medirest to monitor and report on its performance, and where performance failures occurred, the Trust was entitled to award service failure points, and to make deductions from the payments due to Medirest. The level of deductions that the Trust was entitled to make were set out by reference to the different categories of performance failure.

The court noted that Medirest's reporting was haphazard and deficient, and that it failed to report performance failures. The Trust carried out its own monitoring every month and indulged in what the court described as 'extremely harsh' assessments of Medirest's performance, which resulted in significant deductions and the award of a high number of service failure points for relatively trivial incidents (including the now-famous out of date ketchup sachets and chocolate mousse). Relationships at management level broke down, and both parties purported to terminate the contract.

In the original judgment the Judge found that the Trust's conduct constituted a breach of the 'good faith' obligation under clause 3.5. In doing so the Judge implied another term into the contract, that the Trust would not make deductions/award service failure points " an arbitrary, capricious and irrational manner", and found that the Trust had acted in breach of this implied term.

However, on appeal Lord Justice Jackson found that there was no need to imply this term into the contract. In particular, he concluded that such a term would only be necessary if the Trust was exercising discretion in levying deductions or in awarding service failure points. In fact he found that the contract contained "precise rules" for determining the level of service failure points incurred and in calculating the amount of deductions due. The exercise involved did not require the Trust to exercise discretion. The only discretion available to the Trust under the relevant contractual provisions was whether or not to make deductions or to award service failure points, and not the level of those deductions or the number of service failure points. Therefore, no further term need be implied into the contract.

In relation to clause 3.5, the 'good faith' clause, Lord Justice Jackson commented that it was a 'jumble' but found that it should be read as follows:

"The Trust and the Contractor will co-operate with each other in good faith and will take all reasonable action as is necessary:
(1) for the efficient transmission of information and instructions; and
(2) to enable the Trust or, as the case may be, any Beneficiary to derive the full benefit of the Contract."

Thus the good faith obligation was specifically limited to the two purposes stated. Lord Justice Jackson noted that there is no general doctrine of good faith in English contract law and that any such duty is "heavily conditioned by its context". He found that the Trust had breached its contractual obligations regarding the awarding of service failure points and the making of deductions, but that there was no evidence that it was acting dishonestly in doing so. Further, the Trust had effectively "cured" these breaches of contract by repaying the wrongly deducted sums. As a result, Medirest was not entitled to terminate the Contract, and its notice of termination was invalid.

Lord Justice Beatson, agreeing with Lord Justice Jackson, noted that the test of good faith is objective, in that it depends on whether the conduct in question would be regarded as commercially unacceptable by reasonable and honest people. He went on to comment that clause 3.5 should be reviewed in the light of the provisions of that clause, the other provisions in the contract, and its overall context. He found that the original judge "gave insufficient weight to the other provisions of the contract and, to this extent did not take sufficient account of the context of clause 3.5". As the excessive deductions and service failure points put the Trust in breach of the relevant clauses of the contract, it was not necessary to give clause 3.5 a wider meaning.

The original judgment was hailed in the PFI context as showing that parties to a PFI agreement had obligations to act reasonably to each other, and that "good faith" obligations in a contract were not just empty words. This court of Appeal judgment is in some ways disappointing, in that it reverses this. This latest judgment counters the perception that recently the English courts have been more open-minded to the concept of a general obligation to act in good faith, and makes it clear that any such express term will be interpreted carefully, in the context of the entire contract and the commercial relationship between the parties.

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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