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When are discretionary powers subject to the obligation of good faith?

13 April 2022

#Construction, Infrastructure & Projects

Published by:

Annie Papageorgiou

When are discretionary powers subject to the obligation of good faith?

Most commercial contracts are subject to an implied obligation on the parties to act reasonably and in good faith, but there are also many contracts that include an express obligation on the parties to act reasonably and in good faith.

In this article, we consider two recent decisions of the NSW courts which determine whether the obligation to act in good faith applies to contract terms that give one party a power exercisable at their “sole discretion”.

Case one: Growthbuilt Pty Ltd v Modern Touch Marble & Granite Pty Ltd [2021] NSWSC 290

Growthbuilt Pty Ltd (Growthbuilt) entered into four subcontracts for the supply and installation of various marble products with the respondent, Modern Touch Marble and Granite (Modern) at four different locations.

Modern failed to complete any of the subcontract works by the completion dates in the subcontracts. Growthbuilt terminated each of the subcontracts and commenced proceedings to recover liquidated damages and post-termination costs incurred to complete the works.

Each of the subcontracts was in essentially similar terms, and included an extension of time clause (clause 11) which provided that:

  • if Growthbuilt commits an act of prevention and Modern submits a claim for an extension of time, Modern will be entitled to a reasonable extension of time to the date for completion of the works (DFC)
  • Growthbuilt may, in its absolute discretion, extend the DFC, but Growthbuilt is under no obligation to extend, or to consider whether it should extend, the DFC.

The primary issues in dispute between the parties were:

  • whether Growthbuilt was obliged to act reasonably and in good faith in deciding whether to exercise its discretion to provide an extension to the DFC under clause 11
  • whether Growthbuilt’s failure to issue an extension to the DFC was an act of prevention, which meant that it was not entitled to claim some, or all, of the liquidated damages, which was the subject of the claim.

The NSW Supreme Court determined that Growthbuilt was not obliged to act in good faith in considering whether to issue an extension to the DFC.  

In reaching this decision, the Court noted that whether an implied obligation to act in good faith applies to the exercise of a unilateral contractual power will depend on the wording of the particular term, and that the implication of a duty to act in good faith cannot extend to imposing obligations on parties that are, in effect, inconsistent with the terms of the relevant agreement itself.

Where the discretionary clause is strictly worded, the Court may find there is “no room” to impose an obligation of reasonableness and good faith on a party’s discretionary power. Here, there was no room to make such a finding, as the power in clause 11:

  • was expressed to be exercisable in Growthbuilt’s absolute discretion
  • expressly stated that Growthbuilt was under no obligation to consider whether to exercise the discretion.

The full decision can be read here.

Case two: Macquarie International Health Clinic Pty Ltd v Sydney Local Health District [2020] NSWCA 161

In 1996, Macquarie International Health Clinic Pty Ltd (Macquarie) entered into a contract with Sydney Local Health District (SLHD) for Macquarie to construct and lease a private hospital and ancillary facilities on land adjacent to the Royal Prince Alfred Hospital (Contract). The hospital was never built.

Clause 2.5 of the Contract gave SLHD the power to grant an extension of time for the performance of any activity in the milestone program in its “absolute and unfettered discretion” if there was a delay to works caused by an event beyond Macquarie’s control.

Clause 10.8 of the Contract imposed an obligation on the parties to act in the utmost good faith in their dealings with each other and the exercise of their powers under the Contract. The clause was stated to apply without limiting the generality of any other provision of the Contract.

Macquarie had obtained a building approval to proceed with works at the property that were not consistent with the development proposal it had submitted to SLHD before entering into the Contract. As a result of delays outside its control, Macquarie was required to obtain a new approval. SLHD amended the milestone program to grant Macquarie an extension to obtain that new approval pursuant to clause 2.5. 

One of the primary issues in dispute on appeal was whether SLHD’s exercise of power to grant the extension was inconsistent with its obligations to act reasonably and in the utmost good faith. Macquarie’s position was that where an action has been completed, it is not possible to grant an extension of time in which to complete it.

The NSW Court of Appeal determined that the obligation to act in good faith did apply to the exercise of the power to grant an extension of time, and that SLHD had acted reasonably and in good faith.

In reaching its decision, the Court found that where a contract contains two apparently inconsistent terms, the conflict should be resolved on the basis that one is intended to qualify the other, this being an aspect of the general rule that requires contracts to be read as a whole document, with both clauses having some meaning and effect. Consideration should also be given to the context and purpose of the provision in question.

Applied to this case, the Court found that clause 2.5, which provides for the exercise of a sole, absolute or unfettered discretion, is subject to the good faith obligation in clause 10.8.

The intention of the Contract was to facilitate the construction of a hospital in accordance with an agreed timetable. It was necessary to obtain a further permit to enable the works to proceed, and accordingly the granting of an extension of time to obtain a permit was reasonable and consistent with SLHD’s obligation to act in good faith in exercising its power under clause 2.5.

The full decision can be read here.

Conclusion

Upon review of these two decisions, it is clear that whether the obligation to act in good faith applies to the exercise of a particular power will depend upon the factual circumstances of each case. The duty will apply to clauses containing a sole or absolute discretion where this is consistent with the terms of the contract as a whole, the intention of the contract, and where it is not directly inconsistent with the terms of the clause granting the power.

Authors: Marie-Louise Scarf & Annie Papageorgiou

Disclaimer
The information in this article is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, we do not guarantee that the information in this article is accurate at the date it is received or that it will continue to be accurate in the future.

Published by:

Annie Papageorgiou

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