Good faith; contractual discretion

Morley (t/a Morley Estates) v Royal Bank of Scotland Plc [2020] EWHC 88 (Ch)

The question

Was a loan agreement a "relational” contract and, if so, to what extent did that limit the lender’s contractual discretion?

The key takeaway

The Court held that the loan agreement was not a “relational” contract. The lender’s exercise of contractual discretions under that agreement were subject only to a duty to exercise them for a legitimate commercial aim, so as not to vex the borrower. 

The background

There is no general requirement for good faith in English contract law, nor is a general duty to act in good faith usually implied in a commercial contract. However, as considered in Bates v Post Office Ltd¹, in certain cases a specific or general duty of good faith may be implied where the contract is a “relational” contract, eg a long-term commercial contract with a non-commercial aspect involving a high degree of communication, co-operation and performance based on mutual trust and confidence and expectations of loyalty or fidelity. 

In this case, the borrower had entered into a three-year loan agreement with the bank in 2006, which was secured on a portfolio of properties. In early 2009, the bank obtained an updated valuation of these properties and found that the value had fallen, which demonstrated a breach of the loan to value covenant. The bank therefore started charging interest at an increased default rate and attempted to restructure the loan. Eventually, the parties reached an agreement enabling the borrower to salvage some of the portfolio, but the rest was transferred to the bank’s subsidiary. 

The borrower claimed rescission of those agreements, or damages in lieu of rescission, asserting the loan was a ”relational” contract and that the bank had an implied duty to act in good faith, which it had breached by obtaining a new valuation of the portfolio and “forcing” a breach of the loan to value covenant.

The decision

The High Court held that the loan agreement was not a relational contract. It was an ordinary loan facility agreement and there was no implied duty of good faith. 

The bank’s exercise of its contractual discretions to obtain a revaluation of the mortgaged properties and charge default interest were valid, connected to the bank’s commercial interests and not limited by a need to act in good faith. The bank’s contractual discretions were subject only to a duty to exercise them for a legitimate commercial aim, so as not to vex the borrower.

Why is this important?

The decision confirms that the Court will not readily find a contract is “relational” and/or subject to an implied general duty of good faith. The exercise of contractual discretion is not therefore subject to additional restrictions in those circumstances.

Any practical tips

Parties should continue to review whether they wish to include express duties of good faith, whether for specific provisions or generally – or even whether they wish to expressly exclude any obligations of good faith – within their agreements.
¹Bates v Post Office Ltd (No 3) [2019] EWHC 606 (QB)