Legal Indemnities Newsletter: Good faith and reasonable endeavours

Contracts sometimes contain obligations that lack precision; for example, an agreement to act towards one another in good faith, or an agreement to use reasonable endeavours to achieve an outcome. The parties may wonder how enforceable those obligations are. However, courts generally try to find meaning and purpose to obligations that the parties have agreed to take on, and there are numerous examples in case law of contracting parties being found in breach of contract where a lack of good faith has been shown, or insufficient endeavours have been pursued.

In Brooke Homes (Bicester) Ltd v Portfolio Property Partners Ltd & Ors [2021] EWHC 3015 (Ch), a property developer brought claims for specific performance of what it alleged to be an agreement to buy up to 500 acres of land for development as part of the Bicester eco town. In the alternative, the claimant sought to enforce an understanding reached in heads of terms through equitable means (i.e. a ‘Pallant v Morgan’ equity, or a constructive trust), and brought claims for equitable compensation, or damages in excess of £500 million by reason of alleged breaches of contract and/or misrepresentation.

The defendant group of companies had identified the claimant as a potential developer a site in Bicester. The development site had been put together over a five-year period through a series of option agreements acquired by the group. An agreement referred to as ‘Heads of Agreement’ was entered into in April 2015 relating to an unspecified area consisting of 100 acres of the site with intended options for up to a further 400 acres priced at £800,000 per acre.

Under the heads of agreement, the parties agreed to “use all reasonable endeavours to enter into a final binding Agreement which captures legally these Heads of Agreement acting in good faith towards each other” throughout the period of the agreement. At the time of the heads of agreement, the claimant agreed to make a non-refundable pre-payment of £250,000. By way of an addendum to this agreement in July 2015, the claimant agreed to make further pre-payments but on terms that all of the pre-payments would be refunded if a conditional sale agreement was not entered into within an agreed timescale. A total of £1.8m of pre-payments were made.

The Heads of Agreement anticipated that a conditional sale agreement (subject to the grant of planning permission and satisfaction of other conditions) would be entered into, but no such contract was able to be reached despite many months, and some years, of communication and negotiation, and despite the grant of outline planning permission. By December 2018, with no formal agreement concluded, and relations breaking down, the claimant instituted proceedings. At first, these were settled by a consent order, but the stay on proceedings was lifted when the defendants failed to adhere to the payment terms of the order.

The judge held that there was certainly no contract for the sale of land in respect of which specific performance could be granted. First, the Heads of Agreement document was essentially an agreement to enter into a formal agreement, not itself an agreement for a land transaction. Second, there had been no precise identification of the area of land to be included in the sale, so there could be no binding contract for the sale of land. Third, the agreement had been varied subsequently in a manner that would have resulted in the alleged contract for sale not complying with section 2 of the Law of Property (Miscellaneous Provisions) Act 1989, since there would not have been one document signed by both, or a single exchange of contracts, incorporating all of the terms the parties had expressly agreed.

While satisfied that the claimant was not entitled to any proprietary relief, the defendants were nevertheless held to be in breach of contract; in particular, in failing to act in good faith and in failing to use all reasonable endeavours to bring about a conditional sale agreement. Damages, based on the loss of a chance to enter into a contract, were assessed at £13.4m.

Students of the law will ask whether it is permissible under contract law to have an agreement to agree – which was effectively what the heads of agreement amounted to. The judge was of the view that “in commercial dealings where the parties have acted in the belief that they had a binding contract, the courts are willing to imply terms, where that is possible, to enable the contract to be carried out. The courts will assist the parties to preserve rather than destroy bargains, on the basis that what can be made certain is itself certain the courts will now be willing to recognise an obligation to negotiate on some matter using reasonable endeavours, or in good faith, where it is found in a binding agreement.”

Of greater interest to property lawyers in this case is the judge’s consideration of the scope of an obligation to use all reasonable endeavours and a contractual duty to operate in good faith. The judge identified three types of ‘endeavours’ clauses. The first is simply to use reasonable endeavours, which the judge said: “might mean that if one reasonable path is taken then the obligation is discharged”.

However, one would expect ‘endeavours’ to be pursued, rather than a single endeavour. Reasonable endeavours are: “what a reasonable and prudent person acting properly in their own commercial interest and applying their minds to their contractual obligation [would] have done” to try to achieve the objective. (See Mactaggart & Mickel Homes Ltd v Moore [2010] CSOH 130, per Lord Hodge). The second type is to use all reasonable endeavours. This is normally interpreted as requiring that all reasonable paths or actions are exhausted. In line with other cases, the judge suggested that there is little difference between this kind of endeavour obligation and the third category of obligation - the duty to use best endeavours.

However, he noted that some best endeavours clauses might be seen as requiring a party to sacrifice some of its commercial interests, whereas an obligation to use all reasonable endeavours is probably less likely to require that (as suggested in CPC Group Ltd v Qatari Diar Real Estate Investment Company [2010] EWHC 1535 (Ch)). Confirming the difficulty for lawyers in giving clients precise advice on the effects of these clauses, the judge said that “the precise requirement will depend on the precise wording and context in which that wording arises. So even with ‘all reasonable endeavour’ clauses some subordination of commercial interests may be required”.

In this case, a failure by the defendant, despite requests, to provide a definitive 'red-line' plan or agree a mechanism for identifying precisely the land that might be sold to the claimant, thereby preventing the conclusion of a sale agreement, was a breach of the obligation to use all reasonable endeavours (and also to act in good faith). The inability to conclude a sale agreement was, in part, linked to the defendant’s growing desire over time to deal with another interested party. This also was a breach of the duties to use all reasonable endeavours and to act in good faith as it constituted a breach of an exclusivity clause agreed with the claimant.

As regards good faith clauses, the judge said that the precise nature of the obligation would take its colour from the rest of the terms of the agreement. He said that while the modern prevailing view was that good faith clauses contemplated a duty to act honestly, dishonesty was not a necessity for there to be a breach. He summarised the duty of good faith as requiring, subject to the other terms of the agreement, (a) a duty to act honestly, judged by reference to reasonable and honest people; (b) the observance of reasonable commercial standards of fair dealing; (c) fidelity or faithfulness to the common purpose, or contractual purpose; and (d) more generally to act consistently with the justified expectations of the parties.

Cases such as these are helpful, but the meaning of words and phrases can only ever be explained in the context in which they are used. The courts will interpret phrases such as “best”, “reasonable”, and “all reasonable” endeavours by reference to the meaning that they would convey to a reasonable person, having all the background knowledge that would reasonably have been available to the parties in their situation at the time of the contract. This explanation of the courts’ approach to interpreting contracts tells the client very little, and shows why it is so difficult to advise a client on the precise extent of the obligations to which they are committed.

This content was provided by Alan Riley, Property Law Consultant.