Good faith
Cathay Pacific v Lufthansa (High Court) [2020]
The latest chapter in the ongoing see-saw saga of ‘good faith’ and ‘relational contracts’
Facts:
This case concerned a dispute relating to a contract for aircraft engine maintenance, repair and overhaul (“MRO”) services (the “Agreement”). Cathay Pacific entered into the Agreement with Lufthansa under which the latter was obliged to provide MRO services for certain specified aircraft engines. Following the expiry of the Agreement, Lufthansa sought payment of around USD 36m from Cathay Pacific as so called ‘end of term’ charges. Cathay Pacific agreed that Lufthansa was entitled to this sum but argued that two amounts were due to them resulting in a net balance payable by Lufthansa.
Lufthansa was appointed as the exclusive provider of MRO services in respect of the identified engines, but this exclusivity was explicitly ‘subject to’ a clause which provided that Cathay Pacific could “at its option” remove engines from the scope of a specific service provided under the Agreement (the “Servicing Provision”) prior to the end of the Agreement (the “Option”). The wording of the relevant provision said:-
“"CP may at its option remove Engines from the Service programme prior to the completion of the Term. A financial reconciliation will be performed with respect to each engine removed from the Service programme in accordance with Schedule 13 …"
Lufthansa argued that the Option, when properly construed, or otherwise by way of implication, could only be exercised if the claimant removed the aircraft engines from the scope of the Servicing Provision for ‘operational reasons’ (such as a sale of the aircraft in question). Lufthansa argued that the engines were not removed for such reasons, as they continued to be operated by Cathay Pacific. They argued that there was an implied term in the Option which prevented it from being exercised in an arbitrary and/or unreasonable manner and that the Option was subject to a “good faith” obligation as the Agreement was a “relational contract”. As a result, the Option could only be exercised in a way that would be objectively regarded by reasonable and honest people as commercially acceptable.
Cathay Pacific argued that the Option was a unilateral provision which was not restricted to being exercised only for operational purposes. They also denied that there was an implied good faith obligation contained in the Option, but in any event the Option had in fact been exercised for reasonable commercial reasons.
Decision:
The Court held that the disputed provision in the contract between the parties was not qualified by way of implication, whether by way of additional wording which had not been expressly included in the clause or an implied term preventing one party from acting in an arbitrary and/or unreasonable manner and/or requiring it to act in good faith.
The fact that the exercise of the Option in accordance with its terms led to the “highly uncommercial result” of Lufthansa owing Cathay Pacific money was an “unimpressive” argument as “the process of contractual interpretation cannot be used to rectify a failure to think through the financial consequences of the operation of a clause”. Lufthansa were said to have been guilty of “an ambitious attempt at linguistic manipulation”.
The Agreement worked perfectly well without any implied qualification. The Court noted that for this argument to succeed, the proposed implied qualification must be something which a reasonable reader of the Agreement would consider to be so obvious as to go without saying or necessary to give business efficacy to the Agreement. That test was not satisfied.
The defendant’s argument that there was an implied term to the effect that the Option could not be exercised in an arbitrary and/or unreasonable manner was rejected by the Court, as the Option was closer in nature to unilateral rights of termination which had previously been held not to be subject to such an implied term. In this case, the parties were commercial entities aided by lawyers who had agreed that one of them should have the benefit of the Option and had agreed the financial consequences of the exercise of the same.
The Court considered the principal cases in relation to the implication of good faith obligations in commercial contracts and acknowledged that the law on relational contracts “had not yet reached a stage of settled clarity”. The judge expressly acknowledged “there is no getting away from the fact that there is a difference of approach” [between different previously decided cases] in relation to this issue.
In this particular case the judge concluded that the main test of whether a term of good faith is to be implied in a contract is whether a reasonable reader of it would consider the term to be so obvious as to go without saying or necessary for business efficacy. This is a very traditional and restrictive test for the implication of terms.
The parties had expressly provided for an obligation of good faith in other provisions in the Agreement but had not provided for the same in the Option. The judge said that the parties had given careful consideration to all the terms of the Agreement as they were commercial parties assisted by law firms, and a reasonable reader would therefore not conclude that an obligation of good faith in respect of the Option was “so obvious as to go without saying”.
Points to Note:
- This decision represents a much more traditional, conservative, approach to the issues of good faith and relational contracts. The reality is that, for the time being at least, this is an area of great uncertainty (something which is distinctly unwelcome) and this will undoubtedly lead to more disputes and more parties willing to pursue matters to a trial.
- English law does not easily accept that people have made linguistic mistakes, especially in formal documents drawn up by sophisticated commercial parties with the assistance of commercial law firms on both sides.