Relational Contracts in Construction Law
Those working in the construction industry will be aware that many standard forms of contract used nationally include obligations that could be commonly interpreted as good faith-type obligations. Examples are most obviously apparent in partnering contracts and in clause 10.1 of the NEC3, which states that parties should act in accordance with a contract and in a spirit of mutual trust and cooperation.
Employers and contractors need to differentiate between so-called relational contracts and other commercial contracts in order to understand how they are treated in law following an interesting ruling. The High Court has implied a duty to act in good faith into an oral joint venture agreement, on the basis that it was held to be a relational contract. So what does this mean for your business arrangements? Whilst the case did not relate strictly to construction contracts, it would appear that the principles are equally applicable to the construction industry.
What’s a relational contract?
A relational contract is, as the judge explains in his ruling, a type of contract “where the parties are committed to collaborating with each other … in ways which respect the spirit and objectives of their venture but which they have not tried to specify, and which it may be impossible to specify, exhaustively in a written contract”.
Such ‘relational’ contracts are usually long term and involve a different kind of trust and confidence than typical contracts. Under such contracts, there is trust that the other party will act with integrity and in a spirit of cooperation.
What happened in this case?~Two friends went into business together – an investor and a hotelier. A joint venture (JV) was agreed under which an investor (a member of Abu Dhabi royalty) agreed to invest a 50% stake in a hotel and travel business belonging to a friend who was a Greek businessman. The JV was an oral agreement only, but a lot of money was involved, with the investor ultimately contributing a total of €31.1m of capital.
Approximately three years later, the JV fell into serious financial problems and was on the verge of collapse. The investor decided it was time to pull out from the arrangement and the parties agreed to a demerger. This included a framework agreement and promissory note in favour of the investor under which the hotelier agreed to repay a proportion of his capital.
However, it was alleged that the investor had been involved in secret, opportunistic conduct in making attempts to sell his stake without informing the hotelier, and trying to use his shareholding to benefit himself financially at the other’s cost. The hotelier also claimed that his agreement to the framework agreement and the promissory note was obtained by the investor through physical threats and economic duress, and that he had therefore breached his fiduciary duties and / or an implied duty of good faith.
What was the outcome?
Though the courts do not usually imply a duty of good faith into commercial contracts, this was held to be a relational contract. Therefore, the court found there was an implied contractual duty on both parties to the JV to act in good faith.
This was a contract in which they “naturally and legitimately expected of each other greater candour and cooperation and greater regard for each other’s interests than ordinary commercial parties dealing with each other at an arm’s length”. The court found that the investor’s conduct was such that it breached his duty of good faith to the hotelier.
What does this mean for you?
If you enter into similar long-term contractual arrangements, you should consider the nature and extent of your obligations towards the other party. It is possible that you may have greater legal obligations than you have in your other construction contract arrangements, including the duty to act in good faith. With this in mind, think about reviewing any existing relational contracts you may have, and consider taking specialist legal advice on your rights and obligations.
If a party wants to rely on a good faith obligation in a contract, it should expressly provide for one. Where a party chooses to do this, it is important that the scope and substance of that obligation is made clear to avoid any ambiguity as to what it means or to which provisions of the contract it applies. Certainty is key.
How can we help?
We advise employers, contractors, consultants and sub-contractors in the construction industry on their statutory and contractual rights and obligations. For strategic advice on your legal obligations to other contractual parties, contact the expert construction solicitors at Herrington Carmichael LLP as early as possible.
Please contact Cesare McArdle on 0118 977 4045.
This reflects the law at the date of publication and is written as a general guide. It does not contain definitive legal advice, which should be sought as appropriate in relation to a particular matter.
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