16 Sep 2009

What do you mean I have to negotiate in good faith?

by Frank Bannon, Julia Dreosti, Rebekah Poole

A contractual obligation to act in "good faith" is not just a feel-good phrase - commercial parties need to be aware of the very real (and enforceable) obligations that an agreement to negotiate in good faith imposes upon them.

The meaning of an obligation to negotiate in good faith and the enforceability of clauses that contain it has been given greater clarity in the recent NSW Court of Appeal case of United Group Rail Services Limited v Rail Corporation New South Wales [2009] NSWSCA 177. The judgment also provides a comprehensive overview of the development of the law in this area.

In this case, United challenged the enforceability of a dispute resolution clause contained in two contracts with RailCorp to design and build rolling stock. The clause obliged senior representatives to "meet and undertake genuine and good faith negotiations" to resolve certain disputes that had arisen in relation to the contracts. United argued that the obligation to negotiate was uncertain and therefore unenforceable. United argued that although this obligation was just one step in a dispute resolution process that was to be followed by the parties, if the obligation was unenforceable then all of the subsequent provisions were too.

Is an agreement to negotiate in good faith enforceable?

In support of its argument that the obligation to negotiate in good faith was uncertain and unenforceable, United relied on a line of cases that likened an agreement to negotiate to an "agreement to agree". An agreement to agree is unenforceable because it lacks essential terms and is therefore incomplete: Booker Industries Pty Ltd v Wilson Parking (Qld) Pty Ltd [1982] HCA 53; 149 CLR 600 at 604.

The most recent of such cases is the NSW Supreme Court decision in Laing O'Rourke (BMC) Pty Ltd v Transport Infrastructure Development Corporation [2007] NSWSC 723. In that case, the judge concluded that an obligation to negotiate in good faith is uncertain because there can be no objective yardstick by which to measure the good faith, or otherwise, of a negotiating party's stance.

The court at first instance (United Group Rail Services Limited v Rail Corporation New South Wales [2008] NSWSC 1364) and on appeal in the United Group case took a very different view. The Court was of the view that an agreement to negotiate, if viewed as an agreement to behave in a particular way, may be uncertain but could not be considered to be incomplete, and therefore could not be equated to an "agreement to agree".

As to the added qualification that the negotiation be undertaken in "good faith" the Court of Appeal decided that it was enforceable, and not vague, illusory or uncertain, because:

  • while subjective, it was not impossible to assess; and
  • the yardstick for measuring good faith is honest and genuine negotiation within a framework of fidelity to the contract and the dispute.

Does this mean that I have to act in the interests of a party on the other side of the negotiating table and forego my own interests?

No, but it does require a party to make an honest and genuine assessment of its rights and obligations and to negotiate by reference to that assessment. In the Court's view, doing so is not necessarily incompatible with self-interested behaviour.

As a guide, the types of conduct in a negotiation that would not be in good faith are:

  • threatening a future breach of contract in order to bargain for a lower settlement sum than it knows it is due; or
  • having made the decision not to settle what is a good claim, pretending to negotiate in order to drive the other party into an arbitration that it believes the other party cannot afford.

So does this mean that an express contractual obligation to do something "in good faith" will always be enforceable?

Not necessarily. The enforceability of an obligation to act in good faith will largely depend upon the context and the particular contract.

This decision was confined to an express obligation to negotiate forming part of a dispute resolution clause in relation to a specific issue (ie. the subject matter of the dispute) for a finite period. A clause requiring negotiation in good faith of more general commercial interests might well be considered differently. The Court said that the difference between this dispute resolution clause and clauses requiring good faith negotiations in bringing about a commercial agreement in the first place was a difference "of great importance".

If my contract doesn’t say I have to negotiate in "good faith" then can I behave any way that I like?

No. You may have an implied obligation to act in good faith not only in negotiating, but in undertaking all of your contractual obligations. This is an unsettled area of the law and one that elicits strong views from those for and against the concept, as noted by the Court in the United Group case, but the Court did say that NSW courts should "work from the position that good faith, in some degree or to some extent, is part of the law of performance of contracts".

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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication. Persons listed may not be admitted in all States and Territories.