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Development agreements: the contractual duty to act in good faith

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25th October 2023

Jonathan Upton looks at why parties to a development agreement need to be aware of the general principles applying to good faith clauses.

Introduction

In recent years it has become increasingly common for parties to a development agreement to agree to act towards one another with “good faith”.  The meaning and extent of the obligations on the contracting parties imposed by such clauses is often difficult to ascertain.  The purpose of this article is to consider a number of cases in which good faith clauses, implied and express, are discussed and identify the general principles that apply to development agreements.

Good faith in English contract law

It has long been said that there is no general doctrine of “good faith” in English contract law.  In Interfoto Picture Library Ltd v Stiletto Visual Programmes Ltd [1989] 1 QB 433, having alluded to the fact that in most legal systems outside the common law world, the law of obligations recognises and enforces an overriding principle that in making and carrying out contracts parties should act in good faith, Bingham LJ famously said: “English law has, characteristically, committed itself to no such overriding principle but has developed piecemeal solutions in response to demonstrated problems of unfairness.”

Three main reasons have been given for the hostility towards a doctrine of good faith.  First, the preferred method of English law is to proceed incrementally by fashioning particular solutions in response to particular problems rather than by enforcing broad overarching principles.  Second, English law is said to embody an ethos of individualism, whereby the parties are free to pursue their own self-interest not only in negotiating but also in performing contracts provided they do not act in breach of a term of the contract.  Third, the fear that recognising a general requirement of good faith in the performance of contracts would create too much uncertainty: there is concern that the content of the obligation would be vague and subjective and that its adoption would undermine the objective of contractual certainty to which English law has always attached great weight.

Express terms: what does “good faith” mean?

A matter of contractual interpretation

Two preliminary observations are worth noting.  The first, and most important, point to emphasise is that like any question of interpretation of a contract, an express clause in a contract requiring a party to act in “good faith” must take its meaning from the context in which it is used: see Compass Group UK and Ireland Ltd (t/a Medirest) v Mid-Essex Hospital Services NHS Trust [2013] EWCA Civ 200 (“Compass Group”) at [109] and [150]- [151] and Faulkner v Vollin Holdings Limited [2022] EWCA Civ 1371 (“Faulkner”) at [147].

The second point is that when considering the interpretation and meaning of an express good faith clause in context, cases from other areas of law or commerce, which turn upon their own particular facts, may be of limited value and must be treated with considerable caution.  As Auld LJ explained in Street v Derbyshire Unemployed Workers’ Centre [2004] EWCA Civ 964 at [41]:

“Shorn of context, the words “in good faith” have a core meaning of honesty. Introduce context, and it calls for further elaboration. …  The term is to be found in many statutory and common-law contexts, and because they are necessarily conditioned by their context, it is dangerous to apply judicial attempts at definition in one context to that of another. “

In Faulkner, the Court of Appeal emphasised that it is not appropriate to attempt to analyse other cases, decided on other facts, in order to deduce a number of further “minimum standards” of conduct that a defendant must be taken to have agreed to comply with in every case in which a good faith clause has been used in a contract (disapproving the approach adopted by HHJ Klein in Unwin v Bond [2020] EWHC 1768 (Comm) which had been followed at first instance in Faulkner [2021] EWHC 787 (Ch)).  Whilst the concepts and ideas advanced in other cases might well be useful analytical tools in the process of interpretation of a particular contract, it is not appropriate simply to apply them in a formulaic way in every case, irrespective of the context and the other terms of the agreement in issue.

Acting honestly and not bad faith

It has been said that acting in good faith means simply not acting in bad faith.  In Manifest Shipping Co Ltd v Uni-Polaris Insurance Co Ltd [2001] UKHL 1, [2003] 1 AC 469 insurers alleged that shipowners had failed to observe “utmost good faith” (as required by s. 17 of the Marine Insurance Act 1906) in the presentation of a claim.  The Commercial Court judge, the Court of Appeal and the House of Lords all rejected that defence.  Their Lordships held that in the particular context the duty of utmost good faith required no more than that the insured should act honestly and not in bad faith.

In HIH Casualty v Chase Manhattan Bank [2003] UKHL 6 Lord Hoffman observed at [68]:

“parties contract with one another in the expectation of honest dealing … in the absence of words which expressly refer to dishonesty, it goes without saying that underlying the contractual arrangements of the parties there will be a common assumption that the persons involved will behave honestly.”

Good faith, however, is wider than behaving honestly.  In the landmark decision of Yam Seng Pte Ltd v International Trade Corp Ltd [2013] EWHC 111 (QB) Leggatt J (as he then was) said the duty extends to the observance of “standards of commercial dealing which are so generally accepted that the contracting parties would reasonably be understood to take them as read without explicitly stating them in their contractual document”.  Leggatt J considered that other epithets which might be used to describe bad faith include “improper“, “commercially unacceptable” or “unconscionable“.

In Faulkner, Snowden LJ reviewed the authorities and rejected the proposition that a contractual duty of good faith can only be breached by conduct that is dishonest.  He concluded at [241]:

“Depending on the contractual context, a duty of good faith may be breached by conduct taken in bad faith. This could include conduct which would be regarded as commercially unacceptable to reasonable and honest people, albeit that they would not necessarily regard it as dishonest.”

Fidelity to the bargain and “spirit of the agreement”

Another aspect of good faith which overlaps with the duty to act honestly and not in bad faith is “fidelity to the parties’ bargain”.  As Leggatt J explained in the Yam Seng case “The central idea here is that contracts can never be complete in the sense of expressly providing for every event that may happen.  To apply a contract to circumstances not specifically provided for, the language must accordingly be given a reasonable construction which promotes the values and purposes expressed or implicit in the contract.”

In Faulkner, Snowden LJ traced the origins and development of the concepts of “fidelity to the bargain” and “spirit of the agreement”.  Having reviewed many cases decided in this jurisdiction and in New South Wales, Snowden LJ saw “no sound juridical basis for saying that all of the same concepts should automatically be regarded as incorporated in a formulaic way whenever any contract governed by English law contains an express term requiring the parties to act in good faith”.  Rather, the concept of fidelity to the bargain or adherence to the spirit of the agreement could only operate to support the common purpose and aims of the parties as objectively ascertained from the express or implied terms of the contract.  Further, when interpreting a good faith clause, the court should not resort to “the spirit of the contract” to impose additional substantive obligations (or restrictions on action) outside the other terms of the contract. That is especially so where the contract is professionally and comprehensively drafted and contains an entire agreement clause.

An implied duty of good faith?

A decade has passed since Leggatt J’s landmark decision in the Yam Seng case.  In that time, the general law of implied terms in contracts has been comprehensively restated by the Supreme Court in Marks and Spencer plc v BNP Paribas Securities Trust Company (Jersey) Ltd [2015] UKSC 72; [2016] Q.C. 742 . That decision reaffirms the traditional approach that a term will not be implied into a contract unless, at the time the contract was made, a reasonable reader of it would consider the term to be so obvious as to go without saying or the term is necessary for business efficacy.

Excluded from that general approach are contracts of a particular type where, as a matter of law, a term is treated as being implied if not expressed, such as an obligation of fidelity in an employment contract or, as in Liverpool City Council v Irwin [1977] A.C. 239, a right to safe access to and egress from a flat let under a contract of tenancy.

In Yam Seng, Leggatt J implied an obligation of good faith into the distributorship contract as a matter of fact and not because the contract was a distributorship contract or, more generally, a “relational” contract:

“[131] Under English law a duty of good faith is implied by law as an incident of certain categories of contract, for example contracts of employment and contracts between partners or others whose relationship is characterised as a fiduciary one. I doubt that English law has reached the stage, however, where it is ready to recognise a requirement of good faith as a duty implied by law, even as a default rule, into all commercial contracts. Nevertheless, there seems to me to be no difficulty, following the established methodology of English law for the implication of terms in fact, in implying such a duty in any ordinary commercial contract based on the presumed intention of the parties].”

He continued:

“[142] In some commercial contexts the relevant background expectations may extend further to an expectation that the parties will share information relevant to the performance of the contract such that a deliberate omission to disclose such information may amount to bad faith English law has traditionally drawn a sharp distinction between certain relationships – such as partnership, trusteeship and other fiduciary relationships – on the one hand, in which the parties owe owner’s obligations of disclosure to each other, and other contractual relationships in which no duty of disclosure is supposed to operate. Arguably at least, that dichotomy is too simplistic. While it seems unlikely that any duty to disclose information in performance of the contract would be implied where the contract involves a simple exchange, many contracts do not fit this model and involve a longer term relationship between the parties in which they make a substantial commitment. Such ‘relational’ contracts, as they are sometimes called, may require a high degree of communication, cooperation and predictable performance based on mutual trust and confidence and involve 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 efficacy to the arrangements. Examples of such relational contracts might include some joint venture agreements, franchise agreements and long-term distributorship agreements. “

It is clear therefore that, while certain types of joint venture agreements may require the implication of such a term, in order to give them business efficacy, other types of joint venture agreements may not do so.

In Sheikh Tahnoon bin Saeed bin Shakhboot Al Nehayan v Kent [2018] EWHC 333 (Comm) Leggatt LJ again held that  the implication of an obligation to act in good faith was essential to give effect to the reasonable expectations of the parties, i.e. the term was implied in fact on the conventional approach.  In that case an oral joint venture had been agreed relating to the acquisition and operation of hotels, and part of the business was later demerged under a rudimentary framework agreement. The express terms were very limited, and yet the joint venture had been intended as a long-term collaboration requiring the cooperation and commitment of both parties. It was based on a strong personal friendship between them.  Leggatt J described agreement as a “relational” contract and held that, given the nature of the contract, the term would also have been implied as a matter of law.  In other words,  a particular type of contract, which may be called a “relational” contract, is one that will as a matter of law include an obligation of good faith.

What is a “relational contract”?

In Sheikh Tahnoon Leggatt LJ explained at [167]:

“[In Yam Seng] I drew attention to a category of contract in which the parties are committed to collaborating with each other, typically on a long-term basis, in ways which respect the spirit and objectives of their venture which they have not tried to specify, and which it may be impossible to specify, exhaustively, in a written contract. Such ‘relational’ contracts involve trust and confidence but of a different kind from that involved in fiduciary relationships. The trust is not in the loyal subordination by one party of its own interests to those of another. It is trust that the other party will act with integrity and in a spirit of cooperation. The legitimate expectations which the law should protect in relationships of this kind are embodied in the normative standard of good faith.”

In Bates v Post Office [2019] EWHC 606 (QB) Fraser J asked what the characteristics are that are expected to be present that will determine whether a commercial contract ought to be considered a “relational contract“. The Judge set out nine relevant factors, of which only the first was determinative, namely that there must be no express term of the contract that prevents a duty of good faith being implied.

In UTB LLC v Sheffield United Limited 2019] EWHC 2322 (Ch) Fancourt J explained the danger in using the term “relational contract” and declined to decide the issue by identifying and weighing likely indicia of a such a contract.  In his view, the question is whether a reasonable reader of the contract would consider that an obligation of good faith was obviously meant or whether the obligation is necessary to the proper working of the contract. The overall character of the contract in issue will of course be highly material in answering that question but so will its particular terms, as recognised by the principle that no term may be implied into a contract if it would be inconsistent with an express term.

Where are we now?

As Fancourt J explained in UTB LLC v Sheffield United Limited [2019] EWHC 2322 (Ch) at [196]:

“The law on this subject has evolved rapidly since the (as it now appears) landmark decision of Leggatt J in [Yam Seng]. However, the law has not yet reached a stage of settled clarity, nor is there binding authority, though there is a body of first instance decisions and dicta in the Court of Appeal that establish various principles.”

Those decisions suggest that, depending on the context, the courts may be willing to imply a term that the parties would deal honestly with one another but not the more onerous obligation that they would deal with one another in good faith (that being a more onerous obligation): see Wales (t/a Selective Investment Services) v CBRE Managed Services Ltd [2020] EWHC 16 (Comm) at [66]–[67].  The courts are likely to decline to imply such a term because it does not fit with the express terms of the contract or because of the arm’s-length nature of the relationship between the parties.  In an arm’s length commercial relationship the courts will generally incline against the implication of a good faith term and will put the onus on the parties to include an express term to this effect if they wish to be bound by such a duty: see Chelsfield Advisers LLP v Qatari Diar Real Estate Investment Co [2015] EWHC 1322 (Ch) at [80].

Conclusions

Although English contract law recognises no general principle of good faith, it has become increasingly common for parties to a development agreement to agree to such clauses.  In the absence of an express clause, it is now more likely that the courts will imply a duty to act in good faith, particularly where the parties have entered into a joint venture which is dependent upon co-operation between the parties.  The content and scope of the duty of good faith depends on its context.  Developers and landowners should not overlook the duty of good faith when taking decisions affecting a development agreement.

 

This article first appeared in Practical Law’s Property Litigation column.

If you would like more information, please contact Richard Powell.

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