Express Duty of Good Faith And ‘Constitutional Omnipotence’

Judges often have to consider whether there is an implied duty of good faith on one party in commercial litigation. Less usual are cases where an express duty of good faith is considered, as happened in an important appeal decision1.  The specialist corporate and commercial lawyers at ParrisWhittaker are experienced legal advisers and advise shareholders and directors on compliance with their duties.

What’s the background?

This case has a complex factual background but, in a nutshell, the minority shareholders claimed to have been unfairly prejudiced by three major investors when two of the company founders were ordered to resign or be removed as directors – and were thus excluded from any continuing management role in the company. 

Under the company’s articles and shareholders agreement, the shareholders were to “at all times act in good faith in all dealings with the other Shareholders and with the Company in relation to the matters contained in the [shareholder agreement]”. Notably, the Board were not permitted to pass a resolution removing either of the two founder directors.

Plans for the business, which was founded in 2009, did not go according to plan despite significant investment; and discontent and disagreements began to arise. This culminated in the three major investors using their powers under UK company law to remove one of the founder/directors who had refused to go voluntarily (the other had already resigned under pressure). Two new directors were then appointed. 

The two founders and the minority shareholders claimed unfair prejudice and argued that the majority investors had breached their express obligation of good faith in the SHA. The investors argued that a finding of dishonesty was pre-requisite for a finding of breach of their contractual duty of good faith. 

Interpretation and context

The Court of Appeal emphasised the following general principles (then went on to consider how the judges have previously approached the issue): 

1. An express clause in a contract requiring a party to act in good faith must take its meaning from the context in which it is used.
2. When interpretating the meaning of an express good faith clause in context, other cases turning on their own particular facts may have limited value and must be treated with considerable caution

The CA ruled in favour of the investors. It clarified that dishonesty is not required for an express duty of good faith to be breached – depending on the context, it may be breached by conduct taken in bad faith.  This could include conduct which would be regarded as commercially unacceptable to reasonable and honest people, even if they would not necessarily regard it as dishonest. 

Importantly, the court noted: “The structure of a limited company and the relationship and interests of its members form a very different backdrop to that of an ordinary commercial contract.” There is inherent flexibility in the case of a company and it cannot be presumed that a good faith clause has been designed to prescribe how the parties should behave in unforeseen future circumstance.

The court did not accept that the parties had to adhere to the concept of a bargain akin to a constitutionally omnipotent board on which the two founders held “an unalterable balance of power”. Therefore, the good faith requirement did not prevent the major shareholders removing the two founding directors. The investors had not behaved in an unfairly prejudicial way.  

What does this mean?

This is far from a simple ruling applying long-standing rules of contractual interpretation. Rather, it is decision on the express duty of good faith against the backdrop of contractual and corporate relationships, the nature of the documentation and the scope of the contractual and statutory duties of the shareholders and directors. 

Businesses should note the CA’s clarification that the duty of good faith can be breached where one party acts in a “commercially unacceptable” way – even if it falls short of dishonesty. 

Businesses and investors would be wise to expressly state in formal documentation what their responsibilities are in the context of a good faith clause.  

For expert advice on your commercial obligations and to protect your interests, speak to the experienced commercial litigation solicitors at ParrisWhittaker. You can contact us at info@parriswhittaker.com or +1.242.352.6112

1Re Compound Photonics Group Ltd [2022] EWCA Civ 1371