Historically, English law has been reluctant to imply the obligation of conducting negotiations in good faith into an agreement. Although in the recent past English courts have tried to adopt the implied concept of good faith in contracts after taking into account the factual background of the contracts, the High Court judgment in Knatchbull-Hugessen and others v SISU Capital Ltd. (Case No. A40BM014 on 02/04/2014), has once again asserted that in case an agreement contains an exclusivity clause for a specified period during which the parties agree to act in good faith, the contractual value of such a clause can only be upheld for the specified duration and cannot be said to be implied in the agreement for as long as the negotiations continued.
Facts of the matter:
This judgment is a result of the Alan Edward Higgs Charity (the “Charity”) filing a claim before the court for the recovery of professional fees and other expenses incurred in connection with the abortive negotiations between a London-based hedge fund named SISU Capital Limited (“SISU”) and the Charity.
The home ground of the Coventry City Football Club (the “Club”) at Richoh Arena in Coventry was operated by the Arena Coventry Limited (“ACL”) which was partly owned by the Charity. The Club had a license to use the arena which was granted to them by a wholly owned subsidiary of ACL. ACL had incurred a substantial loan of £22 million from the Yorkshire Bank for obtaining the funds for acquiring the lease of the arena and ACL serviced its debt to the bank through the license fee from the Club.
Around March 2012, the Club stopped paying the fee to ACL due to financial difficulties. In a bid to rescue the Club, SISU decided to enter into negotiations with the Charity of which an element was to purchase the 50% interest of the Charity in ACL for a total consideration of £1.5 million. Indicative terms were agreed between the parties for a share purchase agreement (“Term Sheet”) which was signed on 19 June 2012.
The Term Sheet mentioned that the offer was non-binding till the completion of due diligence by SISU, which was expected to last for 30 days, save only two clauses that would have binding value once the Term Sheet was countersigned. Thus the only clauses having contractual value were the clauses on ‘Costs’ and ‘Exclusivity’. The first clause stated that SISU shall be liable to underwrite the costs and expenses incurred by the Charity in connection with the transaction up to a maximum of £29,000 in case the transaction remained unconcluded due to certain pre-conditions mentioned in the Term Sheet; the latter clause states that the parties have agreed to a period of exclusivity for a period of 6 weeks during which the Charity shall conduct negotiation with SISU in good faith and shall not enter into any negotiations related to this transaction with a third party (“Exclusivity Period”).
The Exclusivity Period expired on 31 July 2012 without any share purchase agreement being concluded and no further share purchase agreement was ever concluded. Subsequently, the Charity, represented by Knatchbull-Hugessen, brought an action against SISU for recovery of the maximum amount of £29,000 on the ground that the conditions precedent could not be met as the Charity had repaid its loan to the bank with assistance from the Coventry City Council which made it impossible for the transaction to be concluded. The negotiations for this transaction had taken place in August 2012.
SISU contested the claim and filed a counter-claim alleging breach of an implied term of the contract that the parties were to conduct the negotiations in good faith and that the claimants were not entitled toact in a way that would render the conclusion of the transaction impossible. SISU alleged that the Charity’s negotiations with the bank during the pendency of its negotiations with SISU would amount to breach of conducting negotiations in good faith. Thus one of the main issues before the court was to decide whether the Charity did actually breach the implied term of conducting negotiations in good faith.
With regards to the above mentioned issue, the Hon’able Judge laid down the default position with respect to the claims of both the parties. The Judge stated that there is no general duty currently recognised in English law to conduct contractual negotiations in good faith. Although there is a duty not to misrepresent facts, there is no duty to disclose facts which would be material for the other parties to the negotiation to know and nor is there any constraint in law which prevents a party from carrying on negotiations with anyone else other than the counterparty at the same time without informing them of the existence of the others. Similarly, it is also not the general principle that a party may recover costs in case of an aborted negotiation. However, it is open to the contracting parties to depart from such general principles in their agreement.
In the present matter such default positions are applicable except to the extent that the contract provides otherwise. The Judge took into account the Exclusivity Period clause in the Term Sheet which provides for the Charity to conduct negotiations in good faith and not contract with a third party only for duration of 6 weeks and not beyond the expiry of the said term. The negotiations between the bank and the Charity had taken place in August 2012 after the expiry of the term. The Judge held that in circumstances where the parties have specifically mentioned an exclusive period for such good faith negotiations against the background that in absence of such agreement there is no legal duty to act in good faith, the clear and unambiguous meaning of the agreement is that the undertaking is limited to the period of exclusivity and the obligation does not extend beyond the expiration of such period.
Other English Judgments on Good Faith Negotiations:
As per the rulings of several English judgments, a legally binding principle of conducting negotiations or acting in good faith undermines the commercial freedom of the parties to regulate their contractual relationship in accordance with express terms in a written contract, rather than by reference to an unwritten and implied standard of commercial morality.
However, in the recent past, the courts have on certain occasions implied terms into contracts in circumstances where the concluded contract is not clear or is ambiguous. In such cases, the courts have taken into account the relevant facts and circumstances for the formation of the contract in order to interpret whether the parties may have intended to imply into the contract the conducting of negotiations in good faith.
The courts have been prepared to imply an obligation of good faith in relation to the exercise of certain specific rights or obligations by one party to a contract. For example, in the case of Astrazeneca UK Limited v. Albemarle International Corporation and another ( EWHC 1574 (High Court)),the High Court held that a contractual clause in a supply agreement which granted the supplier a ‘right of first refusal’ must be invoked by the customer in ‘good faith’. In Lymington Marina v McNamara ( EWCA 151 (Court of Appeal)), the Court of Appeal confirmed that where the contract does not explicitly give the decision-maker absolute discretion, the right to withhold such consent must still be exercised in “good faith” and not ‘capriciously’ or in an ‘arbitrary fashion’.
Most recently, the decision in Yam Seng Pte. Ltd. v International Trade Corporation Ltd. ( EWHC 111 (QB)) has come to be regarded as a major change of direction in English law with regards to the ‘good faith’ principle. Yam Seng claimed that it was an implied term of the contract that the parties would deal with each other in good faith and asserted that ITC had certain implied obligations under the contract. Upholding two of the three claims made by Yam Seng, Leggatt J commented obiter that the contract was a long-term distributorship agreement which required the parties to communicate effectively and cooperate with each other in its performance. Accordingly, there would probably have been an implied obligation upon ITC to keep Yam Seng informed of any material change in the relevant information without Yam Seng having to ask.
However, the above judgments cannot be construed to mean that the English courts are ready to imply upon contracting parties a duty to act in good faith even in the absence of an explicit term stating the same. The courts have adopted more of a piece-meal approach, taking into account the background and facts and circumstances of the contract but have not evolved a general principle of reading an obligation of good faith in the contacts. In cases where it is evident that the parties could not have meant to include a term to conduct negotiations in good faith at all or beyond a specified period, courts may not apply the principle of good faith going against the intention of the parties. The present judgment by the High Court further intensifies such approach taken by the courts that the will and understanding of the parties, as borne out by the agreement, shall be given primary importance.
Position under Indian Law:
Following common law, Indian laws too do not have an implied principle of conducting negotiations in good faith. While the Indian courts have repeatedly implied the principle of negotiations in utmost good faith in insurance contracts, no such explicit judgment has been passed regarding the application of the principle in general contracts. However, in cases where the contract contains an explicit clause of conducting negotiations in good faith within a fixed time period, the courts have followed the intention of the contract to limit the conducting of negotiations in good faith to the specified period. In a parallel to the Kantchbull vs. SISU matter, the Supreme Court, in the matter of Percept D’Markr (India) Pvt. Ltd. v Zaheer Khan and Anr. (AIR 2006 SC 3426), held that a party to a contract may be free to conduct negotiations with a third party after the expiry of the specified period of conducting negotiations in good faith unless the other party to the contract has a ‘right of first refusal’ after the expiry of the said period, and so long as such right does not result in restraint of trade.