Download Implied Duty of Good Faith

Addisons Contractual Interpretation
Series – Implied Duty of Good Faith
Date
: 11 October 2012
Author/s : David Ferguson, Kristy Dixon
Introduction
In an earlier article, we looked at the meaning and usage
in commercial contracts of an express obligation to
“negotiate in good faith”. This article examines a
different aspect of the law on good faith, namely, when a
requirement of good faith will be implied into a contract.
We also identify the kind of obligations that good faith
imposes on contracting parties, and consider whether you
can expressly exclude these obligations from your
contract.
Is There an Implied Duty of Good Faith?
While this question has not been examined by the
Australian High Court,1 in NSW at least, the case law
indicates that a duty of good faith will be implied into
contracts in certain circumstances. However, when it has
been implied, courts have adopted different approaches to
defining what the duty entails. As indicated below, the
most common context in which a duty of good faith has
been considered is in relation to the termination of a
contract.
The Position in NSW
The implication of a contractual duty of good faith is often
traced to the judgment of Priestley JA in the seminal case
of Renard Constructions (ME) Pty Ltd v Minister for
Public Works.2 The case involved a building contract
clause that empowered the principal to take over the work
or cancel the contract upon the contractor’s default, if the
contractor failed to show cause as to why the contract
should not be terminated. Default occurred and, despite
the contractor’s response that it was willing and able to
complete the contract within a reasonable time, the
principal purported to terminate the contract and take
over the construction. The contractor sued for
repudiation of the contract, arguing that the principal's
conduct was unreasonable and lacking in “good faith”.
The NSW Court of Appeal held that the power conferred
on the principal under the termination clause must be
exercised reasonably. Priestley JA construed the clause as
containing an implied term that the principal would give
reasonable consideration to the question of whether the
contractor had failed to show cause and, if the principal
had reasonably concluded so, to the question of whether
any power should be exercised.3 His Honour also
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discussed in great depth the development of an implied
duty of good faith in the performance of contracts under
Australian law.
Handley JA held that there was a requirement of
reasonableness implied in the power to terminate, and
concluded that the principal’s decision, however honest,
was “objectively unreasonable and therefore an invalid
exercise of the power”.4
While Priestley JA in Renard regarded the duty of good
faith as an ad hoc term arising by implication based on
the facts, the majority of subsequent cases in NSW have
preferred to imply the duty as a matter of law. For
example, Giles J in Vodafone Pacific Ltd v Mobile
Innovations Ltd5 expressed the view that “an obligation
of good faith and reasonableness in the performance of a
contractual obligation or the exercise of a contractual
power may be implied as a matter of law as a legal
incident of a commercial contract”.
Good Faith in Other Australian Jurisdictions
In Esso Australia Resources Pty Ltd v Southern Pacific
Petroleum N L,6 Buchanan JA of the Victorian Supreme
Court appeared to accept that a duty of good faith could
be implied into some contracts. However, his Honour was
reluctant to conclude that this duty should be implied as a
matter of law, so as to apply to all rights and powers
conferred by a commercial contract.
On the other hand, in the recent case of Alstom Ltd v
Yokogawa Australia Pty Ltd & Anor (No 7),7 Bleby J of
the South Australia Supreme Court held that a duty of
good faith is implied into every commercial contract.
In another recent case, Trans Petroleum (Australia) Pty
Ltd v White Gum Petroleum Pty Ltd,8 the Western
Australia Court of Appeal examined whether a right to
terminate a franchise agreement for no cause upon notice
must be exercised in good faith. Without deciding the
point, the Court was prepared to accept that, while not
universally accepted, the law in Australia reflects an
implied duty of good faith in the context of commercial
contracts. However, while the parties to a contract may
be under an implied duty to cooperate in the performance
of obligations, this duty does not rise above the express
promises made by the parties. The Court ultimately
refused to imply a duty of good faith in this case on the
basis that it was inconsistent with the terms of the bargain
agreed upon by the parties, which allowed either party to
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terminate the agreement for any reason and without
regard to the rights and interests of the other party.
What Does Such a Duty Involve?
In Renard, Priestley JA observed that the reasonableness
required has much in common with the notion of good
faith. This approach received support in a number of
subsequent decisions of the NSW Court of Appeal.9 For
example, the Court in Burger King Corporation v
Hungry Jack’s Pty Limited10 held that, in the context of
the exercise of an express right of termination, the
implied requirement of good faith means that right must
be exercised reasonably.
A variety of other approaches have been developed and
adopted by different judges over time to define “good
faith”. For example, Finkelstein J in Garry Rogers
Motors Aust Pty Ltd v Subaru (Aust) Pty Ltd11 took the
view that the obligation of good faith required a party not
to act capriciously. Meanwhile, other approaches have
attempted to overcome the difficulties of defining good
faith by relying on the negative proposition that good faith
is “not acting in bad faith” (assuming that everyone knows
what “bad faith” is).
Another frequently cited approach is that of Sir Anthony
Mason, which suggested that the concept of good faith
includes the following elements:
•
an obligation on the parties to co-operate in
achieving the contractual objects (loyalty to the
promise itself);
•
compliance with honest standards of conduct; and
•
compliance with standards of conduct that are
reasonable having regard to the interests of the
parties.12
In light of the various approaches of defining the content
of the good faith obligation and the conceptual difficulties
associated with each approach, McDougall J of the NSW
Supreme Court made the following observations in a
judicial speech delivered in 2006:13
Thus, I do not think that it is fruitful to enquire, in
some a priori way, as to the content of the concept of
“good faith” in a contractual context. It is necessary
to look at the particular contract, to see what might
be comprehended as a particular expression of the
general concept of good faith, and then to enquire
whether that particular term, or a term having that
particular content, should be implied, or whether is
excluded by express terms or necessary implication
from them.
Can You Exclude Good Faith?
The simple answer is yes. Contracting parties are free to
agree that no term of good faith is to be implied.
Innovations to manage. In determining whether
Vodafone was restrained by any duty of good faith when
exercising this power, Giles J emphasised the use of the
term “sole discretion” and held that these words weighed
against an implied obligation of good faith and
reasonableness in the exercise of the power. His Honour
further observed that Vodafone was given control over the
acquisition activities of Mobile Innovations and could
exercise this control in accordance with its own interests
rather than those of Mobile Innovations. On this basis,
Giles J concluded that the implied obligation of good faith
was excluded from the contract in this case.
This approach was followed by Hammershlag J in the
more recent case of Solution 1 Pty Limited v Optus
Networks Pty Limited.14 The contract in this case gave
Optus the right to terminate for any reason and at any
time in its absolute discretion by giving 120 days’ notice.
While Hammershlag J was willing to imply an obligation
of good faith, his Honour concluded that such obligation
should be excluded in the particular circumstances as it
was inconsistent with Optus’ termination right being an
“absolute discretion” and a provision in the contract
which expressly excluded any implied terms.
What Happens if Good Faith is not Excluded?
Generally speaking, an implied duty of good faith has the
potential to turn what would otherwise be a proper
exercise of contractual right into wrongful conduct. For
example, if a court finds that an express right of
termination was in fact restrained by an implied duty of
good faith, an otherwise valid termination would become
repudiation if the good faith requirement was not
complied with. The terminating party can suddenly find
itself liable for substantial damages.
Practical Tips
When negotiating a contract, consider whether the
implied duty of good faith should be excluded. For
example, consider whether you want either party’s right of
termination or right to withhold consent to be subject to
any implied restrictions. If the answer is no, you should
exclude the implied duty.
Based on existing case law, there are at least two ways of
preventing a duty of good faith from being implied into a
contractual provision:
1.
expressly state that the power or right in question
may be exercised at the absolute discretion of the
party and include a provision in the contract that
excludes any implied terms; or
2.
“grasp the nettle” and exclude, in express words, any
obligation of good faith either in the performance of
all or certain specified contractual duties.15
In the Vodafone case, the contract provided that
Vodafone had the “sole discretion” to determine the
number of new subscribers it would provide to Mobile
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One Final Note
A topic of recent focus and debate among the legal
industry is whether the principles of good faith should be
enshrined in Australian legislation.16 If good faith
ultimately becomes a duty implied by statute, it will
certainly affect the way contracts are drafted and the
range of options available to contracting parties when
exercising their rights.
David Ferguson, Partner
Telephone +61 2 8915 1053
Email
[email protected]
Kristy Dixon, Senior Associate
Telephone +61 2 8915 1057
Email
[email protected]
The assistance of Chuanchan Ma, Solicitor, of Addisons
in the preparation of this article is noted and greatly
appreciated.
© ADDISONS. No part of this document may in any form or by any means be
reproduced, stored in a retrieval system or transmitted without prior written
consent. This document is for general information only and cannot be relied upon
as legal advice.
1
The High Court declined an opportunity in Royal Botanic Gardens and
Domain Trust v South Sydney City Council (2002) 240 CLR 45 to consider
the existence of an implied duty of good faith and dealt with the dispute
without needing to consider the issue.
2
(1992) 26 NSWLR 234 (hereafter Renard).
3
Above n1 at 257 per Priestley JA.
4
Above n1 at 279 per Handley JA.
5
[2004] NSWCA 15.
6
[2005] VSCA 228.
7
[2012] SASC 49.
8
[2012] WASCA 165.
9
See for example, Alcatel Australia Ltd v Scarcella (1998) 44 NSWLR
349; Burger King v Hungry Jack’s Pty Ltd [2001] NSWCA 187 (hereafter
Burger King).
10
[2001] NSWCA 187.
11
(1999) ATPR 41-703.
12
Sir Anthony Mason, “Contract, Good Faith and Equitable Standards in
Fair Dealing” (2000) 116 LQR 66 (being an article based on Sir Anthony
Mason’s Cambridge Lecture: ‘Contract and its Relationship with Equitable
Standards and the Doctrine of Good Faith’, The Cambridge Lectures, 1993
(8 July 1993)).
13
Justice Robert McDougall, ‘The Implied Duty of Good Faith in Australian
Contract Law’ on 21 February 2006.
14
[2010] NSWSC 1060.
15
Above n12.
16
See for example, Insurance Contracts Act 1984 (Cth) s 13.
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