The relational contracts trend: should private businesses and shareholders consider whether they owe duties of good faith to each other?

Insight

12.08.2019

The term “relational contracts” was originally coined in Yam Seng Ptd Ltd -v- International Trade Corporation Ltd [2013] to describe agreements between parties in long-term ongoing dispute in Bates v Post Office (No.3) [2019] between the Post Office and 550 claimants, most of whom are sub-postmasters responsible for running local branches of the Post Office.

Following the introduction of a new computerised accounting system (Horizon) in 1999/2000, accounting shortfalls were discovered by the Post Office and the sub-postmasters were pursued personally for the missing money. The sub-postmasters denied the claims on the basis that the Horizon software was defective.

The resulting group litigation, in which the claimants seek damages for financial loss, personal injury, deceit, duress, unconscionable dealing, harassment and unjust enrichment, has been long and costly for the parties with the first hearing taking place back in 2017 and costs supposedly reaching £25 million.

Implied duty of good faith

The Court found that the contracts between the Post Office and the claimants were “relational” in nature and that terms relating to payment, liability, termination and suspension were subject to an implied duty of good faith.

The duty was held to go beyond a duty to act honestly and requires both parties to refrain from conduct that would be regarded as “commercially unacceptable by reasonable and honest people”. As a result, the Court found that the Post Office owed various obligations to the claimants, such as a duty to not demand compensation for losses without first establishing the fact of the loss and investigating the cause.

The Court maintained that what constitutes a “relational contract” will depend on the particular circumstances of the relationship and declined to set out an exhaustive definition. That said, the Court listed the following as being relevant characteristics:

the contract will be a long-term contract, with the mutual intention of a long-term relationship;
the parties must intend that their respective roles are performed with integrity and with fidelity to their bargain;
the parties will be committed to collaborating with each other;
the “spirits and objectives” of their venture may not be capable of being expressed exhaustively in a written contract;
the parties will repose trust and confidence in each other (but in a different way to that of fiduciary relationships);
the contract will involve a high degree of communication, co-operation and predictable performance based on mutual trust, confidence and expectations of loyalty;
there may be a degree of significant investment by one (or both) parties; and
the exclusivity of the contractual relationship.

The Court held that the one determinative factor which would prevent a contract being construed as “relational” was the presence of an express contractual term which prevents a duty of good faith being implied into the contract. If this is the case, the Court will not imply such a duty against the express intentions of the parties.

The Post Office have recently been denied permission to appeal the decision (after throwing the kitchen sink at the Court in order to try and overturn it) and so the case remains the leading authority on the point.

Conclusion

The prospect that an agreement is “relational” in nature, giving rise to a duty of good faith, is a very real consideration for shareholders and companies engaged in long-term joint ventures, or where the business is effectively managed as a “quasi-partnership”.

In those circumstances thought should be given to:

whether a duty of good faith should expressly be excluded in the agreements governing the relationship;
if not, whether the parties wish to expressly include it, so that there is no room for doubt about the standard of conduct which is expected from all involved; and
where a relational contract is already in existence, whether the parties are aware of and are conducting themselves in accordance with a duty of good faith, and in particular the duty to refrain from conduct which would be regarded as “commercially unacceptable by reasonable and honest people”.

Despite the outcome of this case, it is likely that an implied general duty of good faith will remain the exception, rather than the rule.

If you require further information about anything covered in this briefing, please contact Kate Allass or Victoria Atkins, or your usual contact at the firm on +44 (0)20 3375 7000.

This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.