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Negotiate in Good Faith

What is required by an obligation to negotiate in good faith and what would breach that obligation?

Legal commentary on good faith can be divided into three categories:

• What does good faith require?
• What will be a breach of good faith?
• What does good faith permit?

There are some clear and accepted answers to these questions: good faith will require honesty and a commitment to the negotiation. Unreasonable delay, providing false information, threating a breach of contract or shifting position may breach an obligation to negotiate in good faith. But good faith does not require a party to act in the interests of the other party, and good faith does not require anyone to come to an agreement. If negotiations fail, even if good faith was required and not exercised by one party, the other party could not obtain a Court order enforcing an agreement that should have been reached if good faith were observed.

However, there are some possible aspects of good faith that are less settled and less clear:

• Does good faith require parties to share information?
• Does good faith require a party to make a counter proposal?

These seem to be crucial aspects of a negotiation for rent relief under the COVID-19 Code of Conduct and the State Regulations. How do they operate practically?

What good faith requires will vary from contract to contract. In relation to the COVID-19 Code of Conduct, good faith has been retrospectively imposed on landlords and tenants by regulation. This is different to a circumstance where the parties had incorporated good faith within their contract terms. The COVID-19 circumstance imposes good faith between landlord and tenant as part of regulations designed to assist tenants during the pandemic. This context must be considered when assessing what this obligation to negotiate in good faith means.

Although many aspects of good faith are clear and settled, there is a divided history of caselaw in Australia in relation to the requirement to negotiate in good faith – in some circumstances good faith can mean nothing at all. This article is based on the case United Group Rail Services Ltd v Rail Corporation New South Wales [2009] NSWCA 177, which contains a helpful analysis of the obligation to negotiate in good faith.

Duty to disclose

Good faith can include a duty to disclose where the failure to disclose could amount to an attempt to profit from the ignorance of the other party.

In relation to COVID-19, a landlord would breach good faith by describing the regulations incorrectly or incompletely. There is no obligation on a landlord to set out for a tenant what the regulations provide, however if they choose to do so, they should do so accurately and completely. For example, a landlord would breach the obligation of good faith if they make an offer of rent relief and states that they could terminate the lease if the tenant does not accept that offer within 7 days.

Similarly, a tenant would breach the obligation of good faith if they withheld part of their sales information so as to exaggerate the impact of COVID-19 on their business.

The COVID-19 Code of Conduct mentions sharing sufficient information. Good faith will require disclosing information to demonstrate the financial impact of the pandemic and so as not to profit from the ignorance of the other party. This seems to both a requirement to share all relevant information, and is a restriction on withholding information so as to deceive.

Would the landlord be required to correct a tenant if they believed the tenant misunderstood the COVID-19 regulations? Taking advantage of a misunderstanding can amount to unconscionable conduct in some circumstances (eg: where parties are in unequal bargaining positions, or where the one party knows that the other party will not understand the documentation). Considering that, good faith would require the landlord to correct the tenant if not doing so gives the landlord an unfair advantage in the negotiation.

Duty to make a counter proposal

While it is accepted that negotiating in good faith does not require either party to come to an agreement, if there is an obligation to make a counter proposal, then an agreement may naturally follow. For example, if I do not want to sell, but someone offers $100 – if I am required to make a counter proposal, say $1,000, this may be accepted and I would have to sell. Does good faith require me to make that counter proposal?

A tenant may have demonstrated a reduction in revenue over March to May and the landlord and tenant agree on an amount of rent relief for that period. The tenant may seek ongoing rent relief based on those figures. If the tenant proposes a level of on-going rent relief (say 50% for a further 3 months) is the landlord required to make a reasonable counter proposal or may the landlord refuse to make any offer, and instead want to wait to see the continued effect of the pandemic?

The answer must be based on the context of the Code: the parties are to negotiate in good faith to “share, in a proportionate, measured manner, the financial risk and cashflow impact during the COVID-19 period”.

If the tenant can demonstrate a need for certainty, then the landlord may be required to consider a proposal for the next three months. However, it will probably be adequate for the landlord to insist that the tenant demonstrate its reduction in revenue each month, provided the landlord remains open to provide relief based on those monthly figures.

A more difficult situation is where the tenant is excluded from the Code due to its size (having annual revenue of more than $50 million) however may claim that the Code still requires the landlord and tenant to negotiate in good faith. Does a landlord have to make a counter proposal to such a tenant? The answer again must come from the context of the Code – is rent relief required to share the financial risk and cashflow impact during the COVID-19 period? Have the tenant’s decisions during the pandemic period been proportionate and measured?

We would suggest that where a tenant was seeking to negotiate based on somewhat abstract concepts (eg: we closed the store because it was not safe for our staff), then it remains open for the landlord to request information showing how rent relief is now required to share the financial risk and cashflow impact of the pandemic and why the tenant closed before commencing negotiations regarding rent relief.

The obligation to negotiate good faith so as to apply the spirit of the Code of Conduct is quite different to the situation analysed in the United Group Rail Services Ltd case referred to above. Whilst not empty, the good faith in this circumstance seems more vague, illusory and uncertain.

Conclusion

An obligation to negotiate in good faith has a clear meaning in Australia, however it means more in some contexts than it does in others. Where COVID-19 Regulations impose an obligation to negotiate in good faith between a landlord and tenant to share the financial impact of the pandemic, each party is required to observe certain kinds of behaviours and standards during the negotiation. The requirements are less certain where the Code of Conduct imposes an obligation to negotiate in good faith to apply only the spirit of the Code.

Matthew Rafferty, Partner