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Good faith’s relationship with the relational contract – new guidance
English law has traditionally placed very strict limits on implying duties of good faith in contracts. However, it has been allowed in certain types of contracts said to have a “relational” nature. Recent decisions in the High Court have explored this topic and provide useful examples of when the court will imply such terms and, more often, when the court will not.
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Published 22 April 2020
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Robin Henry
Partner - Head of Dispute Resolution Services
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What is a relational contract?
A relational contract in this context is one that has implied good faith obligations.
The concept of and conditions for generally implying terms into a contract (other than by legislation) is firmly cemented in English law by Marks and Spencer plc v BNP Paribas [2015] UKSC 72. For a term to be implied, a reasonable reader of the contract at the time the contract was made would have to consider the implied term ‘so obvious as to go without saying or to be necessary for business efficacy.’
The concept of a relational contract was articulated by Leggatt J in Yam Seng v International Trade Corp Ltd [2013] EWHC 111 (QB), a case involving a distribution contract. Such contracts ‘may require a high degree of communication, cooperation and predictable performance based on mutual trust and confidence and involve expectations of loyalty which are not legislated for in the express terms of the contract but are implicit in the parties’ understanding and necessary to give business efficacy to the arrangements. Examples of such relational contracts might include some joint venture agreements, franchise agreements and long-term distributorship agreements.’
What is not a relational contract?
In many cases where a party has sought to have good faith obligations implied into an agreement, the court has rejected the arguments presented.
In Morley v The Royal Bank of Scotland plc [2020] EWHC 88 (Ch) the claimant (a property developer) argued that the agreement with the bank was a relational contract and the bank was under an implied duty of good faith. However, the court held that there existed no relational contract on the facts. Instead the contract was ‘an ordinary loan facility agreement’. Though the claimant sought to rely on Yam Seng and other cases, the court spent relatively little energy explaining the decision to reject the claimant’s position.
In UTB LLC v Sheffield United Limited [2019] EWHC 2322 (Ch), the court applied the test from Marks and Spencer, namely ‘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.’
In UTB v Sheffield, the court explicitly narrowed the concept of a relational contract to mean precisely the sort of contract which necessitates the implication of good faith obligations. This case involved an investors and shareholders agreement. The court held that the contract, which was ‘carefully drafted’, worked well without implying good faith obligations. The defendant’s argument that good faith obligations were implied as a matter of law (because the agreement was similar to a joint venture and therefore relational) was rejected.
The definition of relational came into play again in TAQA Bratani Ltd v Rockrose UKSC8 LLC [2020] EWHC 58 (Comm), a case involving the purported termination of the defendant’s role as an operator within a joint operating agreement. In this case, the court was content to view the contracts in question as being at least arguably relational in a broad sense. However, obligations of good faith could not be implied in respect of termination as this power was absolute within the contract.
New Guidance
There has been further guidance recently in the case of Bates v Post Office [2019] EWHC 606 (QB). This case involved a dispute between the Post Office and its subpostmasters. The court accepted that this was an issue of relational contracts. It held that the Post Office’s rights to terminate the contracts were governed by implied obligations of good faith.
Fraser J provided a non-exhaustive list of characteristics found in relational contracts:
- There must be no specific express terms in the contract that prevent a duty of good faith being implied into the contract;
- The contract will be a long-term one, with the mutual intention of the parties being that there will be a long-term relationship;
- The parties must intend that their respective roles be performed with integrity, and with fidelity to their bargain;
- The parties will be committed to collaborating with one another in the performance of the contract;
- The spirit and objectives of their venture may not be capable of being expressed exhaustively in a written contract;
- They will each repose trust and confidence in one another, but of a different kind to that involved in fiduciary relationships;
- The contract in question will involve a high degree of communication, co-operation and predictable performance based on mutual trust and confidence, and expectations of loyalty;
- There may be a degree of significant investment by one party (or both) in the venture. This significant investment may be, in some cases, more accurately described as substantial financial commitment;
- Exclusivity of the relationship may also be present.
Conclusion/Comment
The guiding characteristics set out in Bates may provide a useful reference point for parties that seek to present their contracts as relational. However, it remains to be seen whether the court will be persuaded by such an approach in future cases. The court may prefer a simpler two-step approach, implying a term because it is so obvious that it goes without saying or is necessary for business efficacy, as stated in Marks & Spencer and used in UTB. The approaches of Bates and UTB are not mutually exclusive. Nonetheless, it seems likely that even if parties’ contracts match the characteristics of Bates, they will still need to pass the overarching test from Marks & Spencer.
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Good faith’s relationship with the relational contract – new guidance
English law has traditionally placed very strict limits on implying duties of good faith in contracts. However, it has been allowed in certain types of contracts said to have a “relational” nature. Recent decisions in the High Court have explored this topic and provide useful examples of when the court will imply such terms and, more often, when the court will not.
Published 22 April 2020
Associated sectors / services
Authors
What is a relational contract?
A relational contract in this context is one that has implied good faith obligations.
The concept of and conditions for generally implying terms into a contract (other than by legislation) is firmly cemented in English law by Marks and Spencer plc v BNP Paribas [2015] UKSC 72. For a term to be implied, a reasonable reader of the contract at the time the contract was made would have to consider the implied term ‘so obvious as to go without saying or to be necessary for business efficacy.’
The concept of a relational contract was articulated by Leggatt J in Yam Seng v International Trade Corp Ltd [2013] EWHC 111 (QB), a case involving a distribution contract. Such contracts ‘may require a high degree of communication, cooperation and predictable performance based on mutual trust and confidence and involve expectations of loyalty which are not legislated for in the express terms of the contract but are implicit in the parties’ understanding and necessary to give business efficacy to the arrangements. Examples of such relational contracts might include some joint venture agreements, franchise agreements and long-term distributorship agreements.’
What is not a relational contract?
In many cases where a party has sought to have good faith obligations implied into an agreement, the court has rejected the arguments presented.
In Morley v The Royal Bank of Scotland plc [2020] EWHC 88 (Ch) the claimant (a property developer) argued that the agreement with the bank was a relational contract and the bank was under an implied duty of good faith. However, the court held that there existed no relational contract on the facts. Instead the contract was ‘an ordinary loan facility agreement’. Though the claimant sought to rely on Yam Seng and other cases, the court spent relatively little energy explaining the decision to reject the claimant’s position.
In UTB LLC v Sheffield United Limited [2019] EWHC 2322 (Ch), the court applied the test from Marks and Spencer, namely ‘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.’
In UTB v Sheffield, the court explicitly narrowed the concept of a relational contract to mean precisely the sort of contract which necessitates the implication of good faith obligations. This case involved an investors and shareholders agreement. The court held that the contract, which was ‘carefully drafted’, worked well without implying good faith obligations. The defendant’s argument that good faith obligations were implied as a matter of law (because the agreement was similar to a joint venture and therefore relational) was rejected.
The definition of relational came into play again in TAQA Bratani Ltd v Rockrose UKSC8 LLC [2020] EWHC 58 (Comm), a case involving the purported termination of the defendant’s role as an operator within a joint operating agreement. In this case, the court was content to view the contracts in question as being at least arguably relational in a broad sense. However, obligations of good faith could not be implied in respect of termination as this power was absolute within the contract.
New Guidance
There has been further guidance recently in the case of Bates v Post Office [2019] EWHC 606 (QB). This case involved a dispute between the Post Office and its subpostmasters. The court accepted that this was an issue of relational contracts. It held that the Post Office’s rights to terminate the contracts were governed by implied obligations of good faith.
Fraser J provided a non-exhaustive list of characteristics found in relational contracts:
- There must be no specific express terms in the contract that prevent a duty of good faith being implied into the contract;
- The contract will be a long-term one, with the mutual intention of the parties being that there will be a long-term relationship;
- The parties must intend that their respective roles be performed with integrity, and with fidelity to their bargain;
- The parties will be committed to collaborating with one another in the performance of the contract;
- The spirit and objectives of their venture may not be capable of being expressed exhaustively in a written contract;
- They will each repose trust and confidence in one another, but of a different kind to that involved in fiduciary relationships;
- The contract in question will involve a high degree of communication, co-operation and predictable performance based on mutual trust and confidence, and expectations of loyalty;
- There may be a degree of significant investment by one party (or both) in the venture. This significant investment may be, in some cases, more accurately described as substantial financial commitment;
- Exclusivity of the relationship may also be present.
Conclusion/Comment
The guiding characteristics set out in Bates may provide a useful reference point for parties that seek to present their contracts as relational. However, it remains to be seen whether the court will be persuaded by such an approach in future cases. The court may prefer a simpler two-step approach, implying a term because it is so obvious that it goes without saying or is necessary for business efficacy, as stated in Marks & Spencer and used in UTB. The approaches of Bates and UTB are not mutually exclusive. Nonetheless, it seems likely that even if parties’ contracts match the characteristics of Bates, they will still need to pass the overarching test from Marks & Spencer.
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- Commercial Contracts
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Robin
HenryPartner - Head of Dispute Resolution Services
Specialising in Banking & financial disputes, Commercial disputes, Corporate recovery, restructuring & insolvency, Financial regulatory and Personal insolvency
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