New South Wales case law indicates that a duty of good faith will be implied in contracts in some circumstances, however, courts have adopted different approaches in defining the content of the duty. The implications of this duty are relevant to parties entering commercial contracts, as it may define or vary contractual obligations.
In the NSW case of Renard Constructions (ME) Pty Ltd v Minister for Public Works (1992) 26 NSWLR 234, an implied contractual duty of good faith was found. This case involved a building contract clause empowering the principal to cancel the contract, or take over the work when the contractor defaults. This clause could be used if the contractor could not show why the contract should not be terminated. Upon default, the principal terminated the contract and took over the construction. The principal was sued for repudiation of the contract, with the contractor arguing that the termination was unreasonable, and was not done in ‘good faith’.
Priestley JA determined in the NSW Court of Appeal that the termination must be exercised reasonably as the clause contained an implied term that the principal would give a reasonable consideration to contractor had showing why the contract should not be terminated. Handley JA found that the principal’s termination was ‘objectively unreasonable and therefore an invalid exercise of the power’. Therefore, the duty of good faith arose as an ad hoc term based on the facts.
In contrast, other cases imply the duty of good faith as a matter of law. For example, in Vodafone Pacific Ltd v Mobile Innovations Ltd  NSWCA 15 Giles J stated that an obligation of good faith and reasonableness in the performance of a contract or the exercise of a contractual power can be implied as a matter of law as a ‘legal incident of a commercial contract’. This was confirmed more recently in Alstom Ltd v Yokogawa Australia Pty Ltd & Anor (No 7)  SASC 49. However, this approach was not reflected in the case of Esso Australia Resources Pty Ltd v Southern Pacific Petroleum N L  VSCA 228 where Buchanan JA decided in that good faith could be implied, however it should not apply as a matter of law reflected in all terms of a commercial contract.
In addition to how the duty is implied, the content of the duty has been argued. In Renard Constructions (ME) Pty Ltd v Minister for Public Works, Priestley JA found that good faith was similar to ‘reasonableness’. This means that in the context of the right of termination of a contract, all rights should be exercised reasonably.
However, other interpretations have been made. For example, in Garry Rogers Motors Aust Pty Ltd v Subaru (Aust) Pty Ltd, good faith meant that a party cannot act capriciously. Notably, Sir Anthony Mason provides a differing definition with three elements. Firstly, good faith contains an obligation on the parties to a contract to co-operate to achieve the contractual objectives. Secondly, it requires compliance with honest standards of conduct. Thirdly, this compliance must be reasonable in consideration of the parties’ interests.
Clients should be aware that the duty of good faith can be excluded from a contract. This may be preferable for some clients seeking a contract without implied restrictions. In Vodafone Pacific Ltd v Mobile Innovations Ltd, the contract provided Vodafone with a discretionary power to determine the number of new subscribers. This meant that good faith did not need to be exercised in determining subscribers.
The exact content of the duty of good faith, and how it should be implied has not be determined by the High Court. However, prospective parties to a contract should be aware of it, as it may affect the exercising of contractual obligations and powers. If you require any advice about the duty of good faith please get in touch! If you require further advice about contractual issues please check out our Resource Centre!
This article was authorised by Warwick Heeson.