Good faith: relational contracts and the implied duty of good faith

Essex County Council v UBB Waste (Essex) Limited [2020] EWHC 1581 (TCC)

The question

When will the courts imply a duty of good faith into a contract and when can a contract be categorised as a “relational” one?

The key takeaway

Long-term contracts are likely to be described as relational contracts, which in the absence of any provisions to the contrary, may imply a duty of good faith between the parties. The 25-year PFI contract in issue in this case was considered “a paradigm example of a relational contract in which the law implies a duty of good faith”. 

The background

Essex County Council (the Employer) contracted with UBB (the Contractor) to design, build, finance and operate a biological waste treatment plant for treatment of Essex’s ‘black bag’ household waste. The agreement was a 25-year £800m Private Finance Initiative contract. 

Once the plant was built, the contract anticipated a commissioning period followed by “Acceptance Tests” designed to ensure the plant could meet performance requirements set out in the contract. Once the Contractor passed the Acceptance Tests, they would receive increases in remuneration. 

However, the plant underperformed and did not pass the Acceptance Tests by the “Acceptance Longstop Date”. The Employer blamed the plant’s failure on design and construction flaws, which were allegedly a default by the Contractor. Consequently, the Employer was entitled to terminate in accordance with the contract terms.

The Contractor claimed that the Employer could not terminate as the Employer had breached the contract in several ways. The Contractor argued that the failings were due to the waste that the Employer was sending to the plant. Further, the contract was a “relational” contract, which implied a term requiring the parties to act in good faith. If the Employer had acted in good faith and agreed to changes in the contract, the facility would have been deemed to have passed the Acceptance Tests in July 2016. 

As a consequence, the Contractor claimed that the Employer should pay damages reflecting the Contractor’s lost payments to date (approx £100m). 

The decision

Drawing on recent case law (eg Yam Seng; Bates v Post Office), Pepperall J agreed with the Contractor that this was a “relational” contract and that there was an implied duty to act in good faith - noting that a “relational” contract would typically be long-term in nature; require a high level of communication and co-operation between the parties; and otherwise show an intention that the parties perform their duties with integrity, trust and confidence. 

However, despite concluding that there was an implied duty of good faith, the Judge did not find that the Employer was in breach of that duty. The failure to pass the Acceptance Tests was due to the Contractor’s design errors and not because of the Employer’s actions or omissions. The plant was severely undersized and was not fit for its intended purpose. Attempts to remedy the defects by the Contractor were implemented in a way that amounted to breach of contract.

The Employer could therefore validly terminate the contract as the Contractor had defaulted on its obligations and the right to terminate did not have to be exercised within a reasonable time. 

Why is this important?

If the circumstances mentioned above apply to a long-term contract, it may be considered a “relational” contract and the parties are likely to be subject to an implied duty of good faith – unless such a duty is expressly excluded by the contract terms. 

The judgment also rejected the notion of a general principle requiring contractual termination rights to be exercised within a reasonable time. Whilst the conduct of the parties and the contract terms could mean that such an implied term applies in certain circumstances, it was not implied into this contract. 

Any practical tips?

If parties do want to exclude an implied duty of good faith – particularly when entering long-term contractual relationships – they must do so through explicit drafting.  In any event, careful drafting of a party’s obligations, how these may be affected by the performance of the other party, and change management provisions remains crucial.  

Autumn 2020