The following article was published by Lexology on 24 February 2021:
Contracting parties are free to include in their agreement an express provision requiring them to act reasonably and in good faith. Even where it is not express, however, such a term might be implied.
In many cases, the question of whether such a term is implied has arisen in connection with the purported exercise by one of the parties of an express right to terminate the contract.
Further, there is a practical issue as to what a duty of good faith requires of the parties where it applies.
Express termination provisions
In negotiating a contract, many parties choose to include a term which provides that the right to terminate will exist in specified circumstances.
Where they choose to do so, the parties are free to stipulate:
- what circumstances will give rise to the right to terminate; and
- whether the right will operate in favour of both parties or alternatively, only one of them.
They are also able to stipulate whether the termination provisions in the contract are:
- intended to operate alongside any right to terminate that may arise under the common law; or
- alternatively, intended to be exhaustive, so that the common law is ousted with respect to termination and the only circumstances in which termination will be permitted are those referred to in the contract.
If the express provisions of the contract are not clear in those respects, a Court will seek to ascertain the intention of the parties at the time when the contract was formed, based on the objective evidence.
The decision in Champtaloup v Thomas [1976] 2 NSWLR 264
A non-lawyer may be inclined to think that where a contract provides that a party will have a right to terminate in specified circumstances and those circumstances have arisen, then the right to terminate undoubtedly exists.
That was, in substance, what the NSW Court of Appeal held in the case of Champtaloup v Thomas. In that case:
- a purchaser of land had an express right to rescind a contract in certain circumstances and those circumstances eventuated;
- however, the purchaser admitted in evidence that his decision to rescind the contract was not related to those circumstances;
- nevertheless, the Court held that the right to terminate was validly exercised; and
- specifically, the Court held that where a party has a contractual right to terminate, that right is not restricted or lost even where it is exercised capriciously, arbitrarily, unreasonably and not bona fide.
While there is an attractive simplicity to that analysis, subsequent decisions have resulted in a much more complex position.
Renard Constructions (ME) Pty Ltd v Minister for Public Works (1992) 26 NSWLR 234
The series of relevant decisions subsequent to Champtaloup v Thomas began with the case of Renard Constructions (ME) Pty Ltd v Minister for Public Works. In that case:
- there were provisions stating that, if the contractor breached the agreement, the principal could require it to show cause as to why the agreement should not be terminated;
- the principal issued a notice requiring the contractor to show cause under those provisions; and
- the contractor purported to show cause but the principal terminated the contract anyway.
The NSW Court of Appeal held that the principal’s power to terminate the contract under the show cause provisions was required to be exercised “reasonably”, due to the existence of an implied term to that effect.
In the circumstances, the Court held that the principal had not complied with that implied term and consequently, the purported termination by the principal was not valid.
Burger King Corporation v Hungry Jack’s Pty Ltd [2001] NSWCA 187
The NSW Court of Appeal then revisited the issues of reasonableness and good faith in a seminal decision handed down in 2001, in the case of Burger King v Hungry Jack’s.
In that case:
- Burger King operated a worldwide chain of fast food outlets;
- in 1973, Hungry Jack’s had obtained the right to develop fast food outlets in Australia;
- by 1996, Hungry Jack’s operated 170 outlets itself or through third-party franchisees;
- Hungry Jacks’ right to develop and operate franchises in Australia was governed by a Development Agreement executed in 1990;
- under the Development Agreement:
- Hungry Jack’s was required (either itself or through third-party franchisees) to develop a minimum of 4 new Burger King restaurants per year; and
- it could not open any new restaurant without operational, financial and legal approval from Burger King;
- notwithstanding that agreement, Burger King wanted direct participation in the Australian market;
- in 1993, it began discussions with Shell, with a view to using Shell service stations as sites for Burger King outlets;
- Hungry Jack’s was initially included in those discussions but in 1994, Burger King and Shell (with the clandestine assistance of a Hungry Jack’s employee) commenced separate discussions as between themselves;
- Hungry Jack’s was not informed of that development until 1995;
- in that year, Burger King also:
- began to withhold approvals of new restaurants developed by Hungry Jack’s; and
- imposed a freeze on Hungry Jacks’ recruitment of third-party franchisees;
- as a result, Hungry Jack’s failed to develop 4 restaurants in a year as required under the Development Agreement; and
- in 1996, Burger King terminated the Development Agreement, relying on that failure.
The Court of Appeal found that there was an implied term of reasonableness and good faith, on the basis that the clause in question (which set out the procedural framework for the approval of Hungry Jack’s franchises by Burger King) contained such an extraordinary range of detailed considerations that unless such an implied obligation existed, Burger King could, for the slightest of breaches, bring to an end the very valuable rights which Hungry Jack’s had under the Development Agreement.
The Court of Appeal also found that in the circumstances, this term had not been complied with and so the purported termination by Burger King was not valid.
Decisions in New South Wales subsequent to the Hungry Jack’s case
In the years since the Hungry Jack’s decision, issues concerning implied terms of reasonableness and good faith have taken up a considerable amount of time in the Supreme Court of New South Wales.
In Vodafone Pacific Limited v Mobile Innovations Ltd [2004] NSWCA 15, the NSW Court of Appeal indicated that the law had not yet gone so far as to deem commercial contracts to be a class of contract carrying the implied term of good faith as a matter of law. Their Honours were willing to assume, however, that:
” … unless excluded by express provision or because inconsistent with the terms of the contract, Vodafone was under an implied obligation to act in good faith and reasonably in exercising its powers under the … Agreement“.
Subsequently, in Solution 1 Pty Ltd v Optus Networks Pty Ltd [2010] NSWSC 1060, Hammerschlag J. was willing to assume that a term of good faith could be implied into a contract, but held that there was no implied term of good faith in the particular contract at issue because such a term would have been inconsistent with other provisions of the agreement (including a clause providing that the right to terminate could be exercised in the “absolute discretion” of the relevant party) and because the contract expressly excluded any implied terms.
The following year in Starlink International Group Pty Ltd v Coles Supermarkets Australia Pty Ltd [2011] NSWSC 1154, Bergin J. held that:
- a special condition in the contract providing for termination allowed Coles to terminate for its own reason and to keep that reason to itself;
- the only prerequisite in the special condition was the requirement to give 45 days’ notice; and
- in those circumstances, the implication of a duty to act in good faith in exercising the right under the special condition would be to impose a condition inconsistent with the express terms of the contract.
A year later, however, in NSW Rifle Association Inc v Commonwealth (2012) 293 ALR 158, White J. found an implied obligation requiring the Commonwealth to act reasonably and in good faith in the exercise of its powers. His Honour held that the purpose of the relevant contractual provision was to give the NSW Rifle Association the opportunity to remedy a breach and this implied (as a matter of contractual construction) that the power to issue a notice under that provision was required to be exercised reasonably and in good faith.
In Adventure World Travel v Newsom (2014) 86 NSWLR 515, the issue was back before the NSW Court of Appeal, which said:
“Even where a clause in a contract gave a power to one party for a purpose but in terms wider than necessary for the protection of its legitimate interests, the exercise of the power could be constrained by implied obligations of reasonableness and good faith.”
Their Honours referred to the decision in Hungry Jack’s as authority for that finding.
Finally, in Bundanoon Sandstone Pty Ltd v Cenric Group Pty Ltd; TWT Property Group Pty Limited v Cenric Group Pty Limited [2019] NSWCA 87, the NSW Court of Appeal upheld the trial Judge’s finding that TWT had breached an implied term of good faith and reasonableness in the head contract, by issuing a show cause notice but closing its mind on the subject and deciding to terminate the head contract regardless of any cause that Cenric might show. Gleeson JA (with whom the other Judges of Appeal agreed) said:
“The power to issue a show cause notice under cl 39.2 of the head contract is conferred for the purpose of giving advance notice of taking the work out of the contractor’s hands or terminating the head contract. It is well accepted that, where a contractual power is given to one party for a purpose but in terms wider than necessary for the protection of its legitimate interests, the exercise of the power may be constrained by implied obligations of reasonableness and good faith.”
and:
“TWT did not dispute that such obligations should be implied in the present case as part of the head contract. That is consistent with the approach adopted in this Court in a number of decisions involving commercial contracts … ”
but also:
“This Court has noted that the necessity for the implication of such terms in commercial contracts has not been universally accepted … Those issues need not be considered in the present case.”
Decisions in other Australian jurisdictions
There have also been some key decisions concerning implied terms of reasonableness and good faith in other Australian jurisdictions. They include the following.
In the Queensland Supreme Court decision of Kendells v Sweeney [2005] QSC 64 (a case which did not concern a purported termination), Muir J. stated that the implication, as a matter of law, of a term of reasonableness in a commercial contract:
” … will tend to superimpose an often unwarranted layer of complexity and uncertainty into commercial bargains.”
Further, the 2005 Victorian Court of Appeal decision of Esso Australia Resources Pty Ltd v Southern Pacific Petroleum NL [2005] VSCA 228 (which also did not concern a purported termination) is significant in this context because Buchanan JA (with whom the other Judges of Appeal agreed) had this to say:
“I am reluctant to conclude that commercial contracts are a class of contracts carrying an implied term of good faith as a legal incident, so that an obligation of good faith applies indiscriminately to all the rights and powers conferred by a commercial contract. It may, however, be appropriate in a particular case to import such an obligation to protect a vulnerable party from exploitative conduct which subverts the original purpose for which the contract was made.”
His Honour did not expressly decide the issue in the circumstances of that case because, as he found:
“… it is not necessary to determine whether a term requiring the exercise of good faith is to be implied in the agreement, for even if such an obligation was imposed upon [Southern Pacific], in my opinion it was not breached.”
Later, in Specialist Diagnostic Services Pty Ltd v Healthscope Pty Ltd (2012) 41 VR 1, the Victorian Court of Appeal was concerned with the validity of a restraint of trade clause and said:
“We do not accept that an obligation of good faith should be implied indiscriminately into all commercial contracts.”
That position was then affirmed by the Victorian Court of Appeal in the 2013 decision of Androvitsaneas v Members First Broker Network [2013] VSCA 212.
In Mineralogy v Sino Iron Pty Ltd (No 6) (2015) 329 ALR 1 (a decision of Edelman J, when His Honour was on the Federal Court of Australia), His Honour said:
“The Victorian Court of Appeal has said that they did “not accept that an obligation of good faith should be implied indiscriminately into all commercial contracts“: [citing Androvitsaneas]. There are two related reasons why this conclusion must be accepted. The first is that questions of implication, like those of construction, require close focus upon the terms of the contract itself. Where a duty is said to arise because of the manifest agreement of the parties, it is always necessary to examine the terms of the contract itself. The second reason is the potential for the content of “good faith“ to differ from one contractual context to another.
These two reasons (the need to focus on the terms of the contract and the potentially different content of the abstract principle of good faith) mean that to the extent that other decisions have suggested that there exists a universal implication of any particular duty to be discerned from the principle of good faith then those authorities should not be followed …“
So, does a duty of reasonableness and good faith constrain the exercise of an express right to terminate a commercial contract or not?
There are a few key takeaways from the above review of the case authorities.
First, Renard remains authoritative in New South Wales but it must be remembered that the case concerned a show cause provision, which will not be true of all commercial contracts.
Second, the Hungry Jack’s case is probably still the leading decision in this area, but it was also very fact-specific. As noted above, the “extraordinary range of detailed considerations” in the Development Agreement was central to the reasoning of the NSW Court of Appeal.
Third, despite the number of decisions in this area handed down since Hungry Jack’s, even in New South Wales, it is still not clear that an express right to terminate is always subject to implied obligations of reasonableness and good faith.
Fourth, the position depends heavily on the words used in the relevant contract. In cases such as NSWRA v The Commonwealth, Adventure World Travel v Newsom and Bundanoon Sandstone v Cenric, such a term was not inconsistent with express terms and was found to be implied. Yet, in other cases, such as Solution 1 v Optus Networks and Starlink International Group v Coles Supermarkets, implied terms of reasonableness and good faith were held not to be present because they would have been inconsistent with the express terms of the contract.
Fifth, on one view, Courts outside of New South Wales have been more reluctant to find that a term requiring reasonableness and good faith is implied into a commercial contract.
And what does “good faith” mean anyway?
Where it applies (either expressly or because it is held to be implied), the law is not settled as to precisely what a duty of good faith requires of the parties.
To the extent that the Courts have provided guidance on that issue, the following decisions should be highlighted:
- In the Hungry Jack’s case, the lack of good faith consisted of the pursuit by Burger King of an ulterior purpose (namely, to prevent Hungry Jack’s from expanding in the Australian market), being a purpose different from that for which the termination power under the Development Agreement had been conferred. Subsequent decisions relying upon Hungry Jack’s have adopted similar reasoning.
- In the 2017 Victorian Court of Appeal decision of Masters Home Improvement v North East Solutions (2017) 372 ALR 440, it was held that a duty of good faith entailed obligations:
- to act honestly and with fidelity to the bargain;
- not to undermine the agreed bargain or the substance of the contractual benefit bargained for; and
- to act reasonably and with fair dealing, having regard to the interests of the other party (but not to the extent of subordinating one’s own interests) and the provisions, aims and purposes of the contract (which are to be objectively ascertained).
Practical Tips
Drafting Termination Clauses
On a practical level, what flows from all of the above is that careful drafting might be the difference between:
- on the one hand, a Court finding that an express right to terminate a contract can only be exercised subject to implied obligations of reasonableness and good faith; and
- on the other hand, a finding that reasonableness and good faith are an unwarranted gloss on an express contractual right to terminate.
In drafting an express termination provision, consider whether the right to terminate is intended to be exercised only reasonably and in good faith or alternatively, those obligations should be excluded. If the obligations are not expressly excluded, there is a risk a Court will hold that they are implied.
Further, if the intention is to confer an unfettered right to terminate in the specified circumstances, some things which might assist include:
- using language in the termination provision such as “absolute and unfettered discretion” and “for any reason”;
- including a clause in the contract which excludes implied terms; and
- not having detailed and technical grounds for termination.
Exercising rights under express termination provisions
When considering whether to exercise an express right to terminate a contract in which obligations of reasonableness and good faith are not expressly excluded, be alive to the risk of a Court finding that the termination right can only be exercised subject to those requirements.
Further, the terminating party should be aware of the case authorities discussed above, as well as the potential consequences if the Court finds that there is an implied obligation to act reasonably and in good faith. The implication of such terms will not be a problem if the terminating party has complied with them, in any event.
