Keeping the faith: Contractual discretion and implied duties

English courts place great importance on parties’ freedom to contract, and have repeatedly resisted the temptation to impose on parties general duties of good faith, the like of which are fundamental in many other European jurisdictions. Nevertheless, particularly where contracts are long-term and depend on close cooperation between the parties, those parties are not entirely free to act as they want.

In Portsmouth City Council v Ensign Highways, the court had to consider whether the exercise of discretion by one party was subject to duties of good faith or fairness. The court held that nothing in the contract or English law imposed such a duty but, distinguishing the case from a recent authority, was prepared to imply a term that the Council must act “honestly and on proper grounds and not in a manner that is arbitrary, irrational or capricious”.

Medirest: No general duty of good faith

Unlike some other jurisdictions, English law does not recognise a general duty on contracting parties to act in good faith. Nevertheless, some types of contract rely on the mutual trust and cooperation of the parties to work. Portsmouth v Ensign, like the recent case of Mid Essex Hospital Services NHS Trust v Compass Group UK and Ireland Ltd (trading as Medirest), involved a long-term public-private contract – in this case relating to the maintenance of highways. In both cases, disputes had arisen regarding the way that the public authority had exercised its discretion to award financial deductions and contractual ‘service failure points’.

In Medirest, the contractor (Medirest) sought to rely on a clause that imposed an express duty of good faith:

“The Trust and the Contractor will co-operate with each other in good faith and will take all reasonable action as is necessary for the efficient transmission of information and instructions and to enable the Trust … to derive the full benefit of the Contract.”

At first instance, the High Court held that the duty of good faith referred to in this clause applied to the contract as a whole. In any event, it held that the clause allowing the Trust to award service failure points was subject to an implied duty not to act arbitrarily, capriciously or in an irrational manner.

On appeal, the Court of Appeal reversed both of these findings. As a matter of interpretation, the Court of Appeal held that the duty of good faith only applied to the transmission of information, or to enable the Trust to derive the full benefit of the contract. In relation to the award of service failure points, the exercise to be performed by the Trust was essentially a mechanical one – either a certain event would trigger the imposition of points, or it would not – the award of points was not an exercise of discretion by the Trust.

Ensign: Room for discretion?

At first glance, the issues in Ensign seem remarkably similar to Medirest. The case also involved the imposition of service failure points by the public authority (the Council), and required the court to decide whether to impose duties on the Council: either by implying such a duty into the relevant clause, or by giving a wide interpretation to an express good faith clause. In this case, the clause (clause 44.4.1) was as follows:

“[The Council] and [Ensign] shall deal fairly, in good faith and in mutual co-operation with one another and with Interested Parties.”

Adopting similar reasoning to that in Medirest, the High Court held that the express duty of good faith did not apply to the contract as a whole. In this case, the duty was confined to clause 44, which dealt with the exercise of the Council’s ‘Best Value’ public obligations (to look for continuous improvement in efficiency and value).

The Judge reasoned that the Council’s exercise of its Best Value obligations did require a duty of good faith, and there were other narrow duties of good faith or similar throughout the contract. The inclusion of these narrow, express duties could be understood on the basis that there was no general obligation of good faith. He noted that, if such a duty were imposed, it might cut across the more narrow obligations and any limitations to those duties.

The Judge did differ from the result in Medirest in one important regard, though. He held that the imposition of service failure points in this case was an exercise of discretion. As such, it was subject to duties not to act “honestly and on proper grounds and not in a manner that is arbitrary, irrational or capricious.” The distinguishing feature, he felt, was that in Ensign, the Council could award different numbers of service failure points for a given event (from 1 to 5). On the evidence, this decision involved a true exercise in discretion.

Where does that leave good faith?

Ensign further confirms that English courts will be reluctant to either imply any general duties of good faith, or to give a wide meaning to any express duty of good faith within the contract. If the parties do intend a duty of good faith to apply to the whole contract, they should state this clearly.

Beyond this, where a contract confers a right on a party, that party will largely be unencumbered when it comes to exercising whether or not to exercise that right (it must at least act honestly, and not in bad faith). The situation will be different, however, where that party has discretion as to how it exercises that right (such as a range of levels of service failure points that it can award). Where it has such discretion, that discretion is likely to be subject to certain duties. These have been expressed in various ways in different cases, but will typically prohibit acting in an arbitrary, irrational or capricious way. If parties expect more than this, this should be made clearly and expressly in the contract.