The concept of “good faith” in commercial contracts: what is it and when does it apply in the sports industry?
Published 24 October 2018 By: Luka Krsljanin
“Good faith has two elements or aspects: (1) Adherence to reasonable commercial standards of fair dealing; and (2) Faithfulness to the agreed common purpose of the contract and to the reasonable expectations of the parties arising from it.”
The concept of ‘good faith’ has been acknowledged by numerous judges and commentators and, while somewhat nebulous, is broadly captured by the quote above. The question of whether or not a contract imposes obligations of good faith (whether by express provision or implication) can have significant ramifications for the parties both in terms of performance of the contract, and termination.
This article examines the development of the case law on ‘good faith’ in recent years, where it currently stands, and the key questions the sports industry should ask when considering the issue of good faith. Specifically, it looks at:
The established case law on “good faith”
The Landscape After Yam Seng
The circumstances that determine whether or not there is a “relational contract”
Key checklist for the sports industry on when good faith obligations might arise
The existence of good faith obligations will have a qualitative effect on the parties’ obligations under the contract; it is likely also to affect the standard to which parties must perform their obligations under the contract.
The existence (or not) of good faith obligations will be particularly important if a contract is not clearly drafted, or if it leaves matters unresolved, and to be agreed at a later date: in the absence of a good faith obligation a party may be permitted to act cynically or in its own commercial self-interests to the detriment of the other without breaching the terms of the contract, whereas in its presence, the parties will likely be stymied from such behaviour.
Equally importantly, the existence of good faith obligations will ordinarily broaden the circumstances in which the parties are able to terminate the contract, and seek remedies following such termination: if a party has not dealt honestly with the other, or has acted in a way that undermines the purpose of the agreement, that might not otherwise entitle the innocent party to terminate. If, however, good faith obligations exist, such conduct is likely to entitle the innocent party to terminate.
For these reasons, the question of whether or not such long-term contracts have implied obligations of good faith may be critical to resolving the disputes that may arise in litigation. Recent years have seen an increased focus on this question.
The Established Case Law
“[T]here is no general doctrine of good faith in English contract law and such a term is unlikely to arise by way of necessary implication in a contract between two sophisticated commercial parties negotiating at arms' length.” (paragraph 150)
Other countries have readily embraced the need for good faith to be implied into all commercial contracts at law. The English Courts, however, have demonstrated a longstanding scepticism of such an approach. It is routinely said that a general doctrine of good faith would undermine the adversarial nature of contract negotiations, the fundamental principle of freedom of contract, and would risk expressly agreed terms being undermined3.
A sea change came with Leggatt J’s judgment in Yam Seng v International Trade Corp4. The case concerned a contract under which the Claimant was contracted to distribute Manchester United fragrances manufactured by the Defendant in numerous territories in the Middle East and Far East. The products’ sales were underwhelming, and the parties’ relationship broke down. Amongst other allegations, the Claimant alleged that the Defendant’s agent had provided the Claimant with false information, and that this breached an implied term of good faith that was said to exist in the parties’ contract.
At the heart of the judgment is a realisation that there are certain contracts which are fundamentally different to the traditional “arms’ length” or one-off transactional contract; contracts premised on the idea of cooperation, to which good faith is essential:
“[M]any contracts do not fit [the arms’ length] model and involve a longer-term relationship between the parties to which they make a substantial commitment. Such "relational" contracts… may require a high degree of communication, co-operation and involve expectations of loyalty which are not legislated for in the express terms but are implicit in the parties’ understanding and necessary to give business efficacy to the arrangements. Examples of such relational contracts might include some joint venture agreements, franchise agreements and long term distributorship agreements.”
“I respectfully suggest that the traditional English hostility towards a doctrine of good faith in the performance of contracts… is misplaced.” (paragraphs 142, 153)
The Landscape After Yam Seng
Unsurprisingly, this prompted a number of parties in commercial litigation to assert the existence of implied good faith obligations. A number of judgments after Yam Seng sought to emphasise that Leggatt J had not created a new doctrine of general application. In Boots UK Ltd v Hamsard 3147 Ltd5 Norris J held:
“I do not regard the decision in Yam Seng Pte Ltd v International Trade Corporation as authority for the proposition that in commercial contracts it may be taken to be the presumed intention of the parties that there is a general obligation of 'good faith'. I readily accept that there will generally be an implied term not to do anything to frustrate the purpose of the contract. But I do not accept that there is to be routinely implied some positive obligation upon a contracting party to subordinate its own commercial interests to those of the other contracting party.”
Subsequent consideration of Yam Seng has involved some notable approving judgments. Most significantly, the Court of Appeal appeared to approve Leggatt J’s analysis in the cases of Globe Motors v TRW Lucas Varity Electric Steering6, and Ilkerler Otomotiv v Perkins Engines7 (albeit obiter).
The judgment in Globe Motors is particularly useful in reiterating that good faith obligations are simply a form of implied terms; as such, the usual principles relevant to consideration of implied terms and contractual interpretation will apply. Parties cannot resort to sweeping allegations of good faith as a shortcut to their desired outcome when the evidence does not support the implication of such a term:
“[A]n implication of a duty of good faith will only be possible where the language of the contract, viewed against its context, permits it. It is thus not a reflection of a special rule of interpretation for this category of contract.” (paragraph 68)
The Court of Appeal also sounded a further note of caution in the case of MSC Mediterranean Shipping Co S.A. v Cottonex Anstalt8, in which Moore-Bick LJ warned:
“The recognition of a general duty of good faith would be a significant step in the development of our law of contract with potentially far-reaching consequences… “There is in my view a real danger that if a general principle of good faith were established it would be invoked as often to undermine as to support the terms in which the parties have reached agreement.” (paragraph 45)
Is it a Relational Contract?
In line with these two Court of Appeal decision, the Courts post-Yam Seng have been keen not to overextend its ambit, and to emphasise that a contract must truly and properly meet the definition of a “relational contract” in order for good faith obligations to be implied. The Courts will scrutinise closely whether or not the contract before them properly requires the implication of good faith obligations: see for example National Private Air Transport Services Co v Windrose Aviation Co9, in which Blair J held that an aircraft lease agreement was not a relational contract, saying that the contract was “conventional” and the fact that there might be some expectation of cooperation was not enough to make the contract relational: paragraph 136.
A useful demonstration of the Court’s strict approach came from Warren J in General Nutrition Investment Company v Holland and Barrett International Ltd (formerly known as NBTY Europe Ltd) and another10. After a summary of the case law (paragraphs 309-321) Warren J made clear that just because a contract had some of the superficial aspects of a “relational contract” would not lead the Courts easily to imply good faith obligations:
“I do not consider that the LA [the contract in the case] is a relational ... Although the LA is a long-term contract, it is one where there ought to be no need for any ongoing communication of the sort envisaged in the cases and required to enable the contract to operate effectively.”
This line of case law has, appropriately enough, led to a recent judgment from its originator: Leggatt J’s judgment in Nehayan v Kent11; one of his Lordship’s last judgments before being elevated to the Court of Appeal.
Leggatt J was here keen to emphasise that (in his view) there is a flaw in the traditionalist English contract lawyer’s mentality of drawing a dichotomy between fiduciary contracts and other contracts, and acting as though every contract must fall into one or the other of these two categories. In the same judgment, Leggatt J gave further useful guidance as to the features that must be present for a contract to be a “relational” one into which good faith obligations will be implied:
“I have previously suggested in YamSeng… that it is a mistake to draw a simple dichotomy between relationships which give rise to fiduciary duties and other contractual relationships and to treat the latter as all alike. In particular, I drew attention to a category of contract in which the parties are committed to collaborating with each other, typically on a long term basis, in ways which respect the spirit and objectives of their venture but which they have not tried to specify, and which it may be impossible to specify, exhaustively in a written contract. Such 'relational' contracts involve trust and confidence but of a different kind from that involved in fiduciary relationships. The trust is not in the loyal subordination by one party of its own interests to those of another. It is trust that the other party will act with integrity and in a spirit of cooperation. The legitimate expectations which the law should protect in relationships of this kind are embodied in the normative standard of good faith.” (para. 167)
It will be interesting to see if the Court of Appeal is soon engaged on an appeal concerning good faith obligations, and whether or not Leggatt LJ will form part of that tribunal. It may also be noted that Sir Martin Moore-Bick (formerly Moore-Bick LJ), a vocal sceptic12 of the Yam Seng analysis, has retired from the Court of Appeal’s bench.
Whilst we await further judicial guidance, the following checklist – derived from the existing case law – will hopefully act as a useful (non-exhaustive) summary of the key questions for practitioners to ask themselves when considering whether or not any obligations of good faith are likely to be implied into a particular contract. It is important to recognise that the Court will look at the contract as a whole, and not simply at the factors below in isolation. However, these should serve as a useful checklist when considering whether or not a contract is likely to be considered to be relational
Key checklist for the sports industry on when good faith obligations might apply
Is it a long-term contract? Are there break clauses/renewal clauses and, if so, how do they operate? Whilst this factor alone will not a “relational contract” make, the long life of a contract is a potentially compelling factor. A potentially strong example would be a naming rights sponsorship deal with a notably long term, and limited or strictly prescribed break clauses. Take for example the $400 million contract under which Citigroup Inc. were granted the rights to name the New York Mets’ Home Stadium for a period of 20 years.13
Are the parties required to “invest” significant sums or efforts into the relationship? If the contract requires the parties to make such investments, which will have limited value outside of this particular contractual relationship, then that is a compelling factor. This may be especially relevant to consideration of any sports contract under which a party is agreeing to invest in a Club as an equal-rights shareholder. A related question to ask may be whether the contract envisages a situation in which the parties may have limited profit/benefit at an early stage but where these are intended to increase over time? The more that a contract appears to have the spirit of the classic joint-venture scenario, the more likely it is to be a “relational contract”. This is a factor that may arise with contracts under which a party is granted the right to manufacture officially licensed products for a Sports club, but under which the Club (the brand owner) insists on a substantial upfront payment rather than simply royalty payments on sales actually made: the initial performance of the contract can be costly to the manufacturer, who must make the upfront payment but also invest sums upfront in order to produce the merchandise.
Is there any element of exclusivity or commitment? Where parties have committed to one another in a significant way, and in so doing deprived themselves of other commercial opportunities, that will tend to support the conclusion that it is a “relational contract”. The paradigm example might be a sponsorship agreement between Club and sponsor, under which a sponsor might seek to preclude the Club from taking on any other sponsors during the life of the contract. This is an interesting area for debate in an era where multiple sponsors are becoming increasingly common: see for example the recent acceptance of shirtsleeve sponsors in the Premier League.
Must there be consistent ongoing communication between the parties in order for the contract to be performed? Recall that the absence of this factor was crucial to Warren J in the Holland and Barrett case. If ongoing communication is essential to the contract’s performance – and not simply “optional” in the performance of the contract – this may be a highly compelling factor. So, for example, a contract governing the provision of security equipment or personnel for matchdays might require a closer degree of cooperation between parties than a straightforward contract for the manufacture and supply of merchandise. For a further example, look at the distributorship agreement in the Yam Seng case, in respect of which Leggatt J highlighted:
“[ITC’s] needed to plan production and take account of the expected future demand from Yam Seng for Manchester United products. For its part Yam Seng, which was incurring expense in marketing the products and was trying to obtain orders, was arguably entitled to expect that it would be kept informed of ITC's best estimates of when products would be available to sell and would be told of any material change in this information without having to ask.” (paragraph 143)
Does the language permit a good faith obligation? It is to be noted that in Globe Motors, the Court of Appeal simply restated the trite proposition that an implied term cannot contradict an express term, but the reminder is a useful one. Whilst the Court did not go so far as to prescribe the need for particular positive language existing to support the implication of good faith obligations, it was clear that such obligations (if they are to be implied) must be permitted by, or consistent with, the express wording of the contract.
As a final point, the author currently acts on behalf of West Ham in their ongoing claim against E20 Stadium LLP, the owners of the former Olympic Stadium. The claim relates to the 99-year contract between the parties, under which West Ham are entitled to the use of the Stadium as their home football ground, in return for an annual Usage Fee. The case is concerned in large part with whether or not E20 has breached its obligations under the contract by refusing to apply for a General Safety Certificate from the relevant authorities that would allow 60,000 spectators to attend the Stadium per match.14 It is hoped that the judgment will give valuable guidance on contracts in the sports context. The case is listed for trial commencing on 19 November 2018. This article is not concerned with the case itself, for obvious reasons given its ongoing nature.
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Barrister at 2TG
“A self-confident and bright advocate”, who is “very good technically, very thorough and approachable”, Luka is ranked as a leader in the field for his work in Private International Law (Chambers UK).