Last year, Leigh blogged about when it might be reasonable to withhold consent under a contract. Today, I’m going to blog about another contract cliche, the obligation to act in good faith.
Last month, the High Court considered a case where one of the parties to a long term outsourcing contract was alleged to have breached an obligation to act in good faith. Given that an obligation to act in good faith is often viewed as fairly weak, the result may come as a surprise to some readers.
Contracts often contain obligations on the parties to act in good faith, particularly where there is an agreement to agree, as a court will not step in and “make” an agreement where the parties have been unable to do so themselves.
In this case, Mid Essex NGS Trust entered into an outsourcing agreement with Compass Group (trading as Medirest) for the provision of catering services.
The contract contained a general duty on both parties to act cooperate in good faith throughout the term:
The Trust and the Contractor will cooperate with each other in good faith and will take all reasonable action as is necessary for the efficient transmission of information and instructions and to enable the Trust or, as the case may be, any Beneficiary to derive the full benefit of the contract.
Unusually, it appears that the process for determining and calculating service credits was not clearly defined in the contract (or if it was, there was a disconnect between the pro forma schedule and the front end of the contract).
Instead, the Trust had rights under Clause 5.8 of the contract:
The Trust or any beneficiary shall ascertain whether the Contractor’s provision of the Services meets the performance criteria as specified in the Service Level Specification or, if the criteria are not so specified, meets the standards of a professional provider of the Services. Where such performance criteria or standards have not been met by the Contractor in the performance of the Services then the Trust shall be entitled to levy payment deductions against the monthly amount of the Contract Price payable to the Contractor in accordance with the terms of the Payment Mechanism. In addition, the Trust may by notice to the Contractor award Service Failure Points depending on the performance of the Services as measured in accordance with the Service Level Specification. Service Failure Points which are agreed or determined to have been awarded in circumstances where such award was not justified shall be deemed to have been cancelled
Under the contract, the Trust was entitled to terminate the contract if the number of service failure points (SPFs) exceeded 1,400 in any six month rolling period.
Break down in the relationship
There appear to have been a number of initial teething problems, which led to the Trust conducting it’s own monitoring. The Trust then appeared to act irrationally in determining what was required to remedy a failure, and imposing incredibly high and repeated deductions and SPFs.
Following a number of incidents where Medirest felt that service failure points and charges deductions for service level breaches were being set unreasonably, Medirest gave notice to terminate for material breach because it believed that the Trust was acting in a manner that constituted a material breach of the Trust’s obligations. The Trust also claimed that it was entitled to terminate on the basis that Medirest had exceeded the specified number of SPFs.
The court’s decision
Where a party has discretion under a contract, the law (Abu Dhabi National Tanker Co v Product Star Shipping Ltd) says that such discretion should be exercised in good faith and not in a manner that is arbitrary, capricious and irrational.
Cranston J held that Clause 5.8 contained a discretion on the part of the Trust, and that the manner in which the Trust exercised that discretion breached both that duty and its obligations under Clause 3.5, which the court construed widely.
Amongst the more absurd examples of behaviour cited by Cranston J in coming to this conclusion were the following SPFs and deductions that the Trust sought to impose:
- a box of out of date ketchup sachets in a store room: 30,860 SPFs and a deduction of £46,320. Box was removed immediately on being brought to attention of Medirest ( a mere 1,400 SPFs were required to trigger a right for the Trust to terminate for material breach).
- a bag of out of date (by three days) bagels belonging to staff or patients: £96,060 deduction. Bagels had been removed immediately.
- one day out of date chocolate mouse: deduction of £84,540
This was against charges of approximately £180,000 per month!
As the Cranston J said, the Trust’s actions not only had a financial implication. They also “poisoned” the relationship between the parties. Indeed, not only did the court hold that the Trust was in material breach, it also held that there had been repudiatory breach by the Trust (although given that the Trust was also entitled to terminate, no post termination damages were due by either party).
From the Trust’s perspective, being able to set and determine the service credits and SPFs that would apply (rather than have a detailed service credit regime in the contract) must have appeared very attractive, as it would give the Trust a very strong stick with which to manage to contract.
However, as is so often the case, power corrupts, and in this case the Trust misused that power to such an extent that a court has held that it was in breach of contract.
For other organisations, the case is a good reminder not only of how the courts will interpret an obligation to act in good faith (particularly in a long term contract), but also the underlying obligations to exercise discretion in a fair an just manner.
It also emphasises the importance of acting with a calm head when problems arise in a contractual relationship. This is something that the Trust may now be regretting.
On April 25, 2012