Comparative commercial law – the law of good faith

The principle of “good faith” in agreements

When two parties enter into a contract,  there is an implicit moral understanding that underlies the agreement which is referred to as “good faith”, which may be defined as the intention not to defraud or cheat the other party but to carry out the terms of the contract in a gentlemanly fashion although every little detail may not be spelt out in the contract.

A “good faith” agreement is one which may also be classified as a “lock-in” agreement wherein the parties agree to negotiate.[Agreement, n.d]. When there is no time frame stipulated within an agreement to negotiate, then it is not considered enforceable in a Court of law, whereas the imposition of a time frame on a good faith agreement  makes it a “lock out” kind of arrangement where an exit route is left open for the parties if the negotiations fail.

An agreement of good faith falls more in line with arbitration principles wherein parties enter agreements in order to negotiate with each other. But in the early 1800’s, efficiency of British Courts was determined by the number of cases being disputed and  therefore the thrust of the Courts was directed away from agreements :to agree” [Knutsen, 2004]. As far as British Courts are concerned, the contention of “good faith” that underlies an agreement has been systematically rejected on the grounds that it neglects the self interest of the negotiating parties. According to Lord Ackner (1992) in the Walford case,1

“The reason why an agreement to negotiate, like an agreement to agree, is unenforceable, is simply because it lacks the necessary certainty…………… However the concept of a duty to carry on negotiations in good faith is inherently repugnant to the adversarial position of the parties when involved in negotiations.”

This position holds that each party is essentially interested in his own interests and if the party considers it in its own interests to threaten to withdraw from agreement in order to negotiate better terms, it is entitled to do so, without it necessarily constituting a breach of contract.[Agreement, n.d.]

Another reason why British Courts have rejected the tenet of “good faith” is the fact that it is subjective in nature. The law is based upon facts, not intentions and it is difficult to render judgment on promises as opposed to definite acts that constitute breach or violation of a contract. For example, if a contract is terminated, it would be difficult to enforce the law solely on the grounds of a breach of good faith, as follows.

How can a Court be expected to decide whether, subjectively, a proper reason existed for  the termination of negotiations?

Therefore, a third reason why British Courts have consistently rejected the law of good faith lies in the fact that it is difficult to enforce such a subjective contract, and to determine the extent of monetary or other compensation that needs to be made.[Agreement, n.d.]. It is difficult to quantify the damages  accruing from what essentially constitutes the breaking of a promise, for which there is no definite guarantee offered.

“No Court could estimate the damages because no one can tell whether the negotiations would be successful or would fall though; or if successful, what the result would be.”

Therefore from the foregoing, it may be noted that a general agreement of “good faith”  is considered legally enforceable and especially when there is no time frame specified, the inherent subjectivity of the “good faith factor makes it difficult to adjudicate in a Court of law, where facts predominate.

However, in general, the “food faith” clause used in a legal agreement refers to the intention of the parties to negotiate amicably, to put forward offers and counter offers , not to act in a manner that would be deceitful or breach the trust of the other party and not withdraw form the negotiations without attributing a good reason for doing so.[Agreement, n.d.] Therefore, in essence, the good faith clause is based on a reasonable code of conduct that is expected of the two negotiating parties.

The position taken by the British is  advantageous or not, depending upon one’s perspective. The principle of good faith is based upon a common set of standards of good and bad, in reference to the standards of morality of society. It is considered a basis for consensual negotiations rather than adversarial (Zimmerman 16) A good faith clause has merit in that it obligates the negotiating parties to refrain from arbitrary or unethical behavior. According to the Principles of European Contract law,4  “each party owes to the other a duty to cooperate in order to give full effect to the contract.” This obligation to cooperate and to behave in a gentlemanly moral fashion rather than an arbitrary one is the inherent understanding when two parties enter into a contract and helps to encourage negotiations on the underlying understanding that the two parties will conduct themselves honorably and fairly  in their dealings with each  other.

However the British courts’ view is also valid, since it is difficult to enforce a breach of good faith which does not quantify the exact boundaries of each party’s obligations. The British Courts have been accused of eschewing traditional morality in the interest of economic efficiency. Its reluctance to enforce the good faith clause of legal agreements is attributed to be a function of its greater interest in the “predictability of the legal outcome of the case” rather than “absolute justice” (Goode 7). But when a time element is assigned, then a definite element is introduced which helps to quantify the boundaries beyond which the matter can become subject to litigation.

While British courts are predisposed to focus more on the legal issues rather than the morality of an agreement, German Courts have adopted a different principle in the matter. In Germany, the “bona fide” principle is based upon the notions of Treu and Glauben, which means fidelity and faith.(Zimmerman 18). These two principles are an inherent part of the German Civil Code of 1900, which states: “contracts shall be interpreted according to the requirements of good faith, ordinary usage being taken into consideration.”5

Every contract has been left open to interpretation, however the principles of good faith are clearly to be applied, and therefore German contract law favors the consensual rather than the adversarial kind of contract negotiations. Conciliation and dispute resolution is a common legal recourse in Germany and is in fact mandatory, so that no case may come up to the Supreme Court before conciliation has been attempted. The clear leaning of the Courts in the direction of good faith and the adherence to it thereof is demonstrated in the text of the judgments of the German Courts as follows:

“It would be contrary to good faith if the non-terminating party were put in a worse position because he was ready to continue under the contract notwithstanding the contractual violation by the terminating party.”6 The principle of good faith has also been applied in other cases where international parties are involved and when agreements have to be concluded on the principles of good faith:

The general principle of good faith also applies to international contracts for the delivery of goods by instalments.7

Thus, British and German courts approach good faith in agreement from different legal perspectives.

                                     WORKS CITED:

  1. “Agreement”. (No Date). Retrieved July 29, 2005 from URL: http://www.oup.com/uk/booksites/content/0199268142/chapter03.pdf.
  2. Goode, Roy. (1992). The concept of “Good faith” in English law, p 7
  3. Knutsen, Robert (2004). Dispute Board processes . Retrieved July 29, 2005 from URL: http://www.robertknutson.com/downloads/Dispute_Adjudication_Board_paper-Nov2004.doc.
  4. Zimmerman, Rienhard and Whittaker, Simon (2000).  Good faith in European Contract Law. Cambridge Press.

1 See statements by Lord Ackner in Walford v Miles 36

2 See Walford v Miles 36 at page 138

3  See  Courtney and Fairbairn v Tolaini Brothers (Hotels) Ltd (1975), at page 301.

4 Article 1.107

5  Article 157, BGB.

6 BGH 11 February 1981, VIII ZR 312/79 NJW 1981,1264,1265; Staudinger/Otto, BGB Sect. 326 nos. 186-187

7 Herber, EWiR 1987, 241, 242.”

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