What is good faith?

Most contractual agreements include express clauses or an implied intention to negotiate or act in good faith. This term 'good faith' is derived from the doctrine known as the doctrine of good faith and fair dealing. It is a general presumption that contracting parties will in their dealings with each other as per that contract act honestly, fairly and in good faith so as not to hold back the rights of either party to enjoy the benefits of the contract.

General Usage

While good faith has no real legal definition in Indian law, English law has evolved a number of interpretations of good faith. Until recently under English Law there was no concept of doctrine of good faith. The principle was used to solve problems as and when they arose.

India being a common law country may thus utilize this principle to resolve commercial disputes since common law jurisdictions are allowed to import legal principles from other similar jurisdictions when their own laws and precedents are silent on the matter.

The Change

In the case of Yam Seng Pvt Ltd v International Trade Corporation Ltd [2013] EWHC 111 (QB) the High Court held that the duty to perform a contract in good faith can be implied in any ordinary contract by examining the presumed intention of the parties. The court however stated that the "good faith requirement" was not any unfettered overarching notion for all contracts. It is heavily dependent on the contractual context and because of this factor is more likely to be applied in cases of relational contracts such as joint ventures and franchise agreements. The court concluded by stipulating that parties should therefore bear in mind the potential for a duty of good faith to be implied when determining how to perform a contract.

Implications

This decision is important as it is perhaps the first instance where an English court has considered in detail the implication of a general duty of performance in good faith in a contract made under English law. The court in its reasoning implied the existence of a duty to act in good faith and in doing so opened the door for implying such a duty in other commercial contracts by holding that an objection to the implication of such a duty under English law is misplaced.

Parties to contracts made as per English law must therefore bear this duty in mind when performing contracts as while an action may not breach the express terms of the contract it may breach the implied term of good faith.

This is especially true with regard to 'relational contracts' such as joint venture agreements, franchise agreements and long term distributorship agreements. It is unlikely that the court would strictly impute a duty to act in good faith for a simple one-time exchange contract. Relational contracts on the other hand involve longer term relationships between the contracting parties. Such relationships are founded on mutual trust and confidence and expectations of loyalty which are not set forth in express terms, but are implicit in the parties' intentions and understanding as they are necessary to give business efficacy to such arrangements.

Link to rationality and contractual discretion

However, the contractual obligation to act in good faith may be limited to certain defined provisions and may not apply to the overall contract and there may not be an implied term preventing parties from exercising a contractual discretion in an arbitrary, irrational or capricious manner as was the case in Mid Essex Hospital Service NHS Trust v Compass Group UK and Ireland Ltd (t/a Medirest) [2013] EWCA Civ 200. This means that in cases where a party is exercising an absolute contractual right there is no implied duty to act rationally.

This is an area of law which can lead to uncertainty and confusion. Therefore, it is essential that when negotiating contractual terms, parties are aware of the differences between different types of contractual rights and the different tests that courts adopt when interpreting which right or discretion has been exercised.

Conclusion - Ultimate Effect

When negotiating joint venture agreements or any other sort of long term relationships via contracts with companies or organizations in the UK, it is advisable that the connotations of contractual terms be kept in mind so that performance is not hampered. Further, the doctrine of good faith now being considered applicable for commercial contracts, parties must be aware that their conduct in executing the contract will be judged by a yardstick not defined either in statutory or contractual terms. This necessitates a degree of care and caution to ensure that there does not occur a breach of faith on any account.

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.