The decision of the NSW Court of Appeal in United Group Rail Services Limited v Rail Corporation of New South Wales [2009] NSWCA 177 has clarified the validity of dispute resolution clauses requiring contractual parties to negotiate in good faith to resolve disputes.

Commercial agreements commonly refer to, and adopt language relating to, the concept of “good faith”. Many contracts include specific good faith clauses that apply to the entirety of the contract. Although such clauses are often not intended to create enforceable obligations, the Court of Appeal’s decision in United demonstrates that good faith negotiation clauses within contractual relationships can be valid and enforceable.

Background

Part of the proceedings related to the validity of a dispute resolution clause in a contract (Contract) between United Group Rail Services Limited and Rail Corporation of New South Wales for the construction of railway infrastructure.

The dispute resolution clause was multi-tiered and, in the event of a dispute, it required the parties to, in the following order:

  1. submit to expert determination,
  2. undertake genuine and good faith negotiations, and
  3. have the matter ultimately referred to arbitration.

The key issue before the Court of Appeal was whether the subclause requiring senior representatives of each party to “meet and undertake genuine and good faith negotiations with a view to resolving the dispute or difference” was uncertain, and therefore void.

Judgment

Allsop P, with whom Ipp and Macfarlan JJ agreed, held that the clause requiring the senior representatives to undertake genuine good faith negotiations was not uncertain.

The Court of Appeal held that there was a critical distinction between the scenario before them – where the parties entered into an agreement to undertake genuine and good faith discussions for the purpose of resolving disputes arising from the performance of a fixed body of contractual rights and obligations – and the situation where parties have entered into “agreements to agree”, or clauses that vaguely provide for good faith negotiations in constructing a commercial relationship in the first instance. In this case, the good faith clause was not illusory or unacceptably uncertain.

It is also noteworthy that the good faith clause in the Contract had the required element of specificity, requiring the good faith negotiations to be conducted by “senior representatives” of the parties and providing a time limitation of 14 days. In the absence of these express requirements, Allsop P stated that the clause may have been too vague and therefore unenforceable.

The Court of Appeal further elaborated that while it would be difficult to ascertain a party’s performance under this type of clause, uncertainty did not warrant the conclusion that “it is not a real obligation with real content”. A mutual agreement of genuineness and good faith between the parties should not be viewed as “empty obligations [or] empty rhetoric” but that parties should be constrained by “an honest and genuine approach to settling a contractual dispute, giving fidelity to the existing bargain”.

The Court of Appeal provided some guidance on the practical obligations arising from an agreement to negotiate genuinely and in good faith. Such clauses require parties to act with an honestly held and genuine belief about their commercial relationship. Allsop P provided the following examples of behaviour that may contravene such an obligation:

  • threatening future breach of contract in order to bargain for a lower settlement sum than it genuinely recognises as due,
  • pretending to negotiate, having decided not to settle what is recognised to be a good claim, in order to drive the other party into an expensive arbitration that it believes the other party cannot afford, and
  • refusing to pay a claim, without qualification, that it, or some material part of it, is due.

While parties are entitled to conduct themselves in a commercially selfinterested manner, they also need to have an honest and genuine appreciation and understanding of their rights and obligations, and those of the other party. Although such clauses do not give rise to a fiduciary obligation, a party who recognises its own weaker legal position may find itself constrained by a good faith clause in terms of what is acceptable strategic behaviour during dispute resolution negotiations.

Implications

Parties need to be alert to the likelihood that a good faith clause within a commercial contract may be enforceable. Courts will seek to give effect to these terms by having regard to the context and intention of the contract in its entirety. In practical terms, parties should be able to act both in commercial self-interest while respecting the agreement to act in good faith, as the decision in United does not require a party to consider the interests of the other party before their own. Negotiating parties should specify time limitations and the identity of negotiators to assist in upholding the validity of such terms.

The Court of Appeal’s decision may prove to be of wide significance. The judgment does not make a distinction between “genuine and good faith” and “good faith”, and so it is likely that the guidelines on enforceability and certainty are likely to be applicable to good faith clauses generally.