Lessons to be Learned from the European View of Good Faith

The concept of good faith is firmly established in the civil law jurisdiction of the European Union (EU), although it manifests itself in different forms in each of them, despite the influence of both the German and French law.

Although common law lawyers may not like it, the traditional idea that good faith is not part of common law business-to-business contracting is now outdated, be it in England, Ireland, Australia or the United States. An implied concept of good faith is steadily gaining recognition as a legally binding concept and independent cause of action in common law systems during the performance phase of contracts, particularly long term relational agreements such as franchise agreements.

Where good faith is treated as a legally binding, independent cause of action, it may involve different behaviors in different contexts, such as fair dealing, transparency and honesty. The Yam Seng Limited v. International Trade Corporation Limited, [2013] EWHC 111 (QB), case in England draws together the different strings making the law on good faith more coherent, and perhaps offering some lessons for U.S. Legislators. In Yam Seng , the Singapore-based company Yam Seng entered into an exclusive distribution agreement with International Trade Corporation (ITC), an English company, to market soccer club Manchester United branded toiletries to duty-free outlets in Asia and the Middle East. Unfortunately, the relationship was far from successful and the judge held that ITC's CEO misled Yam Seng about legal, commercial and logistical issues and repeatedly missed deadlines for supplying products to Yam Seng. He made promises which he knew to be unachievable, undercut prices agreed with Yam Seng and provided information that the judge held to be false. Yam Seng terminated the agreement and sued ITC for damages for breach of contract and misrepresentation.

The judge found in favor of Yam Seng and awarded it damages for breach of contract and misrepresentation (which equaled the same amount). An important issue that the court was asked to consider ' in the context of whether ITC's conduct involved sufficiently serious breaches of contract to justify Yam Seng's termination of the agreement ' was whether a duty of “good faith” should be implied into the contract. Justice Leggatt held that the agreement contained an enforceable implied obligation on the parties to act in good faith and concluded that ITC breached that obligation by knowingly concealing from Yam Seng the true situation concerning ITC's pricing arrangements with a crucial distribution channel in Singapore. The breach of that implied obligation was held to be repudiatory, thus justifying Yam Seng's termination of the agreement and entitling Yam Seng to the damages that it sought.

Had the matter been litigated in the United States, what conclusions would a U.S. court have reached? While U.S. courts would likely come to a similar conclusion with respect to the misrepresentation claim, it is unclear if they would go as far as Justice Leggatt did with respect to the breach of contracts claim. The implied covenant of good faith and fair dealing is intended as a contract-interpretation tool, but in cases with bad facts, some courts are willing to stretch the doctrine much further. Such was the case in Scheck v. Burger King, 756 F.Supp. 543 (S.D. Fl. 1991), in which the court held that even though the franchisee had no exclusive territory, this did not mean that Burger King had the right to open new restaurants in close proximity to the franchisee's restaurant. It is not exactly the same as in Yam Seng, as the court did not grant the franchisee a right that was not expressly written into the contract, but in reality by denying Burger King the exercise of a right that was not regulated by the contract, it achieved the same results. The facts of Yam Seng being rather extreme, it is possible that a U.S. court would have taken a similar approach had it been asked to decide that case, and would have stretched the implied covenant of good faith and fair dealing, as happened in Scheck.

Justice Leggatt went on to analyze in great detail and clarity why English law should impose an obligation of good faith in a situation like that presented in Yam Seng . His judgment draws together the pre-existing, disparate strands of English case law on the issue of good faith in commercial contracts and explains the importance of implied good faith in what he called “relational” agreements, which are long term agreements requiring extensive cooperation, a high degree of communication, mutual trust and confidence and expectations of loyalty. In his opinion, he referred expressly to joint venture agreements, franchise agreements and long-term distribution agreements. Justice Leggatt relied on the evolving attitude toward good faith in other common law countries, such as Australia, and sought to dispel the traditional English hostility to a binding good faith principle. Justice Leggatt doubted that English courts would recognize a requirement of good faith as a duty implied by law into all commercial contracts. He justified its implication into the distribution agreement between ITC and Yam Seng based on the presumed intention of the parties and the relevant background against which the contract was made. Justice Leggatt concluded that the relevant background could include shared values and behavioral norms (both general and specific to a particular trade or industry), as well as the specific facts known to the parties.

Justice Leggatt held that the test of good faith is an objective, not a subjective, one. The test is whether the conduct in question would be regarded as commercially unacceptable by a reasonable and honest person; it is not based on either party's perception of what is improper conduct. Justice Leggatt argued that the recognition of a duty of good faith is consistent with the case-by-case approach employed by common law systems, and it is not an illegitimate restriction of the parties' freedom of contract as it is open to them to restrict the duty by way of the express terms of the contract.

The Yam Seng case is the high water mark in the current series of good faith cases. Arguably, the concept was used to give legal credence to the judge's view that a wrong had been committed by ITC to which Yam Seng should, as a matter of equity, have some redress. The facts of the case are fairly specific, and there was clear evidence of bad faith and dishonesty by ITC. It would have been interesting to see whether the High Court decision would have been upheld under scrutiny from the Court of Appeal if ITC had chosen to appeal.

Conclusion

If Justice Leggatt's analysis of the common law approach to good faith is valid, it suggests that U.S. legislators may wish to consider adopting an independent cause of action for violations of a covenant of good faith and fair dealing based on an objective test as regards commercial acceptability from the view of a reasonable and honest person, rather than the more technical and interventionist approach taken by the German and French courts.

At the current time, there is some movement in this direction by several states, at least with respect to franchising. For several reasons, there is much opposition to these bills, and it is unlikely that most of them will be adopted into law, at least in their current form. Were they to pass, it is likely that we would not have to wait long before there would be significant amounts of case law available to analyze how the covenant works in a common law framework.

Dr. Mark Abell, a member of our Board of Editors, is a partner at Bird & Bird LLP, London. Beata Krakus is an officer in the Chicago office of Greensfelder, Hemker & Gale, P.C. (www.greensfelder.com). Krakus is a member of the firm's Franchising & Distribution and Corporate Practice Groups and can be reached at [email protected] or 312-345-5004.

The concept of good faith is firmly established in the civil law jurisdiction of the European Union (EU), although it manifests itself in different forms in each of them, despite the influence of both the German and French law.

Although common law lawyers may not like it, the traditional idea that good faith is not part of common law business-to-business contracting is now outdated, be it in England, Ireland, Australia or the United States. An implied concept of good faith is steadily gaining recognition as a legally binding concept and independent cause of action in common law systems during the performance phase of contracts, particularly long term relational agreements such as franchise agreements.

Where good faith is treated as a legally binding, independent cause of action, it may involve different behaviors in different contexts, such as fair dealing, transparency and honesty. The Yam Seng Limited v. International Trade Corporation Limited, [2013] EWHC 111 (QB), case in England draws together the different strings making the law on good faith more coherent, and perhaps offering some lessons for U.S. Legislators. In Yam Seng , the Singapore-based company Yam Seng entered into an exclusive distribution agreement with International Trade Corporation (ITC), an English company, to market soccer club Manchester United branded toiletries to duty-free outlets in Asia and the Middle East. Unfortunately, the relationship was far from successful and the judge held that ITC's CEO misled Yam Seng about legal, commercial and logistical issues and repeatedly missed deadlines for supplying products to Yam Seng. He made promises which he knew to be unachievable, undercut prices agreed with Yam Seng and provided information that the judge held to be false. Yam Seng terminated the agreement and sued ITC for damages for breach of contract and misrepresentation.

The judge found in favor of Yam Seng and awarded it damages for breach of contract and misrepresentation (which equaled the same amount). An important issue that the court was asked to consider ' in the context of whether ITC's conduct involved sufficiently serious breaches of contract to justify Yam Seng's termination of the agreement ' was whether a duty of “good faith” should be implied into the contract. Justice Leggatt held that the agreement contained an enforceable implied obligation on the parties to act in good faith and concluded that ITC breached that obligation by knowingly concealing from Yam Seng the true situation concerning ITC's pricing arrangements with a crucial distribution channel in Singapore. The breach of that implied obligation was held to be repudiatory, thus justifying Yam Seng's termination of the agreement and entitling Yam Seng to the damages that it sought.

Had the matter been litigated in the United States, what conclusions would a U.S. court have reached? While U.S. courts would likely come to a similar conclusion with respect to the misrepresentation claim, it is unclear if they would go as far as Justice Leggatt did with respect to the breach of contracts claim. The implied covenant of good faith and fair dealing is intended as a contract-interpretation tool, but in cases with bad facts, some courts are willing to stretch the doctrine much further. Such was the case in Scheck v. Burger King, 756 F.Supp. 543 (S.D. Fl. 1991), in which the court held that even though the franchisee had no exclusive territory, this did not mean that Burger King had the right to open new restaurants in close proximity to the franchisee's restaurant. It is not exactly the same as in Yam Seng, as the court did not grant the franchisee a right that was not expressly written into the contract, but in reality by denying Burger King the exercise of a right that was not regulated by the contract, it achieved the same results. The facts of Yam Seng being rather extreme, it is possible that a U.S. court would have taken a similar approach had it been asked to decide that case, and would have stretched the implied covenant of good faith and fair dealing, as happened in Scheck.

Justice Leggatt went on to analyze in great detail and clarity why English law should impose an obligation of good faith in a situation like that presented in Yam Seng . His judgment draws together the pre-existing, disparate strands of English case law on the issue of good faith in commercial contracts and explains the importance of implied good faith in what he called “relational” agreements, which are long term agreements requiring extensive cooperation, a high degree of communication, mutual trust and confidence and expectations of loyalty. In his opinion, he referred expressly to joint venture agreements, franchise agreements and long-term distribution agreements. Justice Leggatt relied on the evolving attitude toward good faith in other common law countries, such as Australia, and sought to dispel the traditional English hostility to a binding good faith principle. Justice Leggatt doubted that English courts would recognize a requirement of good faith as a duty implied by law into all commercial contracts. He justified its implication into the distribution agreement between ITC and Yam Seng based on the presumed intention of the parties and the relevant background against which the contract was made. Justice Leggatt concluded that the relevant background could include shared values and behavioral norms (both general and specific to a particular trade or industry), as well as the specific facts known to the parties.

Justice Leggatt held that the test of good faith is an objective, not a subjective, one. The test is whether the conduct in question would be regarded as commercially unacceptable by a reasonable and honest person; it is not based on either party's perception of what is improper conduct. Justice Leggatt argued that the recognition of a duty of good faith is consistent with the case-by-case approach employed by common law systems, and it is not an illegitimate restriction of the parties' freedom of contract as it is open to them to restrict the duty by way of the express terms of the contract.

The Yam Seng case is the high water mark in the current series of good faith cases. Arguably, the concept was used to give legal credence to the judge's view that a wrong had been committed by ITC to which Yam Seng should, as a matter of equity, have some redress. The facts of the case are fairly specific, and there was clear evidence of bad faith and dishonesty by ITC. It would have been interesting to see whether the High Court decision would have been upheld under scrutiny from the Court of Appeal if ITC had chosen to appeal.

Conclusion

If Justice Leggatt's analysis of the common law approach to good faith is valid, it suggests that U.S. legislators may wish to consider adopting an independent cause of action for violations of a covenant of good faith and fair dealing based on an objective test as regards commercial acceptability from the view of a reasonable and honest person, rather than the more technical and interventionist approach taken by the German and French courts.

At the current time, there is some movement in this direction by several states, at least with respect to franchising. For several reasons, there is much opposition to these bills, and it is unlikely that most of them will be adopted into law, at least in their current form. Were they to pass, it is likely that we would not have to wait long before there would be significant amounts of case law available to analyze how the covenant works in a common law framework.

Dr. Mark Abell, a member of our Board of Editors, is a partner at Bird & Bird LLP, London. Beata Krakus is an officer in the Chicago office of Greensfelder, Hemker & Gale, P.C. (www.greensfelder.com). Krakus is a member of the firm's Franchising & Distribution and Corporate Practice Groups and can be reached at [email protected] or 312-345-5004.