Good Faith: English Law v the UAE Civil Code

Introduction

The reluctance of English common law to imply a term of good faith into agreements negotiated between two commercial parties at arm’s length is well known and is based on the long-established doctrine of freedom of contract. In stark contrast in civil law countries such as the United Arab Emirates, performing obligations in a manner consistent with good faith is a fundamental part of the contract.

A series of English cases on good faith in early 2013 had raised the prospect that the English courts may be on their way to recognising an overarching duty of good faith but this prospect now seems to have receded. This article provides an update on the latest position under English law whilst highlighting the contrasting position under the UAE Civil Code. Those working with construction standard forms internationally need to keep these very real differences in mind as they can have a significant impact on how some provisions operate in practice.

English case law on good faith: the latest position

The early 2013 case of Yam Seng Pte Ltd v International Trade Corporation Limited (“ITC”)1 involved a long-term distribution agreement for fragrances produced by ITC bearing the name “Manchester United”. The court adopted a fairly broad and purposive approach regarding the circumstances in which good faith obligations might be implied, raising expectations that the courts were open to an overarching duty of good faith being implied more widely.

In that case Yam Seng (the distributor) argued there was an implied term that the parties would deal with each other in good faith and, specifically, that ITC had: (i) failed to act with an implied obligation of good faith and prejudiced Yam Seng’s sales by offering the same products for domestic sale below the duty free prices that Yam Seng was permitted to offer; (ii) instructed or encouraged Yam Seng to incur marketing expenses for products that ITC was unable or unwilling to supply; and (iii) offered false information upon which Yam Seng relied to its detriment. There were no express terms of the contract covering any of these points.

Leggatt J noted: “The content of the duty of good faith is established by a process of construction which in English law is based upon an objective principle. The Court is concerned not with the subjective intentions of the parties ...”

On the facts, only two obligations were implied. First, the court found there was an obligation not to undercut duty free prices, and secondly, there was an obligation not to knowingly provide false information; a duty of good faith was implied in both these respects. The first obligation was contrary to usual standards of commercial dealing and the second was implied into the agreement between the parties as a matter of fact.

The fact that the contract was a long-term distributorship agreement which, the court noted, required the parties to communicate effectively and cooperate with each other in its performance, appears to have influenced the result. The state of the contract, which had not been drafted by lawyers also appears to have swayed the Court.

In stark contrast, the Court of Appeal took a much narrower and restrictive approach in Compass Group UK and Ireland Ltd v Mid Essex Hospital Services NHS Trust.2 This also involved a long-term contract for catering services.

The issue was whether the Trust was entitled to terminate the contract on the basis that Compass had exceeded the number of Service Failure Points allowed in any given six-month rolling period.

This contract contained an express duty to cooperate in good faith “as is necessary for the efficient transmission of information and instructions and to enable the Trust or, as the case may be, any Beneficiary to derive the full benefit of the Contract”.3

The question before the court was whether this clause provided an overarching obligation on the parties to operate with each other in good faith. The Court of Appeal held that whilst there was an obligation to act in good faith it was specifically focused on the obligation to take all reasonable action as was necessary for the efficient communication of information and instructions. There was nothing that required the parties to act in good faith in relation to anything else.

Overturning the first instance decision,4 the court held that commercial common sense did not favour the addition of an overarching duty to cooperate in good faith in circumstances where good faith had been provided for in the contract in such a precise manner already.

Applying this reasoning to the facts of the case, the Court of Appeal considered that the Trust was not prevented from awarding service failure points for failures in performance. The contract expressly contained precise rules for these matters and the ability of the Trust to impose service failure points for poor performance was an absolute contractual right: “if the parties want to impose such a duty they must do so expressly”.

The issue of good faith was further considered in TSG Building Services plc v South Anglia Housing Ltd (“SAH”)5 in May 2013 in relation to an ACA Standard Form of Contract for Term Partnering.

Clause 1.1 of the contract provided:

“The Partnering 6Team members shall work together and individually in the spirit of trust, fairness and mutual cooperation for the benefit of the Term Programme . . . and in all matters governed by the Partnering Contract they shall act reasonably and without delay.”

The contract contained an “unqualified and unconditional right to terminate” at any time (i.e. termination for convenience).

SAH terminated the contract and TSG argued that the termination was wrongful and in breach of clause 1.1. The issue the court had to decide was whether the good faith clause was pervasive such that it applied to the whole contract and therefore to the termination provisions.

The court accepted that, in principle, an express obligation to act in good faith could be pervasive and, depending on the nature and drafting of the clause, it may be possible for it to affect all aspects of the contract.

However, the court held that this was not the case here. The contract contained an unqualified right to terminate for convenience, to which the obligation to act in good faith could not possibly extend. The entitlement to terminate the contract was absolute. Each party was entitled to terminate at any time. Further, clause 1.1 primarily related to the assumption, deployment and performance of roles, expertise and responsibilities set out in the Partnering Documents.

In the later 2014 case of Bluewater Energy Services BV v (1) Mercon Steel Structures BV and others,7 Ramsey J examined again the impact of a good faith provision in the context of termination.

That contract provided for a notice of default to be issued to the subcontractor requiring them to “immediately commence and thereafter continuously proceed with action satisfactory to Bluewater to remedy such default”. If they did not do so, a notice of termination could then be issued.

The subcontract also provided that the parties “shall uphold the highest standards of business ethics in the performance of the contract. Honesty, fairness and integrity shall be paramount principles in the dealings between the parties.”

Ramsey J referred to the Court of Appeal decision in Socimer International Bank Ltd (in liquidation) v Standard Bank London Ltd,8 which related to the standard to be applied in circumstances where the valuation of assets was left entirely in one party’s hands. In that case it was held that a decision-maker’s discretion will be limited, as a matter of necessary implication, by concepts of honest good faith and genuineness and the need for the absence of arbitrariness, capriciousness, perverseness and irrationality. However, the decision remained with the decision-maker and was therefore subjective.

Ramsey J decided that the same standard applied in these circumstances and was not impacted by the express clause in the contract although that clause was consistent with it. He went on to find that termination had been justified on four of the five main grounds alleged in the contractor’s notice of default.9

Summary

It seems then that the English courts are not ready to imply a general doctrine of good faith. The judgment of the High Court in Yam Seng appears to have been sidelined (if not directly overruled) by the Court of Appeal and subsequent cases.

If the parties want to have an express duty of good faith they need to create one and they should think very carefully about its scope. The English courts will not allow good faith-type wording to overrule an absolute contractual right such as the right to terminate for convenience. The parties will need to expressly provide that a good faith obligation operates in relation to such a provision.

The situation might, however, be different if there was evidence to suggest a breach of an express good faith obligation in circumstances where there was a discretionary right (for example awarding a discretionary bonus to an employee). In those circumstances a decision-maker’s discretion will be limited, as a matter of necessary implication, by concepts of honest good faith and genuineness and the need for the absence of arbitrariness, capriciousness, perverseness and irrationality.

Good faith in UAE contracts

In stark contrast, a duty to act in good faith is implied into all contracts that are subject to UAE law. This is underscored by principles of fairness developed under Sharia law.

Article 246 of the UAE Civil Code provides that:

“a contract must be performed in accordance with its contents, and in a manner consistent with the requirements of good faith”.

This in effect is a requirement not to use the terms of a contract to abuse the rights of the other contracting party, not to cause unjustified damage to the other party and to act reasonably and moderately.

Decisions of the Dubai Court of Cassation have ruled that an act of bad faith by one contracting party may provide a cause of action for the other and the duty of good faith is therefore overarching, unlike at English law. In deciding whether an act constitutes bad faith the court may also look at Article 106 of the UAE Civil Code which provides that a party is prohibited from exercising its rights if:

• it is intended to infringe the rights of another party;
• the outcome is contrary to the rules of Islamic Sharia, the law, public order, or morals;
• the desired gain is disproportionate to the harm that will be suffered by the other party; or
• it exceeds the bounds of custom or practice.

There are some potentially wide-ranging ramifications of this including:

Good faith is most likely to be applied to evidence for, or to support, an allegation of breach. Where, for example, building materials are found to be defective a breach will be easier to establish if there has been some attempt to conceal this or cover up the materials once incorporated into the works.

Reliance on a time bar notice (e.g. FIDIC’s clause 20.1) is likely to be restricted where a party seeking to rely on it knew about that breach previously (for example, if notification of the claim was made informally and is recorded in meeting minutes or similar but was never formally made). In other words, denying a claim due to the time bar when it had already been communicated, albeit informally, would be an act of bad faith.

Avoiding liability for a very substantial claim due to a time bar may also be unlawful where the losses were serious and unequal with the employer’s contractual claim to be notified in a required time period (for example 28 days under clause 20.1 of FIDIC). Article 106 (1) of the UAE Civil Code provides that “a person shall be held liable for an unlawful exercise of his rights” and this, together with the good faith obligation, may be used to challenge the effectiveness of a time bar in such circumstances.

Whilst the UAE Civil Code does provide that parties may fix a pre-agreed compensation mechanism or amount in their contract, the court may also vary the pre-agreed amount of compensation or damages to equal the actual loss in any event, regardless of whether there was any “act of prevention” on the part of the employer.10

Good faith is also applicable in relation to termination for convenience clauses although it is worth noting that the duty of good faith is not applicable to the obligation itself but to the performance of the obligation. Accordingly the parties’ agreement that the employer may terminate the contract for convenience is a valid agreement and the UAE courts will normally uphold this. Although this employer’s right might be looked at as contradicting the good faith principle, it would be an enforceable contract term as it was freely entered into. However, if the employer relies on this contract provision to terminate the contract in circumstances that give rise to performing the contract in a manner that is inconsistent with good faith, then the court might have a different view. For example, if the contract provides for termination for convenience and limits the liability of the employer to compensate the contractor for the work done until the date of termination, but excluding mobilisation cost, the employer who terminates the contract for convenience immediately after mobilisation and before the contractor has done any work is performing the contract in bad faith. In this case, the contractor might rely on Articles 246 (good faith), 106 (abuse of right) and 390(2) (claiming actual loss) of the UAE Civil Code to recoup its losses.11

Overview

The stark contrast between the position regarding good faith under English law and that under the UAE Civil Code remains in place. This may make a real difference with regard to how some standard provisions in construction contracts are interpreted. As outlined above, the same time bar and termination for convenience provisions may result in very different outcomes on similar facts, depending on how the governing law approaches the issue of good faith.

By Claire King12
Senior Associate, Fenwick Elliott LLP

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• 1. [2013] EWHC 111 (QB) (February 2013)
• 2. [2013] EWCA Civ 200 (March 2013)
• 3. Clause 3.5 of the contract.
• 4. At first instance the High Court ruled that the Trust had abused its contractual powers in relation to the service credits and breached the express provision of Clause 3.5. It further held that the Trust had acted capriciously and irrationally in the way in which it deducted out the credits (e.g. deducting £84,540 for one day out of date chocolate mousse).
• 5. [2013] EWHC 1151 (TCC)
• 6. TPC 2005 as amended in 2008.
• 7. (2) Mercon Holding BV; (3) Mercon Groep BV [2014] EWHC 2132 (TCC).
• 8. [2008] EWCA Civ 116
• 9. In the Compass case, Jackson LJ had rejected such an implied term on the grounds that the term in question was an absolute contractual right and not one which could be exercised with discretion.
• 10. See Article 390 (2) of the UAE Civil Code.
• 11. These three UAE Civil Code Articles normally work together and it is common to see arguments referring collectively to the three of them in court pleadings.
• 12. With thanks to Lisa Kingston of Fenwick Elliott for her great assistance in preparing this paper and Ahmed Ibrahim of Ahmed Ibrahim Advocates and Legal Consultants for his assistance in relation to the position  under UAE Law.