Australia - Contracts and Commercial Law - Good faith and reasonable endeavours in commercial contracts (2024)

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It is common for commercial contracts to impose an obligation ofgood faith, a use of reasonable endeavours or a use of bestendeavours. Government agencies are also encouraged to use goodfaith in trying to resolve disputes.

So, what do these phrases mean and what is the law on suchobligations being imposed in a commercial contract?

Am I required to act in good faith?

An obligation to act 'in good faith' can arise by anexpress term in a contract. For example, a dispute resolutionclause may require the parties to negotiate in good faith.Similarly, a termination for convenience clause may require a partyto act in good faith, with the terminating party required to givereasonable notice and the other party required to mitigate its lossarising from the termination.

It has also been argued that there is an obligation to act ingood faith implied in all commercial contracts. This raises thequestion – what does acting in good faith mean?

The good faith obligation - what does it actually mean?

In Paciocco v ANZ Banking Group Ltd [2015] FCAFC 50 wesee the contractual obligation to act in good faith described as anobligation to:

• act honestly
• act with fidelity to the bargain (that is, carry out what eachparty was obliged to do under the agreement)
• not act to undermine the bargain entered or the substance ofthe contractual benefit bargained for
• act reasonably and with fair dealing, having regard to theinterests of the parties
• act in line with the provisions, aims and purposes of thecontract, objectively ascertained.

Whether a party has acted in good faith will require anexamination of their conduct and will be determined on the facts ofeach case. It could be argued that this could be established bypointing to evidence which demonstrates how a party did not act ingood faith.

Extent of the duty

The extent of the duty is demonstrated in MacquarieInternational Health Clinic Pty Ltd v Sydney South West Area HealthService. In this case, Macquarie and Sydney South West AreaHealth Service (SSW Area Health) signed a heads of agreement todevelop a private hospital on land within the Royal Prince AlfredHospital precinct owned by SSW Area Health. Leases were granted toMacquarie over the site for the intended hospital. The heads ofa*greement, and a number of the agreements, required both parties toact in 'utmost' good faith. It was critical for Macquariethat theproposed hospital was located within the Royal PrinceAlfred Hospital precinct.

SSW Area Health created an asset strategic plan which wasinconsistent with the location of the proposed private hospital.This was not revealed to Macquarie when it was preparing itsconstruction and design plans. The Court of Appeal found that theobligation to act in good faith was enforceable and required SWWArea Health to disclose the departures to Macquarie, as thatfailure would have changed Macquarie's expectations of theagreement. The Court found that the duty did not mean the partieshad to ignore their own interests, but they were required toco-operate reasonably to carry out what was required under thecontract.

The High Court has not ruled on the precise meaning and extentof the duty of good faith and, until it does, we are guided by thecase law on the facts of each case.

Is a duty of good faith really implied in allcommercial contracts? The answer's not clear.

The existence and extent of an implied obligation of good faithin the performance of a contract is not yet settled in Australia.In Royal Botanic Gardens and Domain Trust v South Sydney CityCouncil, the High Court commented that it was an importantissue but not appropriate to be considered in that case. The Courtnoted, however, that in argument, both parties accepted that suchan obligation existed in the lessor's determination ofrent.

Different approaches have been taken as to whether an obligationto act in good faith is implied in the performance of a contract.In New South Wales, the Court of Appeal has considered itappropriate to imply the obligation into commercial contractsgenerally. For example, in Cordon Investments Pty Ltd v LesdorProperties Pty Ltd, which involved a construction contractdispute, it was deemed appropriate to imply a good faithobligation, noting this was consistent with the approach taken in anumber of decisions in that Court.

The Victorian Court of Appeal took a different view, indicatingthat the good faith obligation should not be implied in allcommercial contracts and that,

"It may, however, be appropriate in a particular caseto import such an obligation to protect a vulnerable party fromexploitive conduct which subverts the original purpose for whichthe contract was made."

Best endeavours v reasonable endeavours - what's thedifference?

If there is doubt whether a party can achieve something becauseit is not completely within its control, that party will bereluctant to provide an absolute assurance that it will be done.That is where a 'best endeavours' or 'reasonableendeavours' qualification may assist.

Both these terms will consider what is reasonable in thecirc*mstances. However, it can be taken that 'bestendeavours' imposes a higher standard to do everythingreasonably possible to achieve an outcome. 'Reasonableendeavours', on the other hand, would be steps that areasonable person in that situation would take to achieve theoutcome.

In Electricity Generation Corporation v Woodside EnergyLtd the High Court considered a contract between the partiesfor the supply of gas. The contract required Woodside to supply amaximum daily quantity of gas and to use 'reasonableendeavours' to supply an additional maximum daily quantity at aset price. For the additional supply, Woodside had the right to"take into account all relevant commercial, economic andoperational matters" in determining if it could supply.This provided a guide or internal standard in determining whetherWoodside had breached its reasonable endeavours obligation. TheHigh Court, in finding no breach of this obligation by Woodside,made three observations about the use 'reasonableendeavors':

• the obligation qualified by these words is not absolute orunconditional
• the obligation will be considered against what is reasonable inthe circ*mstances, including how it will affect that party'sbusiness
• some contracts will have an internal standard of what isreasonable which may be related to their business interests.

The key to understanding how endeavours may be interpreted andthe steps to be taken to avoid breaching such a clause lies incontractual interpretation and whether the contract itself providesfurther assistance in that interpretation. Drafting factors thatcan be taken into account, for example, may be helpful.

Key takeaways

When NSW Government agencies are entering into commercialcontracts with third parties, it is important to understand whatoutcomes are expected and whether the obligations imposed on eitherparty are absolute or conditional. Reasonableness and good faithwill be interpreted by what the contract provides and what isreasonable in the circ*mstances. Neither dictate, however, that aparty's own interests should be completely disregarded.

The content of this article is intended to provide a generalguide to the subject matter. Specialist advice should be soughtabout your specific circ*mstances.