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HG Alert: “Good faith” clauses in dispute resolution - 2 Nov 2009

Whether a party can be ordered to participate in “good faith” negotiations is a topic that has occupied the courts for a long time. Historically, it had been thought that a requirement to participate in good faith was too uncertain to be enforced by a court, although the law on this topic is continuing to develop.

A recent decision

The New South Wales Court of Appeal recently considered the issue in detail, in its decision of United Group Rail Services Limited v Rail Corporation New South Wales. RailCorp and United entered into two contracts, in which United agreed to design and build new rolling stock for RailCorp.

The two contracts contained detailed dispute resolution clauses. As with many commercial contracts, there were many levels of dispute resolution. In certain circumstances, the clause required the dispute or difference to be referred to a senior representative of each of the parties, who were required to “meet and undertake genuine and good faith negotiations with a view to resolving the dispute or difference”. If the parties could not resolve the dispute within a fixed period of time, the contract provided that the dispute would be referred for mediation.

As it turns out, the parties agreed that the mediation referral clause was uncertain and therefore unenforceable.

United argued that the clause requiring the parties to undertake genuine and good faith negotiations was also uncertain, or alternatively that it was unenforceable because it was linked to the mediation clause.

Was the clause enforceable?

It was necessary for the court to consider whether the clause requiring the parties to undertake good faith negotiations was enforceable.

The President of the Court of Appeal, Justice Allsop, delivered the appeal judgement, with which Justices Ipp and Macfarlan agreed. His Honour noted that the status of a clause purporting to create a legal obligation to negotiate genuinely and in good faith, and whether or not such a clause is enforceable, had been the subject of debate in the common law world for some time.

After reviewing Australian, English and New Zealand authorities in detail, Justice Allsop summarised the proper approach when considering agreements to negotiate in good faith as follows:

  1. An agreement to agree is incomplete, lacking essential terms.
  2. The task of the court is to give effect to business contracts where there is a meaning capable of being ascribed to a word or phrase or term or contract - ambiguity not being vagueness.
  3. Good faith is not a concept foreign to the common law, the law merchant or businessmen and women. His Honour noted that the New South Wales Supreme Court had previously held that a duty of good faith, both in performing obligations and exercising rights, may by implication be imposed upon parties as part of a contract.

While His Honour noted that the law in Australia is not settled as to the place of good faith in the law of contracts, the court should work from the position that it has said, on at least three occasions, that good faith, in some degree or to some extent, is part of the law of performance of contracts.

Looking at the facts of this case, the parties had promised to undertake negotiations in a genuine and good faith manner for a limited period of 14 days. As a matter of language, the phrase “genuine and good faith” in this context needs little explanation as, in His Honour’s view, it indicates an honest and genuine approach to the task at hand.

His Honour held that a promise to negotiate genuinely and in good faith is not vague or uncertain when it respects the contractual rights of the parties and allows for honest and genuinely held views about those pre-existing rights.

Where business people exercise judgement and use express words that are broad and general, and which have a sensible meaning, then the role of the Court is to assist, not impede, these express contractual provisions.

His Honour concluded that the clause to negotiate genuinely and in good faith should be enforced, as the clause was not uncertain and had identifiable content.

Practical impact

It is likely that the Queensland courts will follow the approach taken in this decision. In particular, the Supreme Court of Queensland recently upheld a contractual clause requiring the parties to “use all reasonable efforts in good faith to resolve any dispute” in AMCI (IO) Pty Ltd v Aquila Steel Pty Ltd.

As a result, if you are a party to a contractual clause which requires negotiations in good faith as a step in the dispute resolution procedure, that clause is likely to be upheld by a court. Of course, general contractual rules still apply to such a clause, and a court will always consider the specific wording of the contract should any dispute arise.

While courts are likely to enforce a contractual clause which requires parties to negotiate genuinely and in good faith, the question remains - what conduct counts as negotiating genuinely and in good faith?

Justice Allsop commented upon this exact issue, noting that in some circumstances, it may be difficult to conclude that a party has not undertaken an honest and genuine attempt to settle a dispute. In other cases however, such a conclusion might be “blindly obvious”. Generally speaking, such a clause will not prevent parties from negotiating in their own self interests, provided the parties proceed from the basis of an honest and genuine assessment of their rights and entitlements in respect of the dispute at hand.

However, His Honour suggested that the following examples may infringe an obligation to negotiate genuinely and in good faith:

  • A party may not be entitled to threaten a future breach of contract in order to bargain for a lower settlement sum than it genuinely recognises is due; and
  • A party would not be entitled to pretend to negotiate, having decided not to settle what is recognised to be a good claim, in order to drive the other party into an expensive arbitration that it believes the other party cannot afford.

While those circumstances may well amount to a breach of a requirement to negotiate genuinely and in good faith, proving that in court is likely to be a very difficult proposition indeed.

If you require any advice as to the enforceability of a dispute resolution clause, please contact HopgoodGanim’s Litigation and Dispute Resolution team.