Saturday, July 23, 2011

Good Faith in English Contract Law

Over the past few years, the traditional distinction between the common law and civilian notions of good faith in the law of contract has been blurred. However, instead of incorporating a general obligation of good faith in contract, English law has adopted a piece-meal approach, by accepting the obligation of good faith in insurance contracts, when fiduciary relationships are involved, when expressly provided (Berkeley Community Villages v Pullen), or statutorily through legislations like the Unfair Contract Terms Act 1977. A recent decision of the High Court in Astrazeneca v Albemarle appears to be another incidence of this approach, where Flaux J incorporates good faith into the interpretation of ‘right of first refusal’ clauses in contracts.

The Court was called on to interpret a right of first refusal which was contractually granted by Astrazeneca to Albemarle. The former was a pharmaceutical company, which sold an anaesthetic named ‘Diprivan’. One of the ingredients of this anaesthetic is propofol, which Astrazeneca manufactured itself, by distilling another ingredient DIP, which was supplied to it by Albemarle. However, the supply contract between Astrazeneca and Albermarle provided that if even Astrazeneca decided to cease distillation, and procure propofol directly, Albemarle would be granted the right of first refusal to supply the propofol. The relevant clause in the contract was:

H– Switch to Propofol

In the event that at any time BUYER reformulates or otherwise changes its Diprivan brand to substitute propofol for the PRODUCT, BUYER will so notify SELLER and will give SELLER the first opportunity and right of first refusal to supply propofol to BUYER under mutually acceptable terms and conditions.

Subsequently, Astrazeneca decided to go ahead with procuring propofol from a third company, Sochinaz, which led to litigation between the parties. While the judgment of the Court is lengthy and deals with several issues, the relevant portions for the purposes of this discussion is only from ¶¶ 1-65. There were three issues before Flaux J:

What is the meaning of ‘first opportunity and right of first refusal’?

What degree of flexibility does ‘under mutually acceptable terms and conditions’ allow Astrazeneca?

At what time can such a right of first refusal be said to have been breached?

Flaux J, based on a review of prior precedent, which constituted only four previous decisions of the English High Court, concluded that such a clause could not be said to be void on grounds of uncertainty, and conferred a clear right on Albamerle. Also, the right of first refusal meant that the grantor of the right was under an obligation, when desirous of entering into a contract with a third party, to make an offer to the grantee on terms which the grantor would be willing to accept. This meant that the essence of the ‘deal’ which the grantor was willing to enter into with the third party should be communicated to the grantee, and the grantee should be provided the opportunity to negotiate on the basis of the same ‘deal’. Further, once these negotiations commenced, the grantor had an obligation to carry on these negotiations in good faith. Thus, Flaux J provided for good faith to operate at two stages, albeit having a bit of an overlap, are nevertheless distinct. First, the grantor must convey the deal it was willing to accept to the grantee. The terms of the deal need not be spelled out, especially in cases like the present, where the relevant clause expressly provided for ‘mutually acceptable terms and conditions’ to be arrived at subsequently. However, once this deal was communicated, the grantor also has an obligation to continue the negotiations in good faith. As to the third issue outlined above, on facts, due to procedural and regulatory reasons, there would be a lapse of between eighteen months and three years between the deal with a third party, and the final conclusion of a contract after the procurement of the necessary licenses. In such a case, Flaux J held that the obligation to make an offer to Albamerle (or to provide them an opportunity to make an acceptable offer, as was the case here) arose when the deal with Sochinaz was agreed in principle, and not when the final contract was concluded.

What is most important about this decision, which appears eminently reasonable and not particularly remarkable, is that Flaux J bases Albamerle contractual rights entirely on the meaning of ‘the right of first refusal’ in English common law, starting from the decision of Brightman J in Smith v Morgan, and ending with Park J’s supplemental judgment in QR Sciences v BTG International. This is a clear indication that the very right of first refusal has a stand-alone meaning at common law, which presumably would apply to every contract, unless otherwise expressed by the parties. What Flaux J’s review of precedent also makes clear is that there is no general principle of good faith negotiation in English contract law, with the cases relied on dealing only with rights of first refusal. Thus, this is another instance of the incremental approach which English law has adopted to good faith in the law of contract.

3 comments:

Renganath said...

Analytical, succinct, and useful, as always.

vswami said...

“What degree of flexibility does ‘under mutually acceptable terms and conditions’ allow Astrazeneca?”
So far as one (especially, if endowed just with a mere average intelligence/legal acumen) could see, the second question does not seem to have been so clearly answered as to provide sufficient and useful ‘judicial guidance’; much less, for anyone to decide as to how to proceed/what course of action is to NECESSARILY FOLLOW/BE FOLLOWED, in the QUITE LIKELY event of, even after ‘NEGOTIATIONS IN GOOD FAITH’ (whatever that were CONSIDERED TO MEAN /IMPLY), the parties do not succeed in arriving at ‘mutually acceptable terms and conditions’ as envisaged.

It is hoped, law experts will be in a better position to elucidate /dilate, for the mutual benefit of their fraternity!

Shantanu Naravane said...

Thank you for your comments.
Mr Swami, I am not sure I agree that the judgement is lacking in judicial guidance, particularly in light of para. 44, where Flaux J holds that "...a right of first refusal constitutes a right to receive a contractual offer on terms which the party who has granted the right of first refusal is prepared to accept, even though the detailed terms of any contract may require further negotiation and might ultimately not eventuate in a contract at all". This makes it clear that if the parties negotiate in good faith, and still do not arrive at mutually acceptable terms and conditions, no contractual breach occurs, and no cause of action arises.