High Court provides guidance on relational contracts and implied duties of good faith

The High Court has held that certain contracts between the Post Office and sub-postmasters, which are the subject of group litigation, are "relational contracts" and therefore subject to an implied obligation on the parties to act in good faith: Bates v Post Office Ltd (No. 3) [2019] EWHC 606 (QB).

The court recognised that an obligation of good faith is not implied in all commercial contracts. However, it held that, consistent with earlier decisions including Yam Seng Pte Ltd v International Trade Corpn [2013] EWHC 111 (considered here), English law recognises that there is a type of contract, a "relational contract", in which such an obligation is to be implied. Whether a contract is a relational one depends on the "circumstances of the relationship, defined by the terms of the agreement, set in its commercial context".

The court identified a number of characteristics relevant to an assessment of whether a contract is relational, including, for example, whether the parties' relationship is long-term, and whether the parties repose trust and confidence in each other in performing the contract. No single one of these characteristics would be determinative, save that there must be no express terms in the contract which would prevent a duty of good faith being implied.

The court rejected the argument that a duty of good faith requires only that the parties act honestly. The duty includes honesty but, in the court's view, it goes beyond that, requiring that the parties refrain from conduct which in the relevant context would be regarded as commercially unacceptable by reasonable and honest people.

The decision is of interest in adding to the debate as to whether, or when, duties of good faith will be implied. It suggests that whilst courts will not imply a duty of good faith in all commercial contracts, courts may be prepared to do so in an appropriate case, provided that the implication of such a term is not inconsistent with the express terms.

Rachel Lidgate and Matthew Eglezos, a Partner and Senior Associate (Australia) in our disputes team, outline the decision below.

Background

Approximately 550 claimants, most of whom were sub-postmasters ("SPMs"), brought various claims against the Post Office. Prior to 2011, the SPMs and the Post Office contracted pursuant to a Sub-Postmaster Contract ("SPMC") and, from 2011 onwards, a new contract, the Network Transformation Contract ("NTC"), was introduced. The SPMC and NTC provided (in general terms) that the SPM was responsible for losses caused by negligence on the part of the SPM or his or her personnel. The SPM was required to make good or pay any shortfalls to the Post Office.

In around 1999/2000, the Post Office introduced a computerised electronic point of sale and accounting system called Horizon, which the claimants were required to use in their branches. The Horizon system identified shortfalls and discrepancies in the accounting of various branches, which the Post Office pursued with the claimants and demanded payment. Some claimants paid these shortfalls out of their own resources, even though they did not accept any deficiencies in their own accounting. Other claimants were convicted in the criminal courts of false accounting, fraud and other offences (a Criminal Cases Review Commission review is presently underway in respect of many of these convictions).

The claimants allege in the group litigation that the Horizon system contained, or must have contained, bugs which caused the shortfalls and discrepancies, and that they are not liable for such loss pursuant to either the SPMC or the NTC. The Post Office alleges that Horizon is "robust" and can be relied upon.

In October 2017, the first substantive trial in the group litigation, a "Common Issues" trial, was held which aimed to resolve certain issues concerning (primarily) the construction of the relevant contracts. The judgment does not contain any findings as to breach of contract, causation or loss. Those matters will be addressed in subsequent trials throughout 2019.

Decision

In a lengthy judgment, the High Court (Fraser J) addressed a number of contractual and statutory matters. In this summary, we focus on the court's findings in relation to the characterisation of the SPMC and the NTC as "relational contracts" and the implication of a duty of good faith into those contracts.

Relational contracts

The court held that the SPMC and the NTC were relational contracts. Referring to a number of cases, including Leggatt J's decision in Yam Seng (referred to above) and key decisions which followed it, Fraser J concluded:

"I consider that there is a specie of contracts, which are most usefully termed 'relational contracts', in which there is implied an obligation of good faith (which is also termed 'fair dealing' in some of the cases). This means that the parties must refrain from conduct which in the relevant context would be regarded as commercially unacceptable by reasonable and honest people."

The judge specifically rejected the argument, based on a passage of the leading text Chitty on Contracts, that an implied duty of good faith only requires the parties to act honestly. The judge said that there is more to a duty of good faith than a requirement to act honestly, though the duty includes honesty.

The court accepted that there is no general duty of good faith implied into all commercial contracts, but concluded that "such a duty could be implied into some contracts, where it was in accordance with the presumed intention of the parties".

Characteristics of a relational contract

In deciding whether a contract was relational, so as to carry an implied obligation of good faith, it was necessary to consider (as at the time of contracting) the "circumstances of the relationship, defined by the terms of the agreement, set in its commercial context". The judge rejected, however, the suggestion that an "imbalance of power" between the parties was relevant to the correct characterisation of the contractual relationship as a relational contract. The judge set out a number of characteristics which he regarded as being relevant to whether a contract was relational or not. These are:

1. No specific express terms in the contract that prevent a duty of good faith being implied.
2. A long-term contract, with the mutual intention of a long-term relationship.
3. An intention to perform the parties' respective roles with integrity and fidelity to the bargain.
4. A commitment to collaboration in the contract's performance.
5. The "spirits and objectives" of the parties' venture being incapable of exhaustive expression in a written contract.
6. The parties reposing trust and confidence in each other (but of a kind different to that reposed in fiduciary relationships).
7. A high degree of communication, cooperation and predictable performance based on mutual trust and confidence, and expectations of loyalty.
8. A degree of significant investment by one or both parties.
9. Exclusivity of the contractual relationship.

The judge said that he hesitated to describe this as an exhaustive list and emphasised that no single factor would be determinative, with the exception of the first one: if the express terms prevented the implication of a duty of good faith, that would be the end of the matter.

The court considered that each of the above characteristics was present in the relationship between the Post Office and the SPMs under the SPMC and the NTC, and there were additional features of the relationship that influenced their categorisation as relational contracts. Those features included: the significance of an SPM's investment in buying or leasing premises for the branch; the Post Office's awareness of the size of the investment and the SPM's source of funds; the SPM's entitlement to certain benefits similar to those under an employment contract; the requirement on the Post Office to maintain branches widely, even in locations that would not normally be commercially viable (so the relationship contained an aspect which was not purely commercial); and the importance of trust between both the SPM and the public and the Post Office and the SPMs.

The judge then referred to other "secondary features" that he considered relevant in this case, including that the Post Office was ultimately government-owned and publicly funded, that the SPMs were engaged to perform transactions on its behalf and that the public require access to Post Office services – though he commented that this might be expressing the point  above, concerning the relationship having an aspect which was not purely commercial, in different terms.

The judge commented that the presence of notice provisions, which allowed the Post Office to bring the relationship to an end, was a relevant consideration, but not determinative. These provisions did not undermine the long-term nature of the contractual relationship between the Post Office and the SPMs.

The court therefore concluded that the SPMC and the NTC were relational contracts.

Consequential implied terms

The judge held that, of 21 possible implied terms identified in the Common Issues, 17 were to be implied into the SPMC and the NTC (in some cases, following amendment by the court) as a consequence of the court's conclusion that the contracts were relational contracts.

Those terms included obligations:

• not to take steps which would undermine the relationship of trust and confidence between claimants and defendant;
• to exercise any contractual or other power honestly and in good faith for the purpose for which it was conferred;
• not to exercise any discretion arbitrarily, capriciously or unreasonably; and
• to exercise any such discretion in accordance with the obligations of good faith, fair dealing, transparency, co-operation, and trust and confidence.

They also included more specific duties, such as to keep accurate records of all transactions in the Horizon system, cooperate in seeking to identify causes of alleged shortfalls, disclose possible causes of apparent shortfalls to claimants "candidly, fully and frankly", and not seek recovery from claimants unless and until the defendant had carried out a reasonable and fair investigation as to whether a shortfall was properly attributed to a claimant.

The court also held that a further three proposed terms were to be implied on the basis that they were necessary for business efficacy (and held that four of the terms implied as incidents of a relational contract could, if that finding was wrong, also be implied on the basis of business efficacy).