The Court of Appeal has once again rejected the role of good faith in relation to contractual termination.

In the case of Ilkerler Otomotiv Sanayai ve Ticaret Anonim Sirketi and another v Perkins Engines Co Ltd [2017] EWCA Civ 183, the court upheld a decision to dismiss a claim alleging the wrongful termination of a distribution agreement, rejecting the distributors' argument that there had been a breach of an implied term of good faith or fair dealing as regards termination.

The court also rejected arguments based on implied variation to the termination provisions, and so the decision also provides useful guidance on the court's approach (and reluctance) to implying variations to contractual terms as a result of express variations to other terms.

Facts

The defendant (Perkins), a manufacturer of engines, had appointed the first claimant (Ilkerler) as its distributor in Turkey pursuant to a distribution agreement entered into in May 2000. The agreement was subsequently varied to introduce the second claimant, a subsidiary of Ilklerler, as a second distributor.

The agreement contained a clause permitting termination by either Perkins or the distributors providing six months' notice following the expiry of the initial three year term (Article 2.3). It also included a clause (Article 19.3) which provided that, if Perkins was dissatisfied with the distributors' performance at any time during the term of the agreement, it could request remedial action to be taken within three months. If Perkins remained dissatisfied at the end of that period, it could terminate the agreement upon a further three months' notice.

When Perkins gave six months' notice to terminate the agreement in September 2012 (under Article 2.3), the distributors alleged that the notice was ineffective and sued for wrongful termination based on the following three arguments:

  1. Construction – Due to Perkins being dissatisfied with the distributors' performance, the distributors argued that they should have been given an opportunity to remedy their performance under Article 19.3, rather than Perkins serving notice under Article 2.3;
  2. Variation - The distributors argued that the termination provisions of the agreement had been impliedly varied by the implementation of a business plan which had been varied into the agreement. Given the business plan ran to 2015 and required the distributors to make long term investments, the distributors argued that termination should only be effective from 2015 or when the distributors had recouped their investment (if earlier); and
  3. Implied terms – The distributors argued that Perkins was in breach of an implied term of good faith in terminating when it did so.

Construction

When considering the argument based on contractual construction, the Court of Appeal agreed with the High Court judge that Perkins did not have to terminate under Article 19.3 just because it was dissatisfied with the distributors' performance as a matter of fact. Rather, Perkins had a choice of terminating under either Article 2.3 or 19.3, as both clauses were found to fit perfectly well together even after the expiry of the initial three year term.

Variation

The parties were unable to find an exact authority on the principles to be applied when assessing whether an express variation of some terms in a contract (i.e. the introduction of the business plan) can result in an implied variation of another term (i.e. implied variations to the termination provisions to account for the business plan). The parties therefore agreed that it was appropriate to apply the established principles on determining whether an implied contract arises as a result of the conduct of the parties.

When applying such principles, the Court of Appeal considered whether the express variation introducing the business plan was consistent only with an alteration to the termination provisions, such that notice to terminate could only be given at the end of 2015 (or once the distributors had recouped their investment).

Although this issue was the main reason that an appeal had been allowed, the Court of Appeal agreed with the High Court that it was commercially unrealistic for the distributors to contend that the parties must have intended to amend the termination provisions. Although the court expressed sympathy in relation to the distributors' investment, if no discussion had taken place about any change to the termination provisions, it would be impossible to say what the necessary terms of any new termination provisions would be. Accordingly this line of argument was dismissed.

Implied terms of good faith or fair dealing

The distributors sought to rely on the case of Yam Seng [2013] 1 All E.R. (Comm) 1321 in their contention that two specific terms of good faith or fair dealing should be implied into the agreement; one relating to the introduction of honest appraisals between the parties relating to the prospects of their business relationship continuing and one affording the parties with an opportunity to alter their conduct before any termination of the agreement.

The Court of Appeal agreed with the "short shift" given to those suggested implied terms by the High Court judge, describing the dicta cited from Yam Seng as "interesting and informative", but not supportive of the terms proposed to be implied in this case.

Furthermore, the court noted that the relevant passages of Leggatt J in Yam Seng (at paras 142-143) dealt with implied notions of good faith requiring communication and co-operation as necessary to give business efficacy in the "performance" of so-called relational contracts and not for communication and co-operation in relation to the termination of such contracts which "would take one into a different realm altogether".

This decision adds to the growing case law which rejects the principle of implied good faith, as propounded by Yam Seng, in relation to contractual termination. Although the issue was not considered in detail, it is interesting that the Court of Appeal effectively narrows the application of the principles in Yam Seng to considerations relating to the performance of a contract. To expect parties to communicate and co-operate upon termination, when there could well be conflict, is a different realm altogether and clearly an area where the courts are reluctant to imply notions of good faith even in a relational context. As a consequence, a party should not expect, nor rely on, its counterparty to act in good faith when terminating a contract, regardless of the length and nature of the relationship.

The decision also highlights the importance of ensuring that all contractual variations are expressed in writing, with careful consideration being given to any consequential amendments required where contracts are varied to reflect changes to the parties' obligations or conduct during the life of a contract. This is particularly the case if contracting parties wish to align termination provisions to account for any further investment made during the course of an existing contractual relationship.