Doctrine Of Good Faith in Commercial Contracts Under English Law

04 Jul 2024

It is a well-settled principle in contract law, that parties to a contract must perform their contractually stipulated duties and obligations in good faith. Courts often employ a subjective and objective test to determine whether the conduct of the party was in good faith. Generally speaking, under English law, the doctrine of good faith does not extend to negotiating or in performing a contract and parties are free to pursue their own self-interests, so long as their actions do not constitute a breach of the agreement.

The principle of good faith may still impact a commercial contract in the following cases:

If the parties to a contract expressly agree to act in good faith, clauses to that effect will be taken into consideration by the courts when determining the parties’ intentions;

Courts may imply a general duty of good faith in certain circumstances eg. where the agreement in question is a relational contract;

When a contractual discretion is given to a party, the party is bound to act in good faith especially when discretion confers on that party the power to make a decision that affects the interests of both parties.

Broadly speaking, the duty of good faith is primarily a restriction on parties from engaging in actions that demonstrate bad faith, rather than imposing a positive duty to actively demonstrate good faith. However, express clauses and obligations to act in good faith will neither impact nor prevent parties from exercising other contractual rights, namely, their right to terminate or compel a party to sacrifice its commercial interests. In practice, English courts will often narrowly construe these clauses, so that it applies only to specific provisions and obligations, rather than the entire contract.

Parties in a contract may use language flexibly to create a duty of good faith. Oftentimes, this is seen in dispute resolution clauses where parties may agree to resolve disputes in an “amicable manner” or using “bona-fide endeavors”.

Courts are also more likely to imply a duty of good faith in relational contracts. Relational contracts are a type of business arrangement or contract that is characterized by an ongoing, long-term relationship between the parties. Some examples of this would be joint venture agreements, franchise agreements and public-private partnership agreements. The key indicators of whether a contract would qualify as a relational agreement are: i) whether the relationship is long-term; ii) the degree of collaboration; iii) whether there is a significant investment by one or more parties; iv) the exclusivity of the relationship; and v) the parties hold trust and confidence in each other. However, the specific facts and circumstances will determine the classification of any agreement as a relational contract.

In the event that there is no express provision in the contract regarding the duty to act in good faith and such contract is categorized as a relational contract, the English courts will imply a general duty of the parties to act in good faith. If a contract is “relational,” then the parties are subject to duties of good faith as a matter of law, and prohibited from conduct which in the relevant context would be regarded as commercially unacceptable by reasonable and honest people.

Another instance where English Courts find an implied duty to act in good faith is in the case of contractual discretions. In the landmark judgments in Braganza v BP Shipping Ltd [(2015) UKSC 17] and Socimer International Bank v Standard Bank London Ltd [(2008) EWCA Civ 116], the English Courts found that a duty to act rationally and in good faith is implied into contractual terms that provide for one party to have a discretion to make a decision over the other, which will impact the rights of that other party. This duty is sometimes referred to as the “Braganza duty” or “Socimer duty”.

It is likely to be implied in cases where: i. the decision-making party has discretion to make a decision; ii. the manner in which the discretion is exercised will impact rights held by both parties; and iii. A conflict of interest may potentially arise for the decision-making party. In the absence of clear language to the contrary, courts may find that the decision-making party is bound by the Braganza Duty to exercise its discretion in a manner which is rational and in good faith. Parties to a commercial contract are advised to take these factors into consideration, during their contract negotiations and drafting stage, and be mindful of either excluding a duty of good faith, or defining its particular scope, so that it is capable of objective assessment by a third party. Parties conferred with decision-making power must also expressly define their decision-making procedure in commercial contracts, by way of identification of factors taken into account when making their decision and the manner in which it is recorded, to evidence a proper decision-making process.