Chapter 20 Good faith obligations
There has been much discussion, in courts around the world, as to the possible obligations that parties might owe to one another to act in good faith. The law on the duty of good faith in commercial contracts is largely unsettled, given that Australian courts have been hesitant to define the content of the duty of good faith and the circumstances in which the obligation to act in good faith may arise.
One of the most commonly referred to definitions of the content of the duty of good faith derives from Paciocco v ANZ Banking Group Ltd  FCAFC 50. In this case, good faith was described as including obligations to:
- act honestly;
- act with fidelity to the bargain;
- not to act dishonestly and not to act to undermine the bargain;
- act reasonably and with fair dealing; and
- have regard to the interests of the party.
In a contract, a duty of good faith may arise from an express term of the contract or an implied term of the contract.
Express duty of good faith
A duty of good faith can arise as an express term within a contract. For example, in clause 20 of the Australian Standard contract AS4902 -2000 requires the principal to ‘ensure that at all times there is a Superintendent, and that the Superintendent fulfils all aspects of the role and functions reasonably and in good faith.‘ Similarly, many dispute resolution clauses are often drafted to require the parties to ‘meet in good faith to negotiate and resolve the dispute’.
If the parties to a contract choose to expressly include the duty of good faith, this is beneficial as it may provide protection against parties acting unfairly, as the courts have considered this requires the parties to act honestly and cooperatively but does not require a party to act in the interests of the other contracting parties nor subordinate its own legitimate interests to those of the other contracting parties. See Sundararajah v Teachers Federation Health Ltd  FCA 1031.
The following case demonstrates the potentially far-reaching effect of the duty of good faith in commercial dealings. The NSW Court of Appeal extended the scope of the duty to require a party to positively disclose information in contractual dealings that might differ from the expectation of the other party.
- Macquarie engaged the SSW Area Health Service for the development of a private hospital on land situated within the Royal Prince Alfred Hospital precinct. The agreement provided for the parties to act with the utmost good faith in the performance of their duties.
- Area Health undertook a strategic plan which did not involve a development consistent with the agreement. Notably, the plan did not suggest the hospital be situated near the district as proposed.
- The Court of Appeal held that the obligation to act in good faith was enforceable.
- Though good faith does not require parties to disregard their own interests, they must co-operate in a reasonable way to implement the contract.
- In these circumstances, an obligation of good faith required Area Health to disclose the departures from the agreement to Macquarie. Failure to disclose the information was a breach of the Area Health’s duty to act in good faith insofar as it would have substantially altered Macquarie’s expectations of the agreement.
Implied duty of good faith
If the contract does not contain an express duty of good faith, the courts may imply a duty of good faith between the parties.
In Renard Constructions (ME) Pty Ltd v Minister for Public Works (1992) 26 NSWLR 234, the good faith obligation was equated with reasonableness. It was considered that the term ought to be implied in commercial contracts if it is ‘necessary to give business efficacy to the contract’. Additionally, it was said in Sundararajah v Teachers Federation Health Ltd that good faith will not be implied unless it operates as an aid to further explicit terms of the contract.
An implied good faith obligation can be expressly excluded by the parties in the drafting of a commercial contract. However, to expressly exclude such an obligation will expose the parties to act in whichever way they desire, which may also be commercially unfavourable.
The two cases outlined below show how the duty of good faith has been recently treated by the courts in construction contracts.
- The owner and contractor entered into a contract for demolition and excavation works. The contractor engaged a subcontractor.
- The owner issued a notice under the default provisions requesting the contractor to show cause for an alleged breach. The principal then served a takeout notice which was in substance, a termination of the contract.
- The subcontractor terminated its subcontract. The owner then engaged the subcontractor directly to carry out the remaining works.
- The contractor commenced proceedings against the owner for wrongful termination of the contract and against the subcontractor for the recovery of unpaid royalties.
- The issue considered by the court was whether the take-out notice was issued by the owner in good faith.
- The court held that the take-out notice was not issued in good faith. This was based on principal’s decision to take the works out of the contractor’s hands, which had been made regardless of any cause that the contractor might have shown, and that it was issued for an ulterior purpose, to engage the subcontractor under a direct contract.
- The court said that the owner had a ‘closed mind’ when issuing the show cause notice, given that it had resolved to terminate the contract regardless of the contractor’s response to the show cause notice.
- The court commented that the exercise of a contractual power may be constrained by obligations of reasonableness and good faith.