Discretion and good faith

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Does a contractual duty to co-operate in good faith inform the parties’ obligations across the whole contract, or only in relation to specific aspects?  This question lay at the heart of the dispute in Mid Essex Hospital Services NHS Trust v Compass (trading as Medirest), in which BLP acted for the successful appellant.

The Court of Appeal held that, in this case, the good faith obligation agreed between the parties was limited to certain defined purposes.  It did not expand to cover the conduct of the parties more generally, and there was no implied term preventing the Trust from exercising an absolute contractual discretion in an arbitrary, capricious or irrational manner.

What has happened?

The Mid-Essex Hospital Services NHS Trust entered into a 10 year outsourcing contract with Medirest, for the provision of cleaning and catering services.  The contract allowed the Trust to allocate service failure points (“SFPs”) when Medirest failed to meet defined performance levels.  Those points translated into deductions from the agreed monthly payment schedule, calculated by reference to a set payment formula; and, if the SFPs exceeded a prescribed threshold, the Trust had the contractual right to terminate the contract with immediate effect.

Medirest’s performance was severely lacking; and the Trust was very aggressive in raising SFPs and making deductions.  Ultimately, Medirest purported to terminate the contract for an unremedied material breach, and the Trust responded by also terminating the contract pursuant to a clause which allowed it to terminate the contract if Medirest had exceeded a certain number of SFPs permitted over a rolling six month period (having withdrawn an earlier termination notice).  Medirest issued proceedings for outstanding invoices and loss of profits, and the Trust counterclaimed for the additional costs of bringing and running the contract in-house.

The High Court judge held that both parties had been entitled to terminate the contract.  However, in Medirest’s case, this was based on his finding that (a) the Trust owed a duty to co-operate in good faith with Medirest; and (b) the Trust was exercising its discretion to raise SFPs in an arbitrary, capricious and irrational manner.  The Trust appealed to the Court of Appeal.

What are the key points?

The Court of Appeal overturned the High Court’s decision and held that:

  1. There was no implied term and the Trust did not exercise its powers under the contract in an arbitrary, capricious and irrational manner.
  2. The obligation to co-operate in good faith was not a general one; it was limited to co-operating in good faith for the two specific purposes, and had not been breached in either case.
  3. Accordingly, whilst the Trust’s overbearing approach to allocating SFPs was an event of breach, it was not sufficiently serious to amount to a material breach entitling Medirest to terminate the contract.  Medirest’s claim therefore failed and the Trust’s counterclaim succeeded.

How will this affect me?

There was initial interest surrounding the case following the High Court’s original decision to broadly interpret a contractual duty of good faith (on the basis that it was a long-term service contract that required co-operation between the parties to ensure it ran smoothly).  This interpretation may have carried profound implications for how parties understand the nature of their obligations under similar outsourcing contracts.

Ultimately, the Court of Appeal’s decision restricted the broader impact of the case, since they concluded that the good faith provision in this contract was limited in its scope to two specific limbs.  The Court of Appeal did recognise that whilst there is no general doctrine of “good faith” in English contract law, the scope of any duty to co-operate in good faith will be assessed objectively, and will be heavily conditioned by its context.

BLP Perspective

This decision provides useful guidance as to when an implied term not to act arbitrarily, capriciously or irrationally is likely to be implied on the exercise of a contractual discretion.  Where a contractual discretion simply involves the exercise of an absolute contractual right, the court will be unlikely to impose any such term.  However, in cases where the contractual discretion at issue relates to an assessment or choice as to a range of options where both parties’ interests are relevant, then it is likely that such a term would and/or could be implied.  As Jackson LJ noted, it would be “extremely difficult” to expressly exclude the operation of such an implied term.

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