In the July 2012 edition of The In-House Lawyer, our colleagues discussed the importance of the first instance decision inCompass Group UK and Ireland Ltd (t/a Medirest) v Mid Essex Hospital Services NHS Trust . On 15 March, the Court of Appeal reversed Cranston J’s judgment.
The original decision focused on three distinct aspects of good faith obligations: an implied obligation not to exercise discretion in an arbitrary, capricious or unreasonable way; an express term requiring the parties to act in good faith; and a general implied duty to act in good faith. The latter point was elaborated in the controversial first instance judgment of Leggatt J in Yam Seng Pte Ltd v International Trade Corp Ltd , holding that a contractual duty to act in good faith could be implied as a matter of law. The status of Yam Seng was significantly undermined in the Court of Appeal. Although strictly obiter, Jackson LJ (with whom Lewison LJ agreed) and Beatson LJ, cited Yam Seng but only to endorse its limited statement of conventional doctrine that there is no general doctrine of good faith in English contract law and such a duty could only be implied into a limited range of contracts, principally those of a fiduciary character. As we explain below, their careful selection of the passages of Yam Seng endorsed in their judgments undermines the wider doctrine propounded by Leggatt J in Yam Seng.
Indeed, they held that the construction of express good faith obligations will be limited by their context, that is, they will likely be of limited ambit, unless the contract very clearly states otherwise. In Medirest, the express term was limited to acting in good faith in relation to parts of the contractual activities which were not relevant to the claim. The claimant sought to give it a wider definition so as to cover all contractual activities. That was rejected and the claim made on that basis failed.
Finally, they clarified that an implied duty not to exercise a discretion in an arbitrary, capricious or unreasonable way will only arise where a party had a real discretion to choose from a range of options. The action in question did not involve any real discretion because the criteria were so clear that no real discretion existed. Accordingly the claim made on this basis also failed.
The claimant, Medirest, agreed to provide catering and cleaning services to the defendant Trust over seven years. The contract provided that if Medirest’s performance was below standard, the Trust could impose ‘service failure points’ from which it could calculate deductions to be made to the payments due to Medirest. The contract set out comprehensive service level specifications containing performance parameters, specifying whether a failure would be classified as ‘major’, ‘medium’ or ‘minor’. It also set out precisely how the performance of each parameter would be monitored. This formula in turn entitled the Trust to make deductions to the monthly amount payable to Medirest in accordance with the ‘payment mechanism’ set out in the contract. The mechanism provided for deductions of £5, £15 or £30 to be applied depending on whether the performance failure was minor, medium or major. In addition to the deductions, in the event that the failure points exceeded a certain level, the Trust was entitled to serve a warning notice setting out the failures in performance and requiring their remedy by way of an agreed action plan. If the points exceeded a higher level, the Trust was entitled to terminate. The contract further expressly required that the parties:
‘… co-operate with each other in good faith and will take all reasonable action as is necessary for the efficient transmission of information and instructions and to enable the Trust… to derive the full benefit of the contract’.
From the outset, the Trust alleged that Medirest’s performance was inadequate and awarded large numbers of service failure points, in turn making significant reductions to monthly payments. Relations quickly broke down and both parties purported to terminate the contract. Medirest brought a claim against the Trust alleging that the Trust had awarded excessive service failure points and that this was a breach of its obligation not to award the points capriciously or arbitrarily or that it had failed to act in good faith when awarding such points.
THE FIRST INSTANCE DECISION
Cranston J held that a term was to be implied requiring that the Trust should not award failure points and/or make deductions from the monthly payments in an arbitrary, capricious or irrational manner and that the Trust had acted in breach of that term. He also found that the obligation on the Trust to ‘co-operate… in good faith’ was to be construed as a general duty and so extended to the awarding of failure points. Once again he found the Trust to have breached that obligation.
THE COURT OF APPEAL DECISION
The Court of Appeal reversed the judgment in both respects.
Limitation on discretion
Although recognising as established law the principle that when one party has the power to make decisions which would have an effect on the other party there is an implied term (based on the obvious common intention of the parties) that there would be a genuine and rational exercise of the discretion and a need for the absence of arbitrariness, capriciousness, perversity and irrationality, this only applied to genuine discretions to choose between real alternatives. Jackson LJ explained that the common theme of the authorities was that the discretion involved making an assessment or choosing from a range of options, taking into account the interest of both parties, concluding that:
‘In any contract under which one party is permitted to exercise such a discretion, there is an implied term’.
The contract in this case did not confer on the Trust such a discretion. It specified the exact circumstances in which the Trust was entitled to award service failure points and make deductions from its monthly payments and it further specified the number of points and amount of deduction. This specification meant that there was in fact no discretion; there was only one right answer as to the amount of points or the size of the deduction that could be made. The only decision for the Trust to make was whether or not to assert its contractual rights. With the contract providing an objective control mechanism for the awarding of points/imposing of deductions, it was not in the Court’s power to impose an alternative mechanism based on fairness or good faith. As there was no discretion, there could be no attendant obligation to exercise that discretion in a certain manner and the Trust was therefore not in breach of any obligation in this regard.
No general duty of good faith
Both Jackson and Beatson LJJ emphasised that an express obligation on a party to act in good faith had to be interpreted in a way sensitive to and limited by its context. Simply using the phrase in a contract term would not create a general duty to act in good faith. In this contract the duty to act in good faith was contained in a clause which required the parties to act in good faith for what Jackson LJ referred to as the ‘two stated purposes’: the efficient transmission of information and instructions and the enabling of the Trust to derive the full benefit of the contract. Since there was no claim in respect of the Trust’s transmission of information and instructions, the Court found that the Trust had not breached its duty of good faith.
While this case concerned the interpretation of an express obligation to act in good faith, Jackson LJ (with whom Lewison LJ agreed) discussed the implication of such a term and made reference to the Yam Seng judgment, which had been handed down after the first instance decision and before this appeal was heard and which was relied on by Medirest as supporting a wider construction of the express good faith obligation.
Jackson LJ endorsed the starting point of Leggatt J’s analysis in Yam Seng: there is no legal principle of good faith of general application in contracts, although such a duty can be implied as an incident of certain categories of contract. He referred specifically to the paragraph of Leggatt J’s judgment where he cited fiduciary, partnership and employment contracts as the examples of such categories, but crucially, he did not cite the parts of that judgment which decide that the contract there in question fell into such a category and he concluded that: ‘If the parties wish to do so they must do so expressly’.
Jackson LJ specifically did not endorse Leggatt J’s exposition of wider views that:
‘… the traditional English hostility towards a doctrine of good faith in the performance of contracts, to the extent that it still persists, is misplaced…’
or that the law should recognise a further category of contracts, namely ‘relational contracts’ (ie joint venture agreements, franchise agreements and long-term distributorship agreements), that:
‘… may require a high degree of communication, co-operation and predictable performance based on mutual trust and confidence and involve expectations of loyalty which are not legislated for in the express terms of the contract but are implicit in the parties’ understanding and necessary to give business efficacy to the arrangements’.
Although it is likely that litigants will seek to rely upon Leggatt J’s analysis where the contract provides little other support for their argument, the Court of Appeal decision in Medirest ought to provide a formidable obstacle in the path of success of such reliance. It is an authoritative (albeit obiter) statement of the conventional and limited doctrine made specifically in light of the controversial judgment in Yam Seng.
Jackson LJ’s clear articulation that there is no general doctrine of good faith in English contract law and the Court of Appeal’s narrow approach to construction of an express obligation to act in good faith provides welcome clarity following from the decision in Yam Seng.
While this judgment is likely to discourage a flood of claims based on implied good faith obligations, this is still a relatively unexplored area (Leggatt J noted that there was in fact no authority that dealt with the doctrine in depth). It will also be interesting to see whether other judges will allow comparative law analyses of the type set out in Leggatt J’s judgment and, if so, whether they will require expert evidence of the foreign laws covered. Such evidence does not appear to have been put forward by the parties in Yam Seng; indeed, there is no reference in Leggatt J’s judgment to having had the benefit of submissions to comparative law from the parties. However, Yam Seng may yet encourage parties to test the boundaries of the categories of contract in which such an implied term arises.
The best way of ensuring that wide-ranging and onerous duties of good faith are not implied on parties is to deal with the issue in the contract expressly. Jackson LJ referred to the difficulty of drafting a clear exclusion of fundamental implied terms, finding that a rather weak entire agreement clause was inadequate to exclude the implication of the limits on exercising discretions, although he did not explain why. Nonetheless he did contemplate that such a clause could be drafted.
Once again it would seem that the safest approach will be to set out the extent of duties in as much detail as possible. The more detail is given the less likely the courts are to consider that there is any room for the uncertain operation of a concept of good faith.
By Rod Cowper, partner, and Alex Radcliffe, associate, Edwards Wildman Palmer UK LLP.
E-mail: RCowper@edwardswildman.com; ARadcliffe@edwardswildman.com.