By Oliver Browne

Although there remains no widely accepted definition of good faith under English law, and English law has committed itself to no overriding principle of good faith, English law has developed piecemeal solutions in response to demonstrated problems of unfairness.

The variety of these solutions, and the pace with which they are being adopted, is increasing. Indeed, the English courts are starting to embrace the idea of good faith, bringing English law more in step with the laws of other developed jurisdictions.

What does good faith mean?

Unfortunately there remains some doubt. Some cases have described the duty to act in good faith as an obligation to observe reasonable commercial standards of fair dealing, others have addressed the notion of acting consistently with the justified expectations of the parties. Judges have also referred to acting within the spirit of the contract and working together / honestly endeavouring to achieve the stated purposes expressly linked to the duty. They have also emphasised the objective nature of the assessment of good faith in a number of cases, however, courts will take into account the context of the situation and relationship between the parties. A breach of an obligation of good faith is often evidenced by an act of bad faith.

So, this is all potentially quite unclear. While the courts have not reached consensus on a definition of good faith, good faith is clearly meaningful. Therefore, when and how those words are used requires careful consideration.

When does good faith arise for PE dealmakers?

Good faith obligations appear in many deal documents, for example binding offer letters may refer to parties working together in good faith to implement the deal in line with its terms, or to negotiate additional documents in good faith; shareholders’ agreements may contain general good faith obligations; and restrictive covenants may include an obligation on parties to negotiate in good faith to replace a provision found to be unenforceable.

Provisions in which parties have agreed, expressly, to act in good faith are sometimes used as a belt and braces approach to securing a positive contractual relationship. The consequences of inserting such a provision without carefully considering or limiting its impact might be drastic: quite what the obligation to act in good faith will mean will always remain uncertain unless tied to specific circumstances or outcomes.

The courts are also becoming increasingly comfortable with the idea of implying a duty of good faith in specific circumstances. This includes if the parties have a particularly close or long-term relationship, which could be the case in respect of co-investment or consortium arrangements with regular partners, or if their intentions obviously incorporated an expectation of good faith. A duty of good faith is frequently implied to constrain the exercise of discretion conferred on a party to a contract.

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How does this impact PE transactions?

In our view, PE firms should exercise caution when entering into agreements that include broad good faith obligations. If these obligations cannot be avoided, a description of specific actions or outcomes should be provided to ensure the obligation is limited and a wider obligation to act in good faith does not arise. To avoid good faith obligations being implied, PE firms should consider whether their agreements might be construed as “relational agreements”, and then ensure that their advisers draft carefully in order to avoid such obligations arising by implication. PE dealmakers should also remember that any contractual discretion should be exercised reasonably and not arbitrarily, capriciously, or for an improper purpose.