Publications

Publications

Publications / Projects and Infrastructure

27 May 11
In commercial dealings good faith doesn't mean 'blind faith'

Striking a balance between your commercial interests and your obligations of disclosure

In a memorandum of understanding, heads of agreement, letter of intent or contract, it is common for the parties to agree to deal with each other, and conduct negotiations, in ‘good faith’. A party that enters into an agreement containing a term of ‘good faith’ must proceed cautiously, as recent case law requires the parties to conduct their negotiations to a higher standard than usual negotiation practices.

What is ‘good faith’?

Courts have struggled to define what is meant by the term ‘good faith’. At it narrowest, it is generally considered to mean acting honestly and reasonably. However, there are suggestions that it requires the parties to the agreement to have regard to the interests of all parties and to the terms, aims and purposes of the agreement.

An obligation of ‘good faith’ can be imposed either as an express term in an agreement, or implied as a term in the agreement. As an example, the obligation of ‘good faith’ is commonly implied into franchise agreements.

Irrespective of whether an obligation of ‘good faith’ is an express or implied term, the underlying obligations are similar.

Macquarie International Health Clinic Pty Ltd v Sydney South West Area Health Service [2010] NSWCA 268

The recent case of Macquarie International Health Clinic Pty Ltd v Sydney South West Area Health Service illustrates the far-reaching effect of ‘good faith’ obligations on parties’ conduct during negotiations.

Facts

Macquarie International Health Clinic Pty Ltd (Macquarie) entered into a heads of agreement with Sydney South West Area Health Service (SSWAHS) for the development of a private hospital on land situated within the Royal Prince Alfred Hospital precinct (RPAH) owned by SSWAHS. It was a crucial part of the ‘deal’ that the proposed private hospital be located next to and physically linked to, RPAH. This required the placement of the proposed private hospital at a specific site (Site).

The heads of agreement required the parties to act with the utmost ‘good faith’ in the performance of their respective duties, in the exercise of their respective powers, and in their respective dealings with one another. The parties entered into other agreements in accordance with the heads of agreement.

SSWHAS subsequently undertook an asset strategic plan for RPAH, which did not propose any development of RPAH near the Site or any linkages between RPAH to the proposed private hospital. The asset strategic plan was not disclosed to Macquarie.

Macquarie claimed that SSWHAS had breach its obligation of ‘good faith’ in the heads of agreement by not disclosing the asset strategic plan to Macquarie during negotiations for the other agreements.

Decision

The NSW Court of Appeal confirmed that the obligation of ‘good faith’ in the heads of agreement was enforceable.

The Court held that:

  • the obligation of ‘good faith’ does not require parties to compromise their own commercial interests, but parties must cooperate in a reasonable way to achieve the contract objectives, and
  • in certain situations, the duty for parties to cooperate may require a party to disclose information to the other.

The obligation of 'good faith' required SSWHAS to disclose information regarding its planning processes (including its asset strategic plan) when the information would have made a substantial difference to Macquarie's reasonable expectations under the heads of agreement.

Commentary on the decision

This decision extends the duty of ‘good faith’ into what this author considers to be new territory. Previously, parties complied with their ‘good faith’ obligations if they made proposals and counterproposals which they believed to be commercial, and were ’open’ to the process of negotiation. This decision now requires a party to consider if there is any information it should disclose to the other party during negotiations which may differ from what they expected under a memorandum of understanding, heads of agreement, letter of intent or contract.

This may require a party to disclose any contingency plans that it may have in place if negotiations fail (e.g. commencing negotiations with a third party contractor as a contingency).

How to ensure that your conduct is in ‘good faith’

Flowing from this decision, it is important for anyone involved in negotiations to consider the restrictions on their conduct that will be imposed by a term, whether express or implied, requiring them to act in ‘good faith’. During those negotiations a party:

  • should negotiate honestly and sincerely. This may require a party to put forward its genuine negotiation position and not engage in any unfair tactics or ‘games’ (e.g. prolonging negotiations to achieve an ulterior purpose, or making exaggerated or false claims)
  • can negotiate in its commercial self interest but needs to do so ‘rationally’ i.e. not engage in any vindictive or capricious behaviour
  • should cooperate with the other parties to achieve the agreed contractual objectives. This may require timely disclosure of relevant information from one party to the others. In joint ventures or alliances, parties may be required to disclose a greater scope of information during negotiations
  • should make proposals and counterproposal which respect and gives effect to the material terms already agreed, and
  • should give serious and genuine consideration to proposals and counterproposals made and received.

Failure by a party to conduct themselves appropriately during negotiations may result in a breach of the agreement and liability to pay damages to the other party.

A party proposing to enter into an agreement containing a term of ‘good faith’ should seek legal advice on its implications.

 

Focus covers legal and technical issues in a general way. It is not designed to express opinions on specific cases. Focus is intended for information purposes only and should not be regarded as legal advice. Further advice should be obtained before taking action on any issue dealt with in this publication. If you would prefer not to receive further.

 

In this section

Contact

For further enquiries please contact: