"I respectfully suggest that the traditional English
hostility towards a doctrine of good faith in the performance of
contracts, to the extent it still persists, is misplaced." So
said a High Court Judge, Leggatt J, in the recent case of Yam
Seng Pte Limited v International Trade Corporation
Limited.1 On its face, this was a bold
assertion.
Jurisdictions around the world generally recognise the principle
that contracting parties owe each other a duty of good faith in the
performance of their contractual obligations.
In the United States, this principle is enshrined in the Uniform
Commercial Code which provides that "every contract or duty
within this Act imposes an obligation of good faith in its
performance or enforcement".2
Similar provisions are found in the commercial codes of most civil
law jurisdictions, and the courts in common law jurisdictions such
as Australia and Canada increasingly recognise a broad principle of
good faith and fair dealing.
England stood out as one of the few jurisdictions that did not
recognise an implied duty of good faith between contracting
parties. A leading commentary on the issue notes that:
... in keeping with the principles of freedom of contract and the
binding force of contract, in English contract law there is no
legal principle of good faith of general application, although some
authors have argued that there should be.3
Under English law, duties of good faith are owed by those in a
fiduciary relationship and can exist as the result of an expressly
agreed contractual term. A duty of good faith can be implied in
specific contractual relationships (for example in partnership,
agency, employment or insurance contracts) but, as a general rule,
the English courts would not imply a duty of good faith into a
commercial contract.
That position appears to be changing.
For a long time, commentators have suggested that a general duty
of good faith would be introduced into English law as a result of
efforts to standardise contract law within the European Union. Such
a duty is already recognised in most EU Member States' systems
of law, and the implementation of EU legislation has resulted in
the concept of good faith being applied for various purposes in
relation to specific kinds of contract.4 The further
extension of the principle is widely anticipated. By way of
example, the proposed Common European Sales Law provides that
"Each party has a duty to act in accordance with good faith
and fair dealing".5
Change may have come sooner than expected and from an unexpected
quarter. In the recent Yam Seng decision, Leggatt J found
that a duty of good faith could be implied into contracts as a
matter of English law. Indeed, the judge's reasoning suggests
that such a duty should be implied into many if not all commercial
contracts.
Yam Seng v International Trade
Corporation
The case related to a distribution agreement for Manchester United
branded fragrances, deodorants and other toiletries pursuant to
which ITC granted certain distribution rights to Yam Seng,
primarily in relation to 42 duty-free centres across Asia.
Following a breakdown in the relationship, Yam Seng terminated the
agreement and brought breach of contract and misrepresentation
claims in the English High Court.
Yam Seng claimed, amongst other things, that ITC had breached an
implied term that the parties would deal with each other in good
faith. Yam Seng claimed that ITC had done so, first, by providing
Yam Seng with false information on which ITC knew Yam Seng would
rely in marketing the products and, second, by authorising sales by
third parties in the domestic markets of territories covered by the
distribution agreement at a lower retail price than the agreed
duty-free retail price.
Following a detailed analysis of the authorities, the judge held
that a contractual duty of good faith could be implied and that the
content of the duty to perform a contract in good faith is
dependent on context. He also held that, in the context of the
distribution agreement, it was clearly implied, first, that ITC
would not knowingly provide false information on which Yam Seng was
likely to rely and, second, that ITC would not authorise sales in
the domestic market that undercut the agreed duty-free retail
prices.6
The judge found that ITC had not in fact authorised undercutting
of the duty-free prices but that ITC was in breach of "the
implied duty of honesty". As a result of this and certain
other breaches identified by the judge, Yam Seng had been entitled
to terminate the distribution agreement and was entitled to claim
damages. The judge also found that Yam Seng was entitled to damages
for misrepresentation on the basis that ITC had induced Yam Seng to
enter into the distribution agreement by making certain false
representations as to the rights then owned by ITC.
Leggatt J's Reasoning
The judge's reasoning, on the issue of good faith, was
straightforward.
The judge began by implying a contractual obligation of honesty,
stating that "[a]s a matter of construction it is hard to
envisage any contract which would not reasonably be understood as
requiring honesty in its performance" and noting that such a
requirement meets the traditional tests for the implication of a
term in that (i) it is so obvious that it goes without saying and
(ii) it is necessary to give business efficacy to commercial
transactions.
The judge extended this implied term to include an obligation to
comply with "other standards of commercial dealing which are
so generally accepted that the contracting parties could reasonably
be understood to take them as read without explicitly stating them
in their contractual document". The judge noted that the
observance of such standards (for example not engaging in business
conduct that was "improper", "commercially
unacceptable" or "unconscionable") is a key aspect
of good faith.
The judge then explained that another aspect of good faith that
can readily be implied into commercial contracts applying the
traditional tests "is what may be described as fidelity to the
parties' bargain". In this respect, the judge noted that
contracts can never expressly provide for every event that might
happen and that, in circumstances not specifically provided for,
contractual language must, in accordance with well-established
principles, be given a reasonable construction which promotes the
values and purposes expressed or implicit in the contract.
The judge concluded by noting that "[t]he two aspects of good
faith which I have identified [honesty and fidelity to bargain] are
consistent with the way in which express contractual duties of good
faith have been interpreted in several recent cases". By
applying the traditional tests for the implication of a term, the
judge had reached the same position as if a contractual duty of
good faith had been expressly included in the distribution
agreement.
The judge clearly had at the front of his mind what are sometimes
described as "relational" contracts. The judge noted that
relational contracts may require a high degree of communication,
cooperation and predictable performance based on mutual trust and
confidence and may involve expectations of loyalty which are not
legislated for in the express terms of the contract, but which are
implicit in the parties' understanding and necessary to give
business efficacy to the arrangements. The contract before the
court was a distribution agreement, but the principle could apply
in many other contractual arrangements which go beyond a simple
exchange of obligations: joint ventures, outsourcing contracts,
financing agreements, bank loans and swap contracts, to name a
few.
The judge considered that he was recognising the existence in
English law of an implied duty of good faith and fair dealing which
was neither novel nor foreign. The term may be implied not as a
matter of law but as a matter of fact, meaning that it is based on
the presumed intentions of the parties. It is thus a question of
construction of the contract and decided on a case-by-case
basis.
But What Does It Mean?
A critical issue is what, precisely, is required by an implied
contractual duty of good faith. What does it mean? Some assistance
is given by case law regarding express terms to the same
effect.
In Berkeley Community Villages Ltd v Pullen, Morgan J
held that an express term requiring the parties to act with the
utmost good faith towards one another imposed an obligation:
... to observe reasonable commercial standards of fair dealing in
accordance with their actions which related to the Agreement and
also requiring faithfulness to the agreed common purpose and
consistency with the justified expectations of the [other
party].7
That approach was followed in CPC Group Ltd v Qatari Diar Real
Estate Investment Co, where Vos J held that:
... the obligation of utmost good faith in the [contract] was to
adhere to the spirit of the contract [...] and to observe
reasonable commercial standards of fair dealing, and to be faithful
to the agreed common purpose, and to act consistently with the
justified expectations of the parties.8
In the Yam Seng case, the judge held that what good faith
requires is "sensitive to context" but that it certainly
includes "the core value of honesty". The judge described
the test of good faith as an objective test: whether, in the
particular context, the conduct would be regarded as commercially
unacceptable by reasonable and honest people.
The judge's core value of honesty poses difficult questions of
scope. The judge indicated that the duty of honesty extends beyond
a duty not knowingly to make untrue statements and suggested that
"depending on the context" it might be dishonest to avoid
answering a question, to give an evasive answer or even to fail to
correct an answer which was incorrectly thought to be true at the
time or which, whilst true at the time, has since become false. The
judge even raised the question of whether the duty of honesty
created a positive obligation to volunteer information relevant to
the performance of the contract but held that, on the facts before
him, it was unnecessary for him to decide.
Court of Appeal Approval?
Less than a month after it was handed down, Leggatt J's
decision in Yam Seng was referred to in the Court of
Appeal decision in Mid Essex Hospital Services NHS Trust v
Compass Group UK and Ireland Ltd.9 While the Court
of Appeal did not overturn the decision, their apparent approval of
the decision should be treated with caution.
The Mid Essex case related to a substantial commercial
contract for the provision of outsourced catering and cleaning
services to two hospitals operated by a National Health Service
Trust. Both parties argued that the other was in breach of its
obligations under the contract.
The contract in the Mid Essex case included an express
obligation of good faith, but the Trust argued that this duty was
limited to certain specified matters. Compass argued that,
particularly in light of the Yam Seng decision, the
express clause should be given a wide interpretation and/or that a
wider duty of good faith should be implied. The Court of Appeal
found in favour of the Trust, holding that, on the facts of the
case, the express provision was limited to the specified matters
and that no general obligation of good faith arose.
Two of the Lords Justice referred to the Yam Seng
decision in their rulings. The first, Lord Justice Jackson,
referred only to the section of Leggatt J's decision that
addressed the historical position under English law, stating in
this regard that:
I start by reminding myself that there is no general doctrine of
"good faith" in English contract law, although a duty of
good faith is implied by law as an incident of certain categories
of contract [...] If the parties wish to impose such a duty they
must do so expressly.
This statement is at odds with the conclusion reached in Yam
Seng that such a duty may be imposed implicitly rather than
expressly.
Lord Justice Beatson focussed on Leggatt J's discussion of the
content of a duty of good faith, considering that this was also
relevant to the interpretation of the express obligation to act in
good faith under the contract in question. Beatson LJ concluded
that the express contractual duty of good faith should not be
broadened and he did not imply a more general duty of good faith
into the contract.
Thus, while the Court of Appeal cited Yam Seng, the Court
of Appeal did not base its decision on the principles stated in
Yam Seng. Whether Leggatt J's decision will be
followed in the future remains unclear.
Conclusion
Anyone involved in long-term contractual relationships, including
distribution agreements, joint ventures, outsourcing agreements and
financing agreements, would be well advised to take note of the
Yam Seng judgment and the likelihood that in future
disputes relating to the performance of contracts, a duty of good
faith and fair dealing may very well be an issue, at least until it
is settled by the appeal courts or European legislators.
Footnotes
1 [2013] EWHC 111 (QB).
2 U.C.C. § 1-203. See also, Restatement (Second) of Contracts, § 205.
3 Chitty on Contracts, 31st Ed., Vol 1, ¶ 1-039.
4 See, for example, the requirement of good faith in the test of unfair terms under the Unfair Terms in Consumer Contracts Regulations SI 1999/2083, implementing EU Directive 93/13/EC.
5 Proposal for a Regulation of the European Parliament and of the Council on a Common European Sales Law, Com (2011) 635 final, Annex 1, CESL Proposal, Annex I, art. 2(1) CESL. The Proposal also makes specific reference to the good faith principle in provisions relating to, amongst other things, contractual interpretation, implied terms, mistake and fraud.
6 The judge does not appear to have considered the question of whether such an implied term would have been lawful under any applicable competition laws (i.e., under the competition laws applicable in the domestic markets of the territories covered by the distribution agreement). In many jurisdictions, including EU Member States, such a provision might have been considered to be an unlawful resale price maintenance agreement.
7 [2007] EWHC 1330 (Ch) at [97].
8 [2010] EWHC 1535 (Ch) at [246].
9 [2013] EWCA Civ 200.
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