Contractual Duties Of Good Faith: Court Of Appeal Confirms Context Is King

• Published date: 30 November 2022
• Law Firm: Herbert Smith Freehills
• Author: Mr Jonah Oliver

The Court of Appeal has allowed an appeal against a finding that the majority shareholders of a company had engaged in unfairly prejudicial conduct by removing from office two directors with minority interests, in a case which provides important clarification around the scope and construction of contractual provisions obliging the parties to act in good faith: Re Compound Photonics Group Ltd; Faulkner v Vollin Holdings Ltd[2022] EWCA Civ 1371.

The decision emphasises that good faith clauses must be interpreted by close reference to the particular context in which they appear, and that authorities interpreting similar clauses in other legal or commercial contexts cannot be straightforwardly applied to other situations.

In particular, the Court of Appeal rejected the proposition that it was possible or appropriate to divine from the case law a set of minimum standards that would apply in every case in which a duty of good faith is inserted into a contract, beyond the "very obvious" point that the core meaning of an obligation of good faith is an obligation to act honestly - though it also rejected the argument that a good faith obligation cannot be breached other than by acting dishonestly.

On a practical level, this case serves as a reminder that parties proposing to include an express duty of good faith should define the scope of the duty as clearly as possible within the agreement, including, where feasible to do so, identifying actions that are (or are not) required to satisfy it.

Background

The claim was brought by a group of minority shareholders in Compound Photonics Group Limited (the Company), who alleged that they had been unfairly prejudiced by the conduct of the majority shareholders in forcing one director (S) to resign and removing another (F) from office. Prior to their removal, S was CEO and F was Chair of the Company. Both were among the minority shareholder claimants.

Neither the Company's articles nor the shareholders' agreement (SHA) contained an express term entrenching S's and F's positions as directors. The claimants instead relied on an express obligation of good faith in the SHA:

"Each Shareholder undertakes to the other Shareholders and the Company that it will at all times act in good faith in all dealings with the other Shareholders and with the Company in relation to the matters contained in this Agreement."

The claimants asserted that this provision required the majority shareholders to adhere to the inherent "bargain" set out...