Interpreting the contractual duty of good faith

The duty of good faith has come under the spotlight in the recent Court of Appeal case Re Compound Photonics Group Ltd; Faulkner -v- Vollin Holdings Ltd ([2022] EWCA Civ 1371). The court’s decision in this case provides some clarity on the approach to construing good faith obligations and suggests that the effect of such contractual obligations, whether express or implied, will be highly fact specific. 

Background 

The case concerns the removal of two key directors – the company’s CEO and Chairman, who had been appointed by the minority shareholders. The company’s articles of association sought to entrench the position of these directors by providing that the board could not vote to remove them. However, the shareholders’ agreement did not obligate the majority shareholders to not vote to remove the directors. With growing dissatisfaction with the performance of the company, the majority shareholders forced one of the directors to resign, and the second director was removed by the majority shareholders passing an ordinary resolution. As a consequence, the minority shareholders brought a petition under s.994 Companies Act 2006. 

In the first instance, the High Court held that the minority shareholders had been unfairly prejudiced by the forced removal of the two directors. The judge found that the majority shareholders had breached an express duty of good faith in the shareholders’ agreement by not respecting the ‘agreement’ to entrench the position of the two directors. In considering whether the shareholders had breached their express duty of good faith, the High Court agreed with and adopted the statements of principle in relation to good faith duties set out in Unwin -v- Bond ([2020] EWHC 1768 (Comm)). These five principles are that the parties must: 

• Act honestly
• Be faithful to the agreed common purpose, which is to be derived from the relevant agreement
• Not use their power for an ulterior purpose
• Deal fairly and openly
• Have regard to the other party’s interests

Court of Appeal’s decision 

The Court of Appeal overturned the High Court judge’s decision and in doing so, it made some helpful observations regarding the nature and scope of express good faith provisions. The court called into doubt the existing formulaic approach in Unwin to establishing the duty of good faith and held that: 

• An express contractual good faith clause must take its meaning from the context in which it is used
• The duty of good faith includes a duty to act honestly but it is neither logical nor appropriate to impose any further minimum standards of conduct
• The duty of good faith includes a duty not to act in bad faith – meaning a prohibition on conduct which would be regarded as commercially unacceptable by reasonable and honest people but not necessarily dishonest
• The requirement for parties to be faithful to the parties’ agreed or common purpose should be construed narrowly. In this particular case the Court of Appeal decided that such a requirement would not apply to a shareholders’ agreement in the absence of express wording to the contrary
• The requirement for parties to deal fairly and openly should also be construed narrowly. In this case, the Court of Appeal decided that the majority shareholders were not under any procedural duty concerning the removal of a director which went beyond what is set out in the Companies Act 2006.

Commentary 

This case signals a change in the court’s approach to good faith clauses with less reliance on a set formula and more emphasis on interpretation based on the commercial context and facts. 

While the decision of the Court of Appeal may not provide complete certainty on the precise scope and ambit of a duty of good faith, commercial parties should at least take comfort that it means any obligation of good faith they include in their agreement will be interpreted in the context of that agreement, applying the usual principles of contractual interpretation, rather than by reference to a prescriptive checklist. Nevertheless, parties wishing to rely on a good faith clause should state clearly what they are trying to achieve.