Express contractual duties of good faith – the sky is the limit?
Parties are free to agree an express obligation to act in good faith in a contract. However, the meaning of the words chosen in the contract and the extent of the obligation imposed are open to interpretation and may leave parties uncertain of what is required to comply with the obligations they have agreed to.
In Re Compound Photonics Group Ltd,1 the Court of Appeal considered the scope of the duty of good faith owed by shareholders to each other and to the company in the shareholders' agreement (SHA) and Articles of Association (Articles).
Key takeaways
The Court of Appeal reversed the High Court's decision that the actions of the majority shareholders had unfairly prejudiced the minority shareholders. It found that their conduct was neither dishonest nor in bad faith and did not breach the contractual duty of good faith contained in the SHA.
This case provides some useful guidance on how the courts will interpret express contractual good faith clauses and what will amount to breaches of the obligations imposed. The clause should be considered in its proper context and with regard to the other terms of the agreement. Although concepts from other decisions may be instructive, they will be fact specific, so should not be applied automatically to every case.
The Court of Appeal concluded that express contractual good faith clauses impose a "core" duty of honesty. In certain contexts, they may also impose a duty not to act in a way that could be "characterised as bad faith".2 However, if the parties intend more specific duties to apply, they must be set out expressly, failing which they fall to be derived by interpretation or implication from the other specific contractual terms in the case.
Facts
The minority shareholders in a company (CPGL), including two former board members (JS and MF), brought an unfair prejudice petition under section 994 of the Companies Act 2006, alleging that the majority shareholders had unfairly prejudiced them in (a) forcing JS to resign and (b) removing MF from office by shareholder vote, thereby excluding them from any continuing role in the management of CPGL.
The claims relied on (amongst other things) an express duty of good faith in the SHA which stated:
"Each Shareholder undertakes to the other Shareholders and the Company that it will at all times act in good faith in all dealings with the other Shareholders and with the Company in relation to the matters contained in this Agreement".
At first instance, the majority shareholders contended they had complied with the duty of good faith in the SHA by acting honestly and in a commercially acceptable manner. By contrast, the minority shareholders, including JS and MF, submitted that the shareholders were contractually obliged to adhere to a bargain regarding the directors' positions enshrined in the SHA and in CPGL's Articles. As a result, JS and MF should have been entrenched as directors, and their removal was in breach of the contractual good faith obligation in the SHA.
The High Court found in favour of the minority shareholders, holding that the actions of the majority shareholders had unfairly prejudiced them and breached the contractual duty of good faith imposed by the SHA.
The Court of Appeal's decision
On appeal by the majority shareholders, the Court of Appeal re-examined the High Court's interpretation of the good faith clause in the SHA and provisions of CPGL's Articles relating to the appointment/removal of directors and quorum at board meetings. The Court of Appeal overturned the first instance decision. It found that the majority shareholders:
- did not breach their contractual duty of good faith in requiring JS to resign or threatening to remove him if not. The Court did not agree that an affirmative duty to deal fairly and openly could be read in to the express contractual duty of good faith in the SHA,3 and in any event their conduct was not dishonest and did not amount to bad faith; 4
- did not act in bad faith or dishonestly in removing MF by shareholder vote, since there was no agreement for him to be entrenched in office and no obligation in the SHA either to deal fairly and openly with him or to consider the interests of the minorities when voting to remove him;5
- did not breach their duties under sections 171 and 172 of the Companies Act 2006; and
- did not unfairly prejudice the minority shareholders.6
Scope of the contractual duty of good faith
While the courts have sometimes been prepared to interpret good faith clauses as imposing wider duties on the parties, the Court of Appeal held that they must exercise caution before concluding good faith clauses require a duty of fidelity to the bargain in the context of changes to a company's constitution and the composition of a company’s board.7 The Court had "considerable reservations" about finding a duty of fidelity to the bargain to be inherent in a good faith clause in a shareholders' agreement "in the absence of any other indication to that effect".8
The Court of Appeal rejected the trial judge's wholesale adoption of the idea that an express duty of good faith imposed certain minimum standards of conduct,9 derived from Unwin v Bond.10 The Court also rejected the judge's interpretation of the good faith clause in the SHA that would oblige the shareholders to adhere to a bargain of "a constitutionally omnipotent board" with JS and MF holding "an unalterable balance of power".11 The Court stopped short of implying any more extensive obligations into the provisions of the SHA. Accordingly, the contractual good faith provision did not require the majority shareholders to deal "fairly and openly" with JS or MF, or to have regard to the interests of the minority shareholders "in some undefined way over and above any requirements that would be imposed upon shareholders to have regard to the interests of the Company when voting on particular types of resolutions as a matter of general company law". 12
Instead, the Court of Appeal found that the good faith clause in the SHA simply imposed "a core requirement that the parties should act honestly towards each other and the Company".13 Had the parties intended to alter well-established principles of company law14 so as to prevent the majority shareholders from exercising their powers to remove JS and MF, the Court thought it "inevitable" that they would have expressly excluded these powers.15 Particularly with professionally drafted commercial agreements, the courts would expect the parties to have dealt with this expressly and "spelled out" any further intended consequences.16
The importance of context
The judgment of the Court of Appeal made clear that express duties of good faith are to be interpreted on a case-by-case basis, and that the context of such duties will be critical to their meaning. Consequently, since other cases will be decided on their own particular facts, these decisions will be of "limited value" and the courts should be wary of applying their reasoning too rigidly.17
Context will be key. Whilst using the concepts and ideas from other cases as "analytical tools" may assist the courts in interpreting a contract, they should not be applied regardless of the particular circumstances and the other terms of the contract in question.18 Beyond the core duty of honesty and the context-dependent duty not to engage in bad faith conduct, the courts must only imply additional requirements into express duties of good faith which can be derived "as a matter of interpretation or implication" from the other terms of the relevant agreement.19
However, even when the courts find that a particular good faith clause obliges the parties to act with "fidelity to the bargain" or "adherence to the spirit" of the parties' agreement, the Court of Appeal emphasised that these concepts must only be applied to support the parties' "common purpose and aims… as objectively ascertained" from the express/implied terms of the contract.20 The courts do not have "an open invitation" to read a good faith clause as imposing "additional substantive obligations (or restrictions on action)" which go beyond the other contract terms.21
Comment
The practical implication of this decision is that the courts may be more reluctant to imply additional substantive duties on contracting parties when interpreting express contractual duties of good faith. This is particularly the case with sophisticated commercial parties acting with the benefit of legal representation entering into agreements which have been drafted comprehensively and professionally. In such circumstances, it is unlikely that the courts will find that express contractual duties of good faith require the parties to discharge further obligations beyond their core duty of honesty.
That being said, an express duty of good faith will not only be breached by dishonest conduct. Conduct that reasonable and honest people would consider as "commercially unacceptable", but not necessarily amounting to dishonesty, may also amount to a breach.22 However, an express duty of good faith should not be presumed to be designed to eliminate flexibility and entrench the original structure of a company's management and constitution, and so will not usually be breached by the removal of a director.23
Finally, the context-driven approach to interpreting express good faith clauses endorsed by the Court of Appeal may increase uncertainty for contracting parties. The scope of obligations required by a given good faith clause in a specific context may be unclear where it is not expressly prescribed. Parties should take legal advice on the proposed wording of the clause at the time of entering into an agreement.
1 [2022] EWCA Civ 1371
2 [243]
3 [293]
4 [294]
5 [322]
6 [335]
7 [203]
8 [277]
9 These are that: "i) they must act honestly; ii) they must be faithful to the parties’ agreed common purpose as derived from their agreement; iii) they must not use their powers for an ulterior purpose; iv) when acting they must deal fairly and openly with the claimant; v) they can consider and take into account their own interests but they must also have regard to the claimant’s interest".
10 [2020] EWHC 1768 (Comm)
11 [277]
12 [277]
13 [275]
14 [201]
15 [268]
16 [201]
17 [148]
18 [151]
19 [243]
20 [212]
21 [205]
22 [241]
23 [204]
