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The Implied Duty of “Good Faith” in Australian Contract Law
| Author: |
Matthew Harper
Student, Victoria University of Technology School of Law
|
| Issue: |
Volume 11, Number 3 (September 2004)
|
Contents
- Australia has not yet committed itself to a definitive principle of good faith in contract law. Unlike the legal systems in Europe and the United States, Australia does not demand an explicit legal prerequisite of good faith to form a contract.[1]
Decisions in different jurisdictions have however considered the validity of the values identified in the doctrine of good faith within contract law, such as loyalty, honesty and cooperation. Good faith is valuable because it provides confidence in the formation of contracts between two parties. However there are conflicting views and criticisms of the doctrine of good faith.
- The “pragmatic theory of cooperation”[2]
underlines the effectiveness of the common law system and emphasises that there is not a need for a clearly defined doctrine of good faith. Economic theory (the “repugnancy thesis of self interest”) goes further and criticises the ability the doctrine holds to oppressively “constrain the pursuit of self interest.”[3]
Although the doctrine may be valuable, the ramifications and effects that such a doctrine would create, need to be analysed and evaluated. In addition this essay will explore how established the doctrine of good faith is within Australian contract law.
- The implied doctrine of good faith is not clearly established within Australian contract law. Therefore there are no clearly defined criteria or requirement to formulate “good faith” in a contractual relationship. Concepts such as cooperation, reasonableness, proper purpose and legitimate interest can at times seem vague,[4]
however they are often linked to the implied duty of good faith.
- It can be argued that in Australia, identifying “bad faith” in contract law is more feasible than proving “good faith” (or lack thereof).[5]
This “excluder” analysis formulates an alternative approach in identifying the traits required to formulate “good faith.” To establish good faith, a variety of values contrary to those which form the basis of “bad faith” need to be accumulated. The economic view still supports the right for individuals to negotiate the best contract. Evaluating these philosophies and relative terms individually enables a closer critique of the doctrine of good faith.
- Cooperation as a duty of contract is implied as a term of law. The concepts of cooperation and loyalty are related and are often used interchangeably[6]
Cooperation in contract involves the idea that when a party enters into a contract, opportunities are lost. The authority for cooperation goes back to the 19th century case Mackay v Dick[7]
Attempting to regain such lost opportunities is an act of bad faith[8]
The duty of cooperation implies that parties to a contract “do all such things as are necessary on his part to enable the other party to have the benefit”.[9]
In Secured Income Real Estate and St Martins Investments the court held that both parties had an obligation to do all that was necessary to “secure the success of the contract”.[10]
By creating an environment in which the contract can succeed, the parties must be acting in cooperation and therefore demonstrating “good faith”.
- The doctrine of cooperation is already “entrenched” in the Australian common law system. The economic view however is critical of cooperation being used as criterion for contract. The classical model is shaped on the basis of competitive dealing in the formation of contract. The arguments residing from economic law theorists, show how cooperation may take away the individuals right to form and create the best contract.[11]
The idea of individualism is central to the classical law formation of contract. It is clear however that to provide an environment to create an agreement in contract, cooperation is required. Therefore for good faith to be in existence, cooperation between the parties needs to be evident in the dealings and formation of the contract.
- Reasonableness in contract is implied by the courts in law. Reasonableness requires that due process is carried through appropriately, and that a degree of fairness and justice is carried out by both parties in their contractual relationship. The authority for “reasonableness” is identified clearly in Renard Constructions[12]
which shows how the use of power (even that which is constituted in a clause) may be deemed “unfair” and beyond that of the agreement. Priestly JA held that a duty of reasonableness can be implied in a contract and that it has “much in common” with a duty of good faith.[13]
The adaptation of such a “reasonableness test” has become a common practice in some jurisdictions.[14]
- The economic view on the application of reasonableness is that “to be autonomous a person must not only be given a choice but must be given an adequate range of choices”.[15]
Therefore it could be interpreted that the economic view is supportive of the reasonableness test and the application of reason to comprehend the parties’ actions. The test of reasonableness is relevant to good faith due to the close relationship between the terms. For good faith to be in existence, reasonableness needs to be evident in the dealings and formation of the contract.
- Proper purpose in the use of contractual rights is considered to be an implied duty of good faith. In conjunction with honesty, proper purpose eliminates “capricious” acts which go beyond that of the original agreement. In Burger King Corp v Hungry Jacks, a clause in the franchise agreement stipulated that new restaurants were to be built each year and authorised solely by discretion from the Burger King Corp. [16]
At the time of the grievance Burger King Corp wished to cancel the franchise agreement by not authorising any new restaurants. This act was ultimately deemed to be beyond the intentions of the parties and undermined the purpose of the contract when the agreement was first developed. [17]
- The concept of honesty is linked closely to the notion of proper purpose. Honesty is frequently referred to in legislation as part of the definition of “good faith.” In the Sale of Goods Act for example section 5(2) states that to be “deemed in good faith within the meaning of this Act when it is in fact done honestly”. [18]
For a contract to succeed, honesty must be evident. Burger King Corp were not acting honestly, therefore the corporation was not acting in good faith. [19]
Deceptive acts and lack of honesty can be seen as acts of “bad faith”, which in Australia could be an offence under the Trade Practices Act.[20]
Therefore it is understandable why honesty is highlighted as a prerequisite for “good faith”.
- Having regard for the interests of the other contractual party is another term implied in law.[21]
Legitimate interest acknowledges that each contracting party has an obligation to consider the other parties interests. The term is closely related to cooperation and loyalty to the contract. Legitimate interest can also be interpreted as a term of fact. In Renard Constructions v Minister for Public Works, Priestly JA commented on the prospect of the term being implied in fact.[22]
For a term to be implied in fact, the requirements established in BP Refinery must be satisfied.[23]
These requirements include that formal contracts must be reasonable and equitable, obvious, clear, consistent with express terms and must be necessary to give business efficacy.[24]
- The economic view strongly objects to legitimate interest being necessary to give business efficacy.[25]
Business efficacy requires that all implied terms in the contract enable the agreement to be carried out in a reasonable manner.[26]
Priestly JA, who introduced the proposition, stated that it may be difficult to satisfy the “business efficacy” criteria of implied term of fact.[27]
The economic view, however describes a “rational survival of the fittest” agenda in the business world.[28]
A person’s rational behaviour would include actions made in order to achieve “the greatest satisfaction or maximum fulfilment of their goals”.[29]
From a non-economic viewpoint, however, the formation of “fair” dealings in the formation of contract is important and it therefore must be incorporated in the implied doctrine of good faith.
- Identifying a course of positive dealings may prove to be too challenging in the analysis of case law. The “excluder analysis” principle analyses the accumulation of “bad faith terms”. Summers identified a list of terms which could incorporate such
bad faith acts. These acts include evasion of the spirit of the deal, wilful rendering of only substantial performance, abuse of power to determine compliance, interference, and failure to cooperate in the other parties’ performance. [30]
Excluder analysis takes the view that “one cannot state the necessary and sufficient factual conditions for a finding of good faith or bad faith”. [31]
This statement highlights the relative ambiguity of the notion of good faith. There is no clear meaning for the term. Requirements such as cooperation, reasonableness, proper purpose and legitimate interest are all concepts evident within Australian contract law. It is not clear how well “entrenched” the doctrine of “good faith” is within Australian contract law. It is clear however that the requirements which constitute “good faith” are already “entrenched” as implied terms of law.
- The fundamental principles of good faith do not generally raise such criticism. Criticism is derived from what role good faith should be incorporated into Australian contract law. There are two clearly defined views of the doctrine of good faith. One view is based on an “ethic of cooperation,” and the other is based on “an ethic of self interest”.[32]
The “pragmatic thesis of cooperation” highlights that the common law system does not need a clearly defined doctrine of good faith. As we have seen, the requirements for good faith are already implied in law.
- The pragmatic view suggests that implementing a doctrine of good faith is not required because the contract law system works effectively without it. Contract law already includes provisions such as the contra proferentem rule and estoppel [33]
which can be applied to issues where good faith may be not evident. It is argued that implementing such a doctrine could result in further confusion and inconsistency in judicial interpretation. The law already has “entrenched” provisions of good faith so there is no need to “reinvent the wheel.”
- In the “cooperative view” a contract is viewed as a vehicle for mutual support and cooperation[34]
This utopian view of contract depicts a world where contracts are formed solely for “mutually beneficial exchanges”. This view is challenged on the basis that business contracts in reality do not operate in this fashion. Contracts are made to obtain the maximum benefit from an exchange. In Burger King Corp v Hungary Jacks, the franchise agreement was not made with the intention for a “mutually beneficial exchange”. [35]
The agreement described an agenda in which profit maximisation should exist. It is unreasonable to expect corporations to engage in contract on the principal that all exchanges are “mutually beneficial”. Therefore any principle of mutually beneficial exchanges, such as the cooperative view, rests on non-contingent principles.[36]
- Contingency in good faith relies on the standards and customs of a contracting community. For example in Burger King Corp v Hungary Jacks, the custom would insinuate hostility between the parties due to their competitive industry. Custom would give reason to Burger King Corp withdrawing the franchise agreement so it would gain access to the market. Non contingent principles draw justification on philosophies of reason, and fairness.[37]
The non-contingent view therefore is more socially conscious and upholds the notion of cooperation in dealings.
- The repugnancy theory of self interest is strongly related to the economic theory of law and is constricted by the requirements of good faith. This principle of “self interest” is a fundamental principle of classical law which views contract as “a vehicle for self interested exchange” [38]
for the individual. Both theories (good faith and self-interest) are fundamentally mutually exclusive and are essentially critical of each other. The courts perception on the doctrine of good faith is somewhat undecided. There is a view that “free exchanges should be permitted” when within the law upholding the economic view. [39]
When considering other jurisdictions however there is some feeling that more emphasis should be given to good faith. [40]
- The “repugnant view of self interest” describes the use of contract as a vehicle for “self-interested exchange”.[41]
This fundamental economic perspective depicts a strong capitalist view of the world in which contracts are formed solely for the purpose of profit maximisation. It supports the statement that “in commercial matters one should not substitute lawyerly conscience for the hard headed decisions made by business people.” [42]
A criticism of the repugnant view is that not all contractual relationships in business are conducted with the desire for profit maximisation. Not for profit organisations and charities accept donations from the public and businesses in “good faith” that the funds have been reasonably accumulated.
- The economic view is contrary to a fully fledged doctrine of good faith. A doctrine of good faith would ultimately constrain the individual’s right to negotiate and form a contract because the individual would need to consider the best interests of the other party. In the business sector this requirement would prove to be at times uncommercial and not in the companies’ best interests of profit maximisation. There are already well established restrictions in contract law which protect the third party. These include estoppel and the contra proferentem rule. [43]
As well the terms which formulate good faith are already implied terms in law and can be utilised by the courts where relevant.
- Another reason would be the obvious infringement good faith would have on the classical law principle for the formation of contract. A fully developed doctrine of good faith would require the “ground rules” of contract to change. [44]
As the concept of “good faith” is contrary to the competitive notion of “self interest”, negotiations for example would become unreasonable given that the individual wants the best result for himself. Such an implementation would incur drastic changes in the perception and adaptation of contract in Australia.
- The courts have yet to fully ratify a doctrine of good faith in Australian contract law. Disagreements between jurisdictions and judges have clouded the position of the doctrine in the courts. Debate still continues over the significant ruling in Renard v Minister for Public Works. Priestly JA, as a dissenting judge, proposed that the time was ripe for the imposition “in all contracts of a duty upon the parties of good faith and fair dealing in it’s performance”.[45]
The other judges in the majority did not share his enthusiasm. Meagher JA stated that “there is no possible basis for inflicting such a doctrine on the principal, and his honour was correct to repudiate it. There is no reason why the principal should have regard to any interests except his own”.[46]
These conflicting views do not clearly indicate how “established” the doctrine of good faith is. The judgement ultimately questions how valuable and relevant the doctrine is to Australian contract law.
- The doctrine of good faith is relevant to Australian contract law. It is unclear what exactly constitutes good faith as terms such as cooperation, reasonableness, proper purpose and legitimate interest are already implied in law. Implied terms are pivotal to a contract and without such terms a contract would hold no weight, because the parties would simply not be bound. Ultimately all parties act in good faith to fulfil the obligations of the contract.
- The concept of rationalisation is common to both the economic and cooperative views because it allows for confidence in the contract to be established. The content of good faith rests upon the standards of society. It can be argued that Australia is still very much a strong capitalist nation which compels contract law to sustain such economic values. The doctrine of good faith under this structure is still valuable in holding the classical principles of offer and agreement in contract law together. For good faith to become essential to form a contract as it is suggested in the cooperative view, a greater change in societal priorities is required.
- Good faith as a distinct doctrine is not well entrenched in Australian contract law. The fundamental principles which constitute good faith such as cooperation, reasonableness, legitimate interest and proper purpose are already implied in law. Good faith implied as a separate definitive doctrine would only cover the principles already established in law. Therefore there is no need to “reinvent the wheel”. Economic criticisms of the doctrine of good faith are common due to the perception that the doctrine restricts the individuals’ right to form the “best” contract possible. It is argued that such restrictions are against the classical law principle of “self interest.” The principles which form the doctrine of good faith are valuable because they create confidence in the formation of contracts between the two parties. Without such principles no contract would be binding. Recognition of good faith as an umbrella principle is ultimately required in Australian law to sustain the further development and provide confidence in the area of contract law.
[1]
John Adams, Roger Brownsword, Key Issues in Contract (1st ed, 1995) p.198
[2]
See Sir Bingham in Interfoto Picture Library Ltd v Stiletto Visual Programmes Ltd (1989) QB 433 cited in Adams and Brownsword, op. cit. p.198
[3]
Adams and Brownsword, op. cit. p.200
[4]
Dr Elizabeth Peden, The meaning of contractual good faith (2001) 22 ABR 235
[5]
R.S Summers, “Good faith in general contract law and the sales provision of the uniform commercial code” (1968) 54 Virginia Law Review195 cited in ibid at [2]
[6]
Peden, op. cit. at [3]
[7]
Mackay v Dick (1881) 6 App Cas 251 cited in Dr Elizabeth Peden, “The meaning of contractual good faith” (2001) 22 ABR 235 at [3]
[8]
Peden, op. cit. at [4]
[9]
Griffth CJ in Butt v McDonald (1896) 7 QLJ 68 at [70-71] cited and referred to in the case Secured Income Real Estate (Australia) Ltd v St Martins Investment Pty Ltd (1979) 144 CLR 596 at [607]
[10]
ibid
[11]
Adams and Brownsword, op. cit p.265
[12]
Renard Constructions v Minister for Public Works (1992) 26 NSWLR 234
[13]
Peter Heffey, Jeannie Patterson, and Andrew Robertson, “Principles of Contract Law” (1st ed, 2002) p.265
[14]
Adams and Brownsword, op. cit p.265
[15]
Joseph Raz, “The Morality of Freedom” (Oxford, Clarendon Press, 1986) p373 cited in Peden, op. cit. p.235
[16]
Burger King Corp v Hungry Jacks Pty Ltd (2001) NSWCA 187 [185]
[17]
Heffey, Patterson and Robertson, op. cit. p.266
[18]
Sale of Goods Act 1923 (NSW) s 5(2)
[19]
Heffey, Patterson and Robertson, op. cit. 266.
[20]
Trade Practices Act 1974 (Cth) s52 (deceptive conduct)
[21]
Burger King Corp v Hungary Jacks Pty Ltd (2001) NSWCA 187 at [165]
[22]
Priestly JA in Renard Constructions v Minister for Public Works (1992) 26 NSWLR 234 at [263]
[23]
BP Refinery (Westernport) Pty Limited v President, Councillors and ratepayers of the shire of Hastings (1977) 180 CLR 266 at [26]
[24]
ibid
[25]
Adams and Brownsword, op. cit. p.265
[26]
Lindy Millmott, Sharen Christenson, Des Butler, “Contract Law” (1st ed, 2001) 250
[27]
Priestly JA cited in Peden, op. cit. p.235
[28]
Jackson Mc Ivor, “Macroeconomics” (6th ed 2002) p.16
[29]
ibid
[30]
R.S Summers, “Good faith in general contract law and the sales provision of the uniform commercial code” (1968) 54 Virginia Law Review195 cited in Peter Heffey, Jeannie Patterson, Andrew Robertson, Principles of Contract Law (1st ed, 2002) 269
[31]
R.S Summers, op. cit., cited in Adams and Brownsword, op. cit 221
[32]
Adams and Brownsword, op. cit 223
[33]
Heffey, Patterson and Robertson, op. cit.145
[34]
Adams and Brownsword, op. cit 223
[35]
Burger King Corp v Hungary Jacks Pty Ltd (2001) NSWCA 187 at [165]
[36]
Adams and Brownsword, op. cit 222
[37]
ibid
[38]
ibid 223
[39]
John Wightman, “Law and Social Theory: Contract a Critical Commentary” (1st ed, 1996) 65
[40]
Hector L MacQueen and Joe Thomson, “Contract Law in Scotland” (1st ed, 2000) 104-110
[41]
Adams and Brownsword, op. cit) 223
[42]
ibid 199
[43]
Heffey, Patterson and Robertson, op. cit.145
[44]
Adams and Brownsword, op. cit 201
[45]
Priestly JA in Renard Constructions v Minister for Public Works (1992) 26 NSWLR 234 at 268 cited in Lindy Millmott, Sharen Christenson, Des Butler, “Contract Law” (1st ed, 2001) 262
[46]
Meagher JA in Renard Constructions v Minister for Public Works (1992) 26 NSWLR 234 at 275 cited in Adams and Brownsword, op. cit 199
