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24 September 2013
The English law of contract is well known for not having a general duty of good faith and the approach to dealing with good-faith situations in case law has been piecemeal, in line with the general development of common law. One of the main reasons advanced for this is the uncertainty that would arise if a duty of good faith were imported into contracts generally.
However, judgments in three recent cases have reignited the debate over whether English law recognises a general duty of good faith in commercial contracts, including franchise agreements and long-term distribution agreements. Franchisors and distributors should be aware of these developments and take caution before exercising contractual discretion, while bearing in mind that their longer-term relational contracts may be held to a high standard of performance, including a duty to disclose.
In a recent High Court case between Yam Seng Pte Limited and International Trade Corporation (ITC) concerning an exclusive distribution agreement to sell Manchester United toiletries across Southeast Asia, the judge held that a distribution agreement governed by English law contained an enforceable, implied obligation on the parties to act in good faith.
Subsequent to the Yam Seng case, the Court of Appeal heard a case between Mid-Essex Hospital Services National Health Service (NHS) Trust and Compass Group UK and Ireland Limited concerning the performance of an NHS catering contract and the ability of the NHS trust to award service failure points. Yam Seng was cited in the Court of Appeal's judgment, in which it rejected the first instance ruling that there was an implied term that required the NHS trust not to exercise a contractual discretion arbitrarily, capriciously or irrationally.
An even more recent High Court judgment, TSG Building Services plc v South Anglia Housing Ltd (May 8 2013), also cited Yam Seng, but followed the rationale of the Compass case, in which the judge ruled that an express good faith clause did not extend to acting reasonably when terminating the contract, and that there was not an implied duty of good faith that would restrict the parties' contractual right to terminate at any time.
If the Yam Seng judgment was an attempt to let the genie of good faith out of the bottle, the Compass ruling can be interpreted as the Court Appeal acting swiftly to try to push it back in. The more recent TSG Building Services case was noteworthy as the first opportunity to revisit the issue of good faith since Yam Seng, although the High Court's ruling in this case was closer in spirit to the Compass ruling.
Nevertheless, all three cases highlight a growing tendency to attempt to imply obligations of good faith into commercial contracts. This invites the question: if Yam Seng is more than a mere aberration in English case law, is it indicative of a slow but steady creep towards recognising a general duty of good faith in English law with regard to certain types of commercial contract?
In Yam Seng the judge recognised the "traditional English hostility" towards the doctrine of good faith, but stated that, to the extent that English law does not recognise this general duty, "this jurisdiction would appear to be swimming against the tide". This was evidenced by its introduction in the implementation of various specific pieces of European legislation and an increasing recognition of a general duty of good faith in other common law jurisdictions, such as the United States, Canada and Australia, and much closer to home in Scotland.
The judge argued that implying such a duty is no more uncertain than contractual interpretation – an implied term of good faith is to be determined objectively, based on the presumed intention of the parties to behave in good faith as a reasonable onlooker would assess it and given the relevant background context of the contract. It may extend to a duty to disclose information. This is consistent, he argued, with the case-by-case approach of common law jurisdictions and he made the point that an implied term can be modified by express terms in the contract.
The judge concluded by noting that contracts involving a longer-term relationship and substantial commitment require a high degree of communication, cooperation and predictable performance based on mutual trust and confidence. These expectations are rarely legislated for in the express terms of contracts, but are implicit in the parties' understanding, and are necessary to give business efficacy to such arrangements. Examples of 'relational contracts' included franchise agreements, joint venture agreements and long-term distribution agreements.
Compass demonstrated the Court of Appeal's willingness to defer to the express terms of a contract when assessing culpability for breach. The brief reference to Yam Seng in the Court of Appeal's judgment may itself be a thinly veiled and deliberate attempt to downplay the significance of the judge's comments and reaffirm the cherished certainty of express contractual terms.
In light of the Court of Appeal's judgment, it is far too early to say whether English law now has a general implied duty of good faith that applies to franchise agreements.
However, it is dangerous to disregard the views of a distinguished High Court judge as merely those of a 'lone rider'. The concept of good faith underpins many of the franchise-specific regulations that apply in jurisdictions across the world, and it may be that English law is "swimming against the tide", albeit valiantly, as it sticks to its common law traditions of developing principles in relation to these matters on a case-by-case basis. Indeed, the Australian government recently decided to swim with the tide and has accepted in principle the recommendation from the Wein review to legislate for a statutory general obligation of good faith as part of its Franchise Code. The Californian legislature narrowly voted down a similar proposal. Both examples illustrate an apparent desire on the part of some politicians, lobbyists and legal activists to use the concept of good faith as a means of addressing perceived imbalances in the commercial relationship between franchisors and franchisees, and it may be naïve to think that English law will be immune to similar developments.
One response to this ruling could be to look at franchise agreement boilerplates and consider excluding all implied terms and conditions, but this may conceivably lead to a franchisee asking if a franchisor is therefore intending to engage in commercially unacceptable behaviour. What is clear is that it is prudent for franchisors to take extra care, both when exercising in-term contractual discretions and when they consider the manner in which they provide pre-contractual disclosure (which is a requirement of membership for the British Franchise Association) and ongoing information to franchisees during the course of the relationship.
Businesses that operate corporate and franchise networks should ensure that there is a good two-way line of communication with their franchised network and carefully consider the implications of whether their supply chains are seen to operate transparently and fairly.
For further information on this topic please contact Gordon Drakes or Chris Wormald at Field Fisher Waterhouse LLP by telephone (+44 20 7861 4000), fax (+44 20 7488 0084) or email (firstname.lastname@example.org or email@example.com).
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