Do your contracts require the parties to act in 'good faith'?

If you are in business, it would be normal for you to enter into contract arrangements with different parties as part of your general operations.

Common types of contracts that business owners may encounter include supply contracts with suppliers and customers, leasing agreements with landlords, and Franchise Agreements - if they own a Franchise Business, to name a few. Although, have you actually read each of these contracts?

One important clause to look for is the ‘good faith’ clause.

If there is a good faith clause in your contract, then it is likely to be enforceable against the parties who have entered into the contract. This can be a very good thing as the ‘good faith’ principle obliges each party to:

a) Act honestly;
b) Co-operate to achieve the contractual benefits;
c) Not act to undermine the bargain entered into,
and
d) Act reasonably, with fair dealing and having regard to the interests of the parties.

There could be a general ‘good faith’ clause contained in the contract which obliges each party to act in good faith in every aspect of performing the contract, or there could be a more narrow ‘good faith’ clause which refers to the performance of a certain obligation (such as negotiation in a dispute or termination of the contract).

Even if a contract does not specifically include a term for the parties to act in ‘good faith’, it may be implied in the contract in certain circumstances – such as where a contract requires co-operation and trust or where the relationship between the parties is unbalanced (ie. a Franchisor and Franchisee relationship).

Not all contracts will imply an obligation of good faith between the parties and each case will be determined by its own facts.

In some cases, a party may want to specifically exclude a ‘good faith’ obligation from the contract and accordingly, careful drafting will be required to ensure it is specifically excluded.

An example where a party may want to specifically exclude the ‘good faith’ principle is where they may want a right to terminate in their absolute discretion. In the case where a party does not want the obligation of having to act  in good faith, they will have to include a clause excluding all implied terms and also any conditions and warranties of good faith, fair dealing and reasonableness.

If you are contracting with another party and you want to ensure that they are always obliged to act in good faith towards you - then ensure a specific clause is included in your contract.

Alternatively, if you want to ensure that you are not required to act in good faith towards the other party/ies to the contract - then ensure a specific clause noting this is included in your contract.

The ‘good faith’ principle does not place an obligation on each party to exercise reasonable care and skill or produce a reasonable outcome. As long as the party has acted honestly and in good faith, then they have fulfilled their obligation to act in good faith, regardless of the outcome.

The ‘good faith’ principle came before the Federal Court most recently in 2017 in a case called Virk Pty Ltd (in liq) v. YUM! Restaurants Australia Pty Ltd where Pizza Hut(as the Franchisor) was sued by several franchisees after it exercised its contractual power to reduce the maximum price of the franchisees’ pizza. The reduction was part of a strategy to reverse dwindling profits, however, it also had a detrimental effect on the financial performance of the franchisees.

The evidence brought before the Court was that Pizza Hut had in fact acted in good faith when making the decision as it had modelled potential outcomes, considered its strategy in similar markets and tested its strategy on a small scale.

Pizza Hut was found to have acted honestly and with great care (even though its decision had a detrimental impact on the franchisees).

As the case against Pizza Hut demonstrates, if the good faith principle is either expressly or impliedly included into a contract, it may not protect parties from suffering a detriment or bad outcome in the end. It will however, ensure that if any party suffers from a detrimental outcome from the contract, the detrimented party may have a right to investigate if the other party in fact acted in good faith and if not, have recourse against them.

Where a contract contains a ‘good faith’ clause (or if it is implied into the contract) and another party starts to act dishonestly, unconscionably (conduct that goes against good conscience), or where the conduct is at odds with the object of the contract, then that party may be subject to a claim by the innocent party for a breach of contract.

It is essential that before entering into any contract with any party, whether it is a supply contract, lease for land or even a Franchise Agreement, you engage an experienced commercial lawyer to review the terms before you sign.

At McKays, we have a team of experienced commercial lawyers that can assist you with all of your contract review needs. Contact us here.