The Court of Appeal reiterates the importance of the specific context in interpreting contractual good-faith duties.
By Oliver E. Browne and Alex Cox
English law does not include a general implied duty of good faith. However, the English courts are willing to enforce contractual duties of good faith. In Mark Faulkner & Ors v. Vollin Holdings Limited & Ors, the Court of Appeal provided important clarification on the approach to such contractual good-faith duties.
The case related to an unfair prejudice petition under section 994 of the Companies Act 2006, brought by the minority shareholders (the Minorities) in Compound Photonics Group Limited (CPGL) against the majority investors (the Investors) in CPGL.
CPGL was created in 2009 to commercialise the academic research of Jonathan Sachs into gallium arsenide and liquid crystal technology, with a view to developing and selling a small projector. Sachs was the CEO of CPGL, and Mark Faulkner was a director and the non-executive chairman. The Minorities predominantly consisted of investors who had bought into CPGL at an early stage on the basis of Sachs’ vision for the technology.
The Investors are investment vehicles ultimately owned by Russian businessmen, including billionaire Roman Abramovich. They initially invested in CPGL in 2010.
Following further rounds of investment, by 2013, the Investors’ stake in CPGL increased to 80%. In 2013, the shareholders of CPGL entered into a revised shareholders’ agreement (the SHA) and articles of association (the Articles). The following year, further investment by the Investors increased their share of CPGL to 93%.
After repeated delays in the development of the projector, the Investors lost patience with Sachs and, in March 2016, demanded that he step down as CEO. Subsequently, in September 2016, the Investors removed Faulkner as a director.
The Minorities issued an unfair prejudice petition against the Investors, claiming that the forced resignation of Sachs and the removal of Faulkner prejudiced their rights as shareholders. The judge in the High Court, Mr Justice Adam Johnson, granted the petition, and ordered the Investors to buy the shares of the Minorities. The Investors appealed the judge’s decision to the Court of Appeal.
The Contractual Framework
The SHA included a clause providing that each shareholder would “act in good faith in all dealings with the other Shareholders and with [CPGL]”.
The SHA and the Articles also contained clauses governing the composition of CPGL’s board and the board’s decision-making powers. In particular, they provided that the quorum for any board meeting should consist of three directors including Sachs and Faulkner, and that board resolutions would be decided by majority vote, provided that Sachs and Faulkner formed part of the majority.
Importantly, however, the quorum provision was qualified by the wording “insofar as [Sachs and Faulkner] each remain a director”, and the SHA and the Articles included “leaver” provisions governing how directors (including Sachs and Faulkner) would be dealt with if they ceased being directors.
The High Court’s Judgment
In the High Court, the judge followed the approach of the Court in the case of Unwin v. Bond and held that the express contractual duty of good faith in the SHA required the parties to observe a set of “minimum standards”:
- they must act honestly;
- they must be faithful to the parties’ agreed common purpose as derived from their agreement;
- they must not use their powers for an ulterior purpose;
- they must deal fairly and openly; and
- each party can consider and take into account its own interests, but must have regard to the other party’s interests.
The judge focused on the second of these “standards” and sought to discern the “common purpose” agreed by the Minorities and the Investors in the SHA and the Articles. He held that the corporate structure envisaged by the contracts was a compromise designed to achieve a “constitutional balance” between the interests of the Minorities and the Investors. He considered that this “balance” essentially depended on Sachs and Faulkner being entrenched on the board and having a controlling say in the board’s decisions.
Accordingly, although the judge held that the Investors genuinely believed that the resignation of Sachs and the removal of Faulkner were in the interests of CPGL, he nonetheless found that the Investors had breached the good-faith clause in the SHA because they had exerted their power to “override” the constitutional balance. As a result, the judge concluded that the Minorities had been prejudiced, and ordered the Investors to buy their shares.
The Court of Appeal’s Judgment
The Court of Appeal overturned the judge’s judgment, finding that he had adopted an overly broad approach to interpreting the contractual duty of good faith in the SHA.
In particular, having surveyed the key case authorities on good faith (including authorities relied on by the judge) from England and Wales, Australia, and the United States, the Court of Appeal held that:
- the “core” requirement of the good-faith duty is that a party behaves honestly;
- depending on the contractual context, this duty may be breached by conduct taken in bad faith, which could include conduct which would be regarded as “commercially unacceptable by reasonable and honest people”; and
- any further requirements of an express duty of good faith must be capable of being derived as a matter of interpretation or implication from the other terms of the contract.
The Court of Appeal emphasised that cases from other areas of law and commerce may be of “limited value” in interpreting any good-faith clause and “must be treated with considerable caution”. In its survey of the case authorities, the Court explained how each authority turned on its own facts, and provided limited assistance for interpreting the obligation under the SHA. The Court specifically observed that the structure of a limited company and the relationship and interests of its members form a “very different backdrop” from an ordinary commercial contract, not least due to the statutory framework governing the rights and obligations of shareholders and directors of companies.
In light of this analysis, the Court of Appeal had “considerable reservations” about the judge’s finding that fidelity to the parties’ bargain (i.e., the second of the Unwin criteria) was an inherent requirement of the contractual good-faith duty under the SHA. However, in any event, the Court disagreed with the judge’s interpretation of the bargain agreed by the parties. It found that the judge was wrong to hold that the SHA and the Articles were intended to create a “constitutionally omnipotent” board on which Sachs and Faulkner held the balance of power. The Court also disagreed with the judge’s finding that the Investors were required to consider the interests of the Minorities when exercising their voting rights as shareholders (though they remained subject to their general obligation under company law to consider the interests of CPGL itself).
The Court of Appeal’s judgment confirms a number of important principles shaping the approach to contractual good-faith duties under English law. In particular, the judgment clarifies that, at minimum, a party subject to a good-faith clause must behave honestly. However, a good-faith duty may extend beyond this minimum obligation, and the scope of the applicable duty in each case must be considered in light of the specific provisions and context of each specific good-faith clause.
The judgment provides a reminder that contractual good-faith obligations must be approached under the usual rules of construction under English law. Further, the judgment highlights that the English courts will be reluctant to rely on overarching general principles when interpreting good-faith clauses.
  EWCA Civ 1371.
  EWHC 1768 (Comm).