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08 October 2013
In Mid-Essex Hospital Services NHS Trust v Compass Group UK(1) the Court of Appeal recently considered whether a contract contained a general duty of good faith or a duty limited to two specified purposes. The court held that the duty of good faith, in this instance, should be limited to the specified purposes, and commented on the argument that the contract implied a more general duty: "If the parties wish to impose such a duty they must do so expressly." This statement can be contrasted with the argument and views expressed earlier this year by the judge in Yam Seng Pte Limited v International Trade Corporation Limited (for further details please see "The steady rise of the implied contractual duty of good faith").(2) In that case, the judge considered that when following the standard English law approach to construction, a general duty of good faith should be implied into a commercial contract, noting that "in practice it is hardly conceivable that contracting parties would attempt expressly to exclude the core requirement to act honestly".
However, in its decision in Compass, the Court of Appeal did not endorse this view, and its decision appears to roll back from it. Nevertheless, the Court of Appeal did not expressly disapprove the decision in Yam Seng and it now looks as if the scene is set for further litigation exploiting the uncertainty as to whether, under English law, commercial contracts will be construed as containing implied duties of good faith on the contracting parties.
The dispute concerned a contract for the provision of services to two hospitals. Compass Group UK and Ireland Trading Ltd (trading as Medirest) entered into the contract with Mid-Essex Hospital Services NHS Trust on April 1 2008. Under the contract, Compass agreed to provide catering and cleaning services for the trust over a period of seven years. Clause 3.5 of the contract provided that:
"The Trust and the Contractor will co-operate with each other in good faith and will take all reasonable action as is necessary for the efficient transmission of information and instructions and to enable the Trust or, as the case may be, any Beneficiary to derive the full benefit of the Contract. At all times in the performance of the Services, the Contractor will co-operate fully with any other contractors appointed by the Trust or any Beneficiary in connection with other services at the Location."
From the outset of the performance of the contract, there were disagreements between the trust and Compass about the standard of the services provided by Compass. The trust went on to assert that by virtue of poor performance, Compass had accrued high numbers of 'service failure points' which, under the contract's payment mechanism, entitled the trust to withhold significant sums of money from the regular payments that it was making to compass under the contract. Relations between the trust and Compass deteriorated further and both parties purported to terminate the contract. The parties then agreed that termination would take effect on October 23 2009, without prejudice to whose termination of the contract was effective.
On July 23 2010 Compass issued a claim against the trust for damages for breach of the contract. Compass's claim was based on the premise that it had validly terminated the contract under Clause 28.4, which provided that Compass could terminate the contract on one month's notice in circumstances where the trust had committed a material breach of the contract.
The trust defended the claim and advanced its own counterclaim based on the assertion that Compass's purported termination of the contract was ineffective, and that it was the trust that had terminated the contract and was therefore entitled to damages.
At trial, the judge found that the trust's conduct had breached its obligation under Clause 3.5 to "co-operate… in good faith", and that although the trust had a right under the contract to award service failure points and make deductions from the regular payments due to Compass under the contract, this right was subject to an implied term that it would not be exercised in an arbitrary, capricious or irrational manner, and that the trust's actions had breached this term. However, the judge went on to find that both parties were entitled to terminate the contract and thus neither could succeed in their claims for post-termination losses. The trust appealed.
On appeal, the trust argued that the judge had been wrong to find that:
Lord Justice Jackson began his judgment by noting the importance of the finding by the judge at first instance that there was an implied term that the trust would not act in an arbitrary, capricious or irrational manner in exercising its rights under the contract's payment mechanism, because from this flowed his finding that Compass had breached the express provisions of Clause 3.5 that obliged it to act in good faith.
The trust argued that it had not failed to act in good faith because it did not have discretion in how it acted, but rather followed precise provisions under the contract for the calculation of service failure points and deductions which did not leave room for discretion, meaning that there could be no implied term. Compass argued that the contract did confer clear discretion on the trust.
The Court of Appeal found that although there was no discretion about the calculation of the service failure points and deductions, the trust did have discretion to 'award' the service points and to levy deductions, or to choose not to do so. However, this discretion was very different from that which in previous cases(3) had given rise to an implied term that a contracting party would not act in an arbitrary, capricious or irrational manner. Therefore, the Court of Appeal found that there was no justification for implying into the contract a term that the trust would not act in an arbitrary, capricious or irrational manner, overturning this element of the first instance decision.
As to the construction of Clause 3.5 and its reference to the parties cooperating in good faith, the Court of Appeal noted that the clause was a jumble of different statements, set out in an incoherent order. Compass argued that the clause should be construed as first providing a general duty for the parties to cooperate in good faith and secondly providing that the parties would take all reasonable action for the two stated purposes of:
The trust argued that the clause provided that the parties would cooperate and act in good faith and take all reasonable action as necessary for the two stated purposes. Accordingly, the duty to act in good faith was expressly limited to the two stated purposes.
In addressing this question, the Court of Appeal decision stated:
"I start by reminding myself that there is no general doctrine of 'good faith' in English contract law, although a duty of good faith is implied by law as an incident of certain categories of contract: see Horkulak at paragraph 30 and Yam Seng Pte Ltd v International Trade Corporation Ltd  EWHC 111 (QB) at paragraphs 120-131. If the parties wish to impose such a duty they must do so expressly."
Pausing there, as is discussed below, this statement – although citing Yam Seng – seems to undercut the conclusion reached in the judgment in Yam Seng.
The Court of Appeal went on to consider the arguments of both sides relating to the construction of Clause 3.5 and found that:
"The obligation to co-operate in good faith is not a general one which qualifies or reinforces all of the obligations on the parties in all situations where they interact. The obligation to co-operate in good faith is specifically focused upon the two purposes stated."
The Court of Appeal overturned this aspect of the judgment at first instance and determined that neither party had breached its obligations under Clause 3.5.
Ultimately, the Court of Appeal allowed the trust's appeal and held that it was entitled to pursue its claim for financial relief on the basis that it had terminated the contract, and that Compass's purported termination was ineffective.
Lord Justice Lewison and Lord Justice Beatson agreed with the lead judgment, but made a number of additional comments. In particular, Beatson also referred to the decision in Yam Seng, noting its emphasis that:
These considerations were also relevant to the interpretation of an express obligation to act in good faith, but Beatson went on to agree with the lead judgment that in this case the obligation to cooperate in good faith was determined by reference to the two purposes specified in the contract. The appeal judge also commented that:
"In a situation where a contract makes such specific provision, in my judgment care must be taken not to construe a general and potentially open-ended obligation such as an obligation to 'co-operate' or 'to act in good faith' as covering the same ground as other, more specific, provisions, lest it cut across those more specific provisions and any limitations in them."
Although the Court of Appeal did consider Yam Seng, it did not expressly endorse the conclusion reached by the judge in that case that:
"As a matter of construction, it is hard to envisage any contract which would not reasonably be understood as requiring honesty in its performance… a requirement is also necessary to give business efficacy to commercial transactions."
In contrast, the Court of Appeal clearly stated: "If the parties wish to impose such a duty they must do so expressly." The Court of Appeal went on to find that, contrary to the argument of Compass, the express duty to act in good faith set out in the Contract was not of general application and was limited to two stated purposes. This seems to conflict directly with the sentiment expressed in Yam Seng that a requirement to act honestly (which in the decision in Yam Seng was described as the core of the duty to act in good faith) was necessary in order to give business efficacy to commercial transactions and could (and following the reasoning in Yam Seng, likely would) be implied in a commercial contract. While conforming with the standard English law approach of contractual construction espoused in Yam Seng, the Court of Appeal's decision that there was no general duty of good faith encompassing all of the parties' obligations under the contract, and that the duty of good faith was limited to two specific stated purposes, shows that the conclusion effectively reached in Yam Seng – that "it is hardly conceivable that contracting parties would attempt expressly to exclude the core requirement to act honestly" – should be treated with some caution. On any analysis, the question of whether there is a general duty for contracting parties under English law to act in good faith has some way to run, and further litigation will be required to establish the law with any more certainty.
Undoubtedly, the decisions of both the Court of Appeal in Compass and the High Court in Yam Seng will be subject to further consideration and scrutiny in the litigation to come. Both have already been considered in a recent case, TSG Building Services Plc v South Anglia Housing Ltd.(4) In this case, the judge commented on the Yam Seng judgment, saying: "Because cases and contracts are sensitive to context, I would not draw any principle from this extremely illuminating and interesting judgment which is of general application to all commercial contracts." He went on to find that there was no implied term of good faith in the contract in question, because the parties had "gone as far as they wanted" by providing in the contract that they were to act reasonably and work together in a spirit of "trust fairness and mutual cooperation".
(1)  EWCA Civ 200.
(2)  EWHC 11 (QB).
(3) Such cases include Abu Dhabi National Tanker Co v Product Star Shipping Ltd  1 Lloyd's LR 397; Horkulak v Cantor Fitzgerald International  EWCA Civ 1287,  ICR 402; Socimer International Bank Ltd v Standard Bank London Ltd  EWCA Civ 116,  1 Lloyd's LR 558; and JML Direct Ltd v Freestat UK Ltd  EWCA Civ 34.
(4)  EWHC 1151 (TCC).
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