Have a Little Faith?

Although the orthodox view of no general doctrine of good faith in commercial dealings remains the common perception of most common lawyers, a gradual turn in the judicial prism is slowly shifting that perception.

The Roman law concept of negotia bonæ fidei, or transactions of good faith, as a general legal principle is familiar to a civilian lawyer – for example, Sections 157 and 242 of the Bürgerliches Gesetzbuch, or the Civil Code of Germany, stipulate that “[c]ontracts are to be interpreted as required by good faith” and “[a]n obligor has a duty to perform according to the requirements of good faith”. Similarly, Article 6 of the, or the Contract Law of the People’s Republic of China, also requires contracting parties to “observe the principle of good faith in exercising their rights and fulfilling their obligations.”

This principle is likewise familiar to a common lawyer carrying the Roman-Dutch legal tradition – for example, the Constitutional Court of South Africa recently re-affirmed, at §45 in Botha v Rich NO [2014] ZACC 11, that “in our law all contracts are subject to good faith”. Such principle also features in the laws of the United States, as §1-304 of the Uniform Commercial Code (the UCC) provides that “[e]very contract … within the [UCC] imposes an obligation of good faith in its performance and enforcement”, with §205 of the subsequent Restatement (Second) of Contracts (1981) extending the general duty of good faith to “[e]very contract”, beyond just commercial transactions within the UCC.

At Anglo-Saxon common law, and as early as 1766 (being 10 years before Adam Smith published The Wealth of Nations which arguably laid the foundation for the modern-day laissez faire economics of contracts), Lord Mansfield at [1910] in Carter v Boehm (1766) 3 Burr 1905 considered good faith – in reference to prohibiting against “concealing what [one] privately knows [in order] to draw the other into a bargain … from his ignorance of that fact” – as a “governing principle … applicable to all contracts and dealings”. However, Lord Mansfield’s attempt to plant a general principle of good faith applicable to all English contracts did not subsequently bear fruit, as Bingham LJ indicated in Interfoto Picture Library v Stiletto Visual Programmes [1987] EWCA Civ 6 that “English law has, characteristically, committed itself to no such overriding principle but has developed piecemeal solutions in response to demonstrated problems of unfairness.” Lord Ackner, in a later speech at p.138 in Walford v Miles [1992] 2 AC 128, echoed a similar sentiment and delivered perhaps the strongest disapproval of applying good faith, at least within the context of contract negotiation, by characterizing good faith as inherently “repugnant to the adversarial position of the parties” and “unworkable in practice”.

An Operative Principle

Given such resistance, English common law had traditionally only recognized good faith as an operative principle concerning a limited class of contracts, viz. insurance, employment, and partnership agreements. Nonetheless, good faith, being the antithesis of commercial immorality, was never far away from the minds of the English judges – for example, Lord Bingham himself, subsequent to Interfoto Picture, recognized that “[g]ood faith … is not an artificial or technical concept; nor, since Lord Mansfield was its champion, is it a concept wholly unfamiliar to British lawyers” at §17 in Director General of Fair Trading v First National Bank [2001] UKHL 52 and also observed that “[p]arties entering into a commercial contract … will assume the honesty and good faith of the other; absent such an assumption they would not deal” at §15 in HIH Casualty and General Insurance v Chase Manhattan Bank [2003] UKHL 6. Lord Hoffmann at §68 in HIH further expressed that “[p]arties contract with one another in the expectation of honest dealing …. [I]t goes without saying that underlying the contractual arrangements of the parties there will be a common assumption that the persons involved will behave honestly”.

Around the same time as Lord Ackner’s hostility towards good faith in England, Priestley JA of the New South Wales Court of Appeal in Renard Constructions v Minister for Public Works (1992) 26 NSWLR 234 at 268 was, in contrast, very clear “that people generally … have grown used to the courts applying standards of fairness to contract which are wholly consistent with the existence in all contracts of a duty upon the parties of good faith and fair dealing in its performance. In my view this is in these days the expected standard, and anything less is contrary to prevailing community expectations.” This provided the basis for the New South Wales Court of Appeal to imply good faith in the subsequent case of Burger King v Hungry Jack’s [2001] NSWCA 187, concerning an agreement between a franchiser and franchisee, with the additional recognition at §160 that “[i]f such a term is implied it will require a contracting party to act in good faith and fairly, not only in relation to the performance of a contractual obligation, but also in the exercise of a power conferred by the contract.”

In other words, instead of treating contracting parties in general as adversaries locked in unrelated transactions and limiting the application of good faith to only a rigidly defined class of agreements, the Australian case law indicated the willingness to imply good faith in those situations requiring contracting parties to be treated as deriving mutual and possibly continuing benefits in a relational context. In allowing a litigant to advance a contractual argument based on good faith, Thomas J of the New Zealand Court of Appeal in Bobux Marketing v Raynor Marketing [2002] 1 NZLR 506, concerning a distributor agreement, put the matter as follows at §[35]: “[t]he fundamental flaw of the classical conception of contract law [reflecting ‘laissez faire economics’ as his Lordship had indicated previously at §[34]] was its empirical premise that most contracts are discrete. That premise is false. Most commercial contracts are in fact relational contracts. The great bulk of contracts either create or reflect relationships”.

The Yam Seng Case

The business course of dealings behind Yam Seng v International Trade Corporation [2013] EWHC 111 represented another manifestation of exactly this type of relational arrangement, which presented Leggatt J with the opportunity to reassess the place of good faith in English contract law. In that case, the parties’ agreement conferred Yam Seng with, inter alia, the distribution rights of Manchester United-branded fragrances at Singapore airport duty free shops, whereas International Trade Corporation (ITC) separately contracted with another entity concerning the distribution of the fragrances for the in-town market. In simple commercial terms, and in order for the bargain between Yam Seng and ITC to work, ITC would have to maintain the in-town price to be at least the duty free price plus the duty. However, and notwithstanding the vital importance of such pricing floor, the parties did not expressly incorporate this restriction in their written contract. The evidence subsequently revealed that although ITC had, on multiple occasions, sought to reassure Yam Seng that the in-town price was maintained above the duty free price, Yam Seng eventually found out that the in-town price had undercut the duty free price by approximately 20%.

Yam Seng therefore pleaded, inter alia, that ITC had breached “the implied term … that the parties would deal with each other in good faith”. Having traversed the overseas jurisprudence, Leggatt J agreed with Yam Seng and implied the duty of good faith, as having borne the particular shades of “expectation of honesty” and “fidelity to the parties’ bargain”, at §§135-137 and §139 of the judgment respectively. Leggatt J then clarified that exactly what dishonesty and infidelity would entail in any given case would be fact-sensitive and need to be ascertained on an objective scale as to “what would be regarded as commercially unacceptable by reasonable and honest people”, following the well-known and objective-honesty approach that Lord Nicholls formulated at pp.389-390 in Royal Brunei Airlines v Tan [1995] 2 AC 378. Leggatt J further observed at §142 that “[s]uch ‘relational’ 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.”

Against the background of that distributor agreement, Leggatt J discerned at §163 “an industry assumption that retail prices in domestic markets will be higher than the corresponding duty free retail prices at airports ….”; in other words, reasonable and honest business people would objectively “have understood and expected that their obligations would reflect this assumption without needing to spell this out” and, on such basis, Leggatt J at §230 ruled that ITC had acted “in bad faith in misleading Yam Seng about the steps taken to ensure that the domestic retail price in Singapore was not lower than the duty free price.”

Leggatt J did not forget the criticism that such approach would likely introduce excessive uncertainty, to which Leggatt J responded at §152 that “[t]here is nothing unduly vague or unworkable about the [analysis undertaken above]. Its application involves no more uncertainty than is inherent in the process of contractual interpretation.” This is entirely consistent with the view of Sir Anthony Mason, as expressed in Contract, Good Faith and Equitable Standards in Fair Dealing Law Quarterly Review (2000), in which his Lordship similarly observed at pp.70-71 that “good faith would have been seen as a threat to … the certainty apparently offered by the law of contract”, although litigation experience has shown that such “element of certainty was illusory”. In other words, if contracting parties enter into transactions on the principles of honesty and fidelity to the bargain, then what Lord Bingham said, albeit in a slightly different context, at §38 in Golden Strait Corporation v Nippon Yusen Kubishka Kaisha [2007] UKHL 12 remains apposite: “Certainty is a desideratum and a very important one, particularly in commercial contracts. But it is not a principle and must give way to principle. Otherwise incoherence of principle is the likely result.”

Gaining Traction

In England, Yam Seng has gained traction across different divisions of the High Court, viz. Bristol Groundschool v Intelligent Data Capture [2014] EWHC 2145 (Ch) concerning a joint venture involving content supply and production of pilot training manuals, Emirates Trading Agency v Prime Mineral Exports [2014] EWHC 2104 (Comm), in which Teare J at §51 praised the analysis of Leggatt J as “masterly”, D&G Cars v Essex Police [2015] EWHC 226 (QB) concerning a “relational contract par excellence” according to Dove J at §176 that conferred the right on the claimant to assist the police in disposing of certain vehicles, National Private Air Transport Services v Windrose Aviation [2016] EWHC 2144 (Comm), in which Blair J (who recently sat as a Deputy High Court Judge of Hong Kong) at §135 affirmed the analysis of Leggatt J although without finding such duty of good faith in connection with an aircraft lease, and Sheikh Tahnoon v Kent [2018] EWHC 333 (Comm) concerning a joint venture agreement that required additional tranches of funds for hotel acquisitions and operations.

In Singapore, the Court of Appeal at §44 in The One Suites v Pacific Motor Credit [2015] SGCA 21 regarded Yam Seng as having adopted the same reasoning as exhibited in the earlier Singapore case of Ng Giap Hon v Westcomb Securities [2009] 3 SLR(R) 518. Finally, and in Hong Kong, Lisa Wong J of the Court of First Instance recently took notice of the possibility of an implied duty of good faith within the context of another distributor agreement involving luxury watches at §94 and footnote v in Golden Miles Group Holdings v Jacob & Co [2018] HKCFI 441, although her Ladyship, given the interlocutory nature of the application, did not have to pronounce a definitive view on the applicability of Yam Seng in Hong Kong.

Therefore, even though whether the good faith analysis of Leggatt J will take root in Hong Kong in due course remains an open issue at this time, the gathering tide of the overseas case law across the common law jurisdictions suggests that both transaction and litigation lawyers in Hong Kong can no longer discard good faith in general commercial dealings and must now discern what honesty and fidelity entail within the context of, say, a particular joint-venture transaction that the contracting parties may have envisaged to be long-lasting. In that regard, what Allsop CJ of the Federal Court of Australia said at §9 in Conscience, Fair-Dealing and Commerce (FCA) [2015] FedJSchol 17 is worth bearing mind:

“The obligation of the commercial lawyer and the commercial judge is to understand the limits of legitimate self-interest and the relationship between self-interest, in its inherently selfish character, and honesty, reasonableness, decency and trust, being the qualities that make it possible for commercial people to be self-interested, but to deal with each other peacefully and with mutual benefit.”

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Freshfields Bruckhaus Deringer, Knowledge Lawyer

Peter is a solicitor practicing in general civil litigation. Peter is a former member of the Hong Kong Bar Association and holds his doctorate in Economics from the University of Texas at Austin. He is also active in Freshfields’ pro bono matters in relation to asylum and LGBT issues.