“Bad Faith” Negotiation

A party is free to negotiate and is not liable for failure to reach an agreement. However, a party who negotiates or breaks off negotiations in bad faith is liable for the losses caused to the other party. It is bad faith, in particular, for a party to enter into or continue negotiations when intending not to reach an agreement with the other party. As a rule, parties are not only free to decide when and with whom to enter into negotiations with a view to concluding a contract, but also if, how and for how long to proceed with their efforts to reach an agreement. This follows from the basic principle … of freedom of contract enunciated in Art. 1.1, and is essential in order to guarantee healthy competition among business people engaged in international trade.

Liability for negotiating in bad faith

A party’s right freely to enter into negotiations and to decide on the terms to be negotiated is, however, not unlimited, and must not conflict with the principle of good faith and fair dealing laid down in Art. 1.7. One particular instance of negotiating in bad faith which is expressly indicated in para. (3) of this article is that where a party enters into negotiations or continues to negotiate without any intention of concluding an agreement with the other party. Other instances are where one party has deliberately or by negligence misled the other party as to the nature or terms of the proposed contract, either by actually misrepresenting facts, or by not disclosing facts which, given the nature of the parties and/or the contract, should have been disclosed. As to the duty of confidentiality, see Art. 2.16.

A party’s liability for negotiating in bad faith is limited to the losses caused to the other party (para. (2)). In other words, the aggrieved party may recover the expenses incurred in the negotiations and may also be compensated for the lost opportunity to conclude another contract with a third person (so-called reliance or negative interest), but may generally not recover the profit which would have resulted had the original contract been concluded (so-called expectation or positive interest).

Liability for breaking off negotiations in bad faith

The right to break off negotiations also is subject to the principle of good faith and fair dealing. Once an offer has been made, it may be revoked only within the limits provided for in Art. 2.4. Yet even before this stage is reached, or in a negotiation process with no ascertainable sequence of offer and acceptance, a party may no longer be free to break off negotiations abruptly and without justification. When such a point of no return is reached depends of course on the circumstances of the case, in particular the extent to which the other party, as a result of the conduct of the first party, had reason to rely on the positive outcome of the negotiations, and on the number of issues relating to the future contract on which the parties have already reached agreement.


Good faith in mediation

Good faith in mediation, notes Lande, “is like mom and apple pie—it’s hard to be against them. . . Many people think that they know bad faith when they see it. They “know” that bad faith in mediation is when one side—the other side—refuses to make a new offer or what they view as a “reasonable” offer. This conduct clearly grieves some litigants, lawyers, and judges who would like the courts to sanction the alleged offenders.

In virtually all the final reported opinions on this issue, however, the courts have decided that this conduct is not sanctionable bad faith. The courts have decided that it would be inappropriate to sanction this behavior, which is impossible to adjudicate without evidence about communications in mediation and the participants’ state of mind.

Even proponents of good faith rules recognize that judicial second-guessing of participants’ states of mind would be an inappropriate judicial encroachment into the mediation process. As a result, the judicial interpretation of “good faith” has come to mean attendance at mediation (possibly with a representative having “sufficient” negotiation authority) and submission of any required premediation materials.

The result is that the good faith rules do not prohibit what people think of as bad faith.

“Bad Faith” Negotiation Strategies and Tactics

In our recent survey (with 78 responses) participants were asked to identify which of several acts constituted bad faith negotiation practices or strategies:

Those that garnered the most votes were parties lying about facts important to resolution (65.83%) — which would likely constitute grounds for rescinding any deal reached by the parties due to fraud — and a refusal to compromise “without good reason” (59.76%). Withholding information important to obtaining a “fair” deal garnered less than half but nevertheless a substantial number — 40.51% — of the “votes.” Again, this type of behavior could well constitute fraudulent concealment and is subject to its own set of sanctions — rescission and damages. **

Refusing to compromise with good reason (4.5%) however, and not compromising “enough” (3.4%)received so few votes that we must conclude our survey respondents accept these activities as perfectly appropriate when parties are attempting to negotiate settlement, whether in a mediation or outside of it.


Good faith in negotiations

Good faith is an exceedingly controversial concept both judicially and academically. Yet ironically, it is this doctrine that forms the underlying rationale for numerous other entrenched legal principles. These include misrepresentation, waiver, estoppel and forfeiture. This article will examine the scope of a party’s duty to negotiate or bargain in good faith. It is a duty consisting of two obligations. The first is to act “in good faith” and the second is the obligation to bargain.’ The former is negative in content as it prohibits certain forms of bargaining behavior. The latter is positive in nature because it requires the parties to negotiate with a view to the actual conclusion of an agreement.

The Concept of Good Faith

The cagey attitude that the Canadian academic and judicial communities frequently display towards “good faith” seems to suggest that it is some novel concept to which they both must reconcile themselves. Nothing could be further from the truth. One of themodern roots of the good faith doctrine comes from Lord Atkinson’s dicta in New Zealand Shipping Co. v. Societe des Ateliers and Chantiers de France in which he held that, “…a person shall not be permitted to take advantage of his own wrong.” However, the concept of “good faith” is actually far more entrenched in history than this. The doctrine has been traced back to the Romans who summarized the concept with the expression “pacta sunt servanda” or, “what is so suitable to the good of mankind as to observe those things that parties have agreed upon.”

The fall of the Roman Empire and the rise of Christianity further refined the notion of good faith as a legal obligation. This was primarily done through the ecclesiastical courts who asserted jurisdiction over contractual disputes by arguing that good faith was a test of the sanctity of contractual obligations. Religion is only one aspect in the history of good faith. The rise of the merchant class during the 1I th and 12th centuries was even more influential to the evolution of the doctrine. Commercial necessity required that good faith as a contractual relationship be honored and enforced.

The term “in good faith” is commonly used, but its familiarity does not necessarily make it easy to define, or practice, or enforce. Authors David Bristow and Reva Seth explore the roots of this principle, as well as its evolution, particularly as it applies to negotiation and bargaining. They use the Canadian experience, citing several cases, as the context for their examination. They note that Canadian courts are slowly moving toward an acceptance of the duty to negotiate in good faith as a minimal standard of behavior.

The term “in good faith” is commonly used, but its familiarity does not necessarily make it easy to define, or practice, or enforce. Authors David Bristow and Reva Seth explore the roots of this principle, as well as its evolution, particularly as it applies to negotiation and bargaining. They use the Canadian experience, citing several cases, as the context for their examination. They note that Canadian courts are slowly moving toward an acceptance of the duty to negotiate in good faith as a minimal standard of behavior.

Unlike its ambiguous status in Canada, good faith is a cornerstone concept in the legal systems of many European countries. This is particularly true for nations such as France, Germany, Italy, and Switzerland.2 Even the United States seems to have embraced the concept of good faith with greater ease than Canada. For instance, an explicit good faith and fair dealings requirement has been a part of American sales law for years.3 Specifically, Article 2 of the Uniform Commercial Code establishes a general obligation of good faith. An expanded version of this requirement can be found in section 205 of the Restatement of Contracts.4 Section 205 of the Restatement declares that: “Every contract imposes upon each party a duty of good faith and fair dealings in its performance and enforcement.”5

Definition of Good Faith

Defining what the concept of good faith actually encompasses is an exercise that frequently proves to be frustratingly circular. Commentators have even gone so far as to suggest that the infamous U.S. Supreme Court obscenity test of, “…I will know it when I see it” be used.6 In her article, “Good Faith in Contractual Performance,” O’Bryne argues that attempts to define good faith continually prove to be futile because, “…good faith can have no absolute meaning: it simply assumes its contents from the facts of each particular case.”7 Interestingly, this approach is similar to the one used by ancient Romans who simply recognized that good faith was based on “… an appeal to common sense.”

Essentially, the doctrine of good faith arises from a common concern for fair dealings and the protection of the parties’ reasonable expectations. As a result, definition attempts have centered on concepts and terms such as: “fair conduct,” “reasonable standard,” “decent behavior,” or “community standards of fairness and reasonableness.”8 In Gateway Realty v. Acton Holdings,9 Kelly J. sought to formulate a more precise definition of good faith. On page 197 of the trial decision he stated that:

What will constitute bad faith or breach of the conduct described above will depend on the terms of the contract and the circumstances of each case. In most cases, bad faith can be said to occur when one party, without reasonable justification, acts in relation to the contracts in a matter where the result would be to substantially nullify the bargained objective or benefit contracted for by the other party, or to cause significant harm to the other, contrary to the original purpose and expectations of the parties.

With this attempt to define good faith, Kelly J. has gone further than most other judges have been willing to. Unfortunately, the result is still circular. Commentators have criticized this definition by asking: Can an object or benefit ever be said to be secured by a contract if the other party had not agreed in some manner to confer the benefit or to act towards attainment? This definition raises other questions as well. For instance, what constitutes “reasonable justification” or “significant harm?”

Emulating the approach of the English Chancery judges may be the most pragmatic solution in the search for a definition of good faith. This would mean that good faith would be defined as “…simply the absence of bad faith.” Robert Summers, one of the main architects of the American Restatement of Contracts is an adamant supporter of this approach since:

Good faith is an excluder. It is a phrase without a general meaning of its own and therefore serves to exclude the wide range of heterogeneous forms of bad faith.10

Attempts to precisely define good faith appear to be useless. It is impossible to take into account all the situations, types of behavior, tactics or conduct that may in a given situation constitute a departure from “good faith.” Defining good faith on a case by case basis therefore has a certain appeal. However, the movement to define good faith in terms of what it is not is growing steadily. In fact, it is one that has already been used by the Canadian courts. A recent case in the area of public administrative law held that, “… good faith should be expressed negatively… ideally by reference to instances of [bad faith].”11

Standard for Good Faith

Irrespective of the manner in which good faith is defined, establishing some type of definitive test or standard with which to aid in assessing a party’s conduct remains critical. This would serve two purposes. The first would be to help diminish the sense of arbitrariness often associated with good faith. Second, it would enable parties to evaluate their own actions and subsequently apply preventative measures. To date, there has only been one attempt in Canada to establish a standard with which to determine whether or not the parties have fulfilled the requirement that they act in good faith. This was done by the Nova Scotia Supreme Court in Gateway Realty Ltd. v Arton Holding Ltd. et. al.” This case held that the common law duty to perform in good faith will have been violated when a party acts in bad faith. That is, the duty is breached when a party acts in a manner that, “…substantially nullifies the contractual objectives or causes significant harm to the others, contrary to the original purposes or expectation of the parties.”13

Determining whether a party has acted in good faith involves an element of both the subjective and objective. In the recent case of Dudba v. Smilestone,14 Kelly J. provided one of the few commentaries regarding what state of mind is required if a breach of good faith is being alleged. Kelly J. agreed that the state of mind is important and concluded that the court’s duty is to conduct an objective inquiry into the discretion-exercising party’s state of mind. This ruling, however, has been criticized for failing to resolve whether subjective honesty is sufficient to meet the good faith standard or whether the courts must rely only on an objective assessment. As Kelly J. noted, absent any improper motive or purpose the court would be unwilling to interfere with the exercise of discretion by the party in question. In the case of Greenberg v. Meffert,15 the Ontario Court of Appeal provided some guidelines that may prove to be significant in future good faith cases. In this case Robins J.A. held that:

When the matter to be decided or approved is not readily susceptible to objective measurement such as matters involving taste, sensibility, or personal compatibility of judgements of the party for whose benefit the authority was given, such provisions are more likely to be construed as imposing only a subjective standard. On the other hand, in contracts relating to such matters as operative fitness, structural competition, mechanical utility or marketability, these provisions are generally construed as imposing an objective standard of reasonableness.

If this central distinction to good faith is used, courts ought to invoke a functionally subjective measure of state of mind when the matter at issue relevantly concern “taste, sensibility or personal compatibility.” Conversely, if it is a matter that can be assessed by a third party then an objective inquiry would be conducted. How the Canadian courts will address this issue currently remains to be seen.

Good Faith as a Legal Concept

There are several factors that have contributed to the traditional judicial distrust of the good faith doctrine. The primary one is the fear that an ambiguous good faith doctrine would somehow jeopardize the Anglo-Canadian legal tradition of individual autonomy and freedom to contract. This tension between the individual and the society is clearly illustrated in a recent House of Lords case, Walford v. Miles.16 The facts in this case are as follows. The defendant agreed to sell both business and premises to the plaintiff providing the plaintiff had a bank letter proving sufficient credit to facilitate the purchase. In this context, the defendant agreed to terminate negotiations with any third party. Though the plaintiff provided the letter the defendant withdrew from the negotiations. The defendant cited the concern that its staff would not “get on with” the plaintiff as the explanation for such action. The plaintiff then sought to enforce the agreement that the defendant was not to deal with other parties. What the plaintiff wished to have happen was for the court to imply that the defendant would continue to negotiate with them in good faith. This did not occur.

Instead the sentiment of the court seemed to be that mandating or legislating parties to negotiate in good faith is an intuitively counterproductive request. More specifically, the House of Lords stated that:

The concept of a duty to carry on in good faith is inherently repugnant to the adversarial position of the parties when involved with negotiations.

This case held that provided the parties do not make any misrepresentations during the negotiation, then each is entitled to pursue his or her own interest to the fullest extent possible. This school of thinking believes that to impose any type of duty to negotiate in good faith would be to impede the parties’ ability to achieve what is best for them. Essentially, the fear is that a duty to negotiate in good faith would prohibit the use of traditional negotiation tactics such as threatening to withdraw from the discussion in order to achieve better terms. Other concerns frequently associated with the duty to negotiate in good faith include: issues of uncertainty regarding how a vendor is to know whether it is entitled to withdraw from further negotiations, or at which point and to what extent the court should intervene to enforce such obligations. Underlying all of these concerns is the belief that a duty to negotiate in good faith is both unworkable in practice as well as inherently inconsistent with the position of the negotiating party. There are still judges today who remain convinced that the doctrine of good faith is not a part of Canadian contract law as is evident in several cases.


Reva Seth



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