Do you have to negotiate in “good faith” before you can sue?

Picture this: you’ve fallen out with your commercial partners, and you would rather do anything but speak to them ever again. Sound unpleasantly familiar? Worse than this, you pick up the phone to your lawyers and they say, “Well, you see, there’s an obligation in the contract to pursue good faith negotiations before you can sue …”

Are the lawyers right and do you have to negotiate in good faith? Yes, you do, but even if you don’t want to, there may still be good reason to do so. In this article, our commercial disputes partner Nick Scott outlines your options if your commercial contract requires you to negotiate in good faith before you can take legal action.

How does this arise?

It’s pretty common in commercial contracts to now see, in the dispute resolution section, words to the effect of “… the parties shall first seek to resolve the dispute or claim by good faith negotiation. If the parties are unable to reach agreement within [x] working days, then at any time after the expiry of such period any party may, by written notice to the other require the disputed matters to be referred to [litigation/arbitration]” or some variation of this.

Are you now stuck with something completely unnecessary or have you, perhaps unwittingly, put in place a really helpful commercial break?

Is negotiation necessary?

Good faith negotiation obligations in commercial contracts are, in principle, enforceable and especially so where there is an agreed period for which you have to negotiate in “good faith”.

Two points arise here: how long do you have to negotiate for and what does “good faith” mean.

1. How long for and to what extent?

Say, for example, the commercial contract stipulates that negotiations must be pursued for “20 working days” before you can commence litigation or arbitration, this would not require the parties to lock themselves away from the world and devote themselves 24/7 to the negotiations for the better part of a month. Rather, it requires that negotiations of some reasonable extent, pursued in “good faith”, occur during that time period.

2. What does “good faith” mean?

There isn’t a settled definition of “good faith” in English contract law; rather, there is guidance in the cases to the effect that acting in “good faith” means (i) acting towards your counterparty in a way that is commercially acceptable to reasonable and honest people, and (ii) not acting in bad faith towards your counterparty.

Bad faith appears to mean conduct that reasonable and honest people would regard as commercially unacceptable, but not necessarily dishonest.

What if I don’t want to negotiate?

If you formed the view that negotiating in good faith for the agreed period was a waste of time because your counterparty was unlikely to engage in a similar vein, could you or should you just not engage in those negotiations? What are the consequences of not complying with your obligations? You can be ordered by the court to take part in those negotiations, but only if your counterparty seeks an injunction, which may be more or less likely, depending on the significance and value of the contract. The more common answer is probably that there might be costs sanctions against you in whatever form of formal dispute resolution process you end up in (e.g. litigation or arbitration), so it is certainly not risk-free or advisable to ignore these obligations, even if your counterparty does not seek an injunction to compel you to negotiate.

Still not convinced?

If you’re not convinced that you either have to negotiate or that the consequences of breaching such an obligation don’t seem so terrible in the round, what then? The “good faith” negotiation provisions in the commercial contract, regardless of what their precise scope may be in any given case, ought to be viewed, in all cases, as an opportunity for risk management, by compelling the parties to think about and discuss what an acceptable commercial resolution might look like at that point in time. If the parties are then able to decide that they want to resolve their dispute, but don’t know exactly how, there are a range of facilitated alternative dispute resolution processes (e.g. mediation or early neutral evaluation) that can be used to help try to best manage the risk of a dispute spiralling into something much larger, time-consuming and expensive.

If you have questions about a commercial dispute, please contact Nick Scott.