Express and implied contractual duties of good faith – construing the clause in its context and approach to the implication of terms

Innovate Pharmaceuticals Ltd v University of Portsmouth Higher Education Corp [2024] EWHC 35 (TCC)

The question

How did the court determine whether a party to a commercial agreement was subject to a duty of good faith (either expressly under the agreement or by necessary implication) during a transition period, which started after a party terminated the agreement? 

The key takeaway

Where a duty of good faith is provided for expressly in an agreement the courts will apply the normal principles of contractual construction (including considering the interpretation and meaning of an express good faith clause in the context in which it is used) to determine the extent to which it applies. In a professionally drafted commercial contract, an implied duty of good faith is unlikely to be construed unless it is deemed “necessary to give business efficacy” to the contract or unless it is shown that without the term, the contract would lack “commercial or practical coherence”.

The background

Aston Martin Lagonda (AML) is the manufacturer of Aston Martin cars. Aston Martin MENA (AMMENA), the claimant, is the exclusive distributor of these luxury cars in the Middle Eastern, North Africa and Turkish (MENA) region. The parties entered into an agency agreement in April 2018 whereby AML would act as AMMENA’s agent in respect of all their operations in the MENA region under a distribution agreement.

AMMENA subsequently claimed that AML failed to pay contractually guaranteed minimum payments under the agency agreement. In response AML claimed it was entitled to set-off against those claims expenses it had incurred. This resulted in AMMENA alleging that AML breached its payment obligations under the agency agreement. In April 2021, AMMENA wrote to AML to terminate the agency agreement with immediate effect because outstanding sums had still not been paid.

In June 2021, AML wrote to AMMENA alleging wrongful termination, AMMENA’s repudiatory breach of the agency agreement and purporting to give notice to terminate the agency agreement with immediate effect. A transitional period was agreed between the parties from the date of termination of the agency agreement until September 2021 for AMMENA to resume the obligations under the distribution agreement. AMMENA resumed those obligations on 1 October 2021, however, the nature and basis of the parties’ obligations during the transition period remained in issue.
A key question for the court was whether AML, during the transition period, acted in breach of the express duties of good faith in clauses 2.3 and 3.2 of the agency agreement and/or an implied duty of good faith.

Clauses 2.2, 2.3 and 3.2 provided:

2.2 This Agreement shall come into force on the Commencement Date and (subject to the provisions for earlier termination in Clause 6 below) shall last for an initial period of three years (the “ Initial Period “ ) and shall continue in force thereafter for additional periods of three years each (“Additional Period(s)”) unless and until either party gives to the other not less than 12 months’ prior written notice of termination such notice to expire at the end of the Initial Period or one of the Additional Periods.

2.3 Once either party gives notice of termination, the parties will meet and confer to work out an orderly transition plan so that AMMENA can assume its duties under the AMMENA Distribution Agreement and to minimise insofar as practicable any losses incurred by the Manager in the course of, or as a result of, or in connection with termination of the agency. AMMENA and AML will (acting reasonably and in good faith) agree minimum sales targets for volume and mix for the two years immediately following termination of this Agreement based on the principles set out in Article 3(2) of the Distribution Agreement. (“Interim Targets”)….

3.2 The Manager will establish a regional presence and contemporary and benchmark operations in the Territory known as “Aston Martin Middle East “/” AMME”….. On termination of this Agreement, the Manager shall in good faith take all reasonable steps to pass on to AMMENA the benefit of the experience and structures developed by the Manager in respect of such operations in order to assist AMMENA to commence and continue such operations itself with immediate effect.

It was AML’s position that there was no express or implied duty of good faith during the transition period which they alleged was not a mandatory transition period only one agreed between the parties. Even if there was such a duty AML had discharged it. 

The decision

In construing the extent of the applicability of the express duty of good faith, the court found that:

the objective meaning of the language of clause 2.3 limited the duty of good faith to a notice of termination under clause 2.2;

the duty of good faith in clause 3.2 to take steps to “pass on to AMMENA… structures developed by AML…in order to assist AMMENA to commence and continue such operations…” did not extend to actions alleged to have been taken “to undermine the potential profitability of the business under the Distribution Agreement” or to the “pricing structure” under the agency agreement.

In relation to the eight instances, pursued at trial by AMMENA, of AML’s failure to act in accordance with the implied duty of good faith “to cooperate in good faith upon termination of the agency agreement,” the court applied the test of necessity, i.e. whether, without the term, the contract would lack commercial or practical coherence or whether it was necessary to imply the term “in order to make the contract work”.

Given the strict nature of the applicable legal test, the judge acknowledged that it is now no easy task to persuade a court to imply a term into a contract, particularly a written contract of some length which has been negotiated with the benefit of legal advice. If the contract does not expressly provide for what is to happen when a particular event occurs or in a particular situation, the most usual inference to be drawn is that nothing is to happen, and no term is to be implied. The court decided that the requirements for a term to be implied had not been met. In particular, the pleaded implied terms were not “necessary to give business efficacy to the agency agreement” nor had it been shown that “without the term, the agency agreement would lack “commercial or practical coherence”. 

The court went on to examine the content of the duty of good faith concluding on the scope of the express duty of good faith that the context supported an interpretation that the parties had expressly addressed in the agency agreement the obligations that were to apply on termination. Viewed in context, the express duty of good faith in clause 3.2 did not extend to any wider or general duty to “have regard to the effect of its actions on AMMENA”. The court found the same to apply to any implied duties to cooperate in good faith (had such terms, as alleged, been found to be implied).

Why is this important?

The case highlights a narrow interpretation of express duties of good faith – the court would not look to interpret a good faith clause as imposing additional substantive obligations (or restrictions on actions) outside the other terms of the contract. This was deemed especially so if the contract has been professionally and comprehensively drafted, and where for instance it contains an “entire agreement clause”. Moreover, there is no particular test as to the duty of good faith, courts will construe the particular clause in the context in which it is used.

The decision also reiterates the high bar in establishing implied terms, in particular an implied duty of good faith. The implied term must be necessary to make the contract work, or provide commercial or practical coherence.

Any Practical Tips?

Ensure unambiguous and precise drafting of any express clauses agreeing to act in good faith, including the scope of the obligation. Consider including a non-exclusive list of examples of good faith behaviour and/or specific obligations of steps that should be taken on particular events.
Also note that a general good faith clause is unlikely to override another particular provision in the agreement. A good faith obligation is not a substitute for properly defined and drafted specific rights and obligations.

Proceed on the basis that establishing any implied terms of good faith is likely to be a high bar, particularly where contracts have been professionally drafted, and if express duties of good faith have been included for particular circumstances.

Spring 2024