Exercising rights and obligations under commercial contracts: Must you act in good faith?

Introduction

To what extent is the exercise of rights and obligations under commercial contracts subject to implied duties of good faith and/or reasonableness? The approach of English contract law, where freedom of contract is a central principle, means that the Courts will only recognise the existence of such implied duties in limited circumstances. The current state of play was recently considered by the Commercial Court in TAQA v RockRose [2020] EWHC 58 (Comm).  

Exercise of contractual rights and obligations in commercial contracts: The general position

The exercise of rights and obligations under a commercial contract is governed by the express and implied terms of the contract, properly construed. The principles of contractual construction and implied terms are detailed topics. To summarise some key issues: 

• In construing the terms of a contract, the starting point is the contractual language used and the factual and commercial context. Where a commercial contract uses unambiguous language, the Court must apply it, even if it results in a ‘bad bargain’ for a party. This principle is particularly relevant to complex and professionally drafted commercial contracts, where the parties are likely to have intended the contractual language to constitute a complete ‘code’.
• Terms will only be implied into commercial contracts if necessary to give the contract business efficacy or if the implied term is so obvious it ‘goes without saying’. The Court cannot imply a term which is inconsistent with an express term of the contract.
• The Court’s approach to the construction of a commercial contract and to the legal effect of the parties’ conduct in exercising contractual rights and obligations is an objective assessment. The parties’ subjective intentions, motivations and aims are generally irrelevant.  
• Rights and obligations under commercial contracts are not subject to general duties of good faith, nor duties to exercise them by an objectively reasonable standard. Rather, the question is whether the parties’ conduct is consistent with the terms of the contract.

Express or implied terms to act in good faith

Where a commercial contract includes an express term that the parties must exercise contractual rights and obligations in good faith, the Court will seek to give effect to the parties’ agreement. There is no general approach to such terms, rather “the content of a duty of good faith is heavily conditioned by its context” (Mid Essex Hospital Services NHS Trust v Compass Group UK [2013] EWCA Civ 200).

The circumstances in which the Court can imply terms to act in good faith into a commercial contract are generally limited, due to the Court’s textual approach to construction and implied terms. As noted by the Supreme Court in Marks and Spencer v BNP Paribas [2015] UKSC 72, “a term should not be implied into a detailed commercial contract merely because it appears fair”.

A potential exception, argued by the Defendant in TAQA v RockRose, is ‘relational contracts’. In a key case authority, Yam Seng v International Trade Corp [2013] EHWC 111, Leggatt J identified ‘relational contracts’ as contracts requiring a high degree of communication, co-operation and predictable performance, based on mutual trust and confidence. Typically ‘relational contracts’ involve the parties collaborating on a long term basis. Recent case authorities, such as Bates & Ors v Post Office Ltd (No 3) [2019] EWHC 606 (QB) suggest that where commercial contracts are ‘relational contracts’, the Courts are more likely to imply duties of good faith. 

However, this is not automatic. As the Court of Appeal held in Globe Motors v TRW Lucas Varity [2016] EWCA Civ 396, “an implication of a duty of good faith will only be possible where the language of the contract, viewed against its context, permits it. It is thus not a reflection of a special rule of interpretation for [relational contracts]”. In UTB LLC v Sheffield United Ltd [2019] EWHC 2322 (Ch), the approach taken to an alleged implied term of good faith was “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”.

TAQA v RockRose concerned the Claimants’ termination of the Defendant’s appointment as Operator under Joint Operating Agreements relating to North Sea oil and gas infrastructure. Under the relevant contractual provision, the Claimants were entitled to terminate the Defendant’s appointment on notice, without cause. A decision to exercise the provision required a prior vote of non-Operator participants, but was otherwise unqualified. In the litigation, the Defendant accepted that a valid vote had occurred.  However, it contended that the provision was, as a matter of construction and implied terms, subject to duties of good faith and/or an obligation not to exercise them capriciously or arbitrarily. The Commercial Court (HHJ Pelling QC) rejected this approach. It held that the provision was an “unqualified or absolute right to discharge the Operator” and the Claimants were not required to justify or give reasons for their decision to resolve to terminate the Defendant’s appointment.

Potential limits on the exercise of contractual discretion

Commercial contracts often confer on a party the ability to  exercise discretion (e.g. in relation to the valuation of an asset) or to form an opinion on relevant facts (e.g. whether some factual condition is fulfilled). A potential conflict of interest arises where the contractual decision maker’s exercise of discretion affects it as well as other parties. In such circumstances in Braganza v BP Shipping Limited [2015] UKSC 17, the Supreme Court found such a discretion to be subject to an implied term/duty that the discretion be exercised honestly and in good faith and not in an arbitrary, capricious or irrational way.  

Braganza was an employment law case where the imbalance of power between employee and employer was relevant to the Court’s decision. However, a Braganza duty is often argued to apply in contracts between commercial parties and has been applied in contexts other than employment.

In TAQA v RockRose, the Defendant also argued that the Operator termination provision was subject to a Braganza duty. The approach taken by the Commercial Court was straightforward and robust: “the Braganza doctrine has no application to unqualified termination provisions within expertly drawn complex commercial agreements between sophisticated commercial parties such as those in this case”. The Court identified a distinction between: (1) cases where the contractual party was required to make an assessment or choose from a range of options, taking into account the interests of both parties; or (2) cases were the party was entitled to exercise an absolute contractual right. It held that the Braganza duty has no application to the latter.

Conclusion

In commercial contexts, particularly complex agreements involving sophisticated parties, the approach of English law remains to uphold the express terms and contractual language which the parties have agreed. The Courts do not, as a general matter, seek to imply general duties to act in good faith, or of objective reasonableness, into commercial contracts. 

The circumstances in which such duties can be construed or implied remain limited. However, in light of recent case authorities which have developed this area of law, it may be expected  that such arguments will be deployed when disputes arise. Careful management of contractual communications and advance planning, involving legal advisors as appropriate, can mitigate this risk or at least improve the position in litigation.

While all cases are fact specific as to whether such implied duties arise, a touchstone arising from the authorities is whether the character of the contract and the parties’ relationship amounts to one of  trust and confidence.  Parties should be alive to this when drafting commercial contracts. Critically, remember that even if a contract/the underlying commercial context may suggest such a relationship, careful drafting can avoid or at least mitigate unintended consequences. The position remains that the English Courts will not imply terms which are at odds with unambiguous and express contractual language.