Federal Court Adopts Notion of Good Faith in Commercial Contracts

One of the leave questions in the recent Federal Court case of Lai Fee & Anor v Wong Yu Vee & Ors [2023] 1 LNS 387 was worded as follows:

Is the position by Lord Kerr in paragraph of the grounds in the English Supreme Court case Takhar v. Gracefield Developments Ltd and Others [2019] UKSC 13, namely, “… that the law does not expect people to arrange their affairs on the basis that other people may commit fraud” representative of the position of Malaysian law?

The Federal Court opined that the leave question was related to the notion of good faith in contracts. The Federal Court then embarked on an extensive discussion regarding the jurisprudence in the United Kingdom, Canada, and domestically, in Malaysia.

Ultimately, the Federal Court held that the notion of good faith applies in Malaysia, and the duty extends not only to the performance of a contract but also to its creation. The Federal Court drew support from the requirement of free consent under the Contracts Act 1950 (“CA 1950“), which in essence underscores the notion of good faith.

In the upshot, the English position as canvassed above was held to be consistent with Malaysian law. Hence, the Federal Court answered the leave question affirmatively.

Background Facts

There was an agreement for the Defendants to take over the shares of a partnership firm from the Plaintiffs. Upon the execution of the agreement, the Plaintiffs relinquished their shares, and the Defendants registered themselves as the new partners.

Two companies acted as corporate vehicles to complete the sale transaction. Centennial Asia Sdn Bhd (”Centennial”) was the purchaser under the agreement, and Westhill Equity Sdn Bhd (”Westhill”) made the necessary payments.

Under the agreement, payment was structured to be made in three tranches. However, Westhill, after having paid the initial two tranches, failed to settle the final tranche.

The Plaintiffs filed an action against Centennial to pay the final tranche of the purchase price, and a judgment was obtained. There was no appeal against the judgment.

Then, the Plaintiffs commenced the fraudulent trading action against the Defendants, alleging that the Defendants had structured the agreement in a way that would undermine the Plaintiffs’ claim. In response, the Defendants argued that the Plaintiffs were aware of Centennial’s financial status but failed to raise any complaint, objection, or question.

Both the High Court and the Court of Appeal held that the Plaintiffs had themselves to blame for failing to verify Centennial’s ability to pay the balance purchase price.

Findings of the Federal Court

The Plaintiffs should not be faulted as they have acted in honesty and good faith. Conversely, the Defendants were guilty of fraudulent trading because:-

  • the Defendants fraudulently induced the Plaintiffs’ consent to enter into the agreement;
  • the Defendants fraudulently induced the Plaintiffs to immediately part with the latter’s interests upon execution of the agreement; and
  • the Defendants attempted to insulate themselves against any obligations and liabilities under the agreement through the corporate vehicles.

English Law

Under English law, there is generally no requirement to act in good faith. Non-disclosure, however dishonest it may seem, does not constitute misrepresentation. The law only requires parties to act in good faith in limited circumstances. These are known as uberrimae fidei contracts, for example:-

  • contracts to take up shares in a company;
  • insurance contracts;
  • family settlements; and
  • partnership agreements.

However, the position under the English law is not uncontroverted and was challenged in two notable cases: Yam Seng Pte Ltd v. International Trade Corp Ltd [2013] EWHC 111 (QB), a decision of the English High Court, and Bhasin v. Hrynew [2014] SCC 71, a decision of the Supreme Court of Canada.

Yam Seng Pte Ltd v. International Trade Corp Ltd

In Yam Seng, the Court doubted whether English Law would recognise the requirement of good faith in commercial contracts as a default rule. Nonetheless, such a requirement of good faith can be implied, provided that two conditions are met:-

  • the term is so obvious that it goes without saying; and
  • the term is necessary to give business efficacy to the contract.

Notably, his lordship held that the expectation of honesty, even if not explicitly spelt out, can be a business norm depending on the nature of the agreement.

Further down in its judgment, The Federal Court also discussed the following cases that were decided post Yam Seng:

  • In Pakistan International Airline Corporation (Respondent) v. Times Travel (UK) Ltd (Appellant) [2021] UKSC 40, the Supreme Court affirmed the principle that English Law seeks to protect the reasonable expectations of honest people when they enter into contracts. However, it was held that English law does not recognise a general principle of good faith in contracting.
  • In Candey v. Bosheh & Anor [2022] EWCA Civ 1103, the Court of Appeal opined that a solicitor’s retainer did not impose an obligation of good faith on the client. Neither could the obligation of good faith be implied, as it did not fulfil the test similarly elucidated above in Yam Seng.
  • In Mark Faulkner & Others v. Vollin Holdings Ltd & Others [2022] EWCA Civ 1371, the Court held that duty of good faith can be derived by scrutinising other contract terms.

Canadian Law

The Federal Court went on to discuss the Canadian case of Bhasin v. Hrynew [2014] SCC 71, which opined that the common law duty imposes an obligation to act honestly in the performance of contractual obligations.

The Federal Court also discussed other Canadian Supreme Court cases which endorsed Bhasin:

  • In C.M. Callow Inc v. Zollinger [2020] SCC 45, the Supreme Court expanded the duty of good faith propounded in Bhasin and held that silence that misleads can amount to a breach.
  • In Wastech Services Ltd v. Greater Vancouver Sewerage and Drainage District [2021] SCC 7, the Supreme Court held that contractual discretion must be exercised in good faith. The exercise of discretion must align with the purpose for which such discretion is provided under the contract.

Malaysian Law

The element of free consent is pertinent to the formation of a valid contract (Section 10 of the CA 1950). Without free consent, the contract will be rendered voidable.

Free consent will be vitiated if there is coercion, undue influence, fraud, misrepresentation, or mistake (Section 14 of the CA 1950). The Federal Court observed that these vitiating factors denote the absence of good faith. On this basis, the Federal Court opined that the element of good faith underpins every contract.

Furthermore, free consent is consistent with the principle in the Supreme Court case of Takhar v Gracefield Developments Ltd and Others [2019] UKSC 13 that “…the law does not expect people to arrange their affairs on the basis that other people may commit fraud”.

The Federal Court also referred to the case of CIMB Bank Bhd v Maybank Trustee Bhd [2014] 3 MLJ 169 and HIH Casualty and General Insurance Ltd v Chase Manhattan Bank [2003] 1 All ER (Comm) 349 to support the proposition that there can be a common assumption of honesty and good faith in contractual arrangements.

In arriving at the decision, the Federal Court also noted that the English and Canadian cases were primarily concerned with the performance of contracts in good faith. The cases did not address the duty of good faith in the creation of contracts. Nonetheless, the Federal Court held that the notion of good faith applies to both situations.

Key Takeaways

The Federal Court clarified that the notion of good faith applies to contracts in Malaysia, which extends to their formation and performance. This stands in stark contrast to English law, which generally does not recognise an obligation of good faith.

Grounded on this basis, the Federal Court embraced the English position that “… the law does not expect people to arrange their affairs on the basis that other people may commit fraud“. Consequently, while the legal positions in both countries may appear analogous, the underlying foundation with respect to the notion of good faith evinces a distinct divergence.

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