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English Court Ruling Provides Guidance on Relational Contracts

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There have been a number of cases in which the English courts have considered the extent to which English law recognises an implied duty of good faith in the performance of contractual obligations.1 Although those cases have reaffirmed that English law does not recognise a universal obligation of good faith, they have held that an implied duty of good faith will apply in certain defined categories of agreements. This includes contracts that create fiduciary relationships, and so-called "relational contracts."

Against this background, the recent decision in Bates v. Post Office Limited provides useful guidance on the definition of relational contracts. It also assists in understanding the nature and extent of the implied duty of good faith in contracts where such a duty is found to exist.

Background
The Bates case involves a dispute between the Post Office and approximately 500 sub-postmasters "the Sub-postmasters") regarding the implementation and operation of a computerised accounting system called Horizon. The Sub-postmasters alleged that the Horizon system was responsible for creating shortfalls in the accounts of branch offices that the Sub-postmasters managed, which the Post Office denied.

The proceedings were conducted pursuant to a Group Litigation Order, which consolidated the claims of the numerous Sub-postmasters into a single action. As part of the consolidated trial procedure, the parties agreed upon a number of "Common Issues", which were to be decided as preliminary issues. The intention was that the Common Issues chosen would be those with the widest potential application to the individual claims, so that decisions on these issues would assist with the efficient progress of the case. One of the Common Issues chosen was whether the contractual relationships between the Post Office and the Sub-postmasters were relational contracts, such that the Post Office was subject to an implied duty of good faith.

Relational Contracts and the Implied Duty of Good Faith
The term "relational contract" was first used in this context by Leggatt J (as he then was) in Yam Seng Ptd Ltd v International Trade Corporation Ltd.2 That judgment characterised relational contracts as agreements that involve long-term relationships and in which the parties rely upon a high degree of communication, cooperation and predictable performance based on mutual trust and confidence between the parties. Because those contracts give rise to mutual expectations of loyalty, a duty of good faith should be implied because such a term is necessary to give business efficacy to the agreement. The implication of a duty of good faith in these circumstances was therefore characterised as a result of the application of the usual principles of English law regarding the implication of terms.3

While subsequent decisions have generally recognised the concept of the relational contract, no precise definition of the term had emerged. These decisions did make clear, however, that the bare fact that an agreement displayed some aspects of a relational contract, such as an extended term or an expectation of cooperation between the parties, was not sufficient to establish that agreement as a relational contract.

The Decision in Bates
The decision of Fraser J in Bates contains a comprehensive analysis of the relevant case law on relational contracts, starting with the judgment in Yam Seng.This analysis confirmed that relational contracts are an established concept in English law, noting that previous cases in which particular contracts had been found not to include an implied duty of good faith were fact-specific, rather than a rejection of the principle of relational contracts as a whole.

Fraser J then went on to examine the essential characteristics of a relational contract. Noting that the determination of whether or not a contract is relational is heavily dependent upon context as well as the express terms of the agreement, the judgment explains that the analysis must focus on the entire circumstances of the parties relationship, as defined by the terms of the agreement and set in its commercial context. This analysis should take place as at the time of contracting.

Distilling prior caselaw in a number of principles, Fraser J set out the following features of relational contracts:5

  • the contract must contain no express term disclaiming a duty of good faith;
  • the contract is long-term, with a mutual intention of the parties of a long-term relationship;
  • the parties intend that their respective roles be performed with integrity, and with fidelity to their bargain;
  • the parties have committed to collaboration in the performance of the contract;
  • the parties have reposed trust and confidence in one another, but of a different kind to that involved in fiduciary relationships; and
  • the contract involves a high degree of communication, co-operation and predictable performance based on mutual trust and confidence and expectations of loyalty.

Fraser J further noted a number of other characteristics that may also be present in relational contracts:6
  • a degree of significant investment or substantial financial commitment by one or both parties; and
  • exclusivity of the relationship.

In detailing these principles, Fraser J stressed that the list is not exhaustive and that no single characteristic is determinative.7 The exception to this is the absence of an express term disclaiming good faith, as such an express term would prevent the implication of a duty of good faith through the application of the usual principles applicable to implied terms under English law.8

Applying these characteristics, the judgment in Bates found that the contracts between the Post Office and the Sub-postmasters were relational contracts, and so subject to an implied duty of good faith. A number of factors present in those contracts were found to be among the most determinative:9

  • in many instances, the Sub-postmasters had invested substantial amounts in buying or leasing premises for branch Post Offices and had made significant financial personal commitments to running branches;
  • the Sub-postmasters' role in providing personal service went beyond a conventional contractual relationship and had similar characteristics to an employment contract;
  • the Post Office made a careful assessment of the financial viability of applicants for Sub-postmaster positions; and
  • trust was an integral component to almost all of the Post Offices' activities carried out with the Sub-postmasters to operate branch Post Offices.

Moreover, the fact that the Post Offices operations contain an element of public service meant that there was an aspect to the contractual relationships between the Post Office and the Sub-postmasters that was not purely commercial. In this context, it was held to be appropriate to imply a duty of good faith into the contractual relationships between the Post Office and the Sub-postmasters.

Having reached this conclusion, the judgment then went on to consider the nature and extent of the implied obligation of good faith. In particular, Fraser J rejected the argument that this duty is limited to a requirement of honesty on the part of contracting parties. Instead, the implied duty of good faith was held to have broader scope, specifically requiring that parties refrain from conduct that would be regarded as commercially unacceptable by reasonable and honest people in the context of the agreement.

Key Points
The Bates decision reaffirms and reinforces the concept of relational contracts as a category of contracts in which English law will imply a contractual duty of good faith. Consistent with prior authorities, however, the case also demonstrates that an implied duty of good faith in relational contracts depends on the application of the usual principles of English law (and specifically the "business efficacy" test).10 Indeed, the judgment rejected specifically the existence of any broader principle of good faith in commercial contracts.11

Perhaps most usefully, the decision in Bates provides greater clarity on both the definition of relational contracts and the scope of the implied duty of good faith.12 Neither of those issues were addressed in any detail in prior authorities, and this guidance is greatly to be welcomed. Following the decision in Bates, it is now clear that relational contracts will be limited to those in which the relationship between the parties involves a significant degree of mutual trust, collaboration and loyalty. This obviously excludes the vast majority of normal commercial transactions, but may (depending on the circumstances) include certain types of agreements that are common in the construction industry. This may include, for example, long-term joint venture or consortium agreements.

In sum, whilst it is possible to argue that English law is moving closer to those civil law jurisdictions in which good faith is an overriding principle applicable to all contracts (this includes the United Arab Emirates and many of the other Gulf states), there remains a fundamental difference in approach between English law and these civil law systems. It remains the case, therefore, that contracting parties should consider carefully whether they want contractual duties of good faith to apply to their relationship. This will inform their choice of which law should apply to their agreement and may also need to be reflected in their agreement's express terms.

1 See, e.g., Hamsard 3147 Ltd (t/a Mini Mode Childrenswear) & Anor v Boots UK Ltd [2013] EWHC 3251; Bristol Groundschool Ltd v Intelligent Data Capture Ltd [2014] EWHC 2145; MSC Mediterranean Shipping Co v Cottonex Anstalt[2016] EWCA Civ 789; Ilkerler Otomotiv & Anor v Perkins Engines Company Ltd [2017] EWCA Civ 183.
2[2013] EWHC 111 (QB).
3These principles have relatively recently been confirmed by the Supreme Court in Marks and Spencer plc v BNP Paribas Securities Services Trust Company (Jersey) Limited and another [2015] UKSC 72.
4 [2013] EWHC 111 (QB) at 702 - 720.
5Id. at 725.
6 Id.
7 Id. at 726.
8 Id.
9Id. at 728.
10Id. at 725; 725; 728.For example, Fraser J noted that the level of trust between the Post Office and the Sub-postmasters was "integral" to the Post Office's activities.
11Id. at 721.
12Id. at 711; 725; 728.

 

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