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Implied Duty of Good Faith: A False Dawn?

Posted on Jul 04, 2013 by  | Tags: good faith, contract, lender liability, Yam Seng, implied terms  | 2 Comments

Drawing of Man in a StraitjacketWhen a dispute arises between lender and borrower, it is common for the borrower to allege that the lender has acted in bad faith by using its powerful bargaining position to put difficult and heavy obligations in the loan agreement or by not fully explaining the risks of entering the loan agreement, personal guarantee, interest rate swap etc.

The borrower is often partly to blame for not taking independent advice before entering into the contract. However where there is an imbalance of power then borrowers such as small businesses may be unduly influenced by the lender so there is clearly a balance to be struck.

However often it is difficult to find a legal remedy for the party’s unethical behaviour. A duty to act in good faith would seem to fill this legal black hole. It is a duty to behave with honesty, openness and consideration for the interests of the other party. Could judges use good faith to strike this balance by protecting borrowers from lenders’ unreasonable or oppressive contractual clauses? Recent case law in England has shed some light on the extent to which the Court may imply a duty of good faith into commercial contracts.

HAS GOOD FAITH ESCAPED JUDICIAL STRAITJACKET?

Traditionally English judges have been hostile to a general duty of good faith in commercial contracts as it was viewed as a destabilising principle which caused uncertainty because good faith could be used by a party to justify not honouring a contract. However the recent case of Yam Seng Pte Limited v International Trade Corporation caused a great deal of excitement as it seemed good faith had finally escaped from its judicial straitjacket.

The case concerned an agreement between a supplier of Manchester United branded fragrances and a Singaporean distributor. The distributor alleged that the supplier was in breach for a failure to ship orders promptly, failed to make products available, undercutting agreed prices and providing false information. The distributor argued there was an implied term in the agreement that the parties would deal with each other in good faith. The judge agreed and found in favour of the distributor.

However the judge did say that duty of good faith was unlikely to be able to be implied into every commercial contract but certainly any underhand or dishonest conduct would leave that party vulnerable to an implied duty of good faith argument. The Yam Seng case painted a rather rosy picture for weaker contractual parties (such as borrowers) who could now seek to advance this legal argument against stronger parties.

NORMAL SERVICE RESUMED?

However just when it looked like England was following other jurisdictions such as Canada and Australia, two further decisions were handed down recently which decided that no good faith term could be implied. Normal service was resumed in Mid Essex Hospital Services NHS Trust v Compass Group UK & Ireland Limited, where the Court of Appeal decided that an NHS Trust had the freedom to decide the service failure points to be awarded to its caterer, Compass. An implied term of good faith could only limit the NHS Trust’s decision-making freedom if there were a range of options available to it in which both parties’ interests would need to be considered. While the case restricted the circumstances in which good faith can be implied, it did not extinguish it.

In the most recent case of TSG Building Services Plc v South Anglia Housing Limited the English High Court was asked to decided whether good faith could prevent South Anglia from invoking the termination clause in the parties’ contract. South Anglia never openly explained their reason for terminating (TSG suspected it was financially motivated) there was no evidence of any dishonesty in the decision to terminate. Since the clause allowed either party to terminate at any time and there was no proof of a bad motive to terminate then the Judge decided that in this case there were no circumstances in which good faith could be implied to restrict the termination clause. The case shows that whether good faith can be implied is fact-sensitive.

VIEW FROM SCOTLAND

While a general principle of good faith was recognised by Scots law in the case of Smith v Bank of Scotland where it was used to avoid a personal guarantee, it has not been advanced in commercial contract disputes.

The implied duty of good faith argument is currently being advanced in a Scottish Sheriff Court case and it remains to be seen whether the influence of the Yam Seng case will enable the application of good faith to venture beyond personal guarantees in Scots law or whether a more conservative approach will be taken.

CONCLUSION

It is clear from the recent good faith cases that an implied duty of good faith is here to stay albeit the Courts may limit this to specific circumstances rather a general duty of good faith being implied unless expressly excluded. It is unlikely that commercial parties will expressly exclude good faith in their contracts and so we should see further attempts to use good faith in commercial contract disputes where one party alleges the other has been dishonest or engaged in commercially unacceptable behaviour.

It is unfair that parties with greater bargaining power may behave in an unacceptable commercial manner to the detriment of the other party. It is hoped that good faith will be developed by judges to adapt to the needs of the current times to increase the scope for contractual fairness in the Courts.

Neil Morrison, Associate, Financial Services & Banking Disputes

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