North East Solution Pty Ltd v Masters Home Improvement Australia Pty Ltd [2016] VSC 1:

A recent decision of the Victorian Supreme Court confirmed that in certain circumstances clauses requiring good faith are not only binding, but can also lead to significant damages awards. 

In this case (the Masters case), an Agreement for Lease provided that North East Solution Pty Ltd (NES) would develop, and then lease, a Masters Home Improvement (Masters) store from Woolworths Limited (Woolworths) in Bendigo, Victoria.  The agreement was binding on the parties and could only be terminated if the parties, acting reasonably and in good faith, were unable to resolve any disagreement that arose in relation to the Landlord’s working costs.

Despite being required to include NES in an open book process to determine costing, Woolworths terminated the agreement without participating in any reasonable negotiation.  NES alleged that the termination was in breach of the contract as Woolworths did not partake in genuine attempts to resolve the dispute reasonably and in good faith.

The interpretation and enforceability of the ‘acting reasonably and in good faith’ termination clause was a major issue in the case, with the Court ruling in NES’s favour by finding that Woolworths failed to act reasonably or in good faith during negotiations.  Accordingly Woolworths were ordered to pay $10.875 million in damages.

Acting reasonably and in good faith:

An express requirement on both parties to act reasonably and in good faith to determine costs, and resolve any differences, was set out in the Agreement for Lease.  The cases have shown that an agreement to negotiate reasonably and in good faith is sufficiently certain to be enforceable. [1]  

The major issue in relation to clauses requiring parties to negotiate in good faith was raised in Petromec Inc v Petroleo Brasileiro SA Petrobra (No 3) [2]  where it was argued that courts have difficulty in determining whether terminated negotiations are ended in good or bad faith.  The Court held that the difficulty in establishing reasons for ending negotiations could be overcome by deciding that, in the absence of fraud, it would be unlikely that there would be a finding of bad faith. 

The Masters case relied on, and affirmed, an address of Sir Anthony Mason where he noted that the concept of ‘good faith’ embraced:

  • An obligation on the parties to cooperate in achieving contractual objects;
  • Compliance with honest standards of conduct; and
  • Compliance with standards of conduct that are reasonable having regard to the interests of the parties. [3]

The decision of Paciocco v Australia and New Zealand Banking Group Ltd [4] further clarified the interpretation of good faith clauses by deciding that the obligation to act in good faith does not extend to one contracting party subordinating their interests to those of another.  Put in its simplest form:

“if a contract contains a requirement that the parties act in good faith, they must act honestly, not capriciously, and reasonably”. [5]

NES submitted that Woolworths, by acting with other extraneous objects in mind, breached the Contract by terminating the Agreement and then failing to attempt to resolve the issues reasonably and in good faith.  The Court held that Woolworths was in breach of the contractual obligation to negotiate and resolve any disputes in good faith by:

  • Excluding, or at least not inviting, NES to participate in the open book review process;
  • Failing or refusing to provide NES with the reports and documents produced during the open book review;
  • Failing to communicate any detailed or transparent information in support of the parties’ differences or expand on why the costs estimate provided by NES was “too high” or “unacceptable”;
  • Excluding NES from negotiations due to an undisclosed budget set by the Property Committee of Woolworths restricting the ability to properly negotiate;
  • Deciding to pursue an alternative site and reaching a conclusion to terminate the Agreement for Lease prior to any negotiations taking place;
  • Taking into account perceived council opposition; and
  • Taking into account a misconception that NES were experiencing funding issues and would not have adhered to their contractual obligations.

Following termination of the agreement, Woolworths exhibited a general unwillingness to engage with NES, and failed to communicate any differences that it may have had in relation to the construction cost estimate.  In acting with the abovementioned objects in mind Woolworths breached its obligation to act reasonably and in good faith. 

The Court held that the clause requiring the parties to act reasonably and in good faith in an attempt to resolve differences was not an agreement merely to negotiate.  The clause was a mechanism by which the parties agreed to act “reasonably and in good faith, that is, with the joint object of resolving any differences that may be identified”.

Woolworths were held in breach of contract following a failure to comply with the obligation to act reasonably and in good faith during negotiations.  They were found liable to pay over $10 million in damages following breach of contract.  In awarding damages to NES the Court concluded that there was a very low risk that the parties would not have reached an agreement in relation to the Landlord’s Costs or Masters’ contribution if Woolworths had acted reasonably and in good faith.  This was important because an issue that has led to a successful claim but no damages flowing in the past has been that it is often very difficult to say with certainty if the failure to act in good faith actually led to any loss.  That is to say, if the negotiation was never going to lead to a concluded agreement anyway, then the fact that one party may not have acted in good faith has not actually caused any loss or dame.

Potential Damages arising from a failure to negotiate reasonably and in good faith:

The Court found that the value of NES’s lost opportunity following termination was at least $14.5 million.  In considering the risks attached to such leases, and assessing the degree of probability that the building would have actually been constructed and leased, a discount of 25% was applied.  The final amount $10.875 million plus interest was awarded.

The case should serve as a warning to anyone considering entering into an agreement with an express good faith clause.  Serious financial penalties may apply if contractual obligations to act reasonably and in good faith are ignored. 

Author:  Scott Alden and Jarrad McCarthy

Notes:

[1] Coal Cliff Collieries Pty Ltd v Sijehama Pty Ltd (1991) 24 NSWLR 1, United Rail Group Services v Rail Corporation NSW (2009) 74 NSWLR 618

[2005] EWCA Civ 891.

[2] Sir Anthony Mason, “Contract, Good Faith and Equitable Standards in Fair Dealing” (2000) 116 Law Quarterly Review 66.

(2015) 321 ALR 584.

[3] Sundararajah v Teachers Federation Health Ltd (2011) 283 ALR 720, 731 [68]. 

[4] (2015) 321 ALR 584.

[5] Sundararajah v Teachers Federation Health Ltd (2011) 283 ALR 720, 731 [68]. 

* This article was first published in the March 2016 issue of Governance Directions, the official journal of Governance Institute of Australia.

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