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Australia – The Good Oil On Good Faith: Recent Cases Emphasise The Importance Of Express Terms In Commercial Contracts.

14 November, 2013

 

Legal News & Analysis – Asia Pacific – Australia – Energy & Project Finance

 

The energy and resource sector continues to be impacted by the ongoing debate in Australia as to the existence, scope and operation of obligations of good faith in commercial contracts.

 

Energy and resource projects in Australia commonly operate through unincorporated joint ventures. Participants in these joint ventures, like parties to other commercial contracts, regularly face questions as to whether their conduct is attended by obligations of good faith. It is common for parties exercising rights or powers under their joint venture operating agreements (JOAs) to be met with allegations that they have failed to discharge their obligations in good faith. This uncertainty generates unnecessary disputation and delays conflict resolution.

 

To bring clarity to an area of frequent uncertainty, two questions must be separately dealt with:

 

  1. Is there an express or implied obligation of good faith at all?
  2. If so, how does it regulate conduct?

 

This article briefly surveys recent authorities in Australia to provide some guidance on each and concludes that the risk perceived to arise from implied good faith obligations is overstated. When tested, allegations of breach of good faith rarely survive absent express contractual terms.

 

Contract Is King – When Will Good Faith Obligations Be Implied?

 

The recognition of good faith obligations by various Australian courts is often seen to threaten the freedom and certainty afforded by the consensual relationship between joint venture participants.

 

JOAs often contain an express good faith term, presumably reflecting the parties’ desire to regulate their conduct by reference to a good faith standard. This is entirely consistent with the freedom to define by contract the nature and extent of parties’ respective rights and obligations.

 

A good faith obligation may be implied into the JOA where no such express term exists. This is the source of the uncertainty created when one participant asserts a breach against the other, even where the latter has exercised an express right or power. The effect of the obligation of good faith may be to:

 

  • shape the manner of performance of the joint venture parties, or
  • limit the circumstances in which a participant may exercise a particular right under the JOA.
 

The Court of Appeal in Victoria brought welcome clarity to the issue in 20051 when considering a JOA to exploit shale oil. It rejected the contention that, in effecting a right of assignment under the JOA, one of the parties  had breached the contract by failing to act in good faith. Buchanan JA said:

 

I am reluctant to conclude that commercial contracts are a class of contracts carrying an implied term of good faith as a legal incident, so that an obligation of good faith applies indiscriminately to all the rights and power conferred by a commercial contract. It may, however, be appropriate in a particular case to import such an obligation to protect a vulnerable party from exploitive conduct which subverts the original purpose for which the contract was made.2

 

Similarly, Warren CJ said:

 

Ultimately, the interests of certainty in contractual activity should be interfered with only when the relationship between the parties is unbalanced and one party is at a substantial disadvantage, or is particularly vulnerable in the prevailing context.

Where commercial leviathans are contractually engaged, it is difficult to see that a duty of good faith will arise…3

 

Accordingly, if a good faith term is to be implied into a commercial contract such as a JOA, it must be implied as a matter of fact. The standard preconditions for implication as a matter of fact (or ad hoc implication) apply – the term must:

 

  • be reasonable and equitable,
  • be necessary to give business efficacy to the contract;
  • be so obvious that “it goes without saying”,
  • be capable of clear expression, and
  • not contradict any express terms of the contract.
 

Recent cases reinforce that these criteria are notoriously hard to meet. InSundararajah v Teachers Federation Health Limited,4 the Federal Court of Australia held that a good faith term could not be implied to qualify the exercise of a right to terminate a health fund contract because it:

 

  • was not reasonable or necessary, and
  • contradicted the express provisions which conferred the right in unqualified terms.
 

More recently, in Arhanghelschi v Ussher,5 the Victorian Supreme Court held that voting rights under a deed which regulated the relationship between unitholders in a trust were not subject to an implied good faith term. There, without reasons, the majority unitholders voted to remove another unitholder, Dr Arhanghelschi, from the radiology business operated through the trust. The Court found that there was no basis to imply an obligation of good faith to constrain the majority unitholders’ voting rights because:

 

  • the deed’s express provisions were clear that, in voting to remove another unitholder, the majority unitholders could act in their own self-interest and without reasons, and
  • Dr Arhanghelschi was not so vulnerable as to require the protection of a good faith obligation.
 

The 2012 decision of the Victorian Court of Appeal in Specialist Diagnostic Services Pty Ltd v Healthscope Pty Ltd6 provides a rare recent instance of a good faith term being implied into commercial dealings. The Court reaffirmed that obligations of good faith should not be implied indiscriminately into all commercial contracts7 but held that a good faith term should be implied into the relevant lease agreement. The Court concluded that in circumstances where the landlord had behaved to circumvent an express restraint of trade clause in favour of the tenant,  a good faith obligation met all of the preconditions for ad hoc implication of a term to give effect to the restraint.8

 

What Is The Scope Or Content Of A Good Faith Obligation?

 

Even where an obligation of good faith is implied, the Courts have been careful to point out that these obligations do not prevent a party from acting in its own legitimate self-interest.

The scope of a particular good faith term depends on the particular contract, but such a term typically includes obligations:

 

  • to act honestly and with fidelity to the bargain,
  • not to act to undermine the bargain or the contractual benefit bargained for, and
  • to act reasonably and with fair dealing having regard to the parties’ interests (which may conflict) and the contract’s objectively ascertained purpose and provisions.
 

In NSW Rifle Association Inc v Commonwealth [2012] NSWSC 818, the Commonwealth licensed premises to the Association. The Commonwealth issued notices, demanding the Association repair substantial defaults, but fixing the minimum time required to be given under the licence agreement for repairing defaults. The notices were a precondition to the Commonwealth’s right to end the licence which it wished to do to fulfil an election promise.

 

The New South Wales Supreme Court found that:

 

  • a good faith obligation was implied to qualify the Commonwealth’s power to issue default notices,
  • the Commonwealth had not breached this obligation simply because it acted to fulfil an election promise (which was alleged to be use of the power for an ulterior purpose), but
  • the Commonwealth did act unreasonably (and in breach of the obligation of good faith) in fixing only the minimum time for repairs when a longer period was patently required to effect those repairs.
 

Key Messages For The Energy And Resources Sector

 

  • Good faith obligations will not be implied into a JOA if they are inconsistent with, or are not needed to give effect to, the JOA’s express terms. Any allegation of a breach of good faith should be carefully tested against the language of the JOA.
  • Participants can protect their position through clear provisions in their JOA, including express terms excluding any good faith obligations. Implied good faith constraints upon the exercise of rights can be excluded under a JOA by expressing the rights in unqualified terms. Better still, by carefully expressing the requirements for exercising the rights, participants can crystallise when the rights can and cannot be used.
  • The interests of participants in energy and resource joint ventures sometimes diverge on questions of development and production. Participants should be aware that although a good faith obligation does not permit them to undermine the joint venture, it also does not compel them to sacrifice their own legitimate interests.
 

Endnotes

 
  1. Esso Australia Resources Pty Ltd v Southern Pacific Petroleum NL [2005] VSCA 228.
  2. Ibid at [25].
  3. Ibid at [4].
  4. [2011] FCA 1031
  5. [2013] VSC 253
  6. [2012] VSCA 175
  7. Ibid at [86].
  8. An application for special leave to appeal this decision to the High Court was refused.

 

herbert smith Freehills

 

For further information, please contact:

 

Mal Cooke, Partner, Herbert Smith Freehills
[email protected]

 

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