Most of your business dealings may run smoothly and you and the other parties to your business arrangements may act honestly and in good faith but what is your position if another party in such an arrangement acts in bad faith, as a result of which you end up with something you were not expecting?
Under English contract law there is no general duty of good faith and so you will generally need to ensure that your agreement, whether written or verbal, provides you with all the protection you will need, explicitly. Clearly, a written agreement is much better than a verbal agreement as there is then much less scope for arguing about what was actually agreed.
Notwithstanding this lack of general duty, a duty of good faith can still apply in a number of ways:
- The parties can agree in the contract that they will act in good faith towards each other.
- There is still a duty of rationality under which a party to a contract must exercise a discretion contained in the contract in good faith and not erratically, inconsistently or unpredictably.
- There may still be a duty of honesty.
The problem with these is that they either require to be thought about beforehand and provided for (in relation to an express provision in the agreement to act in good faith) or they are of limited application.
Adding something into the contract is, therefore, the best approach but the words used are also important to get right. In general, a claim of breach of duty of good faith requires proof of bad faith but not necessarily dishonesty. However, where a party has behaved dishonestly; that will usually mean they have acted in bad faith.
Before considering how to word such an obligation, it is worth mentioning some specific situations where a duty of good faith may still be implied.
Insurance contracts (therefore insurance policies) place a duty of utmost good faith on the insured when entering into the arrangement to disclose to the insurer all material facts and not make material misrepresentations. Failure to do this may enable an insurer to void the policy (if the non-disclosure induced the insurer to issue the policy) and to refuse to pay out on a claim. The duty applies on inception of the policy and on renewal. From August 2016 new laws changed the duty of disclosure to a ‘duty of fair presentation’ for business related insurance. However, this is still broadly a duty of disclosure but by another name.
Some relationships create a fiduciary duty between the parties, for example a trustee appointed to deal with a trust or an agent appointed to act for a principal. While a fiduciary duty is not technically the same as a duty of good faith, it still requires a higher standard of behaviour and means that the person, under the fiduciary duty, must put his or her interests behind those of the other party.
Having said it is best to write a duty of good faith into an agreement, we now need to consider how this should be worded.
The first point to make on that is that it needs to be clear what parts of the contract it applies to and you should bear in mind that if it is a reciprocal duty, then it applies to you too! Of course, it may be that you only want it to apply to a particular part of the contract rather than all of it – perhaps some specific obligations of the other party. Therefore, care should be taken to consider every aspect of the contract and where a duty of good faith may be relevant to you.
The courts do not generally differentiate between a ‘duty of good faith’ and ‘duty of utmost good faith’ but what does this phrase mean in practice? In general terms, this means adhering to the spirit of the contract, observing reasonable commercial standards of fair dealing, being faithful to the agreed common purpose.
What an express duty of good faith means will depend on the circumstances of the case and the commercial context but could include some of the following examples of how it has been interpreted in the past:
- Preventing action that frustrates the purpose of the agreement
- Requiring the disclosure of material facts to the other party
- Prohibit knowingly lulling the other party into a false belief
Bear in mind that an express duty of good faith is unlikely to:
- Cut across hard contractual rights
- Require a party to give up its commercial interests
However an express duty is worded, it is important to consider whether it is possible to tighten up the other contract provisions, rather than rely too much on some general duty, which may be capable of different interpretation by each party. An express duty of good faith is not a substitute for clear, detailed and thorough contract terms.