Implied duty of good faith in relational agreements

Published on 21 January 2020

UTB v Sheffield United

The question

When should a duty to act with good faith be implied into an agreement?

The key takeaway

The duty of good faith is not limited to when the agreement is “relational”. The question is whether an obligation of good faith was obviously meant or is necessary for the proper working of the agreement.

The background

The relationship between Kevin McCabe of Sheffield United Limited (SUL) and Prince Abdullah bin Musa’ad of UTB LLC (UTB) began in 2013 when the parties entered into an Investment and Shareholders’ Agreement (ISA). The ISA stated that UTB would provide £10m over a period of around two years in return for 50% of the shares in the Blades, who wholly owned Sheffield United Football Club (SUFC).

Numerous disagreements subsequently arose throughout 2013 to 2018, leading to the two parties considering how to end their joint ownership of SUFC. SUL acted first and offered to buy UTB’s shares for £5m by serving a Call Option Notice under the ISA. However, SUL (purportedly) did not realise that the call option also permitted UTB to serve a counter notice on SUL, enabling UTB to purchase SUL’s shares for the same price that SUL had previously offered.

UTB subsequently sought to enforce the purchase of SUL’s shares and SUL sought to have the contract declared void or set aside and that UTB sell its shares to SUL at the current value (which has hugely increased since SUFC’s promotion to the Premier League in the 2019/2020 season). 

The decision

Whilst the Judgment considered a number of legal issues, such as the validity of the contract, specific performance and unfair prejudice (s994 of the Companies Act), this summary focuses on the Court’s interpretation of whether good faith could be implied into the ISA.

What is the duty of good faith?

Recent case law has held that an express term requiring the parties to act with the “utmost good faith” towards one another imposed an obligation “… to observe reasonable commercial standards of fair dealing in accordance with their actions which related to the Agreement and also requiring faithfulness to the agreed common purpose and consistency with the justified expectations of the [other party]” and that “… the obligation of utmost good faith in the [contract] was to adhere to the spirit of the contract […] and to observe reasonable commercial standards of fair dealing, and to be faithful to the agreed common purpose, and to act consistently with the justified expectations of the parties.” 

Can good faith be implied into a contract?

The most significant development in relation to whether good faith can be implied into a contract was in Yam Seng Pte Ltd v International Trade Corporation Ltd where Leggatt J held that that a duty of good faith could be implied into a “relational” commercial contract. 

Relational contracts normally involve a long-term relationship with a substantial amount of communication, co-operation and predictable performance. Bates v Post Office (No. 3) sets out a number of criteria that may determine if a contract is relational, such as (i) an intention to perform the parties’ respective roles with integrity and fidelity to the bargain, (ii) a commitment to collaboration in the contract’s performance and (iii) a high degree of communication, cooperation and predictable performance based on mutual trust and confidence, and expectations of loyalty.

However; whilst the Judge in this case acknowledged the previous decisions in Yam Seng and Bates, rather than question whether the contract was relational, he considered the test should be whether a “reasonable reader of the contract would consider that an obligation of good faith was obviously meant or whether the obligation is necessary to the proper working of the contract”

As a result: (i) given that there were areas in the ISA where good faith was expressly required (therefore indicating that the parties had considered where and where not to act with good faith); and (ii) the contrasting interests of the parties were both reflected in the ISA and at different points in the relationship, the Court found that the terms of the ISA were not subject to an implied term that each of the shareholders were to deal with the other in good faith.

Therefore, the Court held that SUL must sell its shares to UTB, making UTB the majority owner of SUFC. 

Why is it important? 

This case shows that the Court will not always look to see whether there is a relational contract as a basis to imply a duty of good faith between parties. The Court will look at whether the “reasonable reader of the contract would consider that an obligation of good faith was obviously meant or whether the obligation is necessary to the proper working of the contract” (ie applying the test for an “implied term”).

Any practical tips

Contracting parties should decide at the outset whether or not it is in its best interests for the contract to be subject to a duty of good faith. Parties should expressly set out this duty (or exclude the duty) in the contract (bearing in mind that if they set good faith obligations for specific terms of the contract, the Courts may interpret this as meaning that good faith will not apply to the other terms of the contract). Bear in mind that certain contracts (eg relational contracts) may be more likely to have implied duties of good faith.

Stay connected and subscribe to our latest insights and views 

Subscribe Here