ARTICLE
14 October 2012

Implied Duty of Good Faith in Commercial Contracts

A
Addisons

Contributor

This article examines an aspect of the law on good faith - when a requirement of good faith is implied into a contract.
Australia Corporate/Commercial Law
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Type : Focus Paper

Introduction

In an earlier article, we looked at the meaning and usage in commercial contracts of an express obligation to “negotiate in good faith”. This article examines a different aspect of the law on good faith, namely, when a requirement of good faith will be implied into a contract. We also identify the kind of obligations that good faith imposes on contracting parties, and consider whether you can expressly exclude these obligations from your contract.

Is There an Implied Duty of Good Faith?

While this question has not been examined by the Australian High Court,1 in NSW at least, the case law indicates that a duty of good faith will be implied into contracts in certain circumstances. However, when it has been implied, courts have adopted different approaches to defining what the duty entails. As indicated below, the most common context in which a duty of good faith has been considered is in relation to the termination of a contract.

The Position in NSW

The implication of a contractual duty of good faith is often traced to the judgment of Priestley JA in the seminal case of Renard Constructions (ME) Pty Ltd v Minister for Public Works.2 The case involved a building contract clause that empowered the principal to take over the work or cancel the contract upon the contractor’s default, if the contractor failed to show cause as to why the contract should not be terminated. Default occurred and, despite the contractor’s response that it was willing and able to complete the contract within a reasonable time, the principal purported to terminate the contract and take over the construction. The contractor sued for repudiation of the contract, arguing that the principal's conduct was unreasonable and lacking in “good faith”.

The NSW Court of Appeal held that the power conferred on the principal under the termination clause must be exercised reasonably. Priestley JA construed the clause as containing an implied term that the principal would give reasonable consideration to the question of whether the contractor had failed to show cause and, if the principal had reasonably concluded so, to the question of whether any power should be exercised.3 His Honour also discussed in great depth the development of an implied duty of good faith in the performance of contracts under Australian law.

Handley JA held that there was a requirement of reasonableness implied in the power to terminate, and concluded that the principal’s decision, however honest, was “objectively unreasonable and therefore an invalid exercise of the power”.4

While Priestley JA in Renard regarded the duty of good faith as an ad hoc term arising by implication based on the facts, the majority of subsequent cases in NSW have preferred to imply the duty as a matter of law. For example, Giles J in Vodafone Pacific Ltd v Mobile Innovations Ltd5 expressed the view that “an obligation of good faith and reasonableness in the performance of a contractual obligation or the exercise of a contractual power may be implied as a matter of law as a legal incident of a commercial contract”.

Good Faith in Other Australian Jurisdictions

In Esso Australia Resources Pty Ltd v Southern Pacific Petroleum N L,6 Buchanan JA of the Victorian Supreme Court appeared to accept that a duty of good faith could be implied into some contracts. However, his Honour was reluctant to conclude that this duty should be implied as a matter of law, so as to apply to all rights and powers conferred by a commercial contract.

On the other hand, in the recent case of Alstom Ltd v Yokogawa Australia Pty Ltd & Anor (No 7),7 Bleby J of the South Australia Supreme Court held that a duty of good faith is implied into every commercial contract.

In another recent case, Trans Petroleum (Australia) Pty Ltd v White Gum Petroleum Pty Ltd,8 the Western Australia Court of Appeal examined whether a right to terminate a franchise agreement for no cause upon notice must be exercised in good faith. Without deciding the point, the Court was prepared to accept that, while not universally accepted, the law in Australia reflects an implied duty of good faith in the context of commercial contracts. However, while the parties to a contract may be under an implied duty to cooperate in the performance of obligations, this duty does not rise above the express promises made by the parties. The Court ultimately refused to imply a duty of good faith in this case on the basis that it was inconsistent with the terms of the bargain agreed upon by the parties, which allowed either party to terminate the agreement for any reason and without regard to the rights and interests of the other party.

What Does Such a Duty Involve?

In Renard, Priestley JA observed that the reasonableness required has much in common with the notion of good faith. This approach received support in a number of subsequent decisions of the NSW Court of Appeal.9 For example, the Court in Burger King Corporation v Hungry Jack’s Pty Limited10 held that, in the context of the exercise of an express right of termination, the implied requirement of good faith means that right must be exercised reasonably.

A variety of other approaches have been developed and adopted by different judges over time to define “good faith”. For example, Finkelstein J in Garry Rogers Motors Aust Pty Ltd v Subaru (Aust) Pty Ltd11 took the view that the obligation of good faith required a party not to act capriciously. Meanwhile, other approaches have attempted to overcome the difficulties of defining good faith by relying on the negative proposition that good faith is “not acting in bad faith” (assuming that everyone knows what “bad faith” is).

Another frequently cited approach is that of Sir Anthony Mason, which suggested that the concept of good faith includes the following elements:

  • an obligation on the parties to co-operate in achieving the contractual objects (loyalty to the promise itself);
  • compliance with honest standards of conduct; and
  • compliance with standards of conduct that are reasonable having regard to the interests of the parties.12

In light of the various approaches of defining the content of the good faith obligation and the conceptual difficulties associated with each approach, McDougall J of the NSW Supreme Court made the following observations in a judicial speech delivered in 2006:13

Thus, I do not think that it is fruitful to enquire, in some a priori way, as to the content of the concept of “good faith” in a contractual context. It is necessary to look at the particular contract, to see what might be comprehended as a particular expression of the general concept of good faith, and then to enquire whether that particular term, or a term having that particular content, should be implied, or whether is excluded by express terms or necessary implication from them.

Can You Exclude Good Faith?

The simple answer is yes. Contracting parties are free to agree that no term of good faith is to be implied.

In the Vodafone case, the contract provided that Vodafone had the “sole discretion” to determine the number of new subscribers it would provide to Mobile Innovations to manage. In determining whether Vodafone was restrained by any duty of good faith when exercising this power, Giles J emphasised the use of the term “sole discretion” and held that these words weighed against an implied obligation of good faith and reasonableness in the exercise of the power. His Honour further observed that Vodafone was given control over the acquisition activities of Mobile Innovations and could exercise this control in accordance with its own interests rather than those of Mobile Innovations. On this basis, Giles J concluded that the implied obligation of good faith was excluded from the contract in this case.

This approach was followed by Hammershlag J in the more recent case of Solution 1 Pty Limited v Optus Networks Pty Limited.14 The contract in this case gave Optus the right to terminate for any reason and at any time in its absolute discretion by giving 120 days’ notice. While Hammershlag J was willing to imply an obligation of good faith, his Honour concluded that such obligation should be excluded in the particular circumstances as it was inconsistent with Optus’ termination right being an “absolute discretion” and a provision in the contract which expressly excluded any implied terms.

What Happens if Good Faith is not Excluded?

Generally speaking, an implied duty of good faith has the potential to turn what would otherwise be a proper exercise of contractual right into wrongful conduct. For example, if a court finds that an express right of termination was in fact restrained by an implied duty of good faith, an otherwise valid termination would become repudiation if the good faith requirement was not complied with. The terminating party can suddenly find itself liable for substantial damages.

Practical Tips

When negotiating a contract, consider whether the implied duty of good faith should be excluded. For example, consider whether you want either party’s right of termination or right to withhold consent to be subject to any implied restrictions. If the answer is no, you should exclude the implied duty.

Based on existing case law, there are at least two ways of preventing a duty of good faith from being implied into a contractual provision:

  1. expressly state that the power or right in question may be exercised at the absolute discretion of the party and include a provision in the contract that excludes any implied terms; or
  2. grasp the nettle” and exclude, in express words, any obligation of good faith either in the performance of all or certain specified contractual duties.15

One Final Note

A topic of recent focus and debate among the legal industry is whether the principles of good faith should be enshrined in Australian legislation.16 If good faith ultimately becomes a duty implied by statute, it will certainly affect the way contracts are drafted and the range of options available to contracting parties when exercising their rights.

Footnotes

1 The High Court declined an opportunity in Royal Botanic Gardens and Domain Trust v South Sydney City Council (2002) 240 CLR 45 to consider the existence of an implied duty of good faith and dealt with the dispute without needing to consider the issue.
2 (1992) 26 NSWLR 234 (hereafter Renard).
3 Above n1 at 257 per Priestley JA.
4 Above n1 at 279 per Handley JA.
5 [2004] NSWCA 15.
6 [2005] VSCA 228.
7 [2012] SASC 49.
8 [2012] WASCA 165.
9 See for example, Alcatel Australia Ltd v Scarcella (1998) 44 NSWLR 349; Burger King v Hungry Jack’s Pty Ltd [2001] NSWCA 187 (hereafter Burger King).
10 [2001] NSWCA 187.
11 (1999) ATPR 41-703.
12 Sir Anthony Mason, “Contract, Good Faith and Equitable Standards in Fair Dealing” (2000) 116 LQR 66 (being an article based on Sir Anthony Mason’s Cambridge Lecture: ‘Contract and its Relationship with Equitable Standards and the Doctrine of Good Faith’, The Cambridge Lectures, 1993 (8 July 1993)).
13 Justice Robert McDougall, ‘The Implied Duty of Good Faith in Australian Contract Law’ on 21 February 2006.
14 [2010] NSWSC 1060.
15 Above n12.
16 See for example, Insurance Contracts Act 1984 (Cth) s 13.

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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