DUTY OF GOOD FAITH

Duty of Good Faith

Duty of Good Faith

Introduction

Companies engaged in international business or projects often enter contracts that are governed by laws different from those of the jurisdictions where they are incorporated, where they base their operations or (in some cases) where the contract is to be performed. In such situations, it is important not to make assumptions about how the law governing the contract will approach various contractual issues, even if the law in question seems similar to the laws of other jurisdictions. For instance, many of the principles of English law relevant to the performance of commercial contracts are similar to legal principles applicable in the US and other common law jurisdictions. However, English law may approach some contractual issues in a manner that the parties who selected English law to apply to their contract may not expect.

English Law: Duty Of Good Faith

English law permits a party to a commercial contract to recover a predetermined (liquidated) amount as damages for the other party's failure to, or delay in, performing its obligations. There are, however, two important situations in which such clauses will not be enforceable. First, the damages must represent a genuine pre-estimate of the loss and not amount to a penalty. Second, a clause will not be enforced in a construction contract if there is no fixed date for works to be completed because a liquidated damages clause relies on a known date for completion so that damages can be calculated against it. This later situation has given rise to what is known as the 'prevention principle', where the English courts have ruled that:

• if an employer/owner delays a contractor, the contractor is no longer obliged to complete the work by the agreed date and is instead allowed a reasonable time to complete the work;

• as there is no longer any specific date by which the work has to be completed, there is no specific date from which the calculation of liquidated damages can be made; and

• as a result, the liquidated damages provision is ineffective in such circumstances.

This result can be avoided by a properly drafted clause that allows the employer/owner, in the event it causes delay, to extend the time for completion of the work by the amount of the delay period. However, in the absence of such a clause, an employer/owner risks losing its ability to enforce the liquidated damages clause if it causes delay to the completion of the work. In this situation, the employer/owner would still be entitled to claim damages on the basis of general principles, subject to any other clauses limiting or excluding liability under the contract. However, it is likely to be more timeconsuming and costly for an employer/owner to prove its general damages than it would be to rely on an effective liquidated damages clause. Commercial parties often include provisions in their contracts that either exclude or limit recovery of damages for lost production, profits, revenue, business or the ...