Do you understand what it means to act in good faith? Morally, most people would say that they do but would you understand what was required of you to act in good faith under a contractual obligation?

Many European jurisdictions impose a general duty of good faith which extends to all phases of commercial relationships and exists from the moment that negotiations commence. The UK, on the other hand, does not traditionally recognise such a general duty and, as a result, its courts are less familiar with making judgements on what is and what is not considered to be in good faith between contracting parties. The introduction of EU legislation is slowly changing the UK’s perception on the significance of the concept of good faith and there are now statutory controls regarding good faith in many EU regulations.

A recent case, concerning a long term service contract between two parties, demonstrates this changing perception. The contract allowed the defendant to reduce the fees it paid to the claimant in the event of poor performance. The defendant utilised this clause to reduce the fees it paid and then tried to terminate the contract on the grounds of material breach. At the same time, the claimant served notice of termination on the defendant and the judgement hinged on whether the parties had, pursuant to a clause in the contract, cooperated in good faith. The court commented that the agreement imposed a general duty of good faith and that, by failing to maintain a good working relationship with the claimant and by making 'absurd' calculations of what fee reductions it was entitled to make, the defendant had breached this obligation. The court held that this amounted to a material breach which entitled the claimant to terminate the contract and allowed it to succeed in its claim for damages.

Although this case is not ground breaking, it is significant because it demonstrates a recorded instance of the courts enforcing a good faith clause. Parties entering into contracts containing good faith clauses should, therefore, be aware of the real obligations imposed to work together for the smooth operation of the contract; to be informative during due diligence; to perform contractual obligations to a reasonable standard; to follow moral and ethical behavioural standards; and to maintain their commitment to enter into contractual relations.

It is clear that an obligation to act in good faith implies more than just a vague agreement between contracting parties to be honest with each other. Both advisers and business people alike should therefore beware the casual use of the phrase and ensure that they are fully informed as to the very real obligations that such clauses impose.