The obligation to “negotiate in good faith” is often found in commercial agreements. This article briefly considers the meaning and enforceability of the expression.

What is a duty to negotiate in good faith?

Courts have not always been consistent in defining what it means to negotiate in good faith. It has even been suggested that “a promise to negotiate in good faith is illusory and therefore cannot be binding” (Coal Cliff Collieries Pty Ltd v Sijehama Pty Ltd (1991) 24 NSWLR 1 at 42 per Handley JA).

However, a duty of good faith will be enforceable in certain circumstances. If such a promise is enforceable, the following broad principles will usually apply to the promise to negotiate in good faith:

  1. the parties must act honestly;
  2. each party must have regard to the legitimate interests of the other party; and
  3. neither party must act in a manner which is arbitrary, capricious or intended to cause harm to the other party.

It is also important to note what the duty is not. The duty does not:

  1. limit the parties seeking to strike the best possible bargain in their own interests; or
  2. limit the parties, for instance, from negotiating with someone else at the same time (unless there is a specific contractual prohibition on doing so).

When does a duty to negotiate in good faith arise?

The following are three of the most important Australian cases which have developed the law regarding the obligation to negotiate in good faith:

Enforceable in some situations - Coal Cliff Collieries v Sijehama Pty Ltd (1991) 24 NSWLR 1

In this case the parties agreed in a memorandum of understanding to “proceed in good faith to consult together upon the formulation of a more comprehensive and detailed joint venture agreement ... which when agreed [would] take the place of these heads of agreement.”

It was found that this promise was unenforceable given that it was essentially “an agreement to agree” and therefore too vague and uncertain. However, it was suggested that an explicit promise to negotiate in good faith could be certain enough to be legally binding in some circumstances, including where:

  • the promise is clear and part of an undoubted agreement between the parties; and
  • there is reference to a readily ascertainable external standard, and the court is able to attribute a meaning to a provision.

The need for a “yardstick” -  United Group Rail Services Limited v Rail Corporation [2009] NSWSCA 177

These principles were further developed in the United Group Rail Services case.  The relevant contractual provision required the senior representatives of the parties to “meet and undertake genuine and good faith negotiations with a view to resolving the dispute or difference”. If the dispute was not resolved within 14 days, the clause then directed the parties to resort to mediation and arbitration. United argued that the obligation to negotiate was uncertain and therefore unenforceable.

The Court of Appeal found that the obligation to negotiate in good faith was enforceable in these circumstances because the clause provided an objective “yardstick” by which the Court could determine whether the parties had complied with it. In other words, the clause should contain some criteria or objective measure against which the negotiations can be judged, such as here, where if the senior representatives failed to resolve the dispute within 14 days, the final step was to send the parties to arbitration. In order to determine whether there had been compliance with the clause, the Court looked to whether the parties had brought an honest and genuine approach to settling the contractual dispute, and whether they had given fidelity to the existing bargain.

Balancing commerciality with the duty of good faith -  Macquarie International Health Clinic Pty Ltd v Sydney South West Area Health Service [2010] NSWCA 268

In the case of Macquarie International Health Clinic, it was again emphasised that there is a need for an objectively ascertainable structure to an obligation to “negotiate in good faith”. The heads of agreement considered by the Court in this case required the parties to act with the utmost “good faith” in the performance of their respective duties, in the exercise of their respective powers, and in their respective dealings with one another.

The New South Wales Court of Appeal made the following comments, in finding that the obligation to negotiate in good faith was enforceable:

  • the obligation of good faith does not require parties to compromise their own commercial interests, but parties must negotiate in such a way to achieve the contract objectives; and
  • in certain situations, the duty for parties to cooperate may require a party to disclose information to the other. 

Practical lessons

It is important for parties to be aware that the enforceability of an obligation to negotiate in good faith is entirely dependent on the context of the obligation. Parties should proceed cautiously when they enter into an agreement which requires them to negotiate in good faith, and a party proposing to enter into an agreement containing such a term should seek legal advice on its implications.