What does it mean if a contract is classified as a relational contract? And how does this relate to a duty of good faith?

Lindy patterson bw 2017

What does a dispute between subpostmasters and the Post Office have to do with construction contracts? When it comes to what it means to have a good faith obligation in a contract, quite a lot. Bates vs Post Office (No 3: Common issues) was one of several judgments in a group litigation between various subpostmasters and the Post Office. The litigation concerned the fallout from a new electronic accounting system that the subpostmasters were required to use and that resulted in various shortfalls and discrepancies. The Post Office claimed its subpostmasters contract required the subpostmasters to bear any losses from these problems. The interpretation of various terms of the contracts were tried as common issues – ones that affected all the litigants’ contracts – before breach, causation and loss were considered. 

There are two common situations where this may be relevant. One is in the exercise of contractual remedies such as termination; the other is in the operation of payment arrangements

These common issues concerned the extent to which terms could be implied that prevented the Post Office relying on a contractual term that the subpostmasters assume risk of almost all losses, howsoever caused. 

Mr Justice Fraser in this case considered the contracts to be “relational contracts” and stated that this is a type of contract where a good faith obligation is implied, unlike other commercial contracts. His judgment considered first what a relational contract looks like and then what was the significance of that on parties’ application of express contract terms. 

He found that a relational contract is one where: 

  • It is a long-term relationship
  • Parties intend that their respective roles be performed with integrity and with fidelity to their bargain
  • Parties are committed to collaborating with one another in the performance of the contract in communication, co-operation, mutual trust and confidence
  • The spirits and objectives of the venture may not be capable of being expressed fully in the written contract 
  • There may be significant investment by one or both parties in the venture and there may be exclusivity
  • They must not contain any express terms that contradict the implication of such a term.

This was not an exhaustive list and he made clear that other features might or might not make a contract a relational contract. 

The above characteristics often describe long-term framework/partnering arrangements or joint ventures in the construction sector where there are “pain/gain share” arrangements and/or parties are each making a significant financial commitment to the venture. 

To take as an example, Lord Justice Jackson in Amey Birmingham Highways Ltd vs Birmingham City Council [2018] EWCA Civ 264 found the PFI contract in question was a “relational contract”.

What does it matter if a contract is classified as a relational contract? If a duty or obligation to act in good faith is implied, what does it mean?

Mr Justice Fraser said it meant many terms that might otherwise have to be justified as implied (by application of the normal tests) were incorporated as a consequence of the general duty of good faith. He found that the duty of good faith was not limited to an obligation on parties to act honestly, but extended also to obligations regarding transparency, co-operation, trust, confidence and integrity; and that parties should refrain from conduct that might be regarded as commercially unacceptable to reasonable and honest people. The application of such obligations where good faith is implied has just been followed in New Balance Athletics vs Liverpool Football Club 2019 EWHC 2837.

There are two common situations where this may be relevant. One is in the exercise of contractual remedies such as termination; the other is in the operation of payment arrangements. 

Where the contract provides that the remedy of termination is available on the occurrence of minor breach, the fact it is a relational contract may influence how and in what circumstances a party might be entitled to exercise such a remedy. 

Another category of contractual term that might be applied differently in a relational contract is the payment provisions. For example, where the contract provides for financial deductions or penalties for the most minor of breaches.

In a case concerning another PFI roads maintenance contract, Portsmouth City Council vs Ensign Highways Ltd [2015] EWHC 1969 (TCC), the dispute concerned the awarding of service points for breaches and whether the number of service points to be awarded depended on the severity of the breach. The court’s answer was that the service points identified were the maximum to be awarded and that there was a discretion as to how many might be applied up to that maximum. The terms of the contract as to the application of service points on breach were considered. This decision was reached by applying rules of contract interpretation rather than the incorporation of a duty to act in good faith or a finding that it was a relational contract. 

This takes us full circle to the recent very helpful article on these pages, “Does your contract really need a duty of good faith?” (25 October, page 42).The authors identified a number of situations in which the duty of good faith principle was not required because of, among other things, the implication of certain terms. The judgment in Bates vs Post Office reminds us there is another route to importing such an obligation into relational contracts and how it might work.

Lindy Patterson QC is a barrister, arbitrator and adjudicator at 39 Essex Chambers