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No implied duty of good faith in termination clause

 

16 September 2016

In Monde Petroleum SA v Westernzagros Ltd [2016] EWHC 1472 (Comm) the High Court ruled that there was no implied term in a commercial contract that a party would not terminate in bad faith. There was no indication that the contract would lack commercial or practical coherence without an implied term of good faith, and there were no other special circumstances that would justify an implied term to that effect. The judge also found that, provided the contract requirements (if any) for the exercise of an express contractual right to terminate are met, that right may be exercised irrespective of the exercising party’s reasons for doing so. 

Westernzagros Limited (WZL) negotiated with the Kurdistan Regional Government to reach an exploration and production sharing agreement for oil in Kurdistan. WZL engaged Monde under an agreement (the Consultancy Agreement) to assist WZL with the negotiations. In return for its services it was agreed that Monde would be paid monthly fees, success fees payable on completion of certain milestones and, ultimately, be granted an option to acquire a 3% working interest in the project.

WZL served a termination notice to terminate the Consultancy Agreement in accordance with its express terms, but it failed to give the 30 days’ notice required. Monde sued WZL.

This article focuses on two of Monde’s claims:

  • that the termination provisions in the Consultancy Agreement were subject to an implied term that they should not be exercised in bad faith or in an unconscionable manner, intending to deprive Monde of its remuneration under the Consultancy Agreement, including the 3% option; and
  • the termination notice was invalid and that, by serving it, WZL had committed a repudiatory breach of the Consultancy Agreement entitling Monde to substantial damages.

Was there an implied term not to terminate in bad faith?

Monde relied on the Supreme Court’s decision in British Telecommunications plc v Telefonica O2 UK Ltd [2014] UKSC 42 in which Lord Sumption said “…it is well established that in the absence of very clear language to the contrary, a contractual discretion must be exercised in good faith and not arbitrarily or capriciously…”. Monde argued that this principle extended to the exercise of termination rights in a contract. It could not be right that WZL could bring the Consultancy Agreement to an end after Monde had done most of its work but before it had reaped a substantial part of its reward.

The judge, HHJ Richard Salter QC, rejected this argument.

No general or implied duty of good faith

First, the fact that a contract was long‑term or relational is not, of itself, enough to justify an implied duty of good faith. There is no general doctrine of ‘good faith’ in English contract law. There are certain examples of contracts which may involve expectations of loyalty implicit in the parties’ understanding and necessary to give business efficiency to the contract, and in which an
implied duty of good faith may sometimes be justified. In all other categories of contract, however, such a duty will only be implied where the contract would lack commercial or practical coherence without it and where all the other requirements for implication are met (Marks and Spencer plc v BNP Paribas Securities Services Trust Co (Jersey) Ltd [2015] UKSC 72).1

There was nothing in the commercial background or the relationship between the parties, as set out in the Consultancy Agreement, which indicated that the Consultancy Agreement would lack commercial or practical coherence without an implied term of good faith. The Consultancy Agreement was detailed and professionally drafted, and both sides were advised by lawyers. The Consultancy Agreement did not contain the sorts of mutual obligations and commitments that would be expected in the kind of relational contract where there are “expectations of loyalty which are not legislated for in the express terms of the contract but are implicit in the parties’ understanding” (Yam Seng Pte Ltd v International Trade Corp Ltd [2013] EWHC 111 (QB))2 which may, in the absence of any contrary indications, justify an implied term of good faith.

Reason for termination was irrelevant

Secondly, the judge found that a contractual right to terminate is a right which may be exercised irrespective of an exercising party’s reasons for doing so. Provided that the contract conditions (if any) for the exercise of such a right are met, the party exercising that right does not have to justify its actions. In Lomas v JB Firth Rixson Inc [2012] EWCA Civ 419 the Court of Appeal characterised as “hopeless” the argument that a Non‑Defaulting Party’s express right under the ISDA Master Agreement to bring that agreement to an end upon an Event of Default was impliedly subject to the requirement “to exercise its discretion…in a manner which is not arbitrary, capricious or unreasonable”.
The judge considered that this principle is one of general application. One reason for this is that a contractual right to terminate is not the exercise of a contractual discretion. Contractual discretions arise where there are a range of options to choose from whereas a contractual right to terminate involves a binary choice.

The judge distinguished Leggatt J’s decision in MSC Mediterranean Shipping Company SA v Cottonex Anstalt [2015] EWHC 2833 in which it was suggested that a party may be bound to exercise a termination right in good faith. The judge did so on the basis that: (i) MSC Mediterranean dealt with a different situation, namely the limits placed by law on an innocent party’s common law right to affirm the contract and insist on future performance, not an express contractual right to terminate; and (ii) it did not appear from the MSC Mediterranean judgment that Lomas had been cited to the judge.

COMMENT

Unlike many other jurisdictions, it is a longstanding principle that English law does not recognise a general doctrine of good faith.  

The decisions of Leggatt J in Yam Seng and MSC Mediterranean had suggested a possible move towards the development of a concept of good faith in English contract law. Shortly after the ruling in Monde Petroleum the Court of Appeal ruled on MSC Mediterranean [2016] EWCA Civ 789, reversing in part the High Court decision mentioned above. Although “good faith” did not play a prominent role in arguments before the Court of Appeal, it was one of a number of additional points raised by the lower court judgment that the Court of Appeal said called for comment. In doing so, Moore‑Bick LJ cited with approval the approach put forward by Bingham LJ in Interfoto Picture Library Ltd v Stiletto Visual Programmes Ltd [1989] QB 433 to develop “piecemeal solutions in response to demonstrated problems of unfairness”.  The ruling in Monde Petroleum and the Court of Appeal’s subsequent decision in MSC Mediterranean therefore seem to indicate a return towards a more traditional approach of dealing with matters of good faith on a case‑by‑case basis.


1 http://www.allenovery.com/publications/en‑gb/Pages/Test‑for‑implying‑a‑term‑in‑to‑a‑contract‑is‑stringent‑and‑has‑not‑been‑diluted.aspx

2 http://www.allenovery.com/publications/en‑gb/Pages/A‑new‑era‑for‑good‑faith‑in‑English‑contract‑law.aspx 

3 http://www.allenovery.com/publications/en‑gb/Pages/Right‑to‑affirm‑a‑contract‑after‑repudiatory‑breach‑fettered‑by‑good‑faith.aspx 

Further information 

This case summary is part of the Allen & Overy Litigation and Dispute Resolution Review, a monthly publication.  For more information please contact Sarah Garvey sarah.garvey@allenovery.com, or tel +44 20 3088 3710. ​

 

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