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M&A Diligence: is there an emerging implied duty of good faith in commercial contracts?

No general doctrine of good faith has emerged in English law – the courts prize contractual certainty and are loath to imply terms that are too vague and subjective.  However, recent cases have developed the interpretation of duties of good faith following the decision of Yam Seng Pte Ltd v International Trade Corp Ltd [2013] EWHC 111 (QB), in which the High Court was willing to imply a duty of good faith.  The recent judgment in D&G Cars Ltd v Essex Police Authority [2015] EWHC 226 (QB) appears to broaden further the circumstances in which a duty of good faith can be implied.  The result of this case may leave contracting parties uncertain as to whether such a duty may apply to their commercial dealings.

Legal background

Whilst it is recognised that the English courts have not committed themselves to any general principle of good faith for fear of undermining contractual certainty and interfering with commercial parties’ freedom to contract on their own terms, duties of good faith do exist in certain specific types of contract – for instance, employment contracts, contracts with consumers, and contracts relating to fiduciary relationships and agency.  The courts have no objection to parties agreeing amongst themselves that there is an express duty to act in good faith, although what an express duty of good faith will mean in practice depends largely on the context of the contract and the purpose and expectations of the contracting parties.

The courts reviewed the application of good faith in contract law in Yam Seng - and implied a duty of honesty, as well as a more context-specific duty, into the contract.   The court implied such duty based on the presumed intention of the parties and the background against which they entered into the contract – giving special consideration to the fact that this was a long-term relationship between the parties in which they made a substantial commitment.  The court considered these types of contract to be “relational” – requiring “a high degree of communication, co-operation and predictable performance based on mutual trust and confidence and…expectations of loyalty which are not legislated for in the express terms of the contract but are implicit in the parties understanding and necessary to give business efficiency to the arrangements.”  The court cited joint venture agreements, franchise agreements and long term distributorship agreements to be examples of relational contracts.

D&G Cars

Relational contracts were further considered in D&G Cars.  The claimant, D&G Cars, was a vehicle recovery business, contracted by the Essex Police Authority (the Authority), the defendant, to recover vehicles. The recovered vehicles were to be dealt with as set out in the contract – certain vehicles, for instance, were to be crushed to ensure that no parts of the vehicle could be re-used in other vehicles.  D&G Cars did not carry out the Authority’s instruction to crush one vehicle, but instead changed its identity (with different number plates and identification number) so that it could use it for its own purposes.

Although an implied term to act with honesty and integrity was accepted by both parties, the court in D&G Cars considered the legal basis for implying such a term.  The court determined this contract to be a relational contract “par excellence” which triggered the implied term. In determining what the particular features of a relational contract would be, the judge considered the length of the contractual relationship between the parties, the number of transactions between the parties and the substance of the contract. It is noteworthy that this contract involved the claimant dealing with property belonging to members of the public, which might constitute evidence for criminal investigations and potential prosecutions, and acting on behalf of a law enforcement agency.

Following D&G Cars, it remains unclear how relational contracts are defined and which types of commercial contracts may be considered “relational.”  The context of this particular case means that the contractual interpretation could have wider ranging implications beyond the contracting parties. It is by no means certain whether commercial contracts which are long-term and contain a large number of individual transactions without such specific circumstances could be considered relational - the judge held that “the existence and the content of an implied condition in relation to honesty and integrity is highly sensitive to the context of the contract itself.”  The result of this case may be to increase uncertainty amongst commercial parties as to whether they will be bound to an implied duty of good faith in their contractual relationships, something which the English courts have always sought to avoid.

 

For more information, please contact Pippa dos Santos, Corporate Associate