Written By Paul Bennett – Consultant
This little essay attempts to explain what is meant by a requirement to act in good faith, where the requirement arrives and to set out the elements of the law and then to pose a question in the form of a fairly typical or all too common scenario. So, let’s start with the elements of the law.
Most commercial dealings are based upon a contract. Two or more parties enter into a contract or some course of dealings for their mutual advantages. There is a general legal duty of honesty in the sense of not giving false representations, not falsifying documents, indeed generally behaving legally. But, that is nowhere near as great a duty as the duty to act in good faith.
Let’s take the example of a traditional commercial partnership. There is an ancient duty on partners in a partnership to act in good faith, indeed with the utmost good faith – a doctrine so old it’s still often referred to in Latin still as the doctrine of uberrimae fidei. Partners owe a duty of good faith to each other in addition to straightforward honesty, this requires loyalty to each other, duties of trust and confidence. It is “a fiduciary duty of good faith”. It requires any partner to subordinate his or her interests to the interests of the partnership.
Importantly the rules for LLPs are slightly different. In an LLP the members don’t owe those duties to each other but they do usually owe those duties to the LLP itself.
The above scenario refers to the partnership scenario. Partnerships are very common with professional firms, farming businesses and in certain aspects of marine law and associated insurance. But most contracts are not partnerships. They are simply commercial contracts. Commercial contracts mean what they say. They depend fundamentally upon what the wording of the contract is. The parties to the contract have a contractual duty to do what the contract says but, in general, only to do what the contract says. Obviously the advice always has to be to word the contract properly and to try to take account of likely events when wording the contract – but one can’t ever forecast all future events and it is up to the law then to say what happens if unforeseen events occur. But let’s not get sidetracked with that important issue. It is enough to say that, in general, the duty of good faith does not extend to an ordinary commercial contract. A contracting party’s duty is simply to observe and perform the terms of the contract. Look out for our next article on the insertion in commercial contracts of clauses allowing one party to act “in their absolute discretion” – which doesn’t quite mean what it says as a matter of law. However, commercial contracts mean what they say and they are quite different from the intimate relationships which exist in a partnership.
Let’s take a common example. Business people have been operating for many years at a partnership and as with all well run organisations from time to time the partnership agreement needs updating. A properly drawn partnership agreement will contain important clauses about, above all, how to exit the partnership and what a departing partner is paid or the business that partner can be taken away. The agreement may impose time delays and may pay a good departing partner more than stands to that partner’s name in the books by making an addition for goodwill. Unsurprisingly it is when partners leave or want to leave (or are persuaded to leave!). That arguments arise. The first point of principle is that the partnership agreement means what it says.But the duty of good faith can and often does override this. If a partner or partners have schemed to update a partnership agreement in such a way that it is in fact for their individual advantage, then that promotion of different terms in the partnership agreement, that is in the update, have been put in there in breach of the duty of good faith. A partner, unlike an ordinary contracting party, cannot keep an intention secret from fellow partners and then insert favourable provisions into a partnership agreement and then try to operate them for that partner’s personal advantage. It could be done in an ordinary commercial contract. If a freely negotiated commercial contract allows the contracting party to exit on very favourable terms, then it means what it says. But the partnership is governed by the requirement for utmost good faith. As an ancient commentary on the law says :
“a Partner is bound to communicate to the others every fact and circumstance which may influence that person in deciding to enter into the partnership or not”
The duties of one partner to another are very serious duties of trust, confidence, loyalty and good faith and those go far beyond straightforward honesty and observance of the wording of the partnership agreement.