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Duty of good faith implied in commercial joint venture

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Nettleton Sophie
Sophie Nettleton

Senior Associate

London

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27 March 2018

The High Court has implied a duty of good faith into an oral joint venture contract. While the generally accepted position is that there is no free-standing duty of good faith in English law, this decision is a reminder that the English courts may imply a duty of good faith into a “relational contract”, in this case a joint venture agreement.  In practice, when seen through the lens of Leggatt LJ, a number of the features of joint ventures and long term co-investment could become the basis for one party to raise a defence or counterclaim based on good faith and a restriction on the ability of the other to pursue its own interests in a competitive market environment. This decision will be of interest to parties in long term contracts and joint ventures who are concerned about the scope of their obligations and the considerations which may apply to their performance of and exit from those arrangements: Sheikh Tahnoon Bin Saeed Bin Shakhboot Al Nehayan v Ioannis Kent (AKA John Kent), [2018] EWHC 333 (Comm) (Al Nehayan v Kent), 22 February 2018

In 2008, Ioannis Kent (IK), a Greek businessman, and Sheikh Tahnoon Bin Saeed Bin Shakhboot Al Nehayan (ST), a member of the Abu Dhabi Royal Family, became equal shareholders in IK’s luxury Greek hotel business.  Their joint venture later expanded to include an online travel business.  They did not enter into a written agreement at this stage.  By April 2012, the business was in considerable financial difficulty and ST had invested additional funds in exchange for equity, increasing his share to 70%.  Shortly afterwards, representatives of ST resolved that he should separate his interest from that of IK. On 23 April 2012, IK and ST entered into two agreements: (i) a Framework Agreement to formalise the demerger of the business; and (ii) a promissory note by which IK agreed to pay ST the sum of EUR 5.4 million in annual instalments between 1 November 2013 and 1 November 2018 (the Agreements).  

In 2013, ST began English court proceedings claiming payment of just over EUR 15 million under the Agreements.  IK denied that he was obliged to make the payments, and also raised a counterclaim alleging, among other things, that ST owed him fiduciary and/or contractual duties, which he had breached.  IK alleged that but for ST’s breaches of these duties, he would not have entered into the Agreements.  Since the court held that the relationship between the parties did not give rise to fiduciary duties, we focus in this article on the approach to the contractual duty of good faith. 

A duty of good faith under English law

There is no general doctrine of good faith in English contract law.  A duty of good faith may be implied into certain limited categories of contract by law, for example, contracts of employment and between partners or others who have a fiduciary relationship. For Leggatt LJ, however, “there appears to be a growing recognition that such a duty may readily be implied in a relational contract”. 

What is a “relational contract”?

Leggatt LJ used the term in his judgment in Yam Seng Pte Ltd v International Trade Corp [2013] EWHC 111 (QB) to describe a contract that “may require a high degree of communication, cooperation 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”. He noted that this category might include certain joint venture agreements, alongside franchise agreements and long-term distribution agreements (as was the case in Yam Seng). 

Leggatt LJ used a similarly broad definition here to refer to contracts in which “the parties are committed to collaborating with each other, typically on a long term basis, in ways which respect the spirit and objectives of their venture but which they have not tried to specify, and which it may be impossible to specify, exhaustively in a written contract”.

Joint ventures as relational contracts 

Leggatt LJ cites the following features of the dealings between the joint venturers in this case in support of his finding that it was a relational contract:

  • the parties “naturally and legitimately expected of each other greater candour and cooperation and greater regard for each other’s interests than ordinary commercial parties dealing with each other at arm’s length”;
  • the collaboration was formed and conducted on the basis of a personal friendship and involved “greater mutual trust than is inherent in an ordinary contractual bargain between shareholders in a company”; and
  • they were content to proceed informally on the basis of their mutual trust and confidence that they would each pursue the common project in good faith.

Having found that the joint venture contract was a “relational contract”, he concluded that the implication of a duty of good faith in the contract was essential to give effect to the parties’ reasonable expectations and satisfied the business necessity test for the implication of terms (see Marks & Spencer v BNP Paribas).

Breach of the implied duty of good faith

In the event, the court limited itself in this case to identifying two forms of “furtive or opportunistic conduct” which were held to be in breach of the obligation.  First, it was inconsistent with the duty of good faith for one party to enter into negotiations to sell his interest or part of his interest in the jointly-owned companies to a third party without informing the other party.  Second, it would be contrary to the obligation to act in good faith for either party to use his position as a shareholder to obtain a financial benefit for himself at the expense of the other.

COMMENT

The opening lines of Leggatt LJ’s judgment appear to foresee its potential relevance, noting that the dispute between the parties in this case was an “all too familiar” story.  While it remains to be seen how this first instance decision will be received by fellow judges and commentators (although note that Leggatt LJ is a Court of Appeal judge), it presents two immediate issues for parties involved in longer-term collaborations or joint ventures. 

The first derives from the court’s approach to the implication of the duty.  The approach in this judgment gives primacy to the concept of a “relational contract”, into which it is essential to imply a duty of good faith.  In this case, Leggatt LJ held that the implication of the duty was essential to give effect to the parties’ reasonable expectations and also satisfied the business necessity test. In doing so he does not deal expressly with the stringency of the implied terms test as set out in Marks & Spencer v BNP Paribas. Is it really correct to say that without this duty being implied the contract would have lacked commercial or practical coherence?  Moreover, Leggatt LJ notes (obiter) that failure to satisfy such tests need not be fatal to the implication of a duty of good faith, since such a term can also be implied into the contract as a matter of law “on the basis that the nature of the contract as a relational contract implicitly requires (in the absence of a contrary indication) treating it as involving an obligation of good faith” (applying the test of Lord Wilberforce in Liverpool City Council v Irwin [1976] AC 239).

The second issue derives from the uncertainty surrounding the scope of the duty itself.  While the “bad faith” conduct in this case was arguably a more overt example of concealment in the furtherance of one’s own interests at the expense of those of the joint venture partner, Leggatt LJ himself notes that it is “perhaps impossible” to spell out an exhaustive description of what the obligation involves in any given case.  This presents a challenge for parties engaged in long-term contracts in a competitive business environment where thoughts often need to turn to the exploitation of commercial opportunities and the execution of appropriate exit opportunities.

The decision will likely serve as a useful basis for parties wishing to raise defences and counterclaims based on good faith, though it is also likely that counterarguments will seek to tie the case tightly to its facts.  For parties who wish to control the scope of their contractual obligations from the outset, what steps can be taken to limit the likelihood that a duty of good faith is implied?  Unfortunately, a joint venture agreement, like a long-term distribution or franchise agreement, is likely to be presented as a paradigm “relational contract”.  However, the court was clearly influenced by the close relationship of trust between the parties and the fact that they had decided not to record the terms of their joint venture in writing.  Parties should be sure to record the terms of their arrangement in writing, with thought given to appropriate eventualities in the case of financial difficulty and permissible exit mechanisms in order to preserve flexibility. Implication of terms is more difficult where the parties are legally advised commercial parties operating at arms’ length and where the express terms of the contract contradict the terms sought to be implied. 

Further information

This case summary is part of the Allen & Overy Litigation and Dispute Resolution Review, a monthly publication.  If you wish to receive this publication, please contact Amy Edwards, amy.edwards@allenovery.com.  ​