As you were! Duty of good faith not implied into English law contract.

baconIt is a while since IP Draughts has seen the English Court of Appeal dismiss so comprehensively the contractual analysis of a High Court judge.

Nearly a year ago, IP Draughts reported on a case in the English High Court,  Compass Group UK and Ireland Limited (trading as Medirest) v Mid Essex Hospital Services NHS Trust [2012]  EWHC 781 (QB), which was heard before Mr Justice Cranston.

The decision in the High Court

chocmousseThe case was fascinating for the light it threw on how a hospital procurement manager behaved in a “challenging” manner with a supplier of catering services.  The contract included a provision for “service failure points” – effectively fines – for non-compliance with service standards.  According to Cranston J, the procurement manager deducted an “absurd” amount for minor failures.  For allowing a chocolate mousse to be in a fridge one day after its use-by date, the supplier was fined £84,540.  By the time the contract had come to an end, the fines had amounted to over £700,000.

Cranston J held that the hospital’s behaviour was in breach of a duty of good faith under the contract.  In particular:

In my view the Trust’s material breaches of contract, including the obligation to cooperate in good faith, constituted a serious and continuing breach of its critical obligations, which went to the heart of what was meant to be a long term contract requiring cooperation… After many months of complaints it had refused to accept that its approach was fundamentally flawed.  So there was a repudiatory breach.

The case raised a number of interesting contract law points, but this posting will focus just on the issues of whether a party is required to act in good faith and not in an “arbitrary, capricious or unreasonable manner”.

By way of background, the extent to which national courts imply obligations of good faith into contracts varies between jurisdictions.  Civil law jurisdictions tend to make good faith an important part of the obligations of contracting parties.  US laws focus on this subject to a lesser extent. English law is at the far end of the spectrum, with no general principle of good faith in contracts; however, English case law in recent years has started to nibble away at the absolutist position, and IP Draughts had viewed Cranston J’s decision as further developing the law in this area.

The decision in the Court of Appeal

In essence, the Court of Appeal has rejected Cranston J’s push towards more general obligations of good faith and reasonableness in the operation of contracts, and has reasserted the traditional approach of the English courts.

Jackson LJ, who gave the lead judgment in the Court of Appeal, dealt with the issues in two main stages: (1) was there an implied term to act reasonably (and if so, was there a breach of that term), and (2) was there a breach of an express obligation of good faith that was contained in clause 3.5 of the contract?

Implied duty to act reasonably

Exercising Caprice

Exercise with Caprice

Jackson LJ reviewed the case law on the question of whether, when a party has a discretion, he must exercise that discretion in a way that is not arbitrary, capricious or unreasonable.  He concluded that those cases deal with the situation where a party can choose from a range of options and when doing so they should act in a reasonable way.  In the present case, there was no range of options.  Rather, there was a calculation to be made as to the number of service failure points to be “awarded”.  This calculation might be done correctly or incorrectly, but it was not a matter of discretion.  Therefore the case law on the exercise of discretion was not relevant.  There was no need to imply any term that the hospital should act reasonably.  If the hospital calculated the points incorrectly, the supplier could challenge the calculation through a dispute resolution mechanism.

Thus, Jackson LJ firmly rejected the idea of any general obligation on a party to act reasonably in a long-term contract.

Contractual duty of good faith

The clause in question read as follows:

3.5 The Trust and the Contractor will co-operate with each other in good faith and will take all reasonable action as is necessary for the efficient transmission of information and instructions and to enable the Trust or, as the case may be, any Beneficiary to derive the full benefit of the Contract.

caesuraIn the words of Jackson LJ: “The first sentence of clause 3.5 contains a jumble of different statements, set out in an incoherent order. It has different possible meanings, depending upon where one places the caesuras and what imaginary punctuation one inserts.”

So, where should one stick the caesuras? [Please don’t interrupt, Mr Pettifog!]

According to counsel for Medirest, the clause should be interpreted as if punctuated in the following way:

The Trust and the Contractor:

(1) will co-operate with each other in good faith; and

(2) will take all reasonable action as necessary:

(a) for the efficient transmission of information and instructions; and

(b) to enable the Trust or, as the case may be, any Beneficiary to derive the full benefit of the Contract.

Whereas counsel for the hospital trust argued for the following interpretation:

The Trust and the Contractor will co-operate with each other in good faith and will take all reasonable action as necessary:

(1) for the efficient transmission of information and instructions; and

(2) to enable the Trust or, as the case may be, any Beneficiary to derive the full benefit of the Contract.

(For contract drafters, the lesson is obvious: put in numbering and indentation, and the ambiguity disappears!)

Thus according to the supplier, the obligation of good faith was a general one that applied to all aspects of the parties’ interactions under the contract.  Cranston J had agreed with this interpretation.

According to the hospital trust, the obligation of good faith was not a general one, and was limited to acting in good faith in respect of the purposes described in items (1) and (2).  Jackson LJ agreed with this interpretation.

tramway signJackson LJ also rejected a submission by counsel for the supplier, that there was an implied duty of good faith under the contract, and that clause 3.5 should not be interpreted in a way that reduced that implied obligation.  In Jackson LJ’s view there was no general duty of good faith in contracts, except in certain special categories of contract; in his words, “if the parties wish to impose such a duty they must do so expressly.”

In IP Draughts’ view, Jackson LJ was too brief and dismissive in his discussion of whether there was an implied duty of good faith.  This is an important point for contract drafters and case law in recent years has suggested a trend towards implying such a duty.  IP Draughts seems to recall that an entire book has been written about good faith in English law contracts.

It is instructive to read the judgment of Lewison LJ on this point.  Lewison LJ agreed with the conclusion and reasoning of Jackson LJ but added some brief comments of his own.  At paragraph 141 of the judgment, Lewison LJ commented:

In effect the judge has implied a term that makes it a breach of contract to misinterpret the contract.  In my judgment it is not generally a breach of contract merely to assert rights which the contract does not confer.

Beatson LJ, the third of the Court of Appeal judges in this case, commented briefly (at paragraph 154) that in a detailed contract of this kind:

…care must be taken not to construe a general and potentially open-ended obligation such as an obligation to “co-operate” or “to act in good faith” as covering the same ground as other, more specific, provisions, lest it cut across those more specific provisions and any limitations in them.

The overall conclusion that IP Draughts draws from the Court of Appeal’s judgments is that aggressive and uncooperative behaviour by a contracting party does not breach any general contractual duty under English law.  There is no general obligation on the parties to a long-term contract to work together in a reasonable way.  IP Draughts hopes that the case is appealed to the Supreme Court and that we can hear Lord Neuberger and his colleagues’ views on the developing law in this area.

The old guard versus the new?

Finally, please indulge IP Draughts for airing the scurrilous thought that this is a contest between judicial personalities.

The judge in the case, Cranston J, has a distinguished commercial law pedigree.  According to Wikipedia, after undergraduate degrees in Australia, he obtained an LLM from Harvard, and both a DPhil and a DCL from Oxford.  He was an academic lawyer for many years, including two stints as a professor of commercial law at the London School of Economics.

He was a Labour Member of Parliament 1997 to 2005, and was  the Solicitor General of England and Wales from 1998-2001.  Thus, he had a relatively short political career (8 years) compared with his distinguished career as an academic lawyer and cannot fairly be dismissed as a political judge.

Mmm… someone with these credentials should be able to analyse a contract and apply English law to it in an appropriate manner, you might think.  Yet several features of this CV make IP Draughts think “outsider”.  He was born and grew up in Australia, he was a Labour Party politician, and he was an academic. The vast majority of English judges are former practising barristers.  [Good grief, says Mr Pettifog. An Aussie, a socialist and a university teacher!  Is there nothing to be said in the man’s favour?]*

Senior judges say they want to open the judiciary to a wider range of talented people, and they sometimes cite academia as a place they might look for this diversity.  The experience is not always a comfortable one.  The example of Baroness Hale shows that academics-turned-judges can – how can one put this delicately – act as useful grit in the oyster of judicial life.

The practice of referring to junior army officers as "Ruperts" is said to be based on Prince Rupert

The practice of referring to junior army officers as “Ruperts” is said to hark back to Prince Rupert, who led Cavalier forces in the English Civil War

By contrast, when IP Draughts thinks of Sir Rupert Jackson, who gave the lead judgment in the Court of Appeal, he thinks “Establishment figure”.  Rightly or wrongly, he doesn’t think “contract law guru”.

So, can the overturning of Cranston J’s contractual analysis be fairly regarded as a senior member of the Establishment stamping down on a bumptious outsider?  Unfortunately the theory doesn’t stack up, as the other two judges in the Court of Appeal agreed with Jackson LJ’s conclusions.

IP Draughts would have much preferred Lewison LJ, who was one of those other two judges, to have given the lead judgment on a case about contract interpretation, but it was not to be.  Lewison LJ is a former Patents Court judge and the distinguished author of a practitioner text book, Interpretation of Contracts, that IP Draughts greatly admires.

frog in a wellSlowly, English law is developing a concept of good faith in contracts, but at times it seems to be “two steps forward, one step back“.  The Court of Appeal’s judgments in this case feel like one step back, although they are probably better characterised as rejecting Cranston J’s step forward.

______________________________

* The rest of the IP Draughts team dissociates itself from Mr Pettifog’s inappropriate remark.  An appointment has been made for him to receive remedial diversity training from the firm’s Equality and Diversity Officer, Dr Sonja Konscientz, pursuant to Chapter 2, IB(2.2) of the SRA’s Code of Conduct 2011.  Let us hope he keeps the appointment this time.

11 Comments

Filed under Contract drafting, General Commercial

11 responses to “As you were! Duty of good faith not implied into English law contract.

  1. Reblogged this on IP Draughts and commented:

    Too much focus on personalities in this golden oldie, says Mr Pettifog. And no-one should criticise the saintly Baroness Hale, incoming President of the UK Supreme Court!

  2. vrkoven

    On the politics of appellate review in the UK, I can only quote Francis Urquhart: *you* may say such a thing, but *I* couldn’t possibly comment.

    As to the duty of good faith, from a US perspective this reads differently from a duty to act reasonably. What most US jurisdictions require is that a party to a contract not exercise discretion in a way that defeats the reasonable expectations of the parties at the time the contract was signed. The goal is to enhance, not diminish, the security of expectations that lies at the heart of why the law upholds contracts. A legal regime that countenances “gotchas” whereby a party can defeat the essence of the bargain does no favors for the rule of law.

    That said, when a contract specifies clear criteria for performance, the duty of good faith has little, it seems to me, to do with whether a party has fulfilled them or not. Sometimes course of performance can be an interpretive tool, and doctrines like waiver and laches can affect enforceability, but by and large if the contract says X, then a party ought to have a hard time claiming that Y is good enough.

    • Vance, I loved the original House of Cards, and look forward to seeing the US version when it becomes available without subscription.

      When writing the post, I had to stop myself from jumbling up good faith with reasonableness. They are from different gene pools and the CA discussed them separately. In the CA’s view, neither legal concept assisted the supplier.

      Your comments seem to focus mostly on reasonableness in the exercise of a discretion. Is there any implied term under US laws requiring parties o a long term contract to cooperate?

      • vrkoven

        I don’t think there is, and I’ve always been leery of terms in contracts requiring cooperation, as something dangerously vague. The only level of cooperation that rises to an implied term is, as I’ve said, the obligation not to defeat the reasonable expectations of the other party based on the terms of the agreement itself. And, under the circs, it would appear that the CA had the better argument that, given the detailed performance measurements, the supplier’s reasonable expectations were that it would be measured in accordance with them.

        Once clause in the contract, had it been material to the dispute, might have necessitated consideration of the duty of good faith:

        “…it shall be the duty of the Contractor to provide the Services to the Contract Standard which in all respects shall be to the satisfaction of the Trust’s Representative.”

        If Medirest had performed entirely in accordance with the objective criteria, and yet had its performance rejected by the Trust under this clause, there might be more of a case for breach of good faith. That, however, wasn’t the case: Medirest had screwed up its performance under the objective criteria. To paraphrase Mae West, good faith had nothing to do with it.

      • [I have to reply to Mark because there’s no link to reply to VRKoven (Vance?)]

        Apropos of the language, “…it shall be the duty of the Contractor to provide the Services to the Contract Standard which in all respects shall be to the satisfaction of the Trust’s Representative”:

        1. I’ve sometimes appended language along the lines of: “[to the satisfaction of the Trust’s Representative], with reference solely to the wishes and interests of the Trust’s Representative, and without regard to any putative standard of good faith or fair dealing.”

        (This of course will likely engender pushback from the other side — and who knows how a given judge or appellate panel might react to such language.)

        2. Another possibility is to phrase it as “… to the _reasonable_ satisfaction of the Trust’s Representative,” and to couple it with the following:

        2.1 A micro-arbitration clause: Any dispute about reasonableness is referred to a neutral for fast-track evaluation, either binding or non-binding. (Possible language: http://www.oncontracts.com/general-provisions/#ENERequirement )

        2.2 If one party isn’t happy with the neutral’s evaluation and that evaluation is non-binding, the unhappy party can still challenge the evaluation in court [or arbitration if there’s an arbitration clause], BUT:

        (a) the challenge must be brought within, say, five business days;

        (b) the unhappy party must pay the other party’s attorneys’ fees even if the unhappy party prevails in court; and

        (c) the parties waive trial by jury (subject to the caveat that pre-dispute jury trial waivers are void in California, Georgia, and North Carolina).

  3. Tamsin Miley

    Don’t know how you spot this contractually critical stuff about chocolate mousse, Mark.

    Like Mr Toedt, I’m working on a presentation right now and would love to illustrate it with your “good faith” example. Mine is to university research administrators on contracting for research in an era of increasing international collaboration. I am often asked by research administrators whether it is really worth arguing over the choice of law clause. Your reminder that national courts take such a different approach to implying duties of good faith is therefore very timely. Thank you.

    Do you think these jurisdictional differences on implying good faith contribute to a difference in approach to negotiating the contract?

    • Thanks, Tamsin. You know I won’t bother you with trifles.
      I suspect there is a difference to negotiating, depending on the jurisdiction. Particularly the ability of the courts in civil code countries to “fill in the gaps”, ie decide on terms where the parties have dealt with a point only briefly or not at all. They do this by reference to general principles in local law, including good faith. This tends to make contracts shorter (and therefore the negotiation process shorter).
      By contrast, I suspect that the enthusiasm that people have for litigating in the US, jury trials, the lack of awards of costs, and other factors, all tend to make US contracts longer.

  4. GH

    I suggested “nearly getting away with it” since it seems that the breaching good faith argument was not mentioned by the contractor’s lawyers as a breach at the time (par 59) and the breaches which were brought to the hospital’s attention were corrected swiftly after the hospital “saw the errors of its ways” (par 60).

    It will be interesting to see if there is an appeal, and if successful, the tactic of later introduction of the breach of good faith argument will be seen to have been a correct one.

  5. GH

    I found this piece very interesting, not as someone in the legal profession, but as someone who has managed contracts of this type. Contracts with harsh payment mechanism deductions. When bidding for such contracts it is my experience that service providers very carefully calculate the likely consequences of failing to deliver all aspects of the contract. No contractor is infallible and the usual practice is firstly to negotiate the terms as hard as is possible during procurement. After the terms are negotiated, the contractor would add a “risk margin” for the likely level of deductions (or of course withdraw from the procurement exercise if he felt the risks were too high). In this case, the contractor is part of the Compass family which I believe is one of the largest providers of this type of service – certainly not the “little guy” you described in your article from last year.

    Now it seems to me there are two issues here:

    1/ – Should long term contracts be managed in “good faith” by the parties?
    2/ – In this case did the hospital managers breach “good faith”?

    I don’t think anyone would argue against having a good relationship between parties to such contracts, but if the contract lays down clearly what is to be delivered and what the consequences of failing to deliver are going to be, I can’t help but feel sorry for the hospital managers who are between a rock and a hard place here. If they don’t follow through with the contract remedies, they are likely to be vilified if a patient came to harm through, say, a breach of hygiene regulations.

    The breach of good faith argument looks like a clever tactic by a competent counsel and it nearly came off. Particularly when it seems like the contractor himself agreed he was in breach of a “threshold” or count of failures that enabled the hospital to terminate.

    I think the hospital should be congratulated on taking this to appeal and although, from reading your piece, it looks like the case is simply a theatre of war for legal arguments about changing contract law precedent, spare a thought for the poor old NHS which was just looking after its and its patients interests. It also looks like they have saved us taxpayers some money as well!

    • Several thoughts:
      1. Case precedents are not just an academic exercise for lawyers. If NHS managers don’t comply with the rules laid down in NHS contracts (including terms that the law implies) they will lose in court. That will cost the NHS.
      2. Part of the problem in this case was that actions were being taken without sufficient or any legal advice, or adherence to legal principles. As soon as the Trust took legal advice, they cancelled a large number of service failure points as excessive.
      3. It is surely not a good way to run a contract, that the only way a party can get paid the right amount is to start litigation. That is expensive for the NHS. In principle there should be a way of working that enables these disputes to be resolved in accordance with legal principles before getting to court. And it shouldn’t matter whether a supplier is big or small, the same principles should be applied.
      4. As for “nearly getting away with it”, whether one agrees with that characterisation or not, there is still, presumably, a chance that the case will be appealed to the Supreme Court.

  6. Great example, Mark — I’m going to use it as a quickie object lesson next week in my contracts-drafting course. Thanks for posting it.

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