Contract Law Good Faith

GOOD FAITH Whether a duty to act in good faith should be implied into a K? The duty should be implied on a case-by-case basis Argue by analogy Kirby J indicated his reservations about implying this duty into private contractual dealings Reasoned that the implied term will conflict with fundamental notions of caveat emptor that are inherent in CL conceptions of economic freedom. Appears to be inconsistent with the law in respect of the introduction of implied terms into written Ks which the parties have omitted to include Renard Constructions (ME) Pty Ltd v Minister for Public Works o Priestley JA first suggested that the notions of good faith, fair dealing and reasonableness may be relevant to contractual performance o Parties had entered into a construction K under which the principal was given certain powers upon the contractors default o On default, the principal could call upon the contractor to show cause why the principal should not exercise its powers under the K (for e.g. to exclude the contractor from the site and take over the work to be completed) o Issue: Whether there was an implied duty regarding how the principal should exercise its powers? o Held (Priestley JA): The principal had to exercise its powers reasonably. Priestley JA reasoned that:a) It was appropriate to imply a term that the principal act reasonably in exercising a discretion under the K to give business efficacy to the transaction b) The construction Ks of this kind were standard contracts and as such, a term could be implied as a matter of law in all construction Ks of that type c) Even if it were not possible to categorise construction Ks as a class of ks, an obligation of reasonableness may be implied as a matter of law into the K before the court. Priestley JA also considered whether a duty that parties act in good faith in carrying out contractual obligations should be implied into Ks generally. His Honour suggested that the time may be ripe for the imposition in all Ks of a duty upon the parties of good faith and fair dealing in its performance. His honour also said that the recognition of such a duty is in line with existing community standard. Other justices took a different approach:Handley JA: agreed that the principal had to act reasonably, but this duty arose as a matter of construction of the K. Meagher JA (dissented): did not accept that there was any basis upon which an obligation to act reasonably could be imposed on the K Court reasoned that America is not that different from Australia. Both have English CL tradition, but Australia changed it a little. America is the home of capitalism. If good faith prevents parties being able to protect their interest and it worked in America, why should we not have it Australia? Courts are prepared to imply a duty of good faith into a range of contract but it is NOT ENTIRELY CLEAR WHEN A DUTY OF GOOD FAITH WILL BE IMPLIED. Burger King Corp v Hungry Jacks Pty Ltd o Burger King (P) is an American company that is the franchisor of a fast food chain. o Hungry Jack (D) was, for many years, the sole franchisee in Australia. o There had been disputes between the parties for many years o D was using Ps system o P was irritated as they did not have control of the market o P wanted to buy over Ds trademark but D refused

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Parties attempted to resolve the disputes by entering into 4 agreements being:Settlement Agreement Development Agreement To facilitate the expansion of the franchise within Australia and that D agreed to open a specified number of new stores. D is to open 4 stores/yr for 5 yrs in WA. Service Agreement Registered User Agreement The agreement put some fairly onerous obligations on D. D had to arrange for at least 4 Hungry Jack stores to be opened in a year in WA for 5 years. When D signed the agreement, there was not a problem. D had been doing a deal with Shell Service Station, in which they will open D in the service station P did not notice at the time they signed the agreement, but when they found out about it, they started to subvert D P put a freeze under the agreements of the D franchising to any new franchises which meant that D had to do everything by themselves P also requested for all the financial info from D, flooding them with all the requests, and if D did not provide, they will be in breach of the K Finally, P started making complaints about the way D was operating the stores. They also withheld the operational manuals. Just sending random inspections saying D is not doing this and that, D was in breach of the K P then terminated the K. once they did that, they could put all the P in the Shell Service Stations (Ultimate aim) P purported to terminate the Development Agreement on the ground that D has breached this requirement. D argued that the Development Agreement included an implied term of good faith (that is, that the parties must act in good faith when exercising their rights under the contract), and that P had breached this term by denying the financial and operating approval to new restaurants, leading to D failing to meet the minimum stores requirement. D brought P to court arguing that they had terminated in bad faith Issue: Whether there was an obligation on the parties to act in good faith and reasonably in exercising powers under the Agreement, in particular the power to terminate? Held (NSW CA): Term of good faith and reasonableness was implied in the DEVELOPMENT K entered into between a franchisor and a franchisee P had breached and failed to comply with the term when purporting to terminate the lease Court held in favour of D In respect of the freezing of the agreement of D franchising, it could be done under the K, but P had to give D a 12 months notice Because P had not given D a 12 months notice, D was not in breach of his failure to open the new stores In respect of the requests of info, no reasonable franchisor would require the info P was requesting info with the ulterior motive of acquiring the Shell deal. Similarly with respect to the operations problems, P could not complain that D was not meeting the operations standards, if they are not telling him what he should be doing P was acting dishonestly. They were finding minor breaches, inducing breaches in order to get the shell deal The court had proceeded on the assumption that there may be such an implication in a commercial K.

In Alcatel Australia Ltd v Scarcella and Burger King Corp: o Held: 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 K.

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Although the CA Burger King Corp did imply duty of good faith and reasonableness in the commercial contract, but does it apply to all commercial K? This was later considered in Vodafone. Vodafone Pacific Ltd v Mobile Innovations Ltd o Vodafone was a service provider o Vodafone is the supplier and Mobile is the marketer o Mobile bought mobile telecommunication services from Vodafone and resold the services o Mobiles customers were connected to Vodafone network but were subscribers of Mobile o Mobile and Vodafone entered into an Agent Service Provider Agreement where Mobile will sell its customer base to Vodafone and Mobile will act as Vodafones agent to acquire new subscribers. o Mobile was also to provide management services to existing and new subscribers o They agreed that D will market the post paid telephone services o There are a number of ways D can get paid under the K o Acquisition services fee if D can get a whole heap of customers and do it at a limited costs, they will get a bonus There was a formula in the K that said there was a target of how many customers they had to get If the target exceed the acquisition costs, D will get their bonus P has to set a target, and up to D to reduce the costs o P decided to get out of the post-paid market and set a target at D o By doing this, P enabled themselves to prevent paying D under the K o D argued that P did that in bad faith, had an ulterior motive o Under the Agreement, Vodafone set target levels for subscriptions o Dispute arose when Vodafone inserted a nil target level into the Agreement o The agreement was based such that Vodafone will be more lucrative in provided services on prepaid basis rather than a post-paid basis o Held (NSW CA): Obligation to act in good faith and reasonably in exercising its powers specifically the power of determining target sales should be implied into the AGENT SERVICE PROVIDER AGREEMENT CA noted that duty of good faith at that stage does not apply to all commercial Ks (However, can argue that although not expressly endorsed by the NSW CA, it was assumed in a number of single Justice SC decisions that good faith is implied as a matter of law into all commercial Ks because they all have the common features and is a definable class of contractual relationship Commonwealth Bank of Australia v Spira / Softplay Pty Ltd v Perpetual Trustrees) o Significance of the case 1. NSW CA is clearly seeking to distance itself from any suggestion that Burger King should be viewed as authority for the proposition that an implied obligation of good faith is a legal incident of all commercial K. 2. Decision heralds the need for a careful consideration of contractual context where determining a class of K that should attract the implied obligations (to ensure the class selected is not too broad in its width or indeterminate) Given the caution urged by the NSW CA in Vodafone and the level of judicial caution that has been demonstrated in recent cases. There is now the adoption of a narrower class commercial Ks that are relational in nature rather than commercial contracts per se. Relational Ks are Ks that exist and evolve over long periods of time and is difficult to optimally allocate all risks at the time of contracting due to the possibility of unforeseen contingencies and also the common desire of one contractual party to retain a high degree of control. Only in relational commercial transactions that there is evidence of contractual parties having a reasonable expectation that certain business norm will prevail. Therefore, good faith should not be assumed to be implied in discrete commercial Ks. Article Good Faith in Australian Contract Law by Professor J W Carter and Dr Elisabeth Peden o Authors suggested that it appears that Australian K Law is rapidly moving towards 3 propositions:

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In most Ks, a requirement of good faith must be implied, at least in connection with termination pursuant to an express term of the K, but perhaps more generally Authors suggest that this proposition is a fallacy and has been misconceived. Because good faith is inherent in all aspects of K law and so there is no need for good faith term to be implied. Reasoned that every aspect of K law should be consistent with good faith because good faith is the essence of K. Authors gave 7 illustrations for the theory that contract law is redolent (suggestive of) with good faith. E.g The justification that revocation of a K must be communicated is because of honesty and fairness (good faith) (refer to page 8 to 9 of article for further illustrations) 2. It is an implied term of the K Authors argued that good faith is already inherent in contract doctrines Court is either implying a redundant term or implying a term which by definition must impose a more onerous requirement Such an implied term merely creates a default rule, and since that default rule already exists, it is also an illegitimate implication Contract is a mature institution, good faith operates without the need for an implied term Good faith term should not be implied since it is otiose 3. Implied term must be satisfied by a party who has acted: Honestly; and reasonably Article suggests that good faith is not an independent concept but a concept which must be taken into account when interpreting a K. It will depend on the particular rule or principle and on the terms of each K. Good faith means honesty. An honest conduct includes:1. Not acting arbitrarily or capriciously 2. Not acting with an intention to cause harm; and 3. Acting with due respect for the intent of bargain as a matter of substance not form Authors reject the proposition in Renard that good faith means reasonableness. They argued that it is inconsistent with what the parties have agreed. The show cause procedure in Renard expressly embodied good faith Good faith flows from interpretation and not implied term. It is not a new concept in our law (Carr v J A Berriman Pty Ltd) What good faith means? Courts have not offered much explanation Courts only emphasized that contracting parties need to act reasonably, at least when exercising express rights and discretions. It has not even been explained whether the implied term is promissory in nature. Authors argue that reasonableness must be seen as an element of honesty and not as an additional requirement (see page 13). They argued that honesty does not require a party to act reasonably Well established that good faith requires honesty (s.5(2) Sale of Goods Act 1923 (NSW) A thing is deemed to be done in good faith within the meaning of this act when it is in fact done honestly, whether it be done negligently or not) With regards to termination - Law is clear that a promise is entitled to terminate a K, provided a valid ground existed for the termination (Sunbird Plaza Pty Ltd v Maloney) - Imposition of an obligation requiring good faith and reasonable termination would be contrary to this basic approach Conclusion - Good faith term should not be implied since contract law already requires that - Academics have compared the Australian law with the law applied in the US, particularly the incorporation of good faith in the Uniform Commercial Code. Argue that Australian CL is not a code. It does not always provide a neat list of

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features, inclusions and exclusion. This does not mean that it is inferior. It merely requires lawyers and judges to explain what is inherent in our law. Good faith already exists, underlying and informing the whole framework of K Law Courts do not need to resort to manipulating or misapplying the tests for implying terms in order to incorporate good faith Rather, the modern K construction principles and how they operate should be approached.

WHAT IS GOOD FAITH? Case law said that the meaning to be attributed to the term depend on the context in which it is used (Automasters Australia Pty Ltd v Bruness Pty Ltd) To determine the meaning, courts will look at: Nature of the K Whether the particular term at issue concerns an obligation that must be performed or a power or discretion that may be exercised Features of the K as a while Absence of a meaning, good faith is regarded merely a slogan (Commonwealth Bank of Australia v Spira) As a preliminary point, Priestley JA in Renard suggests that there was no difference of substance between good faith and reasonableness. His Honour also commented that there was a close association between the terms unreasonableness, lack of good faith and unconscionability Greater practical assistance come from Sir Anthony Mason in Contract and its relationship with equitable standards and the doctrine of good faith which has been frequently cited in many cases such as Alcatel and Burger King Corp. He said that the concept embraced 3 related notions:1. Obligation on the parties to cooperate in achieving the contractual objects (loyalty to the promise itself); 2. Compliance with honest standards of conduct; and 3. Compliance with standards of conduct which are reasonable having regard to the interest of the parties (this is the most helpful limb. Does not mean that a person must subordinate their own interests to those of the other contracting party but that in pursuing their own interest, they must have regard to the legitimate interests of both parties in the enjoyment of the fruits of the K as delineated by its terms (Commonwealth Bank of Australia v Spira)

Fitzgerald v FJ Leonhart o Issue: If D has got the license, the contract could have been legally performed o Arguments:D had a duty to cooperate in achieving the objects of the contract Object is to dig holes, required to get a permit D in breach of the obligation to cooperate under the K, he did not get his permit *Pacific Brands Sport & Leisure Pty Ltd v Underworks Pty Ltd (2006) 149 FCR 395 (CB 17.23) o Case involving the KINGGEE and STUBBIES trademarks o The trademark was owned by a French company Savanas, who had the trade marks for all purposes o They licensed the trade marks to their subsidiary, Sara Lee, who then sub-licensed the trademark to D o It was not a full sub-license but the sub-license of the brand so KINGGEE and STUBBIES could be applied to underwears o Savanas sold the brand to P and they had to get the sub-license back o There was an assignment of the sub-license o When P acquired that interests, they told D that they were not happy to rely on their sub-license because there was no direct relationship, had to deal through Sara Lee o They wanted D to enter into a new sub-license with them o D refused because under the sub-lincense there were some condition that entitled Sara Lee to look at business plans etc

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Sara Lee was not a direct competitor but P was P was not happy and started to find minor faults with the performance of the sub-license When they found a few technical breaches, P terminated the sub-license D argued that the termination was in bad faith. They were terminated becase tey were forced into a direct relationship with P and they refused Held (Trial): Conduct of P was reprehensible being motivated as it was by bad faith Held (Appeal): Disagreed They looked beyond the motive and thought that P was relying on their strict contractual rights D should not have allowed the breaches to occur

Australis Media Holdings Pty Ltd v Telstra Corporation Ltd (1998) 43 NSWLR 104 o Involved a K to provide TV content o P was a media company that provides content and D was in process of setting up a cable TV network o D entered into a K with P for 25 years, for P to provide content for the network D was going to set up o 1 year into the K, P assigned its interest in the K to a 3rd party for them to provide content for D and D knew nothing about it o D argued that the K entered into was between them and P, not the 3rd Party o Held: The idea that P was going to provide the content was a benefit that D thought would flow from the K, but it was not actually enraptured in the K itself. There was nothing in the K that said the content had to come from P and no one else. Socimer International Bank Limited (in liquidation) v Standard Bank London Ltd [2008] 1 Lloyd's Rep 558; [2008] EWCA Civ 116 o 2 merchant banks entered into an arrangement in which they were trading with another o Some of the deals they were engaging in: currencies swaps, investing in debt security, investment vehicles o Issue: P went bust and could not meet the obligations under the C o It is provided in the K that if that happens, the liquid party can sell the assets which they hold on behalf of the company in financial trouble, but before selling, they have to set the valuation of those assets o In setting the value, did D had to act reasonably or just in good faith? o Difference in acting reasonably and in good faith was USD$14m o Held: The important thing is that parties retain the right to act in their own interests Not reasonableness in the notion there being some objective standards of the behavior of a reasonable person, but just have to act in good faith WHAT GOOD FAITH ISNT? It isnt: An obligation to negotiate Good faith meant loyalty to the K. if there is no K yet, should be meant to be loyal to your own interest. No restraint on your capacity to operate in your own interest An obligation to disclose information Can withhold whatever information unless it falls within the category of misrep. An obligation to subordinate your own interest A person has the right to act in his own interest

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Jobern Pty Ltd v Breakfree Resorts (Victoria) Pty Ltd (2008 o P is a property developer and D run the resorts o P and D entered into a K, whereby D is going to build the resorts and D will manage it o In the process of drawing up the heads of agreement, P got advice from their lawyers to get indemnity and warranties from D as to how they are going to operate the resorts o P told D if they did not provide that, they will not sign the agreement o Held: - All P was doing was to protect their own interests - Good faith can never extend to the point of taking away that right IMPLIED TERM OR INHERENT IN K LAW? Express Term: - Will be upheld - However, clause needs to be sufficiently certain in order to be upheld - In Breafree, obligation of good faith was struck out for it being uncertain, - E.g of a sufficient express term: parties agreed to act in good faith Arguments Term should not be implied as good faith is inherent in K Law To give business efficacy Refer to Good Faith in Australian Contract BP Refinery (Westernport) Pty Ltd v Shire Law by Professor J W Carter and Dr of Hastings, including the requirement that Elisabeth Peden. the term is necessary and not merely Good faith is the essence of every K, not an reasonable to imply. independent concept. Therefore, it is To protect a vulnerable party from exploitive unnecessary to imply such a term conduct that subverts the original purpose for Good faith arises from commercial which the contract was made. (Esso v construction of the K rather than implying a SPP) specific term Implied in fact: implied as a matter of business efficacy. Have to show that K cannot work without the obligation to act in good faith Implied in law: certain classes of Ks. Term should be implied

ROLE AND RELEVANCE Frustration Applies where it is impossible to perform a K Party can sue the other one in breach when it is unable to be performed Courts will uphold the idea of good faith and call the K to an end Remedies Performance Termination

*Renard Constructions (ME) Pty Ltd v Minister for Public Works (1992) 26 NSWLR 234 o Involved a construction K o The terms of the K were quite common to the terms of construction Ks o One of the terms provided that if there were a number of defaults by the contractor, the government could come in and take over the project. (show cause clause) o It also included a provision for extension of time o P applied a couple of extensions throughout the construction

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Part of the reason P needed the extension was because the work that was required to do depended upon the NSW Minister of Public Works to provide them with some stuff The problem arose when a guy in charge of running the project at the Ministers office quit The new project manager who came in thought that there were too many extensions of time, P was not doing their job and wanted to take over the project P sued D and argued D did not give them enough notice Also, the reason they were late was because D did not provide them with the stuff Held: Court agreed with Ps argument Ds project manager did not take sufficient time to look at the problem and made a rash decision Also, because he had not taken that step in reviewing, he had been acting in bad faith when he terminated, when the govt was the reason why P was late and failed to perform P was entitled to damages No other grounds except for breach of the obligation of good faith.

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