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Implied Duty of Good Faith: Is Commercial Contract Law on the Verge of Embracing Morality?

Posted on Mar 08, 2013 by  | Tags: good faith, contract law, England, Scotland, European approach, contractual interpretation, implied term,  | 0 Comments

By Neil Morrison, Associate, Dispute Resolution

INTRODUCTION

The general principle is that unfair contracts must stand. If a person enters a bad bargain then it is not for the Court to rescue them. A huge flood of claims would occur if the Courts set aside a contract on the ground of “fairness” alone. 

EUROPEAN APPROACH

In European countries like Germany, France and Italy, a duty to act in good faith is imposed upon parties negotiating a commercial contract. In other words, it’s about playing fair by being honest and reasonable in negotiations before entering into the contract. While parties in a contract are free to pursue their own self-interest, good faith should limit any exploitive underhand dealing. If one party does not act in good faith then the contract may be set aside or amended in the other party’s favour.

ENGLISH HOSTILITY TO GOOD FAITH SOFTENS

Traditionally English law has been hostile to the concept of good faith due to concern that it would undermine commercial certainty by an unacceptable degree. In general a duty to perform contracts in good faith was not recognised by the English courts. However it was held in the recent English High Court case of Yam Seng PTE Ltd v International Trade Corp Ltd [2013] EWHC 111 (QB) that a duty of good faith could be implied into the contract in certain circumstances. This is a significant breakthrough for the duty of good faith. 

YAM SENG PTE LTD V INTERNATIONAL TRADE CORP LTD

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 in Yam Seng said that a duty of good faith was unlikely to be able to be implied into every commercial contract. However he said there is no difficulty for implying terms into ordinary commercial contracts based on the presumed intention of the parties. The judge reached the view that an expectation of honesty is so obvious that it goes without saying. 

TEST FOR DUTY OF GOOD FAITH

What’s the legal test for establishing a duty of good faith? It is whether in the specific context the conduct would be regarded as commercially unacceptable by honest and reasonable people. So whether a duty of good faith is implied will very much depend on the facts of case but in the writer’s view, in most cases a duty of good faith should be able to be implied. 

SCOTS LAW LEFT BEHIND?

The recent English decision of Yam Seng arguably makes Scots law appear outdated and out of kilter with the rest of Europe and the common law. 

It is somewhat ironic given a broad principle of good faith and fair dealing was recognised in the Scottish case of Smith v Bank of Scotland over a decade ago and there is authority (albeit old) for general contractual obligations of good faith.

Unfortunately in recent times good faith has been restricted to personal guarantee cases in Scotland. Commentators have suggested that is now simply an underlying principle rather than an active one which could be used to impose a duty to take another party’s interests into account or strike down a contract as unfair. 

THE LEGAL REMEDY FOR UNETHICAL BEHAVIOUR?

It is hoped that a progressive Scottish judge will develop the law so that a duty of good faith can be implied into commercial contracts in certain circumstances. Scots law has broadly accepted English principles of contractual interpretation so it should follow there is no difficulty implying a duty of good faith if the factual circumstances support the implication of the term. 

In financial contracts, where there is often a significant imbalance in the parties’ rights and obligations under the contract, a duty of good faith could strike the right balance between commercial certainty and limiting unethical behaviour. 

DISCLAIMER: While every effort has been made to ensure the accuracy of this blog post, it is not intended to provide legal advice as individual situations will differ. No recipients of content in this blog post should act or refrain from acting on the basis of the blog post without seeking the appropriate legal advice on the particular facts and circumstances at issue from a qualified solicitor in their jurisdiction. The blog post is for general information only and is not legal advice. The law changes frequently and varies from jurisdiction and jurisdiction. No solicitor-client relationship is formed nor should any such relationship be implied. If you require legal advice, please consult with a solicitor qualified to practise in your jurisdiction.  Should you be interested in seeking our assistance with a legal matter, please contact the Dispute Resolution team on 0131 226 8200.

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