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FEATURE ARTICLE - Issue 67 Articles, Issue 67: May 2014

Good Faith in Contract: Why Australian Law is Incoherent

BY Hearsay
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Good-Faith-in-Contract-intro.jpg
Sunday 3rd March, 2013
Good Faith in Contract: Why Australian Law is Incoherent

Context

Introduction

As an underlying concept, good faith plays a crucial role in the law of contract. However, on the basis that good faith ought to be more than that, over the past 20 years some Australian courts have given good faith a more overt role in the resolution of contractual disputes. Unfortunately, these ‘good faith cases’ have produced much confusion and uncertainty. The law is incoherent.

This paper focuses on the two areas in which implied terms have been used to implement the new understanding of the role of good faith: contract performance and the exercise of express rights. Although regularly raised as an issue, only rarely in the reported cases has the decision turned on the new understanding. From that perspective, the main contribution of the good faith cases has been to litigation costs.1 Analysis of express terms of ‘good faith’ has occurred mainly in the context of good faith negotiation clauses. I am not concerned with those.2

There are three principal cases. The first is Renard Constructions (ME) Pty Ltd v Minister for Public Works,3 where Priestley JA held that ‘reasonableness’ was an implied term of a termination clause in a standard form building contract. Although he alone took that view, Priestley JA’s judgment included an extended discussion of the good faith concept. In many subsequent cases that discussion has been treated as legitimising the search for an implied term giving effect to good faith.4 In the second case, Burger King Corp v Hungry Jack’s Pty Ltd,5  it was held that good faith justified three terms which were implied in law in a complex franchising transaction between sophisticated parties: a co-operation term; and ‘terms of good faith and reasonableness’.

Neither case has been approved by the High Court. In fact, dicta from two members of the court in Royal Botanic Gardens and Domain Trust v South Sydney City Council6 point in the opposite direction. Kirby J said7 that a general implied term of ‘good faith and fair dealing’ would ‘conflict with fundamental notions’. And Callinan J referred8 to the ‘far-reaching contentions’ for which certain cases stood as authority. He included Hungry Jack’s. Nevertheless, emboldened by that decision, Renard and other cases,9 some courts assumed that a term of ‘good faith’ is implied in all contracts,10 or at least all commercial contracts.11 Given that only the High Court can create new rules of law,12 this was somewhat surprising. However, in the third case, CGU Workers Compensation (NSW) Ltd v Garcia,13 it was held that ‘good faith’ is not a term ‘to be inserted into every contract or even into every aspect of a particular contract’.14 That decision binds all Australian courts other than the High Court.15 It follows any good faith term must satisfy the rules which govern implications in particular contracts, or particular classes of contract.

Good-Faith-in-Contract.pngKinds of Incoherence

However well-intentioned the efforts of the courts over the past 20 years in the good faith cases, the plain fact is that the law is in an unsatisfactory state. From one perspective at least it is self-evident that Australian Law is incoherent. As Giles JA said in Vodafone Pacific Ltd v Mobile Innovations Ltd,16 there is a ‘regrettable lack of uniformity in the cases’. That is the result of differences of opinion as to whether good faith is a distinct concept, when (and how) it can be called upon, and what good faith ‘means’. Similarly, good faith is variously described as a ‘duty’, ‘requirement’, ‘obligation’, and so on. In addition, commitment to the overt concept has varied not just from court to court but also from judge to judge.17 All of this has contributed to a general lack of internal coherence.

A second kind of incoherence relates to methodology. As noted above, good faith has been promoted through implied terms. There is a lack of uniformity of rationale, and in term formulation. In some cases courts have been content to imply a term of ‘good faith’, if only as a matter of assumption. In others specific implications have been arrived at, usually formulated in terms of ‘reasonableness’. And in some cases courts have taken a ‘two for the price of one’ approach, as in ‘good faith and reasonableness’ or ‘good faith and fair dealing’. As they all derive from the concern to promote good faith overtly, ‘good faith term’ is an appropriate generic description.

This leads to a third, and more general kind of incoherence, namely, ‘legal incoherence’. Except when used to refer to bona fides, ‘good faith’ is not a distinctive legal concept. In effect, the implied terms rules have been used to legitimise a false conception that there is such a concept, and therefore a ‘doctrine’ of good faith. As a means to an end, the application of the implied terms rules has lacked rigour and consistency. Various anomalies have developed.

A fourth kind of incoherence emerges in a comparison between construction and implication. The good faith cases have used implied terms to contradict construction conclusions. Overt use of good faith as a concept has therefore led to the reformation of contracts. This has undermined the sanctity of the written contract. The principal theme of this paper is therefore that the good faith cases have failed to appreciate the importance of giving effect to the reasonable expectations of the parties through the process of ‘commercial construction’.18

‘Good Faith’ Standards

‘Good faith’ is by definition a standard or the description of a standard.19 In commercial law in general, three usages can be identified.20 First, when used as a synonym for ‘bona fides’ good faith states a prescriptive standard of honesty in fact. This is the ‘legal meaning’ of good faith for the common law.21 The standard sometimes receives overt recognition, as in the concept of ‘bona fide purchaser’,22  and in the compromise of a disputed claim, one element of which is that the claim must be made in good faith.23

Second, good faith may describe a prescriptive relational standard. Thus, ‘good faith’ is a shorthand description for the standards applicable where a person stands in a fiduciary position.24

Third, good faith may be a presumptive standard of the market place. It is this standard which underlies, and is expressed by, much of the common law of contract. This usage relies on the existence of a general (community) consensus that good faith is characterised by certain features (‘incidents’). Examples include co-operation in performance, consistency of conduct, communication of decisions and acting reasonably. On this basis, good faith underlies any rule which incorporates one or more of these incidents. Although normative, the standard is not prescriptive. In other words, unless it is prescribed by law, a contract may depart from any market place standard. The basic fallacy of the good faith cases is the view that particular incidents, such as acting reasonably, can be deployed to resolve contractual disputes even though there is no agreement to that effect.

Influence of United States Law

If the question is asked why it has been thought necessary to raise the profile of good faith, the basic answer seems to be a view that, otherwise, Australian law would be deficient when compared with other legal systems and common law jurisdictions. In particular, there has been a tendency to look wistfully at United States law.25

Reference has sometimes been made to §1 203 of the Uniform Commercial Code,26  which states:

Every contract or duty within this Act imposes an obligation of good faith in its performance or enforcement.

Because §1 203 states a requirement of ‘honesty in fact’,27 there is no reason to doubt that Australian law is the same. However, the (Australian) good faith cases have promoted a broader requirement. For that purpose, reliance has been placed on §2-102, which applies the more exacting standard of ‘honesty in fact and reasonable standards of fair dealing in the trade’ to contracts for the sale of goods. However, it is seldom noted that this applies only to ‘merchants’.

The provision most frequently cited is §205 of the Restatement (Second) Contracts (1979):28

Every contract imposes upon each party a duty of good faith and fair dealing in its performance and its enforcement.

While the rule does not have the force of law, it can be assumed that most, if not all, American jurisdictions recognise a common law concept, usually articulated as an ‘implied covenant of good faith’.29

Comparative analysis is important: there is no reason why the solutions for contract problems which arise in Australia should be significantly different from those reached in other jurisdictions.30  However, there are certain difficulties which necessarily undermine the good faith cases. First, borrowing in the good faith context is not supported by decisions of the High Court. For example, in Breen v Williams31  the court emphasised that Canadian decisions requiring ‘utmost good faith and loyalty’ in the doctor-patient context are not reliable precedents.

Second, it is impossible to obtain guidance from an undefined concept.32 What passes for ‘good faith’ under a foreign law may be known by another name in Australia. It remains far easier for Australian courts to appreciate usages in English decisions than in American cases, with which Australian courts can only hope to have a passing acquaintance.33 It therefore seems somewhat paradoxical that the implied term of ‘trust and confidence’ adopted by English law34 as an incident of employment contracts, is yet to be fully recognised in Australia.35

Third, what an Australian lawyer might understand to be required by ‘good faith’ may differ markedly from the actual position. An Australian court investigating how the concept is applied in the United States must examine the case law. But there are a great many jurisdictions to choose from!36 There is a vast and diverse body of law in relation to a concept which has been described as ‘uncertain’.37 Understandably, in no Australian case has an attempt been made to develop an understanding of the law in the way that is routinely done for English law.38 But it seems reasonably clear that the (Australian) good faith cases have adopted a more intrusive approach.39

Fourth, because contract law is a coherent whole, it is dangerous to divorce one rule from other contract rules. For example, the rule stated in §205 of the Restatement (Second) Contracts (1979) is applied by construction. If other provisions are a reliable guide, as compared with Australian law there are significant differences in relation to what raw material is admissible in construction.40 For example, in contrast with Australian law, §214 treats prior negotiations as admissible as a direct aid to construction. Since what ‘good faith’ requires turns on the construction of the particular contract at issue, rules on admissibility of evidence are important.41 In no Australian case has any attempt been made to explain the interaction between the rule stated by §205 and the evidence admissible in construction.

The Underlying Concept

Application of the Implied Term Rules

Good faith in Performance

Good faith in the Exercise of Rights

Conclusions

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J W Carter
Professor Emeritus, University of Sydney
Consultant, Herbert Smith Freehills

 

* A revised version of a paper presented at the Bar Association of Queensland 2014 Annual Conference, Saturday 8 March 2014. My thanks to Michelle Bruce for her comments on drafts of the paper.

  1. Cf E A Farnsworth, ‘Good Faith in Contract Performance’ in Jack Beatson and Daniel Friedmann, eds, Good Faith and Fault in Contract Law, Clarendon Press, Oxford, 1995, p 169.
  2. However, it might be mentioned that although the cases on exercise of express rights have tended to equate good faith with ‘reasonableness’, that has not occurred in the context of express good faith negotiation clauses. See United Group Rail Services Ltd v Rail Corporation of New South Wales (2009) 74 NSWLR 618; [2009] NSWCA 177; Strzelecki Holdings Pty Ltd v Cable Sands Pty Ltd (2010) 41 WAR 318; [2010] WASCA 222. Another oddity is that when it comes to implying terms, courts claim to know exactly what good faith means. However, in the leading case on express good faith negotiation clauses (Coal Cliff Collieries Pty Ltd v Sijehama Pty Ltd (1991) 24 NSWLR 1) the provision was struck down because the court could give it no meaning.
  3. (1992) 26 NSWLR 234 (‘Renard’).
  4. See, eg Hungry Jack’s v Burger King Corp [1999] NSWSC 1029 per Rolfe J, affirmed sub nom Burger King Corp v Hungry Jack’s Pty Ltd (2001) 69 NSWLR 558; [2001] NSWCA 187 (source for implied term of ‘good faith and reasonableness’); Far Horizons Pty Ltd v McDonald’s Australia Ltd [2000] VSC 310 at [120] per Byrne J (source for implied term of ‘good faith and fair dealing’).
  5. (2001) 69 NSWLR 558; [2001] NSWCA 187 (‘Hungry Jack’s’).
  6. (2002) 240 CLR 45; 186 ALR 289; [2002] HCA 5.
  7. (2002) 240 CLR 45 at 75; 186 ALR 289; [2002] HCA 5 at [88].
  8. (2002) 240 CLR 45 at 94; 186 ALR 289; [2002] HCA 5 at [156].
  9. See Hughes Aircraft Systems International v Airservices Australia (1997) 146 ALR 1; Alcatel Australia Ltd v Scarcella (1998) 44 NSWLR 349.
  10. See, eg Central Exchange Ltd v Anaconda Nickel Ltd (2002) 26 WAR 33; [2002] WASCA 94; Pacific Brands Sport & Leisure Pty Ltd v Underworks Pty Ltd [2005] FCA 288 per Finkelstein J (affirmed without deciding the point (2006) 149 FCR 395; 230 ALR 56; [2006] FCAFC 40). Compare Jenkins v NZI Securities Australia Ltd (1994) 124 ALR 605 at 619 per the Full Federal Court.
  11. See, eg Garry Rogers Motors (Australia) Pty Ltd v Subaru (Australia) Pty Ltd [1999] FCA 903 at [34] per Finkelstein J; NT Power Generation Pty Ltd v Power and Water Authority (2001) 184 ALR 481 at 574; [2001] FCA 334 at [395] per Mansfield J.
  12. See, eg Garcia v National Australia Bank Ltd (1998) 194 CLR 395; 155 ALR 614; Farah Constructions Pty Ltd v Say-Dee Pty Ltd (2007) 230 CLR 89; 236 ALR 209; [2007] HCA 22; Narain v Euroasia (Pacific) Pty Ltd (2009) 26 VR 387 at 396; [2009] VSCA 290 at [44] per Nettle JA (with whom Bongiorno JA and Byrne AJA agreed).
  13. (2007) 69 NSWLR 680; [2007] NSWCA 193 (‘CGU’).
  14. (2007) 69 NSWLR 680 at 704; [2007] NSWCA 193 at [132] per Mason P (with whom Hodgson and Santow JJA agreed); see also (2007) 69 NSWLR 680 at 710; [2007] NSWCA 193 at [168] per Santow JA, with whom Hodgson JA agreed (‘no general contractual term, implied in law, requiring the exercise of good faith in contractual performance’). To the same effect see Esso Australia Resources Pty Ltd v Southern Pacific Petroleum NL [2005] VSCA 228 at [4] per Warren CJ, [25] per Buchanan JA (with whom Warren CJ and Osborn AJA agreed); Vodafone Pacific Ltd v Mobile Innovations Ltd [2004] NSWCA 15 at [189], [191] per Giles JA (with whom Sheller and Ipp JJA agreed) and the decision of the Singapore Court of Appeal in Ng Giap Hon v Westcomb Securities Pte Ltd [2009] 3 SLR(R) 518; [2009] SGCA 19.
  15. See Farah Constructions Pty Ltd v Say-Dee Pty Ltd (2007) 230 CLR 89; 236 ALR 209; [2007] HCA 22; Narain v Euroasia (Pacific) Pty Ltd (2009) 26 VR 387 at 396; [2009] VSCA 290 at [44] per Nettle JA (with whom Bongiorno JA and Byrne AJA agreed); CAL No 14 Pty Ltd v Motor Accidents Insurance Board (2009) 239 CLR 390 at 411-12; 260 ALR 606 at 621; [2009] HCA 47 at [49] per Gummow, Heydon and Crennan JJ (with whom Hayne J agreed).
  16. [2004] NSWCA 15 at [192] (‘Vodafone’). Sheller and Ipp JJA agreed. See also Council of the City of Sydney v Goldspar Australia Pty Ltd (2006) 230 ALR 437 at 498; [2006] FCA 472 at [166] per Gyles J (‘bewildering variety of opinions’).
  17. See Council of the City of Sydney v Goldspar Australia Pty Ltd (2006) 230 ALR 437 at 498; [2006] FCA 472 at [166] per Gyles J.
  18. This paper builds on the argument in J W Carter and Elisabeth Peden, ‘Good Faith in Australian Contract Law’ (2003) 19 JCL 155.
  19. For a more sophisticated analysis see S M Waddams, ‘Good Faith, Unconscionability and Reasonable Expectations’ (1995) 9 JCL 55.
  20. Compare Kennedy v De Trafford [1897] AC 180 at 185 per Lord Herschell (‘It is very difficult to define exhaustively all that would be included in the words “good faith” …’.).
  21. See Strzelecki Holdings Pty Ltd v Cable Sands Pty Ltd (2010) 41 WAR 318 at 335; [2010] WASCA 222 at [47] per Pullin JA, with whom Newnes JA agreed (‘honesty’ as ‘natural and ordinary meaning’ of good faith).
  22. See Service Station Association Ltd v Berg Bennett & Associates Pty Ltd (1993) 45 FCR 84 at 91; 117 ALR 393 per Gummow J.
  23. See Wigan v Edwards (1973) 1 ALR 497 at 513; 47 ALJR 586 at 595 per Mason J (with whom Walsh J agreed). See also Hirachand Punamchand v Temple [1911] 2 KB 330 at 339 per Fletcher Moulton LJ (action of creditors after they had agreed to accept payment of lesser sum from third party was ‘inconsistent with the duty of an honest man’); Scuderi v Morris (2001) 4 VR 125 at 145; [2001] VSCA 190 at [58] per Chernov JA, with whom Ormiston JA substantially agreed and Buchanan JA agreed (debtor’s composition with creditors).
  24. See Service Station Association Ltd v Berg Bennett & Associates Pty Ltd (1993) 45 FCR 84 at 91; 117 ALR 393 per Gummow J.
  25. See the judgment of Priestley JA in Renard. See also Yam Seng Pte Ltd v International Trade Corp Ltd [2013] 1 Lloyd’s Rep 526 at 546; [2013] EWHC 111 (QB) at [127]-[128] per Leggatt J, where Australian cases such as Renard are looked at in the same way. And see Lady Justice Arden, ‘Coming to Terms with Good Faith’ (2013) 30 JCL 199.
  26. American Law Institute and National Conference of Commissioners on Uniform State Laws, Uniform Commercial Code, 1990 Official Text.
  27. See §1-201(19).
  28. American Law Institute, Restatement of the Law Second, Contracts 2d, as adopted and promulgated in May 1979, American Law Institute Publishers, St Paul, 1981. See further on §205 below, text at nn 40, 125.
  29. See, eg Metropolitan Life Insurance Co v RJR Nabisco Inc, 716 F Supp 1504 at 1515 (SDNY, 1989). See R S Summers, ‘The General Duty of Good Faith — Its Recognition and Conceptualization’ (1982) 67 Cornell L Rev 810.
  30. And see UNIDROIT Principles of International Commercial Contracts 2010, Art 1.7(1) (‘Each party must act in accordance with good faith and fair dealing in international trade.’).
  31. (1996) 186 CLR 71; 138 ALR 259.
  32. Compare R S Summers, ‘The General Duty of Good Faith — Its Recognition and Conceptualization’ (1982) 67 Cornell L Rev 810 at 820 (absence of definition means that good faith operates as an ‘excluder’).
  33. Similarly, in Yam Seng Pte Ltd v International Trade Corp Ltd [2013] 1 Lloyd’s Rep 526; [2013] EWHC 111 (QB), Leggatt J makes no reference to CGU when commenting on the role of good faith in Australian law.
  34. See, eg Malik v Bank of Credit and Commerce International SA [1998] AC 20.
  35. See Russell v Trustees of the Roman Catholic Church for the Archdiocese of Sydney (2008) 72 NSWLR 559 at 567; [2008] NSWCA 217 at [33] per Basten JA (with whom Giles and Campbell JJA agreed). Cf Merrill Lynch International (Australia) Ltd v Commissioner of Taxation (2001) 191 ALR 420 at 447; [2001] FCA 1127 at [95] per Lindgren J.
  36. See Service Station Association Ltd v Berg Bennett & Associates Pty Ltd (1993) 45 FCR 84 at 92; 117 ALR 393 per Gummow J.
  37. See H O Hunter, ‘The Growing Uncertainty about Good Faith in American Contract Law’ (2004) 20 JCL 50. Several of the cases referred to by Professor Hunter are cited in the discussion below. See also H K Lücke, ‘Good Faith and Contractual Performance’ in P D Finn, ed, Essays on Contract, 1987, p 161 (no ‘coherent theory of good faith’).
  38. See further below, text at n 125.
  39. See H O Hunter, ‘The Growing Uncertainty about Good Faith in American Contract Law’ (2004) 20 JCL 50 at 55-6 (suggesting that argument in J W Carter and Elisabeth Peden, ‘Good Faith in Australian Contract Law’ (2003) 19 JCL 155 is ‘consistent with American law’).
  40. For a brief survey see J W Carter, ‘Context and Literalism in Construction’ (2014) 31 JCL 100.
  41. See, eg Metropolitan Life Insurance Co v RJR Nabisco Inc, 716 F Supp 1504 at 1515 (SDNY, 1989) (‘extrinsic evidence to evaluate the scope of an implied covenant of good faith’).