‘Relational’ contracts and duties of good faith
Bates v Post Office [2019]
English law has traditionally resisted implying an obligation on the parties to act in 'good faith' into commercial contracts. However, over the last few years the English Courts have, in isolated cases, been prepared to imply such a duty into so called 'relational’ contracts. The latest of these cases provides further guidance on the circumstances in which a contract may be classified as a 'relational’ contract
Facts:
The Bates case is a piece of group litigation in which over 500 sub-postmasters (SPMs) claimed damages from the Post Office following problems with the “Horizon” electronic point of sale and accounting system, which the Post Office rolled out in 1999/2000. Subsequently, the Post Office pursued many SPMs for alleged accounting shortfalls. The SPMs claim that Horizon contained a large number of errors which created the alleged shortfalls and that there were problems with the training that was provided on its use as well as the general failure of the telephone helpline.
The Post Office contracted with SPMs on two standard forms and allowed no negotiation over their terms. The two forms were as follows:
- the SPMC: the Sub Postmasters Contract, used before 2011, which stated that each SPM was responsible for all losses caused through his or her negligence, carelessness or error, and also for losses caused by his or her assistants.
- the NTC. In 2011, the Post Office introduced the Network Transformation Contract. With one exception, this stated that the sub-postmaster should be fully liable for any loss, however that occurred and whether it occurred as a result of any negligence by the sub-postmaster, its personnel or otherwise.
Both contracts required the sub-postmaster to pay any shortfall in full. The Post Office maintained that individual sub-postmasters had to prove that the shortfalls were not their individual responsibility.
The SMPC had no minimum term but the Post Office could terminate by 3 months' notice. The NTC had a one-year minimum term, after which either party could terminate by 6 months' notice.
There were many questions for the court to answer including:-
Was the contractual relationship between the Post Office and SPMs a ‘relational’ contract such that the Post Office was subject to duties of good faith, fair dealing, transparency, co-operation, and trust and confidence?
Were certain terms to be implied?
Were some terms ‘onerous and unusual’ such that they were unenforceable unless the Post Office brought them fairly and reasonably to the SPMs’ attention pre-contract and what steps would suffice?
Were any or all of the ‘onerous and unusual’ terms unenforceable pursuant to the Unfair Contract Terms Act 1977?
In what circumstances was the Post Office entitled to summarily terminate for breach?
In what circumstances was the Post Office entitled to terminate on notice, without cause?
Decision:
The judge found that the Post Office is not entirely private or wholly commercial, but has some characteristics of a public body. Undoubtedly this influenced his decision on a number of the following points.
‘Relational’ contracts
The judge found the concept of a ‘relational’ contract to be well established in English law referring to 6 recent cases as evidence of this. He identified a list of 9 non-exhaustive characteristics to ascertain whether a contract is ‘relational’. These are:
- The absence of any express terms that prevent the implication of a duty of good faith. The suggestion seems to be that an express term to the contrary would be conclusive in determining that a contract was not ‘relational’. Whether this means that contract drafters will begin to routinely exclude the implication of a duty of good faith expressly remains to be seen. Would a suitably drafted ‘entire agreement’ clause have the same effect?
- The contract is intended to be long term. Despite the ability for the parties in this case to terminate at relatively short notice, the judge decided that both parties intended each appointment as a sub-postmaster to be a long-term relationship.
- The parties intend that their roles will be performed with integrity and fidelity to their bargain.
- The parties are committed to collaboration.
- The spirits and objectives of the parties' venture may not be capable of being expressed exhaustively in a written contract.
- Each party places trust in the other, but of a different kind to that found in a fiduciary relationship. The court said that trust was essential to the relationship between the SPMs and the Post Office.
- The contract relies on a high degree of communication, cooperation and mutual trust and loyalty.
- There is a significant financial commitment or investment by at least one of the parties.
- The relationship may be exclusive.
The judge held that the following factors are not relevant as to whether a contract is ‘relational’:
- An imbalance of bargaining power between the parties.
- The unfairness of some terms.
- The bad behaviour of a party.
- That a party was a company (as a few of the sub-postmasters were). The fact that the contracts in question were directly related to the income and livelihood of individuals would seem to be relevant and was explicitly mentioned in the context of the discussion on onerous and unusual terms).
- That the contract was a commercial contract.
- The length and detail of the terms.
“It is the circumstances of the relationship, defined by the terms of the agreement, set in its commercial context, that decides whether a contract is relational or not. This must be considered [as] at the time of contracting”.
The effect of being a ‘relational’ contract
The classification of a contract as a relational’ one seemingly has an impact on a whole raft of areas including the willingness of the court to imply terms into the relationship (including an obligation of good faith) and the enforceability of contractual provisions under the Unfair Contract Terms Act.
The judge held that the concept of good faith means more than just honesty. Good faith or "fair dealing" includes an obligation to "refrain from conduct which in the relevant context, would be regarded as commercially unacceptable by reasonable and honest people" and imports an obligation of "transparency, co-operation, and trust and confidence". The implied duty of good faith applies to both contracting parties.
Implied terms
The judge concluded that a multitude of terms ought to be implied into the contracts namely obligations on the Post Office to:-
(c) properly and accurately to effect, record, maintain and keep records of all transactions effected using Horizon
(d) properly and accurately to produce all relevant records and/or to explain all relevant transactions and/or any alleged or apparent shortfalls attributed to SPMs
(e) co-operate in seeking to identify the possible or likely causes of any apparent or alleged shortfalls and/or whether or not there was indeed any shortfall at all
(f) seek to identify such causes itself, in any event
(g) disclose possible causes of apparent or alleged shortfalls (and the cause thereof) to SPMs candidly, fully and frankly
(h) make reasonable enquiry, undertake reasonable analysis and even-handed investigation, and give fair consideration to the facts and information available as to the possible causes of the appearance of alleged or apparent shortfalls (and the cause thereof)
(i) communicate, alternatively, not to conceal known problems, bugs or errors in or generated by Horizon that might have financial (and other resulting) implications for SPMs
(j) communicate, alternatively, not to conceal the extent to which other SPMs were experiencing relating to Horizon and the generation of discrepancies and alleged shortfalls
(k) not conceal from SPMs the Post Office’s ability to alter remotely data or transactions upon which the calculation of the branch accounts (and any discrepancy, or alleged shortfalls) depended
(l) properly, fully and fairly to investigate any alleged or apparent shortfalls
(m) not seek recovery from SPMs unless and until: (i) the Post Office had complied with its duties above (or some of them); (ii) the Post Office has established that the alleged shortfall represented a genuine loss to it; and (iii) the Post Office had carried out a reasonable and fair investigation as to the cause and reason for the alleged shortfall and whether it was properly attributed to the SPM under the terms of the SPM contract (construed as stated above)
(n) not to suspend SPMs: (i) arbitrarily, irrationally or capriciously; (ii) without reasonable and proper cause; and/or (iii) in circumstances where the Post Office was itself in material breach of duty in respect of the matters which the Post Office considered gave it the right to suspend
(o) not to terminate SPMs' contracts: (i) arbitrarily, irrationally or capriciously; (ii) without reasonable and proper cause; and/or (iii) in circumstances where the Post Office was itself in material breach of duty in respect of the matters which the Post Office considered gave it the right to terminate
(p) not to take steps which would undermine the relationship of trust and confidence between the parties
(q) to exercise any contractual, or other power, honestly and in good faith for the purpose for which it was conferred
(r) not to exercise any discretion arbitrarily, capriciously or unreasonably
(s) exercise any discretion in accordance with the obligations of good faith, fair dealing, transparency, co-operation, and trust and confidence
All of the above were to be implied as a consequence of finding that these were ‘relational’ contracts. In addition the following obligations on the Post Office were implied on the grounds of ‘business efficacy’:-
(a) to provide adequate training and support (particularly if and when the Post Office imposed new working practices or systems or required the provision of new services)
(b) to provide a system which was reasonably fit for purpose, including any or adequate error repellency. In this respect it is interesting to note that the ‘helpline’ was regarded by the judge as being an integral part of the Horizon system.
t) to take reasonable care in performing its functions and/or exercising its functions within the relationship, particularly those which could affect the accounts (and therefore liability for alleged shortfalls).
The express right for the Post Office to suspend SPMs where the suspension is ‘desirable’ or ‘necessary’ ‘in the interests of the Post Office’ were, in both cases, qualified with reference to the “legitimate interests” of the Post Office.
The right to terminate for cause was, read literally, capable of allowing immediate termination for minor breaches. But the judge interpreted it as allowing termination only for a repudiatory or serious breach. He also held that, in a relational contract, the right could only be invoked in good faith.
The right to terminate on notice without cause was also to be used only in good faith. The judge drew this conclusion not only from the general duty of good faith, but also from the fact that the specified notice period was a minimum being "not less than three [or six] months’ notice". This, he said, created a discretion and a duty to decide what actual notice to give, which must not be decided arbitrarily or taking into account irrelevant factors. Relevant factors, he said, would include the reason for wanting to close the branch, whether the sub-postmaster lived in the business premises, how long they had been in post and how much they had invested in the business.
Unusual and onerous terms – incorporated or not?
The judge analysed the principle that an onerous and unusual clause is not incorporated unless fairly and reasonably brought to the other party's attention. He concluded that:
- The rule does not apply to terms that have been signed, only to those incorporated by reference or accepted by conduct. It followed that all terms in the NTC, even the onerous and unusual ones, were incorporated, because the sub-postmasters had signed those terms. “Signature of the contract terms is wholly conclusive so far as notice to a SPM of onerous and unusual terms is concerned”. This analysis would mean that a party that looks to trade on its own standard terms and engages in a ‘battle of the forms’ scenario may be at risk if the contracting counterparty accepts contract terms through conduct such as allowing work to start or delivery to be made whilst remaining silent.
- The rule is not limited to consumer contracts, although the context and the parties' relative bargaining strength are relevant. The sub-postmasters were not consumers; a few of them were companies. However, their bargaining strength was far weaker than the Post Office's.
- An "onerous" term, for this purpose, is one with the potential to act very severely to the detriment of the party in question, almost to the point of being a punishment or adding an additional liability. To qualify as an ‘unusual and onerous’ term is a high hurdle according to the judge. The judge then went on to say that there was probably no appreciable difference between the way he had formulated the test and saying that a clause needed to be “literally extraordinary in its harshness” in order to qualify.
- The more severe the effect of the clause, the greater the notice required to incorporate it. Specific notice of terms found to be onerous and unusual is required.
- A recommendation to take legal advice is relevant to the test. (The judge did not, however, explain how this could prevent a term being unusual or onerous, or how it would make an unusual and onerous term more prominent).
The judge found that the following terms of the contracts were (or might be) both unusual and onerous:
- Strict liability without fault. The judge identified as unusual and onerous terms imposing unlimited liability on the postmasters (and what was effectively an indemnity even though the clause in question did not use that term but talked about ‘reimbursing on demand’) for all losses actually incurred, whatever the cause, even if it was entirely outside their control.
- Power not to pay the SPM during any period of suspension. The judge identified the unusual and "potentially financially ruinous" onerous term allowing the Post Office to deny payment to the SPM for a period of suspension while at the same time requiring the suspended SPM to bear the cost and expense of keeping the branch open during that period.
- Termination by notice with no minimum contract period. The contracts demanded considerable initial investment by the postmaster and were intended to last for many years. If the Post Office's right to terminate by notice had not been subject to an implied duty of good faith, the judge would have found the right to terminate by 3 months’ notice was unusual and onerous in allowing the Post Office to give notice of termination as soon as the contract was made, without a minimum initial period.
- No compensation for loss of office. The judge found that provisions denying the postmasters holiday, sick pay and pensions were not unusual or onerous. But provisions denying them any compensation for loss of office were unusual and onerous, even though the postmasters were not employees.
- Instant termination for any breach. The judge thought that a power of instant termination for even a minor breach would be unusual and onerous even though in this case, he found that, properly interpreted, there was no such power in the contract.
- One party's right to change post-contractually the substantive terms of appointment (the judge distinguished a unilateral right to change operating procedures) were found to have the potential to be onerous and unusual. Whether the contractual effect is onerous and unusual depends, according to the judge, upon the content of the new terms sought to be introduced. In the case of a ‘relational’ contract, the right to change the terms was held to be qualified by an implied duty to exercise it only in good faith.
Reasonableness and enforceability
Since the contracts were made on the Post Office's written standard terms of business, the judge went on to apply the UCTA reasonableness test. Although an unusual and onerous term is not necessarily unreasonable, he found that, in this case, the unusual and onerous terms largely failed the UCTA reasonableness test, making them unenforceable. The particular UCTA provision in question is contained in section 3. It provides:-
(2) As against [a party who deals on the other’s written standard terms of business], the other cannot by reference to any contract term
… (b) claim to be entitled
(i) to render a contractual performance substantially different from that which was reasonably expected of him, or
(ii) in respect of the whole or any part of his contractual obligation, to render no performance at all, except in so far as the contract term satisfies the requirement of reasonableness.”
Those provisions which were found to be covered by the scope of section 3 (2) included:-
- Those which permitted a unilateral variation of the terms upon which a SPM was appointed;
- Those related to the way in which the Post Office would be entitled to claim payment from, or reduce remuneration otherwise due to, the SPM for running the branch;
- Suspension: the way in which the Post Office could prevent the SPM from running the branch and also no longer observe the contractual requirements to remunerate the SPM for running the branch;
- Termination: the way in which the Post Office could bring the appointment of the SPM to an end.
Points to Note:
- Most long term, arm's length, commercial agreements are likely to satisfy many of the nine tests for a ‘relational’ contract. However, an implied general duty of good faith is likely to remain the exception in commercial contracts. The element of ‘public service’ and the similarity to employment contracts were notable factors why this is still likely to be a comparatively exceptional case. As the judge said "… accepting the concept of relational contracts does not mean there will be automatic and widespread application of an implied duty of good faith to all commercial relationships. Very specific characteristics are necessary in order that a commercial contract is categorised as a relational one." Those who are in a position to effectively dictate contract terms on a ‘take it or leave it’ basis are perhaps most exposed from this judgment and would be well advised to review their contracts.
- At least some of the clauses in question in this case were very extreme. Making the SPMs liable for ‘shortfalls’ unless they could prove they were not responsible being an obvious example;
- The conduct of the Post Office may not have helped them. They seemingly may have known of problems with the Horizon system for some time but nevertheless sought to hold the SPMs responsible for all shortfalls irrespective;
- On contract interpretation the court quoted a reference that was made during the course of the proceedings to a so called “interpretative spectrum” of contracts, ranging from “sophisticated contracts which have been carefully negotiated and/or professionally drafted, at one end, to informal and/or brief contracts which have not been carefully negotiated and/or professionally drafted at the other. The nearer the contract in question is to the former category, the greater the emphasis that is given to the natural meaning of the contractual words used”. Whilst this is a good analysis, for a contract to sit at the ‘carefully negotiated and professionally drafted’ end of the spectrum there has to have been some active negotiation by both parties and professional advice benefitting each party and not just one;
- The modern approach to the contra proferentem rule, in commercial contracts at least, is something of a sceptical one. The judge said “The “rule” (if rule is the correct word) requires ambiguity in a provision – for example, in an exemption clause - to be resolved against the party who put the clause forward and relies upon it. The rule has been subject to criticism, and is something of a historical remnant”. The judge went on to say “I am very reluctant to apply the rule of contra proferentem, even if any part of that rule survives, which I doubt. Even if it does, I do not believe it is correct to apply it here. If there is [still] such a principle [of interpretation] in my judgment that rule no longer has widespread or general applicability to commercial contracts”.
- The court referred to inadequacies in the process under which contracts with SPMs were formed. Although latterly most were asked to physically sign, earlier SPMs who acquired existing businesses did not always do so and were just assumed to have had knowledge of the contract terms. The formal ‘Appointment’ document did not always even specifically refer to the SMPC and in some instances it was unclear whether a copy of the full terms of the relevant written contract had been supplied to the SPM at or before the date of their appointment. This clearly, significantly undermines the ability of a contracting party to enforce their contract terms. It makes sense to have and to follow rigorously a clear process to ensure there is a record of a contract being properly executed by both parties to aid enforceability and ensure that arguments over whether potentially onerous clauses have been sufficiently brought to the attention of your contracting counterparty are avoided.
- In our view it is unlikely that an ‘entire agreement’ clause, by itself will prevent an agreement being classed as a ‘relational’ contract.
- This is the second recent example of a fairly sophisticated and lengthy contract being declared a ‘relational’ contract which would suggest they are no longer limited to simple arrangements between SME’s who fail to fully document the relationship. Undoubtedly the issues raised by ‘relational’ contracts will feature increasingly in cases going forward. Whether drafters accept (and even encourage) this development or seek to expressly head off the debate through contract drafting remains to be seen.
- It also remains to be seen whether the Post Office appeals the judgment.