Summary

In a ruling that has given rise to some alarm, the High Court confirmed this year in Al Nehayan v Kent that a duty of good faith can be implied into certain kinds of commercial agreements.

What was the position before this case?

The position under English law has long been that contracting parties do not owe a general duty of good faith to each other, except where they are in a  fiduciary relationship. This differs from many civil law jurisdictions where a duty of good faith is included in the civil code. There have been previous attempts by the English Courts to imply a duty of good faith into a wider set of contractual relationships, most notably in the case of Yam Seng PTE v International Trade Corporation Ltd in 2013. Judges in subsequent cases attempted to limit the effect of Yang Seng.  They confirmed that the courts will be generally reluctant to imply an overarching duty of good faith into commercial agreements, but that they may be willing to imply context specific obligations into an individual agreement to give effect to the principle of good faith where the contract would otherwise lack commercial and practical coherence. 

How does this case change things?

The ruling in Al Nehayan appears to have taken us back to the Yam Seng position (interestingly, the same judge presided over each of these cases). Al Nehayan  has confirmed that an overarching duty of good faith may be implied into so called ‘relational contracts’. Broadly speaking these are joint venture agreements, franchise agreements and long term distribution agreements. The consequences for parties negotiating commercial contracts are uncertain but potentially far reaching.

Why does this matter?

It has always been the case that, as long as the parties to a contract comply with its express terms, they can exercise their commercial freedom and pursue their own interests without the possibility of their conduct being actionable in a court as not in good faith. The effect of Al Nehayan may be to restrict that freedom.

Further, although the court in the case was satisfied that the implication of a duty of good faith satisfied the business efficacy test (as set out in Marks & Spencer v BNP Paribas [2015]), the judgment indicates that this may not be necessary and a duty of good faith can also be implied into the contract as a matter of law “on the basis that the nature of a relational contract implicitly requires treating it as involving an obligation of good faith” (in the absence of a contrary indication).

What does a duty of good faith mean?

What does this mean for parties to joint venture agreements, franchise agreements and long term distribution agreements? Unhelpfully, the judgment recognised that “it is nearly impossible to spell out what the duty of good faith means exhaustively in any given case”. Previous cases which considered this issue have indicated that a duty of good faith may mean various different things including faithfulness to an agreed purpose, acting within the spirit of the contract and observing reasonable commercial standards of fair dealing. However, the consistent message that comes through from these cases, as well as various codes applicable in other jurisdictions, is that good faith requires ‘honesty’. One example of not acting in good faith that was provided in Al Nehayan was one of the parties to an oral joint venture agreement entering negotiations to sell his shares without informing the other party.

So, where does this leave us?

A lot of companies will be nervous about any potential restrictions on their ability to pursue their own interests in a competitive way. Further difficulties could arise from the lack of certainty around what good faith actually requires of a contracting party. However, businesses can take comfort from the fact that this case concerned an oral joint venture agreement, where the court had very few express terms to deal with. The courts will not generally imply a duty of good faith in relation to a particular contract term where the implied term would contradict the express term as drafted. On this basis, businesses looking to avoid the uncertainty coming from an implied duty of good faith should look to explicitly set out in the written contract what will happen around core contractual obligations, such as on exit or if one of the parties gets into financial difficulty.  If the steps that the parties are required to take in relation to each of these obligations are clear and explicit, there can be no room for the courts to overlay an additional obligation of acting in good faith. Accordingly, forward thinking and comprehensive drafting will be helpful. 

One issue which we have been asked about regularly since this judgment is whether it is possible to expressly exclude any implied duty of good faith. In our view, this is likely to be resisted in any negotiation on the basis of the rather negative messages that it sends.  However, it may be possible to successfully resist an attempt to actively include an express duty of good faith in a contract on the basis that the meaning and scope of that duty is just too vague.