It is common for commercial contracts to impose an obligation of good faith, a use of reasonable endeavours or a use of best endeavours. Government agencies are also encouraged to use good faith in trying to resolve disputes.
So, what do these phrases mean and what is the law on such obligations being imposed in a commercial contract?
Am I required to act in good faith?
An obligation to act 'in good faith' can arise by an express term in a contract. For example, a dispute resolution clause may require the parties to negotiate in good faith. Similarly, a termination for convenience clause may require a party to act in good faith, with the terminating party required to give reasonable notice and the other party required to mitigate its loss arising from the termination.
It has also been argued that there is an obligation to act in good faith implied in all commercial contracts. This raises the question – what does acting in good faith mean?
The good faith obligation - what does it actually mean?
In Paciocco v ANZ Banking Group Ltd [2015] FCAFC 50 we see the contractual obligation to act in good faith described as an obligation to:
- act honestly
- act with fidelity to the bargain (that is, carry out what each party was obliged to do under the agreement)
- not act to undermine the bargain entered or the substance of the contractual benefit bargained for
- act reasonably and with fair dealing, having regard to the interests of the parties
- act in line with the provisions, aims and purposes of the contract, objectively ascertained.
Whether a party has acted in good faith will require an examination of their conduct and will be determined on the facts of each case. It could be argued that this could be established by pointing to evidence which demonstrates how a party did not act in good faith.
Extent of the duty
The extent of the duty is demonstrated in Macquarie International Health Clinic Pty Ltd v Sydney South West Area Health Service. In this case, Macquarie and Sydney South West Area Health Service (SSW Area Health) signed a heads of agreement to develop a private hospital on land within the Royal Prince Alfred Hospital precinct owned by SSW Area Health. Leases were granted to Macquarie over the site for the intended hospital. The heads of agreement, and a number of the agreements, required both parties to act in 'utmost' good faith. It was critical for Macquarie that theproposed hospital was located within the Royal Prince Alfred Hospital precinct.
SSW Area Health created an asset strategic plan which was inconsistent with the location of the proposed private hospital. This was not revealed to Macquarie when it was preparing its construction and design plans. The Court of Appeal found that the obligation to act in good faith was enforceable and required SWW Area Health to disclose the departures to Macquarie, as that failure would have changed Macquarie's expectations of the agreement. The Court found that the duty did not mean the parties had to ignore their own interests, but they were required to co-operate reasonably to carry out what was required under the contract.
The High Court has not ruled on the precise meaning and extent of the duty of good faith and, until it does, we are guided by the case law on the facts of each case.
Is a duty of good faith really implied in all commercial contracts? The answer's not clear.
The existence and extent of an implied obligation of good faith in the performance of a contract is not yet settled in Australia. In Royal Botanic Gardens and Domain Trust v South Sydney City Council, the High Court commented that it was an important issue but not appropriate to be considered in that case. The Court noted, however, that in argument, both parties accepted that such an obligation existed in the lessor's determination of rent.
Different approaches have been taken as to whether an obligation to act in good faith is implied in the performance of a contract. In New South Wales, the Court of Appeal has considered it appropriate to imply the obligation into commercial contracts generally. For example, in Cordon Investments Pty Ltd v Lesdor Properties Pty Ltd, which involved a construction contract dispute, it was deemed appropriate to imply a good faith obligation, noting this was consistent with the approach taken in a number of decisions in that Court.
The Victorian Court of Appeal took a different view, indicating that the good faith obligation should not be implied in all commercial contracts and that,
"It may, however, be appropriate in a particular case to import such an obligation to protect a vulnerable party from exploitive conduct which subverts the original purpose for which the contract was made."
Best endeavours v reasonable endeavours - what's the difference?
If there is doubt whether a party can achieve something because it is not completely within its control, that party will be reluctant to provide an absolute assurance that it will be done. That is where a 'best endeavours' or 'reasonable endeavours' qualification may assist.
Both these terms will consider what is reasonable in the circumstances. However, it can be taken that 'best endeavours' imposes a higher standard to do everything reasonably possible to achieve an outcome. 'Reasonable endeavours', on the other hand, would be steps that a reasonable person in that situation would take to achieve the outcome.
In Electricity Generation Corporation v Woodside Energy Ltd the High Court considered a contract between the parties for the supply of gas. The contract required Woodside to supply a maximum daily quantity of gas and to use 'reasonable endeavours' to supply an additional maximum daily quantity at a set price. For the additional supply, Woodside had the right to "take into account all relevant commercial, economic and operational matters" in determining if it could supply. This provided a guide or internal standard in determining whether Woodside had breached its reasonable endeavours obligation. The High Court, in finding no breach of this obligation by Woodside, made three observations about the use 'reasonable endeavors':
- the obligation qualified by these words is not absolute or unconditional
- the obligation will be considered against what is reasonable in the circumstances, including how it will affect that party's business
- some contracts will have an internal standard of what is reasonable which may be related to their business interests.
The key to understanding how endeavours may be interpreted and the steps to be taken to avoid breaching such a clause lies in contractual interpretation and whether the contract itself provides further assistance in that interpretation. Drafting factors that can be taken into account, for example, may be helpful.
Key takeaways
When NSW Government agencies are entering into commercial contracts with third parties, it is important to understand what outcomes are expected and whether the obligations imposed on either party are absolute or conditional. Reasonableness and good faith will be interpreted by what the contract provides and what is reasonable in the circumstances. Neither dictate, however, that a party's own interests should be completely disregarded.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.