When parties enter into a contract, the parties often agree to ‘act in good faith’. But what does this mean? Below is a short summary of the position of ‘good faith’ in contracts in Australia.
What businesses need to know
There is no express principle in Australian contract law that good faith must form the basis of negotiating a contract. However, a particular clause in a contract requiring the parties to act in good faith can be carefully drafted and included, in which case such a clause may be effective. There are certain types of contracts where good faith plays a particularly important role such as in Australian Consumer Law (“ACL”). For example, the ACL requires that a person engaging in trade must does not act in a deceptive or fraudulent manner.
Implied obligation of entering a contract in good faith
Although the role of good faith in Australian contracts is unsettled, there are three propositions of implied good faith:
- in most contracts, good faith is implied when a party is exercising a right to terminate the contract;
- where it is present, the source of any implied good faith requirement becomes an implied term of the contract;
- the implied requirement of good faith is satisfied by a party when it has demonstrated that it has acted honestly and reasonably.
View of the Courts
In Masters Home Improvement Pty Ltd v North East Solutions Pty Ltd, the Victorian Court of Appeal threw light on the lack of certainty in the concept of good faith.
This case involved a dispute between Masters Home Improvements (“Masters”) and North East Solutions (“North East”). Masters was accused of breach of an express obligation in an Agreement to Lease, which required Masters and North East to act reasonably and in good faith to resolve differences that arose in relation to certain costs. Failure of the parties to agree on this issue led to party exercise of termination rights.
Masters terminated the agreement and North East brought proceedings, alleging that Masters had breached its obligation to act reasonably and in good faith. North East further argued that Masters terminated the Agreement to Lease for other commercial reasons rather than the breach to act reasonably and in good faith. The Trial Judge agreed with North East and held that Masters had breached the express obligation of good faith in the Agreement to Lease. The Court awarded North East $10.875 million in damages.
The Victorian Court of Appeal disagreed with the Trial Judge that the conduct of Masters constituted breach of good faith and, alternatively, found that:
- there was lack of sufficient basis that Masters had breached the express obligation of good faith; and
- the steps the Trial Judge stated that Masters should have taken to comply with the good faith obligation would take that obligation too far.
The Court of Appeal summarised the duty of good faith in the Agreement to Lease as:
- an obligation to act honestly and with fidelity to the bargain;
- an obligation to not undermine the agreed bargain or the substance of the contractual benefit bargained for; and
- an obligation to act reasonably and with fair dealing, having regard to the interests of the other party (but not to the extent causing detriment to their own interests) and the provisions, aims and purposes of the contract (which are to be objectively ascertained).
It is advised to incorporate express obligations of good faith in any contracts where it is intended to apply, for example, including an express obligation to act in good faith in very specific circumstances, or in a specific provision contractual obligation. This will, in a way, exclude the remaining part of the agreement and offer any intended protection to certain parties.