‘Relational’ contracts and the implied duty of good faith
Which characteristics will the court consider when deciding whether a contract is “relational” and therefore subject to an implied duty of good faith?
Over several years, approximately 550 sub-postmasters (the Sub-Postmasters), who were responsible for running Post Office Branches, entered into either the Sub Postmasters Contract (SPMC) (pre-2011) or the Network Transformation Contract (NTC) (post-2011) with the Post Office. The SPMC stated that the sub-postmaster was responsible for all losses caused through his own (or his assistants’) negligence, carelessness or error. The NTC stated that the sub-postmaster should be fully liable for any loss however such loss occurred and whether it occurred as a result of any negligence by the sub-postmaster, his personnel or otherwise. Both the SPMC and the NTC required the sub-postmaster to pay any shortfall in full.
In 2000, the Post Office introduced, and required the Sub-Masters to use, an electronic accounting system (Horizon) in all branches. Over time, Horizon identified various unexplained shortfalls and accounting errors.
The Post Office maintained that, subject to the SPMC and NTC, individual sub-postmasters were liable and had to prove that shortfalls were not their individual responsibility. The Sub-Postmasters maintained that software defects in Horizon and unsatisfactory training caused the shortfalls and discrepancies. Nevertheless, some Sub-Postmasters paid the (disputed) shortfalls, some Sub-Postmasters’ contracts were terminated and other Sub-Postmasters even received criminal convictions.
The Sub-Postmasters brought claims as a group action for financial loss, personal injury, deceit, duress, unconscionable dealing, harassment and unjust enrichment. The Post Office denied allegations that the Horizon software was defective and raised various contractual defences.
Although various contractual construction issues were considered, one particular question of wider interest was whether the SPMC and NTC were “relational” contracts. The court confirmed that it is the commercial context that decides whether a contract is “relational” and provided a (non-exhaustive) list of characteristics that should be taken into account when deciding whether a contract is relational. These characteristics include:
- that there are no express terms preventing a duty of good faith being implied (this being the only determinative characteristic)
- there is a mutual intention that the contract and relationship are long-term
- the parties intend their roles to be performed with integrity and fidelity to their bargain
- the parties are committed to collaboration
- the spirits and objectives of the venture is incapable of exhaustive expression in a written contract
- the parties place trust and confidence in one another (but a different kind to that involved in fiduciary relationships)
- the contract relies on a high degree of communication, co-operation and predictability based on mutual trust, confidence, and loyalty
- ·one or both parties have invested to a significant degree
- the relationship is exclusive.
To the contrary, the court confirmed that other factors, such as an imbalance of bargaining power, bad behaviour or unfairness of certain terms, were not relevant in determining whether a contract is relational.
The court concluded that, where it is in accordance with the presumed intentions of the parties, a general duty of good faith is implied in “relational” contracts. The court clarified that the obligations implied are good faith, fair dealing, transparency, co-operation, trust and confidence. This involves more than a requirement to act honestly; it is an obligation to refrain from conduct which would be regarded, by reasonable and honest people, as commercially unacceptable when taking into account the circumstances of the relationship as defined by the terms of the agreement in its commercial context. However, the court did accept that the implied duty of good faith could be expressly excluded, even where the contract had all the other characteristics and signs of a “relational” contract.
In this case, taking into account factors such as the significant personal financial commitment of the Sub-Postmasters, similarities of the SPMC and NTC with employment contracts, and the inherent relationship of trust between the Post Office, the Sub-Postmasters and the public, the court was satisfied that the contracts were relational. On this basis the Court ordered that 17 of the 21 possible implied terms were to be implied into the SPMC and NTC.
Why is this important?
Although the courts have previously been reluctant to imply a general obligation of good faith in the absence of express wording, this decision (along with the decisions in Yam Seng Pte Ltd v International Trade Corp Ltd and Bristol Groundschool Ltd v Intelligent Data Capture Ltd ) suggests that (some) courts will accept the concept of the relational contract as a basis to imply a duty of good faith (although the determination will turn on the facts in each case). This is likely to be considered by the Court of Appeal (and, perhaps the Supreme Court in due course).
Any practical tips?
A contracting party should decide whether or not it is in its best interests for the contract to be subject to a duty of good faith. Generally, the position should be expressly set out in the contract to avoid later uncertainty as to whether the contract was intended to be relational and therefore subject to implied good faith obligations. If it is intended for the contract to be subject to good faith obligations, it is preferable to have express terms stating the specific steps/conduct that each party is required to take. This avoids future uncertainty as to the scope of each party's obligations.