New Perspectives on Good Faith in Contractual Negotiation

While common law jurisdictions such as England, the US, Australia and Canada are divided with respect to whether there is a general duty of good faith that governs the performance of contracts (and, if so, whether that duty is rooted in the parties’ intentions or in a broader organizing principle), scholars and courts in these jurisdictions are largely agreed that in the absence of an express agreement to negotiate in good faith no such duty exists in the negotiation context.  Developments in Canada make clear that this perspective needs to be revisited. The Supreme Court of Canada’s decision in 2014 to affirm that there is a duty of honest performance in Canadian contract law has important implications for the context in which many commercial transactions get negotiated. Good faith obligations will now arise in Canada not only with respect to the performance of commercial agreements but also during any negotiations where early-stage agreements are put in place to facilitate and constrain the negotiation process.  This is because early-stage agreements are very often part of a process in which a negotiating relationship emerges that is not ‘pre-contractual’ but is instead structured in part through contractual commitments. They can therefore create a context in which questions about good faith and the duty of honest performance become highly relevant.

Recent developments in Canada reveal that common law jurisdictions need to move beyond the paradigm that has dominated discussion about good faith obligations in contract law, one which: (i) assumes that a clear distinction can be drawn between a pre-contractual (and therefore non-binding) stage in a commercial relationship and a post-contractual stage in which parties are subject to the binding provisions of a definitive agreement;  and (ii) views the question whether there is a duty to negotiate in good faith as typically arising in a pre-contractual setting. It is therefore important to delineate and assess the nature of specific good faith obligations that can arise when the negotiation process has a contractual dimension—and this even if there is no contractual language committing the parties to negotiate in good faith. My paper seeks to do just that with respect to obligations that can arise under three fundamental early-stage agreements that get put in place in many mergers and acquisitions (M&A) transactions: confidentiality, standstill and exclusivity agreements.

My article digs into the question of why these kinds of early-stage agreements get put in place as negotiations unfold. Agreements of this kind give rise to a matrix of reciprocal legal relationships designed to protect a series of interests that often become increasingly intertwined as the negotiation process unfolds. This creates a context in which questions about good faith behaviour can easily arise.   As each of these early-stage agreements is put in place, the relationship between the parties is legally reinforced and questions concerning whether the parties are acting in good faith will become that much more relevant. Rather than cling to a paradigm that is not well suited to exploring negotiations that have a contractual dimension, we need to adjust the paradigm and examine the nature of good faith obligations that can arise during a negotiation process that is in part structured through early-stage agreements.

The article examines case law dealing with confidentiality, standstill and exclusivity agreements that predate recent Supreme Court of Canada decisions on good faith, including both Canadian case law that has influenced the Delaware Court of Chancery’s understanding of the obligations that agreements of this kind can give rise to, and cases from Delaware and England that are relevant to the context in which Canadian courts must analyze these agreements. The article emphasizes that, while courts in Canada will still need to consider what Canadian case law has to say about the purpose of a given early-stage agreement, just as they will still have to look at the parties’ intentions, they must now also contend with questions about the implications of the duty of honest performance. The article works through some of the practical implications of this new perspective for a range of scenarios involving confidentiality, standstill and exclusivity agreements.

Having to think about a counterparty’s interests, and being subject to an obligation not to mislead, deceive or lie to that counterparty, therefore injects new normative perspectives into an analysis of early-stage agreements that must be considered when assessing negotiation strategies.  Importantly, this is a process that will put pressure on parties and their advisors to consider whether those strategies are consistent with a genuine commitment to the integrity of the negotiation process.

Robert M. Yalden is the Stephen Sigurdson Professor in Corporate Law & Finance at Queen’s University.