In any commercial relationship, a good faith approach sets a foundation upon which efforts to deliver mutually beneficial outcomes are built.

Not surprisingly then, the notion of parties acting in ‘good faith’ sometimes finds its way into formal contractual agreements.

One such case revolved around an agreement which Woolworths and its then-subsidiary Masters entered into with Maxi Foods Group subsidiary NES in 2010. Under that agreement, NES was to acquire and construct a store on the McIvor Highway in Bendigo which would subsequently be leased by Masters and guaranteed by Woolworths.

Whilst terms of the agreement enabled termination of the contract where the parties were not able to agree about construction costs incurred by NES, it also set out a requirement which involved all parties ‘acting reasonably and in good faith’ to resolve differences which may have arisen in respect of the determination of these costs, the amount which Masters needed to contribute toward these costs and the manner in which Masters’ contribution was to be made.

Alas, such a dispute arose and the contract was terminated. NES sued, alleging that Masters and Woolworths had breached their obligation to act in good faith to resolve the disagreement and had terminated for ulterior reasons. The trial judge agreed and ordered Woolworths to pay $10.875 million in damages and compensation.

Subsequently, however, the Court of Appeal overturned this. It said that the application of good faith as applied by the trial judge went too far.

Helpfully, the Court outlined several principles about what good faith means and the scope to which its application may extend. This includes acting honestly and with fidelity to the bargain, not undermining contracts and promises, refraining from inhibiting the ability of the other party to fulfil their obligations and acting reasonably and fairly in respect of the interest of both parties.

This case raises questions about the use of ‘good faith’ clauses in contracts involving commercial property. This includes the impact such clauses have upon commercial contracts along with any advantages and drawbacks associated with having these types of clauses included.

First, construction and infrastructure partner Kyle Siebel and construction and infrastructure lawyer Jordan Barling firm Holding Redlich say, it is important to distinguish between clauses which require parties to act in ‘good faith’ and those which require the parties to act with ‘best endeavours’ to complete their responsibilities under the agreement.

By far and away, Siebel and Barling say, the more common term used throughout most parts of commercial property contracts is that of ‘best endeavours’. This essentially requires one or both parties to do all things reasonable in order fulfil their responsibilities under the agreement. Such a concept, they say, is narrower in scope compared with ‘good faith’ and is well defined under common law and reasonably clear in its practical application.

By contrast, the concept of good faith is broader, less well defined and less clear in its application. As a result, Siebel and Barling say the use of good faith clauses tends to be restricted to specific parts of the contract. Where there is a dispute, for example, the contract might stipulate that the parties need to negotiate in good faith to find a resolution. Where a party has a right to terminate the contract, a good faith clause might require that they exercise this right only where there are bona fide grounds to do so.

In terms of practical application, experts stress no good faith clause will override any expressly stated right or obligation upon any party. A good faith clause would not prevent a landlord, for example, from exercising their right to evict a tenant where the tenant failed on a consistent basis to make rent payments (though it may operate to restrict a landlord’s right to terminate a lease where only one payment had been missed).

“The courts and generally the commentators on good faith tend to say, ‘you are not required to do anything which is beyond the language of the contract,'” Siebel said. “So you’ll be guided by what is required of the contract and the general good faith obligation does not generally go any further than not acting capriciously and not trying to undermine the other party’s performance of the contract.

“A best endeavours obligation is really what is reasonable for a person to do to comply with their obligations under the contract given their position and resources. It is much more common to find the term ‘best endeavours’ throughout most of the body of the contract which is fairly well defined. Good faith is much broader and that’s why people tend not to use good faith in that circumstance.

“What you tend to find is that you might find good faith used in certain parts of the contract. If you have to negotiate a dispute, you might have something which says they (the parties) have to discuss it and try to resolve it in good faith. But these (good faith obligations) will not apply more broadly across all of the obligations of the contract.”

Ricky Raad, a commercial lawyer at Western Sydney based law firm Coleman Greig, says the prevalence of good faith clauses within commercial property contracts is growing and that such clauses are now present in around two in every three contracts. This includes contracts which are for sale of land, put and call options, building contracts and lease agreements.

Typically, Raad says, good faith clauses are applied to areas of negotiation. This can include negotiation of prices and fees (sale prices, clean-up fees, marketing fees and the like), arrangements for payment of tax invoices and sorting out who will be responsible for which obligations. Typically, he says, these are not separate clauses in and of themselves but rather extensions of existing clauses within the contract.

In terms of practical impact, Raad says the most significant benefits and effects of good faith clauses revolve around setting the ‘tone’ under which the spirit of the commercial relationship will be guided. Where problems arise, he says such clauses effectively dictate that the parties work together to arrive at mutually acceptable solutions. Whilst specific contractual terms are important, he says good faith clauses also shift the emphasis away from the more technical aspects of the agreement and toward the broader objectives toward which the parties are attempting to work.

In addition, where lawyers become involved in a dispute, Raad says good faith clauses provide a signal to the legal teams of the respective parties about negotiations proceeding not on an adversarial approach but rather one of working together toward solutions which help to deliver upon the bigger picture objectives of the relationship. Where this happens, he says the role of the lawyers shifts away from confrontation and toward a focus of mutual problem solving.

Raad acknowledges that drawbacks can occur, especially from the viewpoint of the party who has not infringed upon the contractual terms. In the case of leasing, for example, a good-faith clause may confer upon a landlord an obligation to work with a tenant who had breached the terms of the lease as opposed to assuming decisive action. Where this happens, the landlord can find themselves having to ‘manage’ and devote resources to a situation which has been brought about by the other party failing to meet their obligations. Especially where money has been spent engaging top-notch lawyers to prepare carefully drafted contracts, he says such a situation can produce understandable frustration.

Nevertheless, he says these drawbacks are outweighed by the benefits.

“It (a good faith clause) puts an obligation on the parties toward ultimately achieving the purpose of the contract,” Raad says.

“At one point or another, the parties agreed to those terms. It’s about staying true to what the deal was and to the intent of the contract. It’s basically a way of saying to one another ‘look, we need to cooperate, we need to work together if we are going to complete this contract, with as little disturbance as possible.’

‘In my opinion, that’s one of the most practical effects of good faith clauses.”

Siebel and Barling agree about the role of good faith clauses in setting expectations about how the parties should behave. They add that if well drafted, such clauses can help to facilitate a degree of certainty on the part of one or more of the parties. Where a commercial landlord had wanted a termination for convenience clause when entering into an arrangement with a commercial builder for the construction of a new office block or shopping centre, for example, the insertion of a clause which specifies that this was to be exercised in good faith would at least provide the builder with a degree of certainty that any termination will not take place in an underhanded way (for instance, where the landlord has simply found a cheaper builder).

Nevertheless, Siebel and Barling caution that such clauses may also create obligations upon the parties which are ambiguous or unclear. For this reason, they stress that it is critical to define what constitutes good faith and what acting in good faith will mean for each of the parties. In this regard, they say the Masters decision was particularly helpful in terms of the Court of Appeal outlining some of the critical things which good faith clauses involve.

Throughout the commercial property landscape in Australia, contractual clauses which require parties to act in good faith have the potential to foster greater confidence and trust within the contracting process and a more collaborative approach toward dispute resolution.

For this to happen, however, clauses must be carefully drafted and exactly what good faith means must be clearly spelled out.