It’s all there in black and white -- maybe

Advice on how to avoid and manage disputes in ongoing business relationships ranges from the guru level to the practical. Still the most popular is the old adage that the best place for the contract, once signed, is the bottom drawer.

Advice on how to avoid and manage disputes in ongoing business relationships ranges from the guru level to the practical. Still the most popular is the old adage that the best place for the contract, once signed, is the bottom drawer.

It is that attitude that is causing the courts to interfere with contracts and inquire into in-contract conduct. If the courts do not like what they see, it appears that they may impose duties such as "good faith" on the parties, even though it is not mentioned in the contract. By imposing (or implying) such duties, the courts can then decide who has been "good" and "bad" and give judgement accordingly.

Recent decisions involving the inclusion of an implied term of good faith have focused on “relational contracts”. These are characterised by an ongoing relationship between the parties that requires ongoing co-operation and has ongoing mutual obligations, as opposed to “transactional contracts”, which tend to be “one-off” and of short duration.

Relational contracts have been described, in the case of Bobux Marketing Limited v Raynor Marketing Limited (“Bobux Marketing”), as:

"In essence, relational contracts recognise the existence of a business relationship between the parties and the need to maintain that relationship.”

A leading lawyer, Raynor Asher QC, has noted that contracts which “…turn on an ongoing relationship of co-operation between the parties … [include] franchise contracts, distributorship contracts, pre-tender contracts, employment contracts, certain building contracts, consultancy contracts and joint venture contracts.”

Relational contracts may also include long-term software maintenance agreements, software services agreements, teaming agreements, outsourcing agreements, hardware maintenance agreements and other such IT contracts.

Two recent cases on the good faith issue are Dymocks Franchise Systems (NSW) Pty Limited v Bilgola Enterprises Limited (“Dymocks”) and Bobux Marketing.

Dymocks concerned the termination of a franchise agreement and went to the Privy Council. The High Court was prepared to imply an overall duty of good faith between a franchiser and franchisee regarding information disclosure. The Court of Appeal rejected this approach. It said that such a general implication would create too much uncertainty.

However, although they did not need to rule on whether a good faith obligation should be read into the agreement, the Privy Council did not appear to accept the Court of Appeal’s approach. As a legal curiosity, Dymocks was decided under the law of New South Wales, even though it was decided by New Zealand courts.

Bobux Marketing was also about the termination of a contract, in this case, a distribution contract. Of interest was that although the majority of the Court of Appeal said: “… a court may well find that to give business efficacy to the contract, it is to be implied that [a party] will use its best endeavours to maximise its sales and therefore its orders”, Justice Thomas, in his dissenting judgement, went even further by saying that a duty of good faith existed in Bobux (if all the facts were proved) in line with his previous statement in Livingstone v Roskilly: “The parties to a contract must act in good faith in making and carrying out the contract.”

He also relied on the case of Stanley v Fuji Xerox (NZ) Ltd where Chief Justice Elias stated that the implication of good faith “… necessarily arises whenever a contract is predicated upon mutual confidence”.

These cases leave the law of implied good faith in an uncertain state.

Executives considering relational contracts such as implementation, outsourcing or any contract for services to be delivered over time will be looking for guidelines to ensure good risk management in their contracting practices.

Two types of good faith duties could be implied, a general duty of good faith between parties to a relational agreement or a duty of good faith regarding the exercise of specific terms of a relational contract. While this issue will require clarification by the courts, the cases suggest that there is at least a strong argument that a duty of good faith exists in the exercise of specific powers under a relational contract.

If a general duty of good faith were implied into relational contracts, it would appear to imply almost a "fiduciary" duty, similar to being a trustee for the other parties’ interests. As our Court of Appeal noted in Dymocks, a broad duty will increase uncertainty in business dealings.

Risk management starts with understanding “good faith”. A simple statement quoted in Bobux Marketing was: “Good faith is closely associated with notions of fairness, honesty and reasonableness …” Fairness and reasonableness are highly subjective terms. The answer, therefore, for risk management is:

First, to contract with precision to reduce the scope for courts to imply good faith.

Second, to provide for mechanisms to force communications between the parties to either follow strict procedures or result in binding variations or settlements as the contract is completed.

And finally, to have escalation mechanisms (as well as dispute resolution processes) to ensure that if relationship mistakes are made these mistakes are corrected by the escalation mechanisms rather than the dispute resolution processes.

Horrocks is a partner and Woo a solicitor in Clendon Feeney’s technology law team. This article, together with further background comments and links to other websites, can be downloaded from www.clendons.co.nz. Questions and comments can be sent to craig.horrocks@clendons.co.nz.

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