No implied obligation of good faith in exercising contractual right of termination

The High Court has again considered the circumstances in which a duty of good faith will be implied into a contract, rejecting an argument that a party's contractual right to terminate a consultancy contract had to be exercised in good faith: Monde Petroleum SA v Westernzagros Limited [2016] EWHC 1472 (Comm). 

An allegation that a party has breached an implied term of good faith may in some circumstances be a useful tool in a claimant's armoury. In the present case, however, the claimant was unsuccessful in its attempts to deploy this tool.  The deputy judge noted that, outside accepted categories of contract where a duty of good faith is implied by law (eg employment or partnership contracts), such a term will only be implied if the contract would lack commercial or practical coherence without it. That was not the case here. He also suggested that a duty of good faith could not apply to a contractual right to terminate, which can be exercised irrespective of the exercising party's reasons for doing so.

The decision provides another illustration of the difficulties that a claimant will face when seeking to imply a good faith term into a contract, particularly in relation to a contractual right of termination. Other recent cases where the courts have rejected an implied duty of good faith are considered here and here, or see our guide: How far can you act in your own self-interest? The role of good faith in commercial contracts, which forms part of our series of contract disputes practical guides.   

Gregg Rowan and James Robson, a partner and associate in our dispute resolution team, consider the decision further below.

Background                                                                                              

Westernzagros Ltd (WZL) was negotiating an exploration and production sharing agreement (EPSA) with the Kurdistan Regional Government in relation to oil production in Kurdistan.  Monde Petroleum SA (Monde) and WZL entered into a Consultancy Agreement under which Monde provided services to assist WZL in those negotiations.  In return, Monde received various benefits including an option to acquire, in certain events, a 3% working interest in the project.  That option would only vest on the occurrence of the final milestone. 

Less than a year after the EPSA was signed, WZL served a termination notice on Monde intending to bring the Consultancy Agreement to an end.  The final milestone had not been reached and so the 3% option had not vested.  Shortly afterward, the parties entered into a Termination Agreement in which they agreed that the Consultancy Agreement was at an end and released each other from all further liabilities. 

Monde brought a claim against WZL arguing that its signature of the Termination Agreement had been procured by misrepresentation and/or economic duress; that the Termination Agreement should be set aside; and that the termination notice was invalid and that, by serving it, WZL committed a repudiatory breach of contract, entitling Monde to substantial damages. 

Decision

The court (Mr Richard Salter QC sitting as a deputy judge) held that the Termination Agreement was procured by misrepresentation, but that WZL was not in repudiatory breach as a result of serving the termination notice.

Good faith

Monde argued that:

1. it was an implied term of the Consultancy Agreement that WZL would not exercise any right to terminate the agreement otherwise than in good faith; and
2. WZL had breached that term because by terminating the Consultancy Agreement it intended to deprive Monde of its remuneration under that agreement and its share of profits arising from the oil project. 

The judge rejected both arguments. He held that there was no implied duty of good faith and that, even if there was, it had not been breached. 

On the question of whether a term should be implied, there were two insuperable problems.

First, even assuming that the Consultancy Agreement was intended to be a long-term arrangement, it would not follow that it was necessary to imply into it any duty of good faith or other limit on WZL's freedom to exercise its contractual rights of termination.   So-called "relational" contracts – which establish a long-term relationship between the parties and require a high degree of communication and cooperation – have in other cases been held to contain an implied duty of good faith on the basis that they "involve expectations of loyalty which are not legislated for in the express terms of the contract but are implicit in the parties' understanding". However, as the judge noted in the present case, the mere fact that a contract is long-term or relational is not sufficient to justify such an implication. 

Citing the Supreme Court's recent decision in Marks & Spencer plc v BNP Paribas Securities Services Trust Co (Jersey) Ltd [2015] UKSC 72, which re-iterated the limited circumstances in which a term will be implied into an agreement, the judge emphasised that a duty of good faith will only be implied where the contract would lack commercial or practical coherence without it. In this case it was not possible to identify any facts forming part of the commercial background, or any aspects of the relationship between the parties, which meant this test was met. The Consultancy Agreement simply did not contain the sorts of mutual obligations and commitments that would be expected in the kind of relational contract where there were implicit expectations of loyalty that might perhaps (in the absence of any contrary indications) justify the implication of a "good faith" term.   

The second problem was that the suggested term was not concerned with the performance of the contract, but with its termination. The judge said that a contractual right to terminate is a right which may be exercised irrespective of the exercising party's reasons for doing so: provided any contractual requirements for the exercise of a termination right have been met, the terminating party does not have to justify its actions.

One reason for this is that a contractual right to terminate is not the exercise of a contractual discretion, which arises where there are a range of options to choose from, but rather involves a binary choice (as the judge noted, a similar distinction has been drawn in other cases, for example Myers v Kestrel Acquisitions Ltd discussed here). Another reason is that the right to end a contract is different from the sorts of right that may arise in the course of a contract's performance. The common law has, for sound commercial reasons, traditionally regarded certainty as a particularly important consideration in relation to contractual termination provisions.  

Despite his decision that a term should not be implied, the judge did go on to consider whether, if there was such a term, it had been breached.  He decided that it had not been breached.  WZL's reasons for terminating were not unconscionable or otherwise than in good faith.  In particular, at the time of termination there was little or no prospect of the final milestone being achieved (and therefore Monde's rights to a 3% interest in the oil project vesting) in the immediate future and good faith did not require WZL to assume that there was such a prospect. 

Defective termination notice

The judge found that the termination notice which WZL served on Monde was defective: the contractual notice provision allowed for termination upon 30 days' notice, but the termination notice purported to terminate the agreement with immediate effect. Monde argued that the service of a defective termination notice amounted to a repudiatory breach of the Consultancy Agreement, entitling it to damages. 

The judge also rejected this argument.  He held that service of a defective notice is not in itself a breach of contract and will not usually be treated as a renunciation of the contract.  That was particularly the case here, where the obligations on WZL (the terminating party) in the Consultancy Agreement were so limited. 

Comment

This decision adds to the growing body of recent case law on the implication of duties of good faith into commercial agreements. In the course of his judgment, the judge reviewed some of those recent decisions and, in the majority, the claimants have been unsuccessful in their attempts to imply good faith terms. This decision adds another example to that list.

Monde relied in argument on a first instance decision of Leggatt J in MSC Mediterranean Shipping Co SA v Cottonex Anstalt [2015] EWHC 283 which appeared to indicate that questions of good faith were relevant to the termination of an agreement. Leggatt J may be seen as something of a standard-bearer in relation to decisions on good faith.  The judge in the present case distinguished Leggatt J's decision on the basis that Cottonex did not involve a contractual right to terminate, but a right to affirm the contract and insist on future performance; and that Leggatt J did not appear to have had a relevant Court of Appeal decision cited to him. 

Interestingly, the Court of Appeal has since handed down its decision in the Cottonex case. Although the Court of Appeal upheld Leggatt J's decision, it did comment on his findings on the "good faith" issue.  Leggatt J had described "an increasing recognition in the common law world of the need for good faith in contractual dealings".  The Court of Appeal, however, said that:

1. 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", and it was not necessary or desirable to resort to it in order to decide the outcome of the case.
2. There is "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.

The Cottonex decision is the subject of a separate recent blog post, which can be found here.