Iain Munro considers the implications of the Court of Appeal decision in Compass Group v Mid Essex Hospital Services NHS Trust and the judgment’s effect on interpretation of IT contracts
English law on good faith in commercial contracts remains out of step with other jurisdictions, unwilling to impose a general doctrine and narrow in its construction of implied and express terms. Over the last two years, two High Court decisions appeared to mark a change: first Compass Group UK and Ireland Ltd (t/a Medirest) v Mid Essex Hospital Services NHS Trust  EWHC 781 (QB) and then Yam Seng Pte v International Trade Corporation Ltd  EWHC 111 (QB). However, progress was slowed or at least not encouraged by the Court of Appeal's decision in Compass (see  EWCA Civ 200). There remains no general doctrine of good faith and, as a consequence, arguably more certain bargains. Whilst good faith obligations are generally enforceable, if the spirit of the Court of Appeal's decision in Compass is followed, expect no generosity in their construction or the potential for their implication.
As express duties of good faith are becoming more common in IT contracts, these attitudes should be monitored with interest.
Smells like Manchester United
Yam Seng concerned a contract for exclusive rights to distribute Manchester United branded fragrances, deodorants and toiletries, predominantly in parts of China, the UAE and Singapore. The Singaporean distributor claimed inter alia that its English supplier had undercut agreed prices and provided false information. The case is optimistic authority for the implication of duties of good faith.
Leggatt J, who heard Yam Seng in the High Court, was unaware of any English court decision in which the question of whether English law recognises a general duty of good faith was considered in any depth. However, he noted that the general view was that there was no such duty. Leggatt J identified three reasons for traditional English hostility towards the duty: (i) a preference for particular solutions to particular problems, rather than enforcing broad, overarching principles; (ii) an ethos of individualism, which permits parties to pursue their own self-interest; and (iii) a fear that a general doctrine would create too much uncertainty.
In Leggatt J's view, such hostility was misplaced. He stated that 'this jurisdiction would appear to be swimming against the tide', noting that a general principle of good faith was recognised in most civil law systems and certain common-law systems (such as the United States and Australia). Whilst he doubted that English law was ready to imply a duty of good faith into all commercial contracts (even as a default rule), he saw no difficulty in implying a duty of good faith into any ordinary, commercial contract based on the presumed intentions of the parties. Perhaps controversially, Leggatt J felt that there was nothing novel or foreign to English law in doing so.
Leggatt J stated that the nature of any such duty is sensitive to context and has a core value of honesty. The duty is subject to an objective test, namely: whether in the particular context the conduct would be regarded as commercially unacceptable by reasonable and honest people. This objective test has a subjective element; whether the party believes it is being honest in its conduct. Leggatt J speculated that in particular contexts the duty might give rise to a positive obligation to disclose information. However, it was not necessary to decide whether the duty of good faith extended so far in Yam Seng.
In this case, Leggatt J was encouraged to conclude that the relevant content of the duty was captured in two specific terms: (i) a duty not to give false information; and (ii) a duty not to undercut duty free prices. In relation to the first, Leggatt J implied a duty of honesty in the provision of information, holding that knowledge of the falsity of the information (the subjective element noted above) was critical. As for the second, he concluded that – as a matter of necessary implication – the defendant supplier would not authorise the sale of any product in the domestic market of any territory covered by the contract at a lower retail price than the duty free retail price for the product which had been specified in the contract. In his view, this was an extraordinary case that justified such an implied term. Particular contextual features included: the skeletal nature of the written agreement that did not attempt to specify the parties' obligations in detail; the specified duty free retail prices in that agreement; and (decisively) the industry assumption that retail prices in domestic markets will be higher than the corresponding duty free retail prices. The defendant supplier was held to be in repudiatory breach of this second implied term, but not to have breached the first.
Following Yam Seng, IT lawyers might anticipate the cautious development of a positive approach to the implication of duties of good faith. However, any such duties would be context specific.
The Ketchup Case in the High Court
The High Court decision in Compass was discussed in this magazine's April 2012 edition (vol 23, issue 1). The claimant supplier, Medirest, entered into a long-term catering contract with the defendant NHS hospital trust. The contract between the Trust and Medirest was a hybrid, combining a standard NHS contract with the procedure found in PFI contracts for service failures and deductions. The latter component provided various clauses for performance management and the calculation of deductions to the monthly payments by the Trust to Medirest.
After a bedding-in period, the Trust's own monitoring revealed minor performance failures, such as:
· out of date ketchup sachets, which were removed immediately on discovery;
· out of date patient or staff food, again removed immediately; and,
· a refrigerator without a temperature display (because it was being defrosted).
As a consequence of miscalculations by the Trust, performance failures such as these became significant deductions from payments: the ketchup sachets were to cost Medirest £46,320; the staff food, £96,060; and the refrigerator, £94,830.
So far as relevant, Cranston J considered: (i) the proper construction of clause 3.5 of the contract, which – on one reading – imposed a general duty of good faith; and (ii) whether the Trust exercised a true discretion in respect of the award of service points and payment deductions; and, if so, (iii) whether there be an implied obligation not to exercise it in an arbitrary, irrational and capricious way.
Clause 3.5 provided as follows:
'The Trust and the Contractor will [Obligation 1] co-operate with each other in good faith and [Obligation 2] will take all reasonable action as is necessary [Purpose 1] for the efficient transmission of information and instructions and [Purpose 2] to enable the Trust or, as the case may be, any Beneficiary to derive the full benefit of the Contract.' (Square brackets added.)
Medirest argued that the clause imposed a general obligation (Obligation 1) to cooperate in good faith and a more limited obligation (Obligation 2) to take all reasonable action as necessary for Purposes 1 and 2. Whereas the Trust preferred a narrower construction: Obligations 1 and 2 were both qualified by Purposes 1 and 2.
Cranston J held it was unnecessary to choose between these rival interpretations, but stated that he would have favoured a more general obligation to cooperate in good faith. In his view, the real issue was the content of the two obligations for the two purposes identified, with Purpose 2 (enabling the Trust or any Beneficiary to derive the full benefit of the contract) being crucial. In relation to the obligation to co-operate with each other in good faith to achieve Purpose 2, Cranston J stated that the Trust was pursuing a common purpose with Medirest of benefit to the public. The objective standard of conduct demanded of both parties primarily encompassed faithfulness to this common purpose, which involved fair dealing and acting consistently with justified expectations. In Cranston J's judgement, the Trust breached the clause 3.5 obligations because of its 'absurd calculations of service failure points' and its failure to respond positively when Medirest challenged the calculations and sought to resolve the dispute.
The judge also held that the calculation of service failure points and deductions was discretionary. In doing so, he relied inter alia on his interpretation of clause 3.5 and contractual language such as 'should be entitled to levy payment deductions' and 'may ... award service failure points'. This discretion was to be exercised in good faith, and not in an arbitrary, capricious or irrational manner. The Trust also breached this implied term.
On the basis of these breaches of clause 3.5 and the implied term, Cranston J found that Medirest was entitled to terminate. However, as Cranston J also concluded that the Trust was entitled to terminate because the termination threshold of service failure points had been exceeded, neither party could succeed in its claim for substantial post-termination losses.
Compass in the Court of Appeal
The Trust appealed, challenging inter alia Cranston J's interpretation of the express obligation to 'co-operate in good faith' and the implied term. The appeal was heard by Jackson, Lewison and Beatson LJJ; one of the strongest courts imaginable for black-letter contract law. All three judges disagreed with Cranston J on these key grounds of appeal.
Jackson LJ, who gave the lead judgment, described clause 3.5 as 'a jumble of different statements, set out in an incoherent order'. He re-considered the two rival interpretations of clause 3.5 that had been advanced in the High Court. Jackson LJ stated (correctly) that Cranston J preferred Medirest's construction, which involved a general duty to cooperate in good faith. Arguably incorrectly, Jackson LJ appears to have suggested that this preferred construction was applied in the High Court. In fact, Cranston J said (at ) that he did not need to decide between the rival interpretations. However, in any event, Cranston J's interpretation of Purpose 2 (enabling the Trust or any Beneficiary to derive the full benefit of the contract) was sufficiently broad that it may have assumed the characteristics of a general duty to good faith.
On appeal, Jackson LJ preferred the Trust's interpretation: there was no general duty of good faith and, instead, Obligations 1 and 2 were specifically focused on Purposes 1 and 2, which Jackson LJ construed narrowly. Applying this interpretation to the facts, Jackson LJ held that there was no breach of clause 3.5 because the High Court had not found the Trust to be dishonest and the Trust's deductions and conduct were irrelevant to the two purposes.
As for the implied term, Jackson LJ distinguished the case from others which involved an assessment or choosing from a range of options, taking into account the interests of both parties. He stated that in those other cases the implied term was intrinsic; the contract would not make sense without it. In Compass, however, the Trust faced a simple decision of whether or not to exercise an absolute contractual right. The Trust was also a public authority delivering a vital service to vulnerable members of the public and therefore, rightly, demands high standards from all those with whom it contracts. In such circumstances, Jackson LJ saw no justification for implying that the Trust would not act in an arbitrary, irrational or capricious manner.
Lewison and Beatson LLJ both agreed with Jackson LJ and offered supplemental observations on clause 3.5. Lewison LJ said that the scope of the duty in clause 3.5 could be no more than a duty to co-operate in good faith. He could see nothing in the Trust's assertion of a right to levy deductions (or even actually levying deductions) that required co-operation at all. Beatson LJ suggested that the Cranston J was willing to construe clause 3.5 broadly because he gave insufficient weight to the other provisions of the contract and, therefore, did not take sufficient account of the context of clause 3.5. The miscalculated service failure points and excessive deductions from the payments put the Trust in breach of other clauses of the contract. As such, it was unnecessary to give clause 3.5 a wide meaning. Beatson LJ said 'care must be taken not to construe a general and potentially open-ended obligation such as an obligation to "co-operate" or "to act in good faith" as covering the same ground as other, more specific, provisions, lest it cut across those more specific provisions and any limitations in them.'
Reconciling the Cases
Both cases emphasize the importance of sensitivity to context when determining the nature of any duty of good faith. In Yam Seng, the absence of detailed contractual provisions prompted the implication of terms. Whereas, in Compass (and at least in Beatson LJ's view), the existence of other contractual machinery meant that no broader construction of an express provision was necessary. Accordingly, it might be said that these cases are consistent. Indeed, the Court of Appeal in Compass mentioned Yam Seng, without any adverse comment.
However, the attitude in these authorities to duties of good faith seems fundamentally different. Jackson LJ summarised the law as follows: (i) there is no general doctrine of good faith in English contract law; (ii) although a duty of good faith is implied by law as an incident of certain categories of contract; and (iii) if the parties wish to impose such a duty, they must do so expressly. He referred to Yam Seng (as well as Cantor Fitzgerald International v Horkulak  EWCA Civ 1287, at ) in support of propositions (i) and (ii). Cantor Fitzgerald International v Horkulak only briefly addressed the non-existence of a 'good faith' doctrine and implied a term (based on the common intention of the parties) that there would be a genuine and rational exercise of discretion. As far as Yam Seng is concerned, propositions (i) and (ii) fail to capture Leggatt J's openness to the implication of good faith duties, at least in commercial contracts. And certainly Yam Seng is no support for the third proposition, for which no authority is cited.
There may also be something in Jackson LJ's silence. The lead judgment's cross-reference to Yam Seng was limited to Leggatt J's summary of the law (at -) instead of the later paragraphs where the High Court showed a readiness to imply good faith duties and challenged the traditional English hostility towards the general doctrine. Compass was an opportunity for the Court of Appeal to encourage the development of a good faith doctrine in line with other jurisdictions. It declined to do so.
Following Compass, IT lawyers should be reluctant to read express obligations of good faith broadly. As Compass did not directly concern implied duties of good faith, it remains possible that Leggatt J's optimism in Yam Seng will be adopted by others. However, given the attitude of the distinguished Court of Appeal in Compass, similar attempts to swim with the international tide towards a general doctrine are likely to be thwarted.
Iain Munro is a barrister at 4 Pump Court. He has a general commercial and common law practice, with particular experience in the fields of shipping, insurance and construction disputes and holds a strong interest in China.