If you want to terminate a contract, do it properly- that was the message from two of our recent blogs. As long as your contract allows you to terminate in the specific circumstances, and you strictly comply with the termination provisions, then your termination will be lawful.

But does this allow a party to terminate a contract in ‘bad faith’? In other words, can a party get away with terminating a contract lawfully by complying with the termination provisions, even if the real reasons for terminating are arbitrary or unfair?

The short answer is ‘no’, because most standard form construction contracts (including JCT contracts) expressly forbid the parties from serving termination notices ‘unreasonably or vexatiously'[1]. However, where there is no such express term, the situation is different, as was highlighted by a High Court decision recently[2].

This case concerned the high risk world of Iraqi oil exploitation. Although it centred on a consultancy services agreement rather than a construction contract, the same principles apply.

Westernzagros Limited (WZL) was trying to gain a foothold in Iraq which would allow it to explore and exploit a large area of Kurdistan for oil. In order to do so, it needed to win the support of various high ranking officials in the Kurdistan Regional Government (the KRG). The ultimate aim was for WZL to enter into a lucrative “Exploration and Production Sharing Agreement” (EPSA) with the KRG.

In order to gain access to, and gain influence with, the KRG officials, WZL engaged the services of Monde Petroleum S.A (Monde), which purported to have the necessary connections. WZL and Monde entered into a consultancy services agreement (the CSA).

WZL eventually entered into an EPSA with the KRG, but it was a far more difficult process than WZL had anticipated and the terms of the EPSA were far less favourable to WZL than it had hoped. WZL blamed Monde and served a termination notice on Monde, which it was entitled to do under the CSA. Monde initially agreed that the CSA was at an end.

One of the upshots was that Monde was not entitled to a 3% stake in the EPSA that it had been promised under the CSA. Despite its initial agreement to the termination, Monde subsequently alleged that WZL had terminated the CSA in bad faith, as its real motive was (amongst other things) to avoid paying Monde its 3% stake.

There was no express term in the CSA that required that termination had to be in “good faith”. Monde therefore had to argue that it was an implied term of the contract that a party would not exercise its right to terminate in bad faith. The Court refused to imply such a term into the CSA. The starting point is that there is no general doctrine of “good faith” in English contract law. A duty of good faith will only be implied where the contract would not make commercial or practical sense without it. In practical terms, this means that a term of good faith will only be implied into contracts where there are “expectations of loyalty”- for example, in joint venture agreements and franchise agreements. Here there were no such expectations of loyalty.

Indeed, the Judge was quite clear on the point, saying “In my judgment, a contractual right to terminate is a right which may be exercised irrespective of the exercising party’s reasons for doing so. Provided that the contractual conditions (if any) for the exercise of such a right (for example, the occurrence of an Event of Default) have been satisfied, the party exercising such a right does not have to justify its actions”.

Conclusion

As mentioned above, most standard form construction contracts include a term that a party cannot give notice of termination unreasonably or vexatiously. However, if that term is omitted, of if you are using a construction contract that doesn’t contain such a term, there will be no implied duty to terminate in good faith. In that case, a party will not have to justify its actions, as long as it has complied with the ‘letter’ of the contract. This is an unsatisfactory situation and it is therefore important that you check your contract to ensure that it does contain an express term preventing a party from terminating unreasonably or vexatiously.

For more information, email blogs@gateleyplc.com.

[1] see, for example, clause 8 in the JCT 2011 Standard Edition and the JCT 2011 Design and Build Edition

[2] Monde Petroleum S.A. v Westernzagros Limited [2016] EWHC 1472 (Comm)


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This blog is intended only as a synopsis of certain recent developments. If any matter referred to in this blog is sought to be relied upon, further advice should be obtained.