Duty of good faith between shareholders

For a long time, the Courts of England and Wales refused to recognise a ‘duty of good faith’ between contracting parties.

The Courts stance

The Courts preferred the principles of freedom of contract and the parties’ ability to negotiate a contract on their own terms and for their own self-interest. In the event of dispute over the terms of the contract, the Courts were reluctant to interfere or re-write the terms of a contract or the bargain struck by the parties.

The Courts however departed from this traditional view in the case of Yam Seng Pte Ltd v International Trade Corp Ltd [2013] where it was held that where the contracting parties have a long-term agreement and arrangement which involves significant mutual trust and communication between them, the contract is likely to be considered a ‘relational contract’. Where a relational contract is established, the Courts found that an implied duty of good faith existed.

More recently, the Courts have had the opportunity to further consider the concept of good faith. In Faulkner v Violin Holdings Ltd [2021], the Courts provided insight and guidance as to when a duty of good faith might be found in the context of shareholder agreements.

Shareholders’ Agreements

Faulkner has shown that the Courts are willing to impose a duty of good faith and that such a duty may be implied even if the shareholders’ agreement does not contain an express duty or obligation to act in good faith.

Where a shareholder can establish that a duty of good faith arises, and that there has been a breach of this duty, the shareholder is likely to be able to show that they have been unfairly prejudiced and therefore are entitled to relief and a remedy against their fellow shareholders pursuant to Section 944 of the Companies Act 2006.

In the Faulkner case, the Courts held that there had been a breach of an express duty to act in good faith as the majority shareholders had, amongst other things, excluded minority shareholders (namely Mr Faulkner and one other) from the management of the company. Adam Johnson J commented that good faith may be surmised as:

“the obligation to deal fairly and openly, the need to take into account the interests of the other party as well as one’s own interests, and the fact that the duty may be breached where an otherwise justifiable result is achieved in procedurally non-compliant way.”

The Faulkner case shows that there is a shift in the way good faith principles are being considered and imposed by the Courts. We anticipate that there will be a steady rise of similar cases as shareholders claim breach of good faith when seeking relief from unfairly prejudicial conduct pursuant to section 994 of the Companies Act 2006.