Cerno.Org Newsletter – To terminate? In good faith?

Deciding whether to terminate a contract is rarely easy. If you get it wrong and you may be in breach yourself; and it is quite common, at least in certain jurisdictions and quarters, for one party to call into question their counterpart’s termination.

Whilst the concept of good faith in English contract law is still developing, recent decisions have provided guidance on whether there exists a requirement to act in good faith when exercising termination rights, whether contractual or at common law.

Other than in a few well-established and restrictive categories, under English law there is no general duty to act in good faith towards your counterparty.

In the High Court case of Yam Seng Pte Limited v. International Trade Corporation Limited [2013] EWHC 111 (QB) the court held that a duty of good faith, or fair dealing, should be implied into the parties’ contract. Although His Honour Leggatt J gave a non-exhaustive list of examples, it remained unclear to what extent the courts would imply obligations of good faith in the future. Similarly, there was uncertainty as to the aspects of the parties’ relationship to which any implied duty of good faith would apply.

From this basis we must then ask, where there are express termination rights in the contract, are they subject to implied duties of good faith?

The recent case of Monde Petroleum SA v. Westernzagros Ltd [2016] EWHC 1472 considered this point. Where there is an express right to terminate a contract, is that right subject to an implied term that the party seeking to terminate must act in good faith?

Monde to provide consultancy services to Westernzagros (WZ) relating to negotiations for an oil exploration and production agreement (an ESPA) for work in Kurdistan. Monde received monthly payments and was to acquire a further interest in the project she the ESPA was signed.

After the ESPA was executed the Kurdistan authorities insisted on various amendments which had the effect of making the ESPA economically less attractive to WZ, who then sought to end its agreement with Monde in reliance upon the express right to terminate. Within its defence Monde argued that WZ was in breach of an implied term that WZ and Monde would act in good faith towards each other.

The court found two insurmountable obstacles to Monde’s case. Firstly, even though Monde argued the parties had intended their relationship to be long term and of a quasi-partnership nature, this did not automatically mean that an implied duty of good faith applied. (The Supreme Court decision in Marks & Spencer plc v. BNP Paribas Securities Services Trust Co (Jersey) Ltd [2015] UKSC 72 has reaffirmed that any term, to be implied, must be either necessary or obvious, and not inconsistent with the express terms.) Secondly, the court held that the implied term proposed by Monde would rarely, if ever, apply to restrict a contractual right to end the contract.

The court distinguished a term providing a right to terminate the contract from a contractual discretion. A discretion generally will be restricted by an implied term that the relevant party must exercise it in good faith, for the purposes for which it is given, and not in an arbitrary, capricious or irrational way; however, a discretion involves a range of options from which that party can choose whereas a right to terminate involves only a binary choice. The judge stated:

“A contractual right to terminate is a right which may be exercised irrespective of the exercising party’s reason for doing so. Provided that the contractual conditions (if any) for the exercise of such a right (for example, the occurrence of an Event of Default) have been satisfied, the party exercising such a right does not have to justify its actions.”

Can a general contractual duty to act in good faith restrict an express right to terminate? Sometimes the parties provide that they must act in good faith towards each other, or set out similar standards of conduct. Without clear language, will such a provision apply to a separate but express right to terminate?

This point did not arise in the Monde case, as the consultancy agreement contained no general good faith requirement but, in reviewing an earlier decision suggested that general good faith (or similar) wording is unlikely to restrict clear contractual rights to terminate. (TSG Building Services plc v. South Anglia Housing Ltd [2013] EWHC 1151 (TCC)).

Is a common law right to terminate for repudiatory breach subject to requirements of good faith? The innocent party can then elect to accept the breach and end the contract, or to affirm the agreement and keep alive the parties’ rights and obligations. Must it make that decision in good faith? This point arose in the Court of Appeal case of MSC Mediterranean Shipping Co SA v. Cottonex Anstalt [2016] EWCA 789.

The carrier under a contract for the international carriage of goods had the right to terminate for the shipper’s repudiatory breach. Due to a dispute between the shipper and consignee about who had title, the goods effectively remained embargoed at the port. The shipper was in repudiatory breach as it could not return the containers to the carrier. But the carrier elected to affirm and keep the contract alive, purely so it could claim liquidated damages in the form of demurrage. These payments were due at a daily rate, without limitation in time.

The Court of Appeal considered the facts of the case and decided the substantive issue on the basis that there was deadlock between the parties. The contract as agreed was no longer capable of performance, in effect it had become frustrated; the contract had terminated automatically at that point and with it the parties’ continuing rights. Addressing the good faith point, the Court of Appeal said it was neither “necessary [nor] desirable” to resort to that principle to decide the case.

The court suggested it was better for the law to develop along established lines and expressed the thought that the cases on express contractual discretions, and the implied good faith restrictions on their exercise, provided no help when considering the exercise of a right to terminate arising at common law.

What are the practical implications of these cases? When taken together these cases suggest the courts will rarely accede to an argument that a right to terminate has to be exercised in good faith, excepting circumstances where the parties have expressly provided for this. We suggest that this is logical; an express contractual right to terminate should not be subject to an implied requirement to exercise it in good faith, and that general good faith wording in the contract should not, properly interpreted, restrict such a right.

Care needs to be exercised when including in your contract a general requirement that the parties do act towards each other in good faith (or set a similar standard of conduct). It may be safer to state expressly if other specific rights are exceptions from such general duties rather than rely on the court’s interpretative powers.

MSC has provided useful clarification when considering whether to exercise a common law right to terminate; the decision whether to elect to end or affirm the contract is not comparable with the exercise of a contractual discretion and, therefore, is not generally subject to a requirement to act in good faith. Newsletter – Retention of Title

Retention of Title

The Court of Appeal of England and Wales has ruled in the recent case of PST Energy 7 Shipping LLC Product Shipping & Trading S.A. v O.W. Bunker Malta Ltd and others [2015] EWCA Civ 1058 that a retention of title clause prevented a contract from being a sale of goods contract. Although the case was decided in the context of shipping, producing direct implications for ship owners, it is likely to have wider implications for retention of title clauses in the context of the supply of goods contracts.

In the PST Energy 7 Shipping case, the contract included a clause that, pending payment, the ship owner held the fuel as a baillee but was able to continue using the bunker.  This did not release the ship owners from their obligation to pay for the fuel.

Overall, as reported, this decision has implications for contracts for the supply of consumable goods where a retention of title clause provides ever diminishing security for payment. Newsletter – Good Faith

Good faith duties are still narrowly construed in English law.

The debate about the extent of a good faith duty in English law continues to rumble on and in 2015 the courts continued to construe express good faith obligations narrowly.

In Portsmouth City Council v Ensign Highways Ltd [2015] EWHC 1969 (TCC), a case that considered a general good faith obligation in a long term, Private Finance Initiative (PFI) road maintenance contract, the judge found that the council was not subject to that duty when it came to its contractual obligation to assess the award of service points, which required the exercise of a discretion.

The Judge did find, however, that the council was subject to an implied obligation to make the contract work; namely that it would exercise its discretion by not acting in an arbitrary, irrational or capricious manner and also by acting honestly and on proper grounds.

It seems that the good faith clause was used to import into the implied term two extra, fact-specific duties. Contrary to the approach that was being taken in order to force Ensign to negotiate the original contract, which the council could no longer afford, the council could not simply award the maximum number of points for each contractor default.

(Note this case was heard before the case of Arnold v Britton was decided, the court followed Rainy Sky SA v Kookmin Bank [2011] UKSC 50 by interpreting the contract using commercial common sense.)