Court considers implied duty of good faith in termination for convenience clauses

A recent decision by the Western Australian Court of Appeal has considered the operation of termination for convenience clauses and whether there is an implied duty of good faith when terminating for convenience.

In Trans Petroleum (Aust) Pty Ltd v White Gum Petroleum Pty Ltd [2012] WASCA 165, the Court held that a general, unfettered and express power to terminate a contract was not subject to a duty of good faith.

Background

Australian courts have indicated that a duty of good faith may be implied into a contract to restrict the performance of contractual obligations or the exercise of contractual rights in certain circumstances. However, the courts have not universally accepted the need to imply a duty of good faith in commercial contracts and the issue remains unsettled in Australia.

A clause that grants general and unrestricted rights to terminate a contract is known as a termination ‘at will’ or ‘for convenience’ clause. It is sometimes claimed that the exercise of such a right is not unrestricted but is subject to a duty to act in good faith.

The case

White Gum leased a site from Trans Petroleum on which there was a service station and convenience store. The parties also entered into a non-exclusive licence agreement permitting Trans Petroleum to operate a convenience store and sell White Gum’s petroleum products from the site. Clause 3 of the licence agreement stated that:
'The Term, unless terminated as provided for in clause 14 of this Deed, shall continue from month to month with either party entitled to terminate this Deed upon two (2) months’ written notice to the other.'

Shortly after execution of the agreements, the sole shareholder of White Gum sold his shares to another company that used a different licensing system. A decision was made to phase out use of the previous system and install the new one. The parties failed to negotiate a new franchise agreement and White Gum issued a notice terminating the licence agreement.

Trans Petroleum commenced legal proceedings seeking a declaration that the termination notice was invalid. It argued that the power of termination under clause 3 was subject to an implied duty to act in good faith, which meant that White Gum could only terminate the agreement for a proper purpose, honestly and not capriciously or arbitrarily.

Trans Petroleum claimed that White Gum had breached that duty by terminating the agreement for the purpose of avoiding a daily fee cap of 12 per cent of gross sales.

The Court rejected Trans Petroleum’s argument that the right of termination in clause 3 was subject to an implied duty of good faith because such a duty would be inconsistent with the commercial bargain that the parties had struck. The right of termination clearly contemplated that either party could terminate the agreement for any reason without regard to the rights and interests of the other party.

What this means for your agency

The case is not binding on Queensland courts, but it may have significant influence on their decisions.

Government bodies should be wary of entering into contracts that grant the other party a right to terminate at will or for convenience because a court may not imply any restrictions on that right.

On the other hand, if a government body can negotiate a contractual right to terminate at will or for convenience, then it would appear that the right may be exercised without regard to an implied duty of good faith.

However, a recent decision of the New South Wales Supreme Court indicates that a court may be more willing to imply a term of reasonableness and good faith where the government is a contracting party (see NSW Rifle Association Inc v The Commonwealth of Australia [2012] NSWSC 818). That case did not involve a termination for convenience clause.

It would be prudent to assume that a duty of good faith may be implied in relation to a government party, including in relation to restricted rights of termination. Unless a right to terminate at will or for convenience is general, unfettered and express, there is still a risk that a duty of good faith may be implied.

^{The information in this publication is provided for general purposes only. It is not to be relied on as a substitute for legal advice. Crown Law and the Department of Justice and Attorney-General accept no liability for losses caused by reliance on the material in this publication. Formal legal advice should be obtained for particular matters.}