For those drafting outsourcing, facilities management and technology contracts (or any contract where there is an SLA and/or service credits regime), there has been an important new Court of Appeal decision dealing with the ability to limit a party’s right to exercise a contractual discretion and related implied terms.

Background

Under the relevant contract in Mid-Essex Hospital Services NHS Trust v Compass Group, the Trust had concluded a catering contract with Compass. Certain services were not supplied in accordance with the service level agreement and the Trust had a contractual discretion to award itself payment deductions and/or “failure points”. The failure points were relevant in determining whether the Trust had a contractual termination right.  Compass had argued, successfully before the High Court, that both the payment deductions and failure points were excessive and had not been correctly calculated in accordance with the contract.  The main findings by the High Court had been that:

  • An obligation on the Trust to co-operate in specified circumstances was not limited to those circumstances and applied generally, which the Trust had breached
  • A term should be implied into the clause under which the Trust could award itself payment deductions and failure points so that it did not behave arbitrarily or capriciously and the Trust had breached that implied term
  • There had been a material breach by the Trust in failing to co-operate and awarding itself excessive payment deductions and failure points

Court of Appeal’s Decision

The CA overturned the High Court decision and decided that:

  • The obligation to cooperate should only apply to the two specific purposes mentioned in it and did not include a general duty to cooperate
  • There was no implied term at all that the Trust should not behave arbitrarily in calculating payment deductions and failure points
  • Accordingly, the Trust was not in material breach of contract, and had validly terminated the contract and could proceed with a claim for damages

Controlling Contractual Discretion

The CA decided that an implied term controlling the exercise of a contractual discretion only applied where the discretion involved an assessment or choosing from a range of options – in this case the discretion related solely to whether or not the Trust exercised its contractual right to make payment deductions and/or award failure points.  The Court also felt that as the contract itself had a formula which ensured that the Trust could not award itself excessive deductions or failure points there was no necessity to imply a term in order to make the contract work.

A General Duty to Co-operate in Good Faith?

On this issue, the Court simply based its decision on the express wording used – as the duty to cooperate only related to two specific purposes, there was no basis for giving a wider interpretation.  The CA commented that there is no general principle of “good faith” in English law although it may be implied in special situations: any such duty would depend heavily on the particular contractual context and would be based on what behaviour would be regarded as commercially unacceptable by reasonable and honest people.

Had the Trust Materially Breached the Contract?

Although the Trust had awarded itself excessive failure points in breach of the relevant clause, this was not held to be a material breach due to several factors:

  • Compass itself conceded that the termination points threshold had been reached, entitling the Trust to terminate
  • The Trust’s attempt to award itself excessive failure points had no contractual effect in any event
  • By the time that Compass served its termination notice, the Trust had already indicated that it would be reviewing its previous award of failure points
  • “Material breach” had to be interpreted as meaning that the breach was a serious matter rather than one of little consequence - the CA did not think that this was the case on the facts

Commentary

When negotiating and drafting high value, long term contracts parties should take note of the CA’s decision in that:

  • Implied terms are unlikely to be accepted by the Courts where one party is simply deciding whether or not to exercise a contractual right – accordingly, clear, express wording must be inserted to regulate or limit such a right
  • The CA confirmed the traditional view that an implied terms should only be upheld where “necessary” to make a contract work properly and would not arise just because it was a reasonable term
  • The Court said that it would be “extremely difficult” to exclude implied terms by contractual wording where the discretion includes an assessment to be made and may require such extremely explicit language that it is  commercially unacceptable to the other party
  • Obligations of good faith – it is important that any obligation to act in good faith is clear and specified in detail to maximise the chance of a Court giving it effect
  • The scope of any obligation to act in good faith will depend heavily on the contract wording, the obligations in question and surrounding circumstances