Principle of 'Good Faith' in Contract Negotiations

Should English law introduce a principle of a “good faith” in contract negotiations as other jurisdictions have done?

Over the recent years, literature has emerged that offers contradictory findings of whether the English law should eventually apply the principle of good faith in contracts as the other jurisdictions have done. In civil law systems, the principle of good faith is used as a tool for assessing and regulating the act of contracting parties. Broadly speaking, good faith is a concept of honesty, which means to act without any malice or the desire to defraud others[1]. It is important to note that the definition and the interpretation of the principle in each and every civil law is applied in a different manner. On the other hand, English law recognises no principle under which the parties must act their contractual duties in good faith. Nonetheless, there is a group of contracts which are known as contracts “uberrimae fidei” or contracts of “the utmost good faith” and also a limited class of fiduciary relationships in which the parties are under an obligation to disclose all the reasonable facts and information.[2] This essay will discuss the disposition of English law towards the principle of good faith and if the existence of the principle of good faith is vital. This will be seen, firstly by discussing the traditional hostility of English Law towards the principle, where today English Law stands, secondly by examining the French and Greek Civil Law in contrast to the English Law and eventually by considering the arguments in favor of the principle.

The doctrine of utmost good faith, also known by its Latin name “uberrimae fidei”, is a legal doctrine of contracts that requires contracting parties to act with honesty and not mislead or withhold information essential to the contract. As an exception to the general rule, the insurance contracts require the highest standard of good faith because the applicant often has more information about the risk that is being insured, than the insurer does; the principle of uberrimae fidei is used in order to reduce moral hazard. An example to illustrate is the medical insurances, in which the cover-up of a relevant fact regarding the history of health and illness issues will be a ground for the insurer to cancel the policy and disown liability. When information on a specific aspect is asked for in the proposal form, the prospective assured is bound to make a true and full disclosure of the information on subject. This duty extends only to facts that are known to the applicant and not to what he ought to have known. The opinion of the assured as to materiality of that knowledge is of no relevance.[3]In these contracts, due to their nature, there is an effort to maintain the trust between the parties by sharing information which may play a major role in the formation of the relation. Correspondingly, in fiduciary relationships, like employment, among the parties there must be a relationship of trust and confidence. The employer is entitled to the single-minded loyalty of his employee. The employee must act in good faith; he must not make a profit out of his trust; he must not place himself in a position where his duty and his interest may conflict; he may not act for his own benefit or the benefit of a third party without the informed consent of his employer.[4]But it must be noted, that in the above relations there is a close co-operation between the parties in contrast with commercial relations.

English contract law, traditionally, tend to have an antipathy to the notion of duty of good faith. In Interfoto Picture Library Ltd v Stiletto Visual Programmes Ltd [1989] QB 433, Bingham LJ noted that:

“In many civil law systems, and perhaps in most legal systems outside the common law world, the law of obligations recognises and enforces an overriding principle that in making and carrying out contracts parties should act in good faith. This does not simply mean that they should not deceive each other, a principle which any legal system must recognise; its effect is perhaps most aptly conveyed by such metaphorical colloquialisms as “playing fair”, “coming clean” or ‘putting one’s cards face upwards on the table’. It is in essence a principle of fair and open dealing…English law has, characteristically, committed itself to no such overriding principle but has developed piecemeal solutions in response to demonstrated problems of unfairness.”[5]

In addition, in Walford v Miles [1992] 2 AC 128, Lord Ackner denied to imply the principle of good faith citing that a “concept of a duty to carry on negotiations in good faith is inherently repugnant to the adversarial position of the parties when involved in negotiations”[6] and it is noted that each party is “entitled to pursue his (or her) own interests, so long as he avoids making representations”.

Consequently, from the aforementioned cases, the following conclusion is reached: that English law incline to treat each case separately and define on an incremental basis what constitutes “bad faith” instead of using a broad principle. Secondly, supported by the nature of commercial relations and by “an ethos of individualism” in which the parties are expected to chase their own interests and to bargain to obtain the best terms which they can for themselves, the principle of good faith is incompatible. Thirdly, it is considered that the principle of good faith is too broad and would generate too much uncertainty and unpredictability. English common law contract principles are well established and provide the legal community with key principles of certainty and predictability. Therefore, the application of this principle may cause problems regards to when would a duty of good faith arise and what would be its content, if good faith it is a subjective or an objective standard and if it should apply to all contracts or only in a non-commercial context where the need for certainty is less pressing.[7]

 Throughout the years, the concept of good faith is reappearing due to the decision of Leggatt J in Yam Seng Pte Ltd v International Trade Corp Ltd, in United Kingdom, and more currently in Canada, the decision of the Supreme Court of Canada Bhasin v Hrynew Ltd. The above cases are considered two of the most important decisions regarding the principle of good faith in which there is an effort to recognise this principle and to define its content. Analyzing and comparing these two decisions, it is interesting to observe the way in which they attempt to define the origin of its rules, the way in which it can be applied and the content of the principle.

  Detailed examination of the different approach of the definition of the aspects of good faith by Zhong Xing Tan (2017)[8] showed that in regard to the origins of the norms of good faith, Leggatt J referred to a diversity of sources of norms stating that “the relevant background against which contracts are made includes not only matters of fact known to the parties but also shared values and norms of behaviour”[9].Cromwell J followed the Leggatt J’s reference to a range of norms and mentioned that the commercial parties “reasonably expect a basic level of honesty and good faith in contractual dealings”[10] which is necessary to the proper functioning of commerce and this is not limited to longer-term relational contracts but includes more discrete transactional exchanges.[11]

 From the legal process perspective for effecting good faith, in Yam Seng, Leggatt J noted that while a duty of good faith is implied by law as an incident of certain categories of contract (contracts of employment and contracts between persons in fiduciary relationships), he doubted that English law has reached the stage where it was ready to recognise a requirement of good faith as a duty implied by law, even as a default rule, into all commercial contracts. However, he preferred to use an established methodology of English law for the implication of terms in fact, in implying such a duty in any ordinary commercial contract based on the presumed intention of the parties.[12]On the other hand, the court in Bhasin approached the topic by two steps: firstly, by recognizing that good faith contractual performance is a general organizing principle of the common law of contract which underpins and informs a variety of rules which recognize obligations of good faith contractual performance; and secondly by accepting a common law duty to act honestly in the performance of contractual obligations, applicable to all contracts.[13] This duty requires “parties not to lie or otherwise knowingly mislead each other about matters directly linked to the performance of the contract” and should be thought as a general doctrine of contract law that imposes as a contractual duty a minimum standard of honest contractual performance.[14]

 The mentioned article provides an overview of how they defined the content of the duty of honest performance in both cases. On the general concept of good faith, in Yam Seng, was underlined that “the test of good faith is objective in the sense that it depends not on either party’s perception of whether particular conduct is improper but on whether in the particular context the conduct would be regarded as commercially unacceptable by reasonable and honest people”.[15] However, in Bhasin endorsed a comparable test which requires subjective honesty but also couples it with objective reasonableness, by defining the organising principles of good faith as requiring parties to perform contractual duties “honestly and reasonably “.[16]On the standard of honesty, in the former was emphasised that good faith is sensitive to context and while there is a minimum or irreducible standard of honestly which prohibits deception in any situation, it is possible that the standard of honesty can be raised in certain circumstances. According to Leggatt J, honesty may prohibit conduct falling short of lie, such as evasiveness or silence in response to a request for information, or sometimes imposes a duty of disclose the true position where a party gives information to the other party knowing that is likely to rely on the information and afterwards discovers that the information was or has since become false.[17]In Addition he held that a duty of disclosure may be implied in “relational contracts” requiring a higher degree of communication, co-operation and predictable performance based on mutual trust and confidence (such as a joint venture agreements, franchise agreements, long-term distributorship agreements).[18]

As per Cromwell J, the minimum standard of honesty may be breached by actively misleading the other party in relation to performance of the contract and he echoed that there is no unilateral duty to disclose information and distinguished the dealership agreement in Bhasin from a contract of utmost good faith such as an insurance contract, which obliges the parties to disclose material facts.[19]

Last but not least, both cases maintain a distinction between honesty and other aspects of good faith. Good faith, apart from honesty, according to Yam Seng, could be described as fidelity to the parties’ bargain, which underlies implied obligations of co-operation. Moreover, he referred other instances which are under the broader umbrella of the implied duty of good faith, such as where a power is conferred by a contract on one party to make decisions which affect them both, where the consent of one party is needed to an action of the other and a term is implied that such consent is not be withheld and where there is an onerous or unusual contract term on which a party seeks to rely, which must be fairly brought to the notice of the other party if it is to be enforced.[20] Bhasin, on the other hand, held that there are three broad types of situations in which a duty of good faith performance of kind has been found to exist where the parties must co-operate in order to achieve the objects of the contract, where one party exercises a discretionary power under the contract and where on party seeks to evade contractual duties.[21]

  The existence of the doctrine of good faith in contracts constitutes a criterion to distinguish the common law from the civil law. The English law appears to stand out from the many other jurisdictions which recognise the existence of a doctrine of good faith.[22]Nevertheless, this contrast between English Law and other jurisdictions can be overstated. In this part of my essay will highlight some of the aspects of good faith, with specific reference to French, Greek in order to see whether good faith should or not keep the common and civil law divided.

  Severine Saintier, in his analysis of the French Civil Law in comparison to English Common Law, identifies many characteristics of the French Civil law which will be mentioned below.First of all, the French Civil law recognizes a general obligation on the parties to act in good faith during the performance of the contract. This is found in current article 1134 of the Civil Code.[23]Despite the absence of an expressed definition of the term “good faith”, the French Courts have used the notion as a tool to impose a certain standard of behaviour on the parties when performing their obligations. The notion of good faith is used as a rule of conduct which requires duties of the parties arising out of good faith, duties such as loyalty and co-operation. The requirements of co-operation and its context will vary depending on the nature of the contracts and is particularly strong in relational contracts while loyalty applies generally to all contracts. Good faith, from the perspective of co-operation, may requires a party not be selfish and take into consideration of the other’s interests but not to the extent to sacrifice its interests to those of others. In some circumstances, co-operation can require one party to protect the economic substance of the deal, but this is clearly constrained within a very particular context and particular class of contract and therefore limited in scope. As regard to the breach of good faith, it is assessed objectively, by making reference to good faith as a social norm as opposed to the good faith/bad faith of the contracting parties, there is no need to venture into the person’s state of mind since one can make reference to a reasonable person in same circumstances. Secondly, in France there is a legal requirement to use a contractual right in good faith and this is linked to the notion of the “abus de droit” since a party who fails to use a contractual right in good faith will be held to have abused it.”Abus de droit” is the exercise of a legal right in such a way to affect annoyance, or harm or injury to the other party. The link between good faith and abuse of right is strong since French case law accepts that a party with a contractual discretion can freely use it as long as it is not abused, i.e. used in bad faith. This link between good faith and “abus de droit” shows that the control by the French courts is over the arbitrary use of a contractual right. A party can still use a contractual right in a manner which is commercially advantageous to them, as long as it is done for a valid reason. The duty to act in good faith exists to negotiations, as well, in which abusive conduct or break-off of negotiations, in breach of the duty to act in good faith, may arise in two situations. Firstly, where one party knows that it will not be able to or never wanted to conclude the contract, but nonetheless lets the other party believe it will and that party incurs costs in relation to the negotiations. This situation is similar to the tort of deceit. Secondly, where one party abruptly breaks off negotiations without a legitimate reason, without prior notice and unilaterally. In one case, for example, parties had been negotiating for over a year, several proposals had been drawn and studies ordered and one party abruptly put an end to negotiations. This was considered abusive behaviour.[24]

   Emanuella Iftime, in her article about Greek Civil Law, demonstrated the influence that Greek Civil Law has from other legal systems, such as German. But as it is mentioned above every country use the notion in a different manner. The Greek Civil law imitated the German Civil law and adopted an accurate translation of the German good faith provision which was inserted at the same place within the structure of the code. In German law, the concept of good faith is governed by the German Civil Code in Article 242 which states that the debtor has to perform his obligation according to the requirements of good faith, taking customary practice into consideration. The corresponding article in Greek Civil Code is Article 288 which stipulates that the debtor shall be bound to fulfill the performance in accordance with the requirements of good faith taking also into consideration business usage. Even if the source of inspiration of Article 288 is German law, this article goes further than Article 242 of German Civil Code, stating that the debtor shall be bound to fulfill the performance in accordance with the requirements of good faith. In other words, this means that the contractual obligations are not to be only interpreted in good faith, but, moreover, each contractual obligation has to be adapted according to the demands of good faith. Therefore, the provision of Article 288 is mandatory law. Consequently, the observance of good faith in the performance of obligations cannot be limited or excluded in advance by a waiver or an agreement. According to Article 174 of Greek Civil Code such a waiver or an agreement is null and void.[25]

  Similarly, Penelope Aggalopoulou explored further the notion of good faith and how it is interpreted. She noted that the concept of good faith is a key principle in the law of obligations based on the directness and honesty. Everyone must act as a direct, honest, fair and sociable human being. The contracting party should not behave selfishly and antisocially. In regard to the definition of the term of good faith, there is a distinction between the objective and the subjective good faith. The definition of good faith in Greek Civil law is the same with objective good faith which it is used as a behavioral standard and is distinguished from subjective good faith. Subjective good faith refers to the contracting party’s inner disposition whereas objective good faith refers to the objectively honest behaviour of the contracting party, regardless of what his inner frame of mind might be. Objective good faith is basically founded on Articles 288, 281 and 200 of the Greek Civil Law. The provision of Article 288 of the Greek Civil Code that the debtor is required to fulfill his performance according to the requirements of good faith, taking also into account business usage, constitutes the guideline for the operation of every obligational relation. The provision of Article 281 of the Greek Civil Code decrees a general ban on the abusive exercise of all rights, [26]the exercise of a right should not be exercised in an unreasonable manner in order to harm others and in order to invoke abuse of right is only necessary to prove the objective harmful effects. In accordance with this provision, a right is considered to be abusive, for example, when the behavior of the beneficiary before the exercise of the right and the actual situation created in time do not justify the exercise of the right and make it incompatible according to the perceptions of the average social person[27].This principle has been inspired by the doctrinal developments in France, as it is analysed above, but it also in accordance with the German doctrine of Verwirkung.[28] The provision of Article 200 of the Greek Civil Law stipulates that the interpretation of contracts needs to be done according to the requirements of good faith, taking also into account business usage.[29] This provision, using objective good faith and business usage as criteria ,offers a balanced interpretation method where both the true will of the parties and the objective meaning of the contract wording are taken into account[30].Business usage is the sum total of practices prevailing in the business world. Business usage does not constitute an independent criterion of the behaviour of the transacting party; it simply plays an auxiliary role while the objective interpretation means that in every concrete case it should be examined what the average honest man could and should have gathered from a declaration of will by the declarant. Furthermore, it is important to be noted that Greek Civil code as the French Civil Code extend the duty of the contracting parties to act in good faith in the stage of negotiations in accordance with the article 197 of Greek Civil Code.

  The following conclusion can be drawn, on the one hand English Law hesitate to adopt the principle of good faith based on the argument that good faith is opposed to the nature of the commercial relations and on the other hand based on the analysis of the recent English case (Yam Seng) and the usage of this principle by French and Greek Civil Law can be noted that there are a number of rules of English law which conform with the notion of good faith.

  In the beginning of the essay, they have been mentioned the arguments why English law is so reluctant to apply the principle of good faith, in this part of the essay will discuss some arguments as a response to those arguments which support the existence of a duty of good faith.

The first is that, in the extent that contracting parties select to use the term “good faith”, both freedom of contract and nature of contracts suggest that effect should be given to their agreement and that the courts should not lightly conclude that an obligation to act in good faith is unenforceable.[31] This seems to be accepted by courts, for example in Compass Group UK and Ireland Ltd v Mid Essex Hospital Services NHS Trust[32], the court noticed that “there is no general doctrine of good faith in English contract law, although a duty of good faith is implied by law as an incident of certain categories of contract” and concluded that “if the parties wish to impose such a duty they must do so expressly”. Another example is the case of Emirates Trading Agency LLC v Prime Mineral Exports Private Ltd[33], in which the court held that a dispute resolution clause in an existing and enforceable contract which required the parties to seek to resolve a dispute friendly discussions in good faith and within limited period was enforceable. In the same, in Petromec v Petreleo Brasileiro SA Petrobas[34], the court declared that an express obligation to negotiate in good faith may be enforceable. Secondly, as regard to the preference of English courts to treat each case separately and on an incremental basis instead to apply a general principle in Yam Seng[35] was noted that there was “no need for common lawyers to abandon their characteristic methods” while the content of a duty is dependent on context and the proper interpretation of the contract. Moreover, in relation to “an ethos of individualism”, the purpose of good faith is not to limit illicitly the freedom of the parties to chase their own interests but to regulate the parties’ relations in such way that one party does not take advantage of the other. As regard to the claim that a duty of good faith is incompatible because will may cause uncertainty, Leggatt J denied this criticism on the ground that it was “unjustified” and there was “nothing unduly vague or unworkable about the concept” and that its application would involve “no more uncertainty than in inherent in the process of contractual interpretation”.[36]Last but not least, as it is referenced above, there are a number of rules of English law which are harmonized with the notion. A good example to demonstrate is that the parties must act honestly and fair and do not use their rights in a detrimental way and irrational. Additionally, the fact that English Law constitutes the minority to the extent that it declines to recognise the existence of the notion can lead to the argument that English law should follow the majority without denying its characteristics.

  In conclusion, through the analysis of the principle of good faith in English and Civil legal systems, an attempt has been made to see how necessary and important the application of the principle of good faith is in English contract law. In English common law, although there is an antipathy to this principle, in some current cases it has been accepted that the parties can use the term good faith as a specified conduct way to apply in their relations and it seems that the definition of good faith is aligned with many characteristics of the civilian legal systems, like French and Greek. In my point of view, although, there are many objections to this principle, like the uncertainty and the unpredictability, it would be effective to apply this principle as a guide to the parties to how they must act in contract dealings, in order to be morally obliged to not act precariously for the others’ rights. The main reason why I am inclined to believe that is, due to the nature of the contracts, the way that each party tries to achieve their ambitions, by using his dominant position, leads sometimes the other party to a very weak position.

References:

Cases:

Bhasin 2014 SCC 71; [2014]3 S.C.R 495

Compass Group UK and Ireland Ltd v Mid Essex Hospital Services NHS Trust Ltd[2013]EWCA Civ 200;[2013] B.L.R. 265

Emirates Trading Agency LLC v Prime Mineral Exports Private Ltd [2014] EWHC 2104; [2015] 1 W.L.R 1145.

Interfoto Picture Library Ltd v Stiletto Visual Programmes Ltd [1989] QB 433

Petromec v Petreleo Brasileiro SA Petrobas [2005] EWCA Civ 891

Walford v Miles [1992] 2 AC 128

Yam Seng [2013] EWHC 111 (QB); [2013] 1 All E.R. (Comm) 1321

Greek Cases:

No.301/2004, Areios Pagos Court

Books:

Ewan McKendrick, Contract Law, (11th Ed., Macmillan Education, 2015)

K.Kannan, Medical and Law, (Oxford Scholarship Online, 2014)

Penelope Agallopoulou,”Basic Concepts of Greek Civil Law”, (Ant. N. Sakkoulas, 2005)

Thomas Bingham, Good Faith in Sales (London, Sweet and Maxwell, 1997).

Journals:

Brodie Douglas, “The Employment Relationship and Fiduciary Obligations” (2012) Edinburgh Law Review, Vol.16 (2), p.199 [Peer Reviewed Journal]

Emanuella Iftime, “Good faith in Greek Civil Code”, in Journal of Public Administration, Finance and Law (2015)

Zhong Xing Tan, ‘Keeping faith with good faith? The evolving trajectory post-Yam Seng and Bhasin” in Journal of Business Law [2016]

Peter Rosher, “French Contract Law Reform”, in Business Law International, Vol 17, No 1, (January 2016)

Severine Saintier, “The elusive notion of good faith in the performance of a contract, why still a bete noire for the civil and the common law”, in Journal of Business Law (2017).

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[1] Sir Thomas Bingham, Good Faith in Sales, (London, Sweet and Maxwell, 1997).

[2] Ewan Kendrick, Contract Law,(11^th Ed., Macmillan Education, 2015)

[3] K.Kannan, Medical and Law,(Oxford Scholarship Online,2014)

[4] Brodie Douglas, “The Employment Relationship and Fiduciary Obligations” (2012) Edinburgh Law Review, Vol.16(2), p.199 [Peer Reviewed Journal]

[5] Interfoto Picture Library Ltd v Stiletto Visual Programmes Ltd [1989] QB 433

[6] Walford v Miles [1992] 2 AC 128

[7] Ewan McKendrick, Contract Law,(11th Ed., Macmillan Education, 2015)

[8] Zhong Xing Tan, ‘Keeping faith with good faith? The evolving trajectory post-Yam Seng and Bhasin” in Journal of Business Law [2016]

[9] Yam Seng[2013]EWHC 111 (QB); [2013] 1 All E.R. (Comm)1321 at [134]

[10] Bhasin 2014 SCC 71;[2014]3 S.C.R 495 at[60]

[11] Bhasin 2014 SCC 71;[2014]3 S.C.R 495 at[60]

[12] Yam Seng[2013]EWHC 111 (QB); [2013] 1 All E.R. (Comm)1321 at [131]

[13] Bhasin 2014 SCC 71;[2014]3 S.C.R 495 at[33]

[14] Bhasin 2014 SCC 71;[2014]3 S.C.R 495 at[73]-[74]

[15]   Yam Seng[2013]EWHC 111 (QB); [2013] 1 All E.R. (Comm)1321 at [144]

[16] Bhasin 2014 SCC 71;[2014]3 S.C.R 495 at[63]

[17] Yam Seng[2013]EWHC 111 (QB); [2013] 1 All E.R. (Comm)1321 at [141]

[18] Yam Seng[2013]EWHC 111 (QB); [2013] 1 All E.R. (Comm)1321 at [142]

[19] Bhasin 2014 SCC 71;[2014]3 S.C.R 495 at[86]-[87]

[20] Yam Seng[2013]EWHC 111 (QB); [2013] 1 All E.R. (Comm)1321 at [145]

[21]  Bhasin 2014 SCC 71;[2014]3 S.C.R 495 at[47]

[22] Ewan McKendrick, Contract Law,(11th Ed., Macmillan Education, 2015)

[23] Article 1134 of French Civil Code:  “Agreements lawfully entered into take the place of the law for those who have made them. They may be revoked only by mutual consent, or for causes authorized by law. They must be performed in good faith.”

[24] Peter Rosher, “French Contract Law Reform”, in Business Law International ,Vol 17 ,No 1, (January 2016)

[25] Emanuella Iftime, “Good faith in Greek Civil Code”, in  Journal Of Public Administration, Finance and Law(2015)

[26] Penelope Agallopoulou,”Basic Concepts of Greek Civil Law”,(Ant. N. Sakkoulas,2005)

[27]No.301/2004, Areios Pagos Court

[28] Emanuella Iftime, “Good faith in Greek Civil Code”, in  Journal Of Public Administration, Finance and Law(2015)

[29] Penelope Agallopoulou,”Basic Concepts of Greek Civil Law”,(Ant. N. Sakkoulas,2005)

[30] Emanuella Iftime, “Good faith in Greek Civil Code”, in  Journal Of Public Administration, Finance and Law(2015)

[31] Ewan McKendrick, Contract Law,(11th Ed., Macmillan Education, 2015)

[32] Compass Group UK and Ireland Ltd v Mid Essex Hospital Services NHS Trust Ltd[2013]EWCA Civ 200;[2013] B.L.R. 265

[33] Emirates Trading Agency LLC v Prime Mineral Exports Private Ltd [2014] EWHC 2104; [2015] 1 W.L.R 1145.

[34] Petromec v Petreleo Brasileiro SA Petrobas[2005] EWCA Civ 891 

[35] Yam Seng[2013]EWHC 111 (QB); [2013] 1 All E.R. (Comm)

[36] Yam Seng[2013]EWHC 111 (QB); [2013] 1 All E.R. (Comm)