Introduction

In Strzelecki Holdings Pty Ltd v Cable Sands Pty Ltdthe West Australian Court of Appeal has clarified the current meaning of negotiating in “good faith”. It is not uncommon for parties considering entering into a significant commercial enterprise to initially agree a Memorandum of Understanding (“MOU”) on the basis that the MOU attempts to lock in the deal before they agree on all the terms.

Frequently, an MOU will contain an express term requiring the parties to negotiate in good faith to finalise the deal.

The Background

Cable had completed its mining of mineral sands from a 120 hectare site near Capel in WA. At a business lunch, Strzelecki held discussions with Cable and others about purchasing the site for a residential housing estate. The group openly discussed the major problem with the site: about 230,000 tonnes of radioactive tailings from the mine. They discussed burying the tailings at a possible cost of $1-$1.5m or removing them from the site at a possible cost of $4-$6m. It was agreed that Cable had expertise to deal with this issue while Strzelecki had development expertise.

In the month after the meeting, the parties entered into an MOU under which Cable was to provide a report on dealing with the radioactive tailings and Strzelecki would then produce a feasibility study on the residential development. The parties were to then negotiate in good faith over the terms of a contract for sale of the land to Strzelecki for the sum of $3.2m.

Cable discovered it would cost $7m to deal with the tailings and initially came back saying there was no point in providing the report and they may as well terminate the MOU. The cheaper options discussed at the lunch were not possible. Strzelecki was not deterred and requested the report. When the report was provided it did not include costings. Strzelecki produced its feasibility study which showed that the project could result in about $5m profit from 250 housing lots. Strzelecki complained about Cable’s report being inadequate and Cable produced an addendum saying it would cost $9m to treat the radioactive tailings.

Strzelecki was still not deterred and the parties began to negotiate the final contract. Cable then said it was not sure that it wanted to treat the tailings itself. Strzelecki offered to contract a third party to do the work. The parties began to negotiate the contract of sale. The indemnity and $25m guarantee Cable asked for a special condition to be included; an indemnity from Strzelecki in favour of Cable against any claims by future residents in the estate. Cable asked for the indemnity to be secured by an unconditional $25m bank guarantee.

Strzelecki said to ask for the indemnity was a breach of the obligation to negotiate in good faith. It said no reasonable person would ask for such an indemnity as it would clearly make the whole deal uncommercial.

Strzelecki goes to Court

Strzelecki issued proceedings to enforce the MOU. It sought specific performance of the MOU or damages for loss of profit. Its claims were dismissed by the Supreme Court. Strzelecki appealed to the Court of Appeal in relation to the obligation to negotiate in good faith.

The obligation to negotiate in good faith

Although in this case the term was written in the MOU, recent case law suggests that there may be an implied obligation to use good faith in carrying out one’s obligations under many contracts.

In 1997 former Chief Justice of the High Court of Australia, Sir Anthony Mason, said that the obligation to negotiate in good faith probably includes three obligations:

1. an obligation on the parties to cooperate in achieving the contractual objects (loyalty to the promise itself);

2. compliance with honest standards of conduct; and

3. compliance with standards of conduct which are reasonable having regard to the interests of the parties.

Strzelecki said Cable had breached the third of these propositions.

The decision on appeal

The Court examined carefully the factual matrix. Importantly, both parties agreed that each had been honest in their dealings. It was said by Strzelekci that the insistence on the indemnity and $25m guarantee was unreasonable in the context of a deal that involved a profit of a fraction of that amount. The Court was not convinced by this point because the indemnity would not have been called upon if no claims had been made.

On a factual level, the realisation after the lunch that it was more difficult than envisaged to dispose of the radioactive tailings making it difficult to criticise Cable for their concerns about potential exposure to a future law suit. Cable said that the $25m indemnity covered only a possible $1m claim by 10% of the future land owners.

The Court discussed the three propositions of Sir Anthony and the various cases that have considered them. The Court noted that Sir Anthony, when first presenting the threefold analysis had added that, he would use good faith mainly in the sense of loyalty to the promise itself and as excluding bad faith behaviour.

The Court referred to a 2002 NSW Supreme Court decision where Justice Barrett said that it is necessary to inquire about the extent to which selflessness is required. He added:

“It must be accepted that the party subject to the [good faith] obligation is not required to subordinate the party’s own interests, so long as pursuit of those interests does not entail unreasonable interference with the enjoyment of a benefit conferred by the express contractual terms so that the enjoyment becomes (or could become) … ‘nugatory, worthless or, perhaps, seriously undermined’”2

In another case, United Group Rail Services Ltd v Rail Corporation of New South Wales3, the Court said the phrase “good faith” does not import any notion or requirement to act in the interests of the other party to the contract.

In relation to Sir Anthony’s third proposition, the Court in Strzelecki said that it is not appropriate to analyse a party’s compliance with the obligation to negotiate in good faith by reference to the interests of the other party. Negotiation in good faith does not require a party to abandon its own commercial interests.

What is required is a willingness to continue to negotiate. Cable had exhibited that willingness in its putting forward of a commercial proposal. The rejection of that proposal by Strzelecki without responding by putting a counteroffer may itself have been without good faith.

Conclusion

It is difficult to successfully claim that a party has breached their obligation to negotiate in good faith in Australia. Provided a party continues to negotiate and to at least listen to what the other party has to say, it would seem an obligation that has little substance. Subject to this proviso, it would be a rare set of circumstances that resulted in a Court awarding damages for a claimed breach of the obligation.

It is clear that the obligation to negotiate in good faith does not require a party to abandon or subjugate its own commercial interests.

Contributor: Tom Grace

1 [2010] WASCA 222
2 Overlook Management v Foxtel Management [2002] NSWSC 17
3 (2009) 74 NSWLR 618