A recent Supreme Court of Victoria decision demonstrates the reluctance of Courts to imply a duty of good faith or reasonableness in commercial contracts, particularly where the duty would conflict with unqualified broad powers expressly included in the contract. Senior Associate, Bianca Battistella and Law Graduate, Liberty Privopoulos discuss the decision.

Arhanghelschi v Ussher [2013] VSC 253

Facts

Dr Arhanghelschi and four other radiologists conducted a radiology business through a unit trust.

Specifically:

  • Each doctor was a director and shareholder of a company which acted as trustee for a unit trust, and which provided radiology services to Ballarat Health Services.
  • Each doctor was also separately employed by Ballarat Health Services.
  • The trustee of the family trust of each doctor held 20% of the units in the trust.
  • Dr Arhanghelschi’s units were held by a company, Cladwyn Pty Ltd, as trustee for his family trust.
  • The relationship between the unitholders was governed by a unitholders deed.

The dispute concerned the exercise of a broad discretion by every unitholder, other than Cladwyn, pursuant to a specific clause in the unitholders deed that permitted a majority of unitholders to give notice to another unitholder stating that they wished for that unitholder to cease its involvement in the business; and further, to procure that the trustee redeem, cancel or purchase that unitholder’s units for $1 per unit.

The majority unitholders gave notice to remove Dr Arhanghelschi from the business and procured that the trustee request that Dr Arhanghelschi take all action and sign all documents necessary to redeem and cancel the units held by Cladwyn for $1.00 per unit. Dr Arhanghelschi was also asked to resign from his positions as a director of the trustee and as an employee of Ballarat Health Services. No reasons were given by the majority unitholders for the removal of Dr Arhanghelschi and Cladwyn.

Dr Arhanghelschi and Cladwyn claimed that in exercising their discretion under the unitholders deed, the majority unitholders were required to act rationally, reasonably and fairly considering the interests of the parties. They further claimed that the actions of the doctors, in their capacity as directors of the trustee, constituted oppressive conduct under the Corporations Act.

Decision

Implied duties

Justice Ferguson dismissed the plaintiffs’ claim that the majority unitholders were under an obligation to act rationally, reasonably and fairly considering the interests of the parties, in exercising their discretion under the unitholders deed to exclude Dr Arhanghelschi from the business. Her Honour also held that an obligation of good faith was not to be implied into the unitholders deed, as this would be at odds with the unqualified power of a majority of unitholders to remove another unitholder, which necessarily permitted those unitholders to act in their own self-interest.

Justice Ferguson reasoned that the unitholders deed must be construed using an objective approach to ascertain the intention of the parties as expressed.

The words in the relevant clause, in her Honour’s opinion:

  • were clear and unambiguous, and
  • did not require the majority unitholders to give reasons if they determined that they wished to remove a unitholder and associated director from the business.

This was held to be the case despite the lack of an adjective, such as ‘absolute’, to describe the discretion. Rather, it was suggested that words of limitation would have been included in the unitholders deed had the unitholders intended to limit the broad discretionary power.

The presence of other general obligations, including an obligation to conduct the business in "a proper and efficient manner" did not qualify the broad discretion of the majority unitholders.

Oppression

Justice Ferguson also dismissed the plaintiffs’ oppression claim, on the basis that the trustee’s affairs were not conducted oppressively to, unfairly prejudicially to, and were not unfairly discriminatory against, Dr Arhanghelschi in his capacity as a shareholder.

In reaching this conclusion, her Honour reasoned that:

  • The doctors structured their business through a unit trust and chose to regulate their relationship primarily through the unitholders deed.
  • Dr Arhanghelschi had received legal advice regarding, and understood the effect of, the unitholders deed.
  • The majority unitholders acted to implement the agreed method set out in the unitholders deed for the removal of a unitholder for nominal value, and the trustee simply acted in accordance with the agreed terms of the deed.

Comments

This decision highlights the Courts’ reluctance to imply a duty of good faith or reasonableness into commercial contracts, particularly where such a duty would be inconsistent with express powers.

Importantly, it should not be assumed that a party to a contract is obliged to have regard to the interests of the other parties in exercising its powers and discretions under the contract, simply by virtue of their relationship. If parties wish to impose limits on the exercise of broad discretionary powers (including requirements of good faith or reasonableness), those limitations should be expressly provided for in the contract.

Finally, this decision also serves as a reminder of the importance for contracting parties to ensure, when entering into business ventures with others, that:

  • the contract governing their relationship adequately provides for exit mechanisms that address all contingencies, and
  • each party understands the practical effect of, and is comfortable with, the potential application of those provisions.