For parties preparing to enter into a joint venture (whether as shareholders through the use of a corporate vehicle or by adopting a different structure) it may seem axiomatic that each would expect the other parties to act “in good faith” in their joint venture dealings. However, English law has traditionally refused to recognise any overriding principle of good faith between contracting parties including where the parties may be co-shareholders. In Walford v Miles Lord Ackner stated that “the concept of a duty to carry on negotiations in good faith is inherently repugnant to the adversarial position of the parties when involved in negotiation” and is “unworkable in practice”. Instead the principles of freedom of contract, the ability for parties to pursue their own self-interest and certainty of contract are upheld by the courts and it is thought that a general doctrine of good faith would create obligations that are potentially too vague and subjective.
However, this rejection of an overarching doctrine of good faith has been occasionally problematic to the courts which have developed a “piecemeal solutions in response to demonstrated problems of unfairness” – and in doing so have muddied the good faith waters.
There are therefore three issues to be considered for parties entering into contractual relationships including where expressed in a joint venture or shareholders’ agreement:
- Agreeing an express duty of good faith. However, interpreting precisely what obligations arise out of this and what the parties must do in practice to make sure they fulfil such a duty may be problematic.
- Will the English courts imply a duty of good faith – despite the over-arching rejection of the concept of good faith, the courts have shown themselves willing to imply a general duty of good faith into certain contracts, particularly so-called “relational” contracts.
- The duty of rationality – also known as the Braganza duty after the case in which it was established, is a now well-recognised duty under which a party must exercise a contractual discretion in good faith and not arbitrarily or capriciously. This is clearly an exception to the general rule of English law that contractual rights are enforceable regardless of whether they are exercised in a reasonable or unreasonable way, and is not considered in detail in this briefing.
Should there be an express duty to act in good faith?
Particularly in the context of a joint venture, the inclusion of an express obligation on the parties to act in good faith may seem to many to be an uncontroversial request. Why would anyone want to enter into a contract with a counterparty who wouldn’t agree to act in this way? However, whilst the parties to an English law agreement are free to expressly agree to act in good faith, the main issue in including such wording is a pragmatic one – good faith may be an imprecise concept which is impossible to pin down with any degree of certainty. This is reflected in case law where, in the absence of a general definition of good faith, the courts have been required to interpret the specific words chosen by the parties on a case by case basis to ascertain the true intention behind including such a provision. Where an express good faith clause is included in a contract, the court must try to give effect to it, but the actions which it should translate to may not be clear.
The difficulty can be seen from those cases which have attempted to establish what is meant by an express duty of good faith. For example, in CPC Group v Qatari Diar Vos J considered various potential definitions or interpretations of the phrase including that it:
- underwrites the spirit of the contract and supports the integrity of its character.
- is a duty to recognise and to have due regard to the legitimate interests of both parties.
- emphasises faithfulness to an agreed common purpose and consistency with the justified expectations of the other party.
In Unwin v Bond the difficulties which may arise, if an express duty to act in good faith is added to a shareholders agreement, were highlighted. Often, the shareholders in a joint venture will not only be a party to the shareholders’ agreement and have rights under the company’s constitutional documents, but they will also be directors and/or employees or have rights deriving from other contractual arrangements. Therefore any good faith obligation arising out of the shareholders’ agreement is operating in the same space as the rights and obligations arising out of these other contracts. This was the case of this company owned by two individual shareholders. Mr Bond was the 80 per cent shareholder and Mr Unwin was 20 per cent shareholder. Mr Unwin was also an employee of the company. Mr Bond dismissed Mr Unwin on grounds of poor performance. Under the company’s articles of association, Mr Unwin was obliged to sell his shares for a nominal amount in these circumstances as termination of his employment (even where he had been unfairly dismissed) made him “bad leaver” as defined in the articles. The court decided Mr Bond had breached the good faith obligation in the shareholders’ agreement even though he had not been dishonest and had been acting in what he considered to be the best interests of the company. The reason for this is that he was found to have failed to "deal fairly and openly" with Mr Unwin, which was one of the “minimum standards” identified by Klein HHJ in relation to the obligation of good faith. The conclusion from this decision seems to be that, where there is an express duty of good faith and either of the shareholders holds a position as director and/or employee of the joint venture, this obligation may extend beyond their relationship as shareholders.
Further, in Re Compound Photonics Group Ltd the High Court considered a claim by minority shareholders that two majority shareholders, in breach of their obligations under a shareholders agreement including an explicit obligation to act in good faith, had been treated in a manner which was both unfair and prejudicial. In holding that the claimants had been unfairly prejudiced, Mr Justice Johnson concluded that the explicit requirement for the shareholders to act in good faith was wide enough to capture the exercise of voting rights and was intended to impose a contractual restriction, binding as between the shareholders, on the otherwise unrestricted rights of the majority shareholders to exercise their power under Companies Act section 168(1) as they saw fit. He stated that whilst they had an unrestricted right as a matter of company law, which could not be excluded; as a matter of private contract it could be and had been restricted. The majority were bound to act with fidelity to the bargain struck under the shareholders’ agreement, and any breach of that would be a breach of the good faith clause. Therefore, although the majority could exercise their statutory powers, and such actions would be effective and not susceptible to revocation; at the same time, if the majority did not deal in a way which was fair an open, that would constitute a breach of the good faith clause, entitling the disadvantaged shareholders in an appropriate case to claim relief for unfair prejudice under CA section 994.
When determining the effect of an express good faith clause, the courts will closely examine the wording of the specific agreement and will only hold the parties to conduct the expressly stated obligations in good faith, not the whole contractual relationship. With a result, generic or wide ranging obligations of this nature may not be enforced by the courts due to lack of certainty or that the obligations are unenforceable because they amount to “agreements to agree”. It is also worth noting that an express duty of good faith is unlikely to be placed at odds with defined contractual rights or require a party to give up its commercial interests. On the other hand, the courts do not necessarily require there to be a finding of dishonesty.
Accordingly, parties should be aware that although an express good faith clause may be intended to fill any gaps in the contractual relationship and encourage both parties to behave in a “fair” way, parties should be aware of the risk that they will be left without an enforceable right if relationships break down; and it also risks spurious claims, based on broad assertions of what good faith means, being raised. At worst it may be interpreted in a way that neither party anticipated or would have written into their agreement.
Can a duty of good faith be implied into English law agreements?
The English courts have struggled to define in a cut and dried way where a duty of faith may be implied into contracts governed by English law with some hard line authority to the effect that this would only be likely to arise where the contract would lack commercial or practical coherence without it.
However, and relevant to agreements in the nature of joint venture or shareholder agreements, the 2013 High Court case of Yam Seng recognised that the concept of good faith was used to imply two terms into a distribution agreement, in part on the basis that the contract was a long-term, “relational” contract. Whilst at the time the judgement received a lukewarm reception, including by the Court of Appeal in Globe Motors, the concept of a “relationship contract” importing special considerations has persisted with certain recent decisions in the courts support the concept of implying good faith into this type of contract. In particular, in 2019, the High Court did imply a duty of good faith into the Post Office’s contract with its sub-postmasters, as this was found to be a “relational” contract, and in doing so set out features of a contract which would indicate it was of this type:
- A long-term contract or a contract the parties intend to be long-term, even though it lacks a fixed-term and allows termination by notice.
- The parties intend their roles to be performed with integrity and with fidelity to their bargain.
- The parties will be committed to collaborating with one another.
- The spirits and objectives of the venture cannot be expressed exhaustively in a written contract.
- The parties each repose trust and confidence in one another.
- The contract involves a high degree of communication, co-operation and predictable performance based on mutual trust and confidence, and expectations of loyalty.
- One or both parties have made a significant investment.
- The relationship is exclusive.
Notwithstanding a number of cases willing to imply a duty of good faith into relational contracts, in 2020 the High Court in Russell v Cartwright held that, rather than trying to establish whether a contract is a “relational” one, which therefore includes an obligation of good faith (as was held in Bates v Post Office), the better starting point was the application of the conventional tests for the implication of contractual terms. This meant that the question to be asked was whether a reasonable reader would consider that an obligation of good faith was obviously meant, or the obligation was essential to the proper working of the contract since it would otherwise lack commercial or practical coherence.
In Russell v Cartwright it was concluded that it was neither obvious nor essential to the proper working of the contract to imply a broader obligation of good faith. The existence of express good faith obligations in the relevant agreement indicated that when the parties intended to impose an obligation of good faith they did so, strongly suggesting that implying a more general obligation of good faith would be inconsistent with the express terms.
A similar conclusion was reached in TAQA Bratani Limited & Ors v Rockrose UKCS8 LLC, where the court found that, despite the contracts in question arguably being “relational”, no duty of good faith should be implied as the clause relied upon provided an absolute and unqualified power. The court held that, had the parties intended to qualify the right relied on, they would have expressly done so, as other provisions of the relevant agreement did expressly refer to good faith. In addition, the implication of a duty of good faith was not required to make the contract work. So taking both of these factors into account, the court would not imply a term which qualified what the parties had expressly agreed to.
What are the implications for the parties to a joint venture or shareholders’ agreements?
It is fairly clear that, whilst the concept of good faith is creeping into English law, the “law has not yet reached a stage of settled clarity”, and this will have implications for the drafting of JVAs or SHAs.
Where no express duty is included, it remains unclear from the case law whether parties to “relational” contracts are able to rely on a duty of good faith implied by the law. The willingness of the court to permit this implication is very fact specific, and that inevitably gives rise to a degree of uncertainty around the contractual interpretation. Accordingly, even if a duty of good faith is implied by a court, there may be a lack of clarity on the contractual implications which may follow. Whilst each party to a contract may be entitled to expect that the other parties will not act dishonestly, if they want other protections these should be written in to the contract clearly enough for the parties to understand what they can do, and what they cannot do. What does appear to be clear is that an express term of the contract can prevent any duty of good faith being implied, so the parties to a JVA/SHA could choose to expressly exclude any implied duty of good faith.
A coronavirus post–script: What impact will the Government’s COVID-19 Guidance have?
On May 7, 2020 (updated on June 30) the UK government issued guidance, as part of its response to the coronavirus pandemic, ‘strongly encouraging’ contractual parties to ‘act responsibly and fairly in the national interest in performing and enforcing their contract’ (the Guidance).. Whilst the Guidance makes clear that it does not override any legal rights or obligations that the parties may have under the terms of a contract or otherwise in law, it does raise the question of whether or not the English courts will take the Guidance into account when considering express and implied obligations of good faith.
Accordingly, where an express good faith provision is included in a contract, while the courts may be prepared to take the Guidance into account when considering a party’s conduct, it seems unlikely they will go beyond the restrictive limitations on the scope of such good faith clauses, as set out above. Accordingly, the Guidance should not be a bar to parties relying on their clear contractual rights and obligations. Similarly, it seems unlikely the Guidance will lead to the courts implying a duty to act in good faith where it would not otherwise have done. However, again, the courts may be prepared to take the Guidance into account when measuring a party’s conduct against any measure of good faith that has been implied.
Nonetheless, parties should be aware that the Guidance encourages parties to go further than the current limits on good faith set out in the case law, making clear that “Responsible and fair contractual behaviour…is strongly encouraged in performing and enforcing contracts where there has been a material impact from Covid-19” and includes “being reasonable and proportionate in responding to performance issues and enforcing contracts (including dealing with any disputes), acting in a spirit of co-operation and aiming to achieve practical, just and equitable contractual outcomes having regard to the impact on the other party (or parties), the availability of financial resources, the protection of public health and the national interest.” This appears to encourage a positive duty to consider the interest of other parties to a contract and it seems that where contractual issues arise as a result of COVID-19, the government may have tried to fill the legal “gap” by trying to import an implied good faith standard.