Up to speed on good faith under English law? It’s never been more relevant

Bizar Male

Over the last few years, implied good faith, the Braganza duty and ‘relational’ contracts have become buzzwords not only in legal circles but also amongst business people. It’s not just academic – it’s relevant on a day-to-day basis for business people within the hotels and leisure sector doing English law deals, from negotiating management and franchise agreements through to the exercise of contractual discretions. Good faith under English law is evolving, and given the impact that COVID-19 is having on contract performance and behaviour, it’s never been more important to have a working understanding.

Below are some take-aways, primarily focused on implied good faith under binding contracts, concluding with drafting points and views on the wider COVID-19 climate.

Pre-contract and pre-renewal ‘good faith’

Pre-contract there is no implied good faith obligation under English law (Walford v Miles, Charles Shaker v Vistajet). But in the context of negotiation under binding agreements, change is underway. Sometimes parties to long term management agreements will leave certain terms (e.g. future minimum occupancy levels or development obligations) open with an ‘agreement to negotiate in good faith’ to agree the future obligations. Such obligations under an existing, binding agreement can be enforced and cannot simply be circumvented: the key factor is that there should be clear machinery under the agreement governing the negotiations. It is worth noting that ‘good faith’ negotiations to renew a contract do not impose a commitment to renew, but they may involve imposing a binding obligation to engage in the process.

Good faith under binding business to business (B2B) agreements

Under English law governed B2B agreements there is no general concept of good faith, but the concept has arisen in certain areas. When it applies, good faith can have various meanings and practical impacts depending on the type of agreement and ‘type’ of good faith.

The three types are, at a glance:

1. Express good faith clauses

The impact of good faith clauses depends on the wording read in context; in general, these can be enforced (a powerful and authoritative example of this is Manifest Shipping v Uni-Polaris, 2001).

They are more likely to ‘bite’ in short agreements than in long agreements, as they cannot be applied in a way that undercuts the express provisions of an agreement or express termination rights. As many hotel management and franchise agreements are long and very detailed documents, such clauses are not particularly common but do sometimes appear. They have mostly been successfully invoked in court cases to provide a contractual remedy for dishonest behaviour, or for behaviour which flouts the so-called ‘common purpose of the parties’ under a contract. The key take-away is don’t treat such good faith clauses as just ‘aspirational’: be careful about their scope and their drafting, and weigh up using them in the context of specific clauses, or even as a generic clause applicable to the agreement as a whole.

2. Implied good faith in the exercise of ‘genuine discretion’ under a contract

This sets a minimum standard of ‘rationality’ in process and outcome of exercising a ‘genuine discretion’ under a contract (the Braganza duty, named after the leading Supreme Court case).

Many clauses under long term contracts such as management and franchise agreements give one party the power to decide a matter which affects the other during the contract lifetime – under certain circumstances these are regarded as so-called “general discretions” under the law. The nature of the relationship including the “balance of power” under the agreement is “a factor” to be taken into account in deciding whether to imply this term (see Cathay Pacific v Lufthansa Technik, 2020).

In hotel management or franchise agreements, it is not unusual for the franchisee to have to seek approval from the brand owner before being permitted to take certain steps or actions such as assignment of the contract; approval of a change in the shareholding of the manager/franchisee or being involved in a competing business.

Where the clause confers such a genuine discretion on the brand owner, there is now a well-established implied contract term that such a decision must be taken in good faith, and not in a way which is “arbitrary, capricious, irrational or perverse”. The shorthand for this implied contract term is “rationality” – this implied term imposes a legally binding, minimum objective standard on the decision-making process of the brand owner.

This implied term operates like an implicit, legally enforceable ‘control mechanism’ on decision-making. The courts are not saying they are better placed to decide the matter than the parties themselves, nor are they seeking to “second-guess” contracting parties – but they do wish to ensure that contractual rights are not ‘abused’.

BUT: there is a major caveat in this area of law: where the contract confers what the law regards as an ‘absolute contractual right’, as opposed to a ‘genuine discretion’, the implied term of good faith is irrelevant – i.e. it is simply not ‘engaged’. One example of this is the right to terminate a contract for convenience.

3. Implied good faith in the context of so-called ‘relational’ contracts

This originates from the landmark case of Yam Seng (2013); ‘relational contract’ is used to describe an agreement underpinned by a relationship of trust e.g. franchise agreements and joint ventures, rather than being a one-off transaction e.g. sale of product or loan of money. Many English courts have grappled with the concept since then, with varied outcomes depending upon the agreement in question and its business context.

BUT: even if a contract is ‘relational’, and it is likely that many management and franchise agreement are due to their long-term nature and obligations to co-operate with each on a regular basis, does an implied term of good faith necessarily follow? There has been some push back and in some cases courts have said no – arguing that the process of implying terms should follow the traditional methodology (‘is it necessary to make the contract work and so obvious it goes without saying?’ etc.) and that there should be no special rule for implying terms into ‘relational’ contracts.

Where this good faith term applies it imposes certain minimum standards of behaviour on the parties, i.e. “The parties must refrain from conduct which in the relevant context would be regarded as commercially unacceptable by reasonable and honest people. Transparency, cooperation and trust and confidence are, in my judgment, implicit within the implied obligation of good faith” – Fraser J. in Bates v Post Office, 2019

Overall legal take-aways

  • Keep the Braganza good faith principle and the ‘relational’ good faith principle distinct in your mind.
  • Even where a contract is relational, the Braganza duty won’t apply to all its clauses e.g. not to clauses which confer absolute contractual rights.
  • Where good faith does apply, it does not require a party to subordinate its interests to those of the other party: i.e. it is not equivalent to the concept of ‘fiduciary duty’’ or a ‘duty of loyalty’.
  • The emergence of ‘good faith’ has increased the importance of prudent record-keeping generally and especially to demonstrate how ‘genuine discretions’ were exercised.
  • The way in which an organisation exercises its ‘genuine discretion’ has to be assessed in the context of that organisation and its resources – e.g. there is a difference between the ‘process standard’ expected of a small independent hotel and a global multinational brand.

Some drafting points

The value of the phrase ‘in our sole and absolute discretion’

It appears from leading cases that clause wording like this in relation to a decision will not oust the Braganza implied term (the Braganza judgment itself was about a decision which BP Shipping was entitled to take “in its opinion” – this power seemed, at face value, to be completely unfettered, yet it was held to be subject to the implied term).

The impact of an Entire Agreement clause?

The implied term of ‘relational’ good faith is not avoided by means of an Entire Agreement clause (this has most recently been confirmed in the High Court in UBB v Essex (2020), and this conclusion is based on various earlier authorities).

Whether it is possible to avoid the impact of relational ‘good faith’ by drafting

For example:

Including an express clause that good faith does not apply at all: this would be very hard to sell in negotiations especially in a long term management agreement where the parties are committing to work together for 10+ years, but you could consider:

  • Using ‘good faith’ language in some clauses, combined with a catch-all statement that ‘good faith’ shall not apply otherwise than where it is specified.
  • Defining what good faith means – as what the courts think good faith means is evolving and likely to change further in the future.
  • Including an express statement that the contract is not relational (again this may be more difficult in a long term contract).

We are discussing the above options and others with our clients.

The wider COVID-19 climate

COVID-19 is having a huge impact on the hotel and leisure industry and on contract performance and behaviour.

At a policy level, the UK Cabinet Office published non-legally binding guidance in May 2020 on ‘responsible contract behaviour’ addressed to all commercial players, and some commentators (with overstatement) have compared this guidance to introducing a general duty of good faith.

The English law principle of ‘good faith’, with its safeguards and limitations, is not a panacea or solution for all the tough challenges which COVID-19 presents – e.g. good faith, even where it is implied, does not empower courts to make contracts fairer in general, or to rewrite deals, and it does not, as a general matter, oblige parties not to exercise valid contractual rights.

How parties maintain operational continuity and sustain relationships – especially where hotels are forced to close and traveller numbers are unlikely to return to pre-COVID levels for the next 12 months at least – will remain, first and foremost, a commercial challenge – involving adaptability and taking the long-term view. The real question is, do you want to continue to operate with your chosen partner be they brand owner, franchisee, landlord or manager in the long-term? If the answer is yes, then the parties need to work together to overcome the short term challenges for the long term mutual good.

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