In commercial contracts, it is common to find the requirement that parties deal with each other in good faith. These clauses seem like a particularly good idea when the parties are still feeling positive about their business together, but, as with all relationships – it’s all fine and well until things start to go downhill.
It’s important to distinguish between a contractual obligation to negotiate in good faith and an unenforceable agreement to agree. The Supreme Court of Appeal recently considered an obligation in a lease to negotiate in good faith. A shopping centre owner terminated a lease on one month’s notice to the retailer tenant. The tenant said that the contract could not be terminated until the good faith negotiations had taken place and, absent those negotiations, the existing lease agreement should be allowed to continue. The tenant also said that for the same reasons, the notice of termination and ensuing application for eviction were premature.
The court noted that generally an agreement that the parties will negotiate to conclude another agreement is not enforceable because of the absolute discretion given to parties to agree or disagree. The position is different where there is a deadlock-breaking mechanism and the parties must participate in a dispute resolution process that is specifically agreed between them. The court aligned itself with Australian case law which requires that any dead-lock breaking mechanism must provide certainty for the agreement to be enforceable. If the parties can achieve this certainty, their choice must be respected and realised.
In this case, there was no deadlock-breaking mechanism in the lease. The court then rejected the retailer’s contention that any deadlock would be resolved by sticking to the current rental and if it turned out to be unacceptable to either of the parties, that party could end the contract. Since payment of current rental and the option to terminate were not aimed at the resolution of the impasse between the parties, this was not a true deadlock-breaking mechanism. The retailer then tried to argue that the common law should be developed to recognise the validity of an agreement to negotiate in circumstances where there is no deadlock-breaking mechanism. But how could a court develop the common law to enforce a duty to negotiate in good faith? The contract did not make it clear how the court should determine what period of negotiation was fair and what criterion should be used to determine whether the negotiation was in bad faith as alleged. The parties had already been at loggerheads for a period of approximately two years.
In the end, the court held that it would be against public policy for a court to coerce a landlord to conclude an agreement with a tenant it didn’t want. The decision is certainly to be applauded for its pragmatism and parties will need to consider carefully the wording of such clauses, if they are to be included at all.