We often see contractual obligations on parties to act in ‘good faith’.
The Company may, acting reasonably and in good faith, set off from any amount due to the Contractor, any amount due or which may become due to the Company under this Contract.
What does ‘good faith’ mean? In the above example, how does it affect the exercise by the Company of its right to set-off?
Despite the long history of good faith, we still don’t know for sure, but we have some suggestions as to what it might mean. According to the High Court of Australia:
- an element of good faith would be “fairness in dealings between contracting parties” and it “is wider than that of honesty”.
From the Federal Court of Australia:
- the obligation of good faith means to “act honestly and with a fidelity to the bargain; an obligation not to act dishonestly and not to act to undermine the bargain entered or the substance of the contractual benefit bargained for; and an obligation to act reasonably and with fair dealing having regard to the interests of the parties (which will, inevitably, at times conflict) and to the provisions, aims and purposes of the contract, objectively ascertained”; but
- acting in good faith does not mean a party has to act against its own interests.
In the absence of a definitive statement as to its meaning, and given ‘good faith’ has been and is still being considered by the courts of various jurisdictions within Australia and within a variety of contexts, there is a broad range of meanings attributed to it. However, it seems that ‘good faith’ likely involves elements of:
- not undermining the contractual objectives
- not acting arbitrarily or capriciously
- having regard to the interests of the other party, without having to subordinate one’s own interests to the interests of the other.
So what does that mean for the parties in our example above? We suggest it means:
- the Company can set off debts due. That is, known debts that have been valued pursuant to the contract
- in considering any debts which may become due, consistent with the elements outlined above, the Company for example would need to have a genuine and honest belief that the debt may become due
- the Company would also need to be honest and reasonable in its valuation of any debts it believes may become due
- the Company need not refrain from setting off both debts due and those which may become due, simply because it would cause hardship for the Contractor.
The last point is interesting, given the elements of good faith such as fairness and reasonableness. However, in Diab Pty Ltd v. YUM! Restaurants Australia Pty Ltd the Federal Court of Australia decided that a discretionary power could be exercised by YUM! Restaurants, in the manner in which it was exercised, even though to do so would cause financial hardship for its franchisees.
Back to our example, also in support of the Company setting off both the amounts due and those which may become due, is “that it is not for the courts to re-write the parties’ bargain for them”.
Of course, what court decisions also tell us, is that in the presence of an express obligation of good faith, the additional obligation to act reasonably becomes redundant. This is because good faith includes more than just acting reasonably.
What if our hypothetical example didn’t include the obligation on the Company to act in good faith but only referred to an obligation to act reasonably:
The Company may, acting reasonably, set off from any amount due to the Contractor, any amount due or which may become due to the Company under this Contract.
Will good faith be implied into a contract which does not otherwise expressly require the parties to act in good faith? Again, we cannot say for sure. The “question whether a standard of good faith should be implied generally to contracts has not been resolved in Australia”.
If there are to be any indications drawn from decisions however:
- decisions of the High Court indicate an unwillingness to consider whether a standard of good faith should be implied into all commercial contracts, while the weight of decisions is against such implication
- the State of Victoria seems most closely aligned with the Commonwealth, holding the view that the term should not be implied indiscriminately into all contracts, but rather on a case-by-case basis such as provided by BP Refinery (Westernport) Pty Ltd v Shire of Hastings
- in New South Wales, while there has been a greater acceptance of applying a term of good faith, there is no definitive position
- in Queensland too there is no definitive position, but recent decisions have supported the implication of good faith.
It’s also difficult to identify, with any material degree of certainty, any general circumstances under which good faith will more likely to be implied.
Therefore, in our modified example with the obligation to act in good faith removed, the obligation to act reasonably becomes important. This is because we cannot be assured a court would imply an additional obligation on the Company to act in good faith.
So, what is the moral of the story? Like anything in a contract, if you want something to be clear, make it clear. If a party or parties are to act in good faith, then say so. Of course, you should then go further and define what good faith is to mean.
Our example clause should read as follows:
The Company may, acting in Good Faith, set off from any amount due to the Contractor, any amount due or which may become due to the Company under this Contract.
A definition for the term Good Faith would be included in the contract.