Principle of Good Faith in Contract Law

The Principle of Good Faith in Contract Law

European Contract Law

German law

There are considerable differences in European attitudes towards good faith as a legal principle. This is most graphically illustrated if one compares German law with the common law of England. Section 242 of the German Civil Code provides that the obligor must perform his duty in accordance with the requirements of good faith and fair dealing. This provision is the kingpin, as it were, of the German law of contract Civil Code. It has been used in all areas of German law as an overriding moral imperative and has influenced the interpretation of other statutory provisions as well as tempering the rigorous individualism of the original contract law of the Civil Code. It has been used as a device for adapting the law to changes in social and moral standards.

The principle has operated in many fields of the law; it governs the interpretation of contracts and gives relief to a party in case of changed circumstances. On the basis of section 242, the German courts have set aside unfair contract terms, and the provision has given rise to a number of contractual obligations to observe the principles of fair play, such as a duty to cooperate, to look after the other party’s interests, to provide information and to submit accounts. Other examples are forfeiture and abuse of rights, which may take many forms. Some such forms are expressed in the formula “Dolo facit qui petit quod statim redditurus est”, the rule which lays down that a party may not rely on a form of behaviour which is inconsistent with his own earlier conduct or impose penalties that are disproportionate to the extent of the breach by the other party. The principle of good faith is also enshrined in the other European legal codes but, apart from the Netherlands, no country has assigned to it the status it is accorded in Germany.

Common Law

Common law, by contrast, does not recognise any general obligation to act in accordance with good faith and fair dealing. English courts have held an obligor to a contractual undertaking even though the obligee had no good reason to insist on performance. Furthermore, English law does not, in general, recognise unreasonableness and unfairness as grounds for the invalidity of contract terms. This rather rigorous approach adopted by English law towards observance of contractual obligations has been explained by reference to the need for predictability. It is necessary in a commercial setting that businessmen should know where they stand. Vague concepts of fairness that are liable to make judicial decisions unpredictable are to be avoided. However, we must not overlook the fact that common law often applies specific rules, which are becoming more and more numerous, to obtain the same results that other legal systems achieve with the aid of the general good-faith clause.

In the Principles of European Contract Law (PECL)

The Principles of European Contract Law also operate with a general good-faith clause. Article 1:201 of the Principles of European Contract Law expressly states that each party “must act in accordance with good faith and fair dealing”. Practical applications of this rule appear in several provisions of the Principles of European Contract Law. The concept, however, is broader than any of these specific applications. The purpose of the good-faith clause is to enforce Community-wide standards of decency, fairness and reasonableness in commercial transactions. It ultimately takes precedence over specific Principles. So even though Article 8:103(a) of the Principles of European Contract Law states that strict compliance with obligations is of the essence of a contract, a party would not be permitted to terminate because of a trivial breach of obligation. The text reads as follows: “A non-performance of an obligation is fundamental to the contract if: (a) strict compliance with the obligation is of the essence of the contract; or (b) the non-performance substantially deprives the aggrieved party of what it was entitled to expect under the contract, unless the other party did not foresee and could not reasonably have foreseen that result; or (c) the non-performance is intentional and gives the aggrieved party reason to believe that it cannot rely on the other party’s future performance.”

“Good faith” means an honest and fair attitude of mind. It is contrary to good faith to pursue a remedy for no reason but to harm the other party. It is an objective test, designed to ensure that each party shows due regard for the other’s interests. Good faith is to be presumed. Where bad faith is alleged, the onus of proof is on the accusing party. The purpose of the principle of good faith is to strike a balance between law and equity. A law or contractual condition which is normally valid may sometimes lead to an inequitable result. There is no general rule as to whether law or equity should take precedence. It all depends on the circumstances of the individual case. Thus, strict compliance with the terms of a contract may be of the essence when the obligor knows that those of the obligee’s employees who are entrusted with the control of the obligor’s performance are able to see whether there is strict compliance or not but unable to judge the gravity of any deviation, however slight, from the terms of the contract. In such a case, the law takes precedence over equity.

Source: Ole Lando, European Parliament

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