Good Faith and Unfairness Principles in US and Australian Contract Law

 

Good Faith and Unfairness Principles in US and Australian Contract Law

 

 

Question B.

 

 

Introduction

 

            This paper compares the principles of fairness and good faith in law of contract in Australia to the principles of fairness and good faith in contract law of the State of New York, United States.  With respect to the doctrine of good faith in Australian contract law the duty of good faith is merely an implied one which is not altogether clearly established.[1]  In the United States however the duty to enter into a commercial contract in good faith is an absolute one and is codified by Federal Statute.[2]  Bound by the tenets of Federal law, the state of New York has codified the statutory requirement of good faith in its Uniform Commercial Code, New York State Consolidated Laws.[3]

In the US in general the principles of equity will not permit the enforcement of a contract in the event it is proved that the contract was entered into unfairly.[4] Although not as thoroughly developed in Australia, Australian common law recognizes a principle of unfairness built around the concept of unconscionable bargains.[5]  In both jurisdiction the principles of good faith and unfairness in the law of contract are intricately tied.

 

Good Faith

            There is no explicit duty to act in good faith under Australian law of contract although the duty to do so is derived from expressions in common law such as reasonableness, legitimate interest, cooperation and proper purpose.[6]  Despite its codification of the duty to act in good faith, the position in the United Sates is not much clearer.  It has even been submitted that perhaps isolating what amounts to “bad faith” may be more useful in attempting to derive a formula applicable to the concept of good faith in American law.[7]  Be that as it may, by identifying what amounts to bad faith is a useful method for identifying what constitutes good faith in both the US and Australia. By identifying what amounts to bad faith a reasonable hypothesis can be drawn by which to assess the existence or non-existent of good faith in both jurisdictions.

            In Australian law, the judiciary have incorporated a number of elements that are directly linked to the implied duty of good faith.  However, in each case the judges are predisposed to balance the integrity of party autonomy against concepts of good faith.  In other words, the courts will attempt to do justice between the parties in such a way as to preserve the well established rule of freedom of collective bargaining.

            As previously noted, in Australian contract law, cooperation is a necessary element of the doctrine of good faith.  In Secured Income Real Estate (Australia) Ltd. v St. Martins Investment Pty Ltd (1979) 144 CLR 596 the duty of cooperation was ruled to imply that parties to a contract are required to:

“…do all such things as are necessary on his part to enable the other party to have the benefit.”[8]

In other words should both parties act in harmony with a view to securing the execution of the terms and conditions of the contract they are cooperating and therefore acting in good faith.

            While the duty of cooperation with respect to good faith is incorporated in the Australian common law principles of contract it can likewise be deduced from a US Statutory provision.  Section 1-203 of the Uniform Commercial Code provides as follows:

“…every contract or duty within this Act imposes an obligation of good faith and fair dealing in its performance or enforcement.”[9]

Secion 201(19) of the Uniform Commercial Code goes on to define good faith as:

“…honesty in fact in the conduct or transaction concerned.”[10]

Each of these statutory provision under US law are parallel to the Australian implied and common law duty of cooperation within the scope and range of good faith principles in the law of contract.  Both legal principles require that the parties to a contract conduct themselves in such a way as to ensure the success of the contract, but they are also required to act with honesty and integrity.  In fact the US Restatement of Contracts Act 1981 clarifies the doctrine of cooperation under the concept of good faith by requiring that:

“…every contract imposes upon each part a duty of good faith and fair dealing in its performance and its enforcement.”[11]

            Tied to the duty of cooperation is the duty to act reasonably.  Section 205 of the Restatement of Contracts Act 1981 cited above clearly requires that both parties to a contract act reasonably.  This tenet of good faith is clearly reflected and practiced in the state of New York.  Every contract governed by the state of New York “contains an implied covenant of good faith and fair dealing.”[12]  Renard Contructions v Minister for Public Works [1992] 26 NSWLR 234 clearly identifies the doctrine of reasonableness in Australian law holding that it is the inherent duty of both parties to a contract to conduct themselves fairly so that justice can be done between them.[13]

As in the US under Section 205 of the Restatement of Contracts Act 1981, where the requirement for good faith and fair dealing is required throughout the contractual relationship the same elements are necessarily implied by the operation of the Australian doctrine of reasonableness.  Under this doctrine, the parties are required to act fairly and reasonably throughout the contract’s course from its inception and throughout their dealing with one another under the terms of the contract.

            Just as Secion 201(19) of the Uniform Commercial Code in the US requires honesty in both fact and conduct, in Australian common law principles honesty is required by the operation of the doctrine of proper purpose.   This doctrine under Australian contract law is tantamount to a doctrine of good faith. In fact under Australian contract law honesty and good faith are placed together in legislative provisions.  For example under Section 5(2) of the Sale of Goods Act 1923 (NSW) the following provision mandates that in order to be:

“…deemed in good faith within the meaning of this Act when it is fact done honestly.”[14]

            The US’s requirement that each party to a contract act in good faith and fair dealing in the enforcement and preformance of their respective duties under the contract[15]is vastly similar to the Australian common law principle of legitmate interest.  In both legal principles the parties are required to not only safeguard their own interests under the terms of the contract but also the other party’s interests.  By doing so the parties are deemed to be acting in good faith.

            The duty to have some regard for the interests of the other party to a contractual arrangement has been established by the Australian case of Burger King Corp v Hungary Jacks Pty Ltd [2001] NSWCA 187.[16]  In this sense the doctrine of legitimate interest is intricately connected to the doctrine of cooperation.

            The doctrines of cooperation, reasonableness, proper purpose and legitimate interests are therefore all necessary elements of both US (New York) and Australian contract law.  Each of these elements have been established in Australia’s common law principles and all imply the existence and acceptance of the doctrine of good faith.  In the United States, the doctrine of good faith readily exists in the Uniform Commercial Code as well as the Restatement of Contracts Act 1981.  In fact it has been held in a New York case, Richbell Information Services Inc v Jupiter Partners LP 765 NYS 2d 575 (2003), 309 AD 2d 288 (2003) that shareholders of shares in closely held companies are not entitled to pursue their respective contractual obligations to the detriment of each other. Those entitlements must be measured against principles of good faith and fair dealing.[17]  Implicit in this ruling together witht the interpretation and/or construction of the federal and New York State  statutory provisions with respect to good faith are the doctrines of cooperation, reasonableness, proper purpose and legitimate interests.  Collectively each of these elements are closely linked to the ideology of cooperation.

            Mathew Harper puts the concept of cooperation within the meaning and intent of principles of good faith under the law of contract as follows:

“In the ‘cooperative view’ a contract is viewed as a vehicle for mutual support and cooperation. This utopian view of contract depicts a world where contracts are formed solely for ‘mutually beneficial exchanges’”.[18]

            Conceding that the doctrine of good faith is a necessary component of the law on contract, Matthew Harper argues and reasonably so that the doctrine of cooperation perhaps goes too far.  It widens the gap between established tensions between self-interests and those of the other contracting party.[19]  As noted the doctrine of coorporation can be implied by an interpretation of the US Federal Statutes that provide for the requirement of good faith in US contract law and was explicitly required by the New York State ruling in Richbell Information Services Inc v Jupiter Partners LP 765 NYS 2d 575 (2003), 309 AD 2d 288 (2003.  Obviously, the doctrine of cooperation is established by the judiciary in Australia’s common law principles of contract.

            When one considers the burden the doctrine of cooperation places on a party who has his own interest to protect under a contract, the doctrine becomes an entirely unnecessary requirement for establishing good faith.  A contracting party can safeguard his interest under a contract without acting in bad faith or in a manner which is outside the terms of the contract.  The requirement to act in good faith should be left to fairness, honesty and reasonableness.

Unfairness

            Under both Australian and New York law of contract the ultimate concept is that a contract should be entered into by competent parties, fairly, free of mistake and under consideration.[20]  In both jurisdictions where a contract has been entered into unfairly equitable remedies are available.[21]  Merrill, Williams and Johnson state the position with respect to unfairness in US law of contract as follows:

“The power of the court of equity to enforce the specific performance of a contract should be exercised under the sound discretion of the court, with an eye to the substantial justice of the case: and where a contract is hard, and destitute of all equity, the court will leave the parties to their remedy at law, and if such remedy has been lost by negligence, they must abide the consequences.”[22]

In other words unfairness will not give rise to claim if it merely arises from the negligence of one or both parties in the law of contract in the US.  The unfairness is required to arise from a deliberate act.

            Aside from the equitable prinicples of unfairness in US contract law the State of New York has implemented  the Consumer Protection From Deceptive Acts and Practices General Business Law which is designed to protect the weaker party (generally the consumer)f rom unfair contract terms instigated by the stronger contracting party (typically a business)[23]  Under this statute New York legislators have not defined nor classified which acts which amount to deceptive practices.  It merely provides that:

“Deceptive acts or practices in the conduct of any business, trade or commerce or in the furnishing of any service in this state are hereby declared unlawful.”[24]

Some guidance can be gleaned from the remaining sections of the Act which go on to provide cautions against false advertising which is generally defined as words or terms that are calculated to mislead the general public.[25]

            Under the New York State Consolidated Laws: Vehicle and Traffic, car dealers are required to make full and frank disclosure of all particulars of title pertaining to the car.[26] This Act is obviously designed to protect the consumer from unfair contracts with respect to purchasing a vehicle.  The implications are that should the dealer fail to disclose defects in the vehicle the consumer would enter into a sales contract in which he or she ends up with a defective product.

Another example of the operation of the doctrine of unfairness is found in the New York case of Carpenter v Carpenter 56 Hun (N.Y.) 647.  In this case the defendant required US$2000 for the completion of a purchase of 52 acres of land.  In order to acquire those funds he contracted with his wife, the plaintiff,  providing that should she enter into a mortgage agreement for the US$2000 he would deed 10 acres of the property which included its buildings to her.  That property was worth US$7000.  The court ultimately ruled that the agreement between the parties violated equitable principles of fairness and would not be enforced.[27]

             The US Supreme court to whom the State of New York is bound adequately summed up the doctrine of unfairness and the court’s role in doing justice between the parties in its ruling in Cathcart v Robinson (1831) 30 US 264.  The US Supreme Court ruled that:

“The difference between that degree of unfairness which will induce a court of equity to interfere actively by setting aside a contract and that which will induce a court to withhold its aid, is well settled.  It is said that the plaintiff must come into the court with clean hands, and that the defendant may resist a bill for specific performance by showing that under the circumstances the plaintiff is not entitled to the relief he asks.  Omission or mistake in the agreement: or that it is unconscientious or unreasonably: or that there has been concealment, misrepresentation, or any unfairness are enumerated among the causes which will induce a court to refuse aid.  If to any unfairness a great inequity between price and value be added, a court of chancery will afford its aid.”[28]

            It is clear under New York’s consumer protection laws and its equitable principles of unfairness that any aspect of a contract in which one of the parties have been induced by deliberate chicanery such as misrepresentation, concealment, mistake or omission the court will interfere to do justice between the parties.  That is provided the misconduct has the result of unfairly disadvantaging one party over another.  Moreover, the party that claims unfairness must also be innocent.  This is necessarily implied by the US Supreme Court’s mandate that the plaintiff has “clean hands”.[29]

            A contract, the terms of which have been negotiated by the use of duress form one contracting party over another will be deemed unfair and unenforceable by the US courts.[30]  For instance should one party secure a contract having threatened to prosecute the defendant criminally, the contract would be void for duress.[31]  At the end of the day, once a contract is negotiated with the use of fear, extortion or by some other means of intimidation the contract is deemed unfair on the grounds that was secured by virtue of duress and should not be enforceable. These are principles of US contract law in general and can be implied into the US Supreme court case of Cathcart v Robinson (1831) 30 US 264 which is binding on all States, including New York.

            Like the State of New York Australian legislature has developed a statutory regiment designed to protect consumers from the unfair business practices.  Section 2B of the Fair Trade Practices Act 1974 reflects the common law developments in the United States with respect to the doctrine of unfairness.  Section 2B provides as follows:

“A term in a consumer contract is to be regarded as unfair if, contrary to the requirements of good faith and in all circumstances, it causes a significant imbalance in the rights and obligations arising under the contract to the detriment of the consumer.”[32]

Section 2B is reflective of the rationale behind the ruling in the US case of Eames v Eames  (1868) 16 Mich 348.  Although the American case involved the interests and obligations of a husband and wife it too reflected terms and conditions between the parties that were unfairly balanced.

            In the Victorian Civil and Administrative Tribunal (VCAT) President Justice Stuart Morris in the case of Director of Consumer Affairs Victoria v AAPT Ltd [2006] VCAT 1943 identified two distinct categories of unfair contract terms.[33] The two types of unfair contract terms identified by Justice Stuart Morris can be summarised as follows:

·         Terms that bring about an imabalance between the parties are unfair even if they had been bilaterally or unilaterally negotiated or had been brought to the consumer’s attention.

·         Other terms although they do not bring about a great imbalance between the parties.  These kinds of terms will only be deemed fair if they had been unilaterally negotiated or the consumer had reasonable notice of their existence.[34]

            In Australia the test is ultimately similar to that developed in the United States with respect to unfairness in the terms of a contract.  The test is whether or not the unfairness contained in the contract’s terms and conditions is so unfair that it causes a detrimental imbalance to one of the parties. In the United States the emphasis appears to be on duress and intimidation.

In Australia the emphasis appears to be on the inequality of bargaining positions between the parties to a contract.  Even so, whether duress or inequality of bargaining position is the measuring stick used to assess unfairness the results of both kinds of conduct are essentially the same.  At the end of the day they can each cause a detrimental imbalance with respect to the weaker party.  In such a case, in both jurisdictions the contract will not be enforced against the weaker party to the contrace who was ultimately robbed of the freedom to negotiate fair terms.

 

Conclusion

            Under both Australian and New York contract law, principles of good faith and unfairness appear to have a common goal.  In each jurisdiction the primary goal is to ensure free and fair enterprise.  Contracts are an essential element of any commercial enterprise and by insisting upon good faith and fairness the integrity of the contract as a commercial facilitator is preserved.  The function of the doctrines of good faith and unfairness in both Australia and New York is to prevent one party taking unfair advantage of the other party.

            The essence of the law of contract in common law jurisdictions such as New York and Australia is founded on principles of equity and good conscience.  The formal requirements of contracts in each of these jurisdictions speak to good faith and fairness.  For instance a contract is not valid if it is negotiated by incompetent parties.  Moreover, each of the parties must obtain a benefit and suffer a detriment.  In order to achieve these ends fairness and good faith are necessary elements of any contract.  This rationale is adequately reflected in the principles of good faith and unfairness in the law of contract in both New York and Australia.

 

 

 

 

 

 

 

 

 

 

 

Bibliography

Adams, John and Brownsword, Roger. (1995) Key Issues in Contract. Butterworths.

Burger King Corp v Hungary Jacks Pty Ltd [2001] NSWCA 187.

Carpenter v Carpenter 56 Hun (N.Y.) 647 cited in Merrill,  John, Houston; Williams, Charles and Johnson, Thomas. (1983) The American and English Encyclopedia of Law. E. Thompson, 1023

Carvel Corp v Diversified Management Group Inc 930 F 2d 228 (2nd Cir, 1991)

Cathcart v Robinson (1831) 30 US 264

CBA v Amadio [1983] 151 CLR

Consumer Protection From Deceptive Acts and Practices General Business Law

Director of Consumer Affairs Victoria v AAPT Ltd [2006] VCAT 1943

Fair Trade Practices Act 1974

Forte, Angelo. (1999) Good Faith in Contract and Property Law. Hart Publishing.

Harper, Matthew. (2004) “The Implied Duty of Good Faith in Australian Contract Law.” Murdoch University Electronic Journal of Law vol. 11(3) Available online at: http://www.murdoch.edu.au/elaw/issues/v11n3/harper113.html Retrieved August 2, 2008

Merrill,  John, Houston; Williams, Charles and Johnson, Thomas. (1983) The American and English Encyclopedia of Law. E. Thompson.

New York State Consolidated Laws: Vehicle and Traffic

Peden, Elizabeth, Dr. (2001) “The Meaning of Contractual Good Faith.”  ADR 22, 235

Renard Contructions v Minister for Public Works [1992] 26 NSWLR 234

Restatement of Contracts Act 1981

Richbell Information Services Inc v Jupiter Partners LP 765 NYS 2d 575 (2003), 309 AD 2d 288 (2003

Sale of Goods Act 1923 (NSW)

Secured Income Real Estate (Australia) Ltd. v St. Martins Investment Pty Ltd (1979) 144 CLR 596

Uniform Commercial Code

Uniform Commercial Code, New York State Consolidated Laws

 

[1] Adams, John and Brownsword, Roger. (1995) Key Issues in Contract. Butterworths, 198 [2] Forte, Angelo. (1999) Good Faith in Contract and Property Law. Hart Publishing, 11. [3] Uniform Commercial Code, New York State Consolidated Laws, Cap. 38 [4] Merrill,  John, Houston; Williams, Charles and Johnson, Thomas. (1983) The American and English Encyclopedia of Law. E. Thompson, 1023. [5] CBA v Amadio [1983] 151 CLR [6] Peden, Elizabeth, Dr. (2001) “The Meaning of Contractual Good Faith.”  ADR 22, 235. [7] Summers, R.S. (1968) “Good Faith in General Contract Law and the Sales Provision of the Uniform Commerical Code.” Virginia Law Review, 54, 195. [8] Secured Income Real Estate (Australia) Ltd. v St. Martins Investment Pty Ltd (1979) 144 CLR 596 [9] Uniiform Commercial Code Section 1-203 [10] Uniform Commercial Code Section 1-201(19) [11] Restatement of Contracts Act 1981 Section 205 [12] Carvel Corp v Diversified Management Group Inc 930 F 2d 228 (2nd Cir, 1991) [13] Renard Contructions v Minister for Public Works [1992] 26 NSWLR 234 [14] Sale of Goods Act 1923 (NSW) Section 5(2) [15] Uniiform Commercial Code Section 1-203 [16] Burger King Corp v Hungary Jacks Pty Ltd [2001] NSWCA 187 [17] Richbell Information Services Inc v Jupiter Partners LP 765 NYS 2d 575 (2003), 309 AD 2d 288 (2003 [18] Harper, Matthew. (2004) “The Implied Duty of Good Faith in Australian Contract Law.” Murdoch University Electronic Journal of Law vol. 11(3) Available online at: http://www.murdoch.edu.au/elaw/issues/v11n3/harper113.html Retrieved August 2, 2008 [19] Harper, Matthew. (2004) “The Implied Duty of Good Faith in Australian Contract Law.” Murdoch University Electronic Journal of Law vol. 11(3) Available online at: http://www.murdoch.edu.au/elaw/issues/v11n3/harper113.html Retrieved August 2, 2008 [20] Merrill,  John, Houston; Williams, Charles and Johnson, Thomas. (1983) The American and English Encyclopedia of Law. E. Thompson, 1023 [21] Merrill,  John, Houston; Williams, Charles and Johnson, Thomas. (1983) The American and English Encyclopedia of Law. E. Thompson, 1023 [22] Merrill,  John, Houston; Williams, Charles and Johnson, Thomas. (1983) The American and English Encyclopedia of Law. E. Thompson, 1023 [23] Consumer Protection From Deceptive Acts and Practices General Business Law Section 349 [24] Consumer Protection From Deceptive Acts and Practices General Business Law Section 349 [25] Consumer Protection From Deceptive Acts and Practices General Business Law Section 350 [26] New York State Consolidated Laws: Vehicle and Traffic Section 417(a) [27] Carpenter v Carpenter 56 Hun (N.Y.) 647 cited in Merrill,  John, Houston; Williams, Charles and Johnson, Thomas. (1983) The American and English Encyclopedia of Law. E. Thompson, 1023 [28] Cathcart v Robinson (1831) 30 US 264 [29] Cathcart v Robinson (1831) 30 US 264 [30] Merrill,  John, Houston; Williams, Charles and Johnson, Thomas. (1983) The American and English Encyclopedia of Law. E. Thompson, 1027 [31] Merrill,  John, Houston; Williams, Charles and Johnson, Thomas. (1983) The American and English Encyclopedia of Law. E. Thompson, 1027 [32] Fair Trade Practices Act 1974 Section 2B [33] Director of Consumer Affairs Victoria v AAPT Ltd [2006] VCAT 1943 [34] Director of Consumer Affairs Victoria v AAPT Ltd [2006] VCAT 1943