A general principle of contracting that can be considered as an application of good faith and fair dealing, is the requirement that parties should not act inconsistently with an understanding that is implied in the contract (Unidroit Principles Article 1.8):
Article 1.8 (Inconsistent behaviour)
A party cannot act inconsistently with an understanding it has caused the other party to have and upon which that other party reasonably has acted in reliance to its detriment.
This general manifestation of the principle of good faith is called (non) ‘venire contra factum proprium’. In other words, a contract imposes a responsibility on each party not to occasion detriment to another party by acting inconsistently with an understanding concerning their contractual relationship that it has – explicitly, implicitly or by its mere behaviour – caused that other party to have, and upon which that other party has reasonably acted in reliance.
How an understanding reasonably relied upon comes to existence. A party may cause the other party to have an understanding concerning their contract, its performance or enforcement, in many ways. For example, the understanding may result from a representation made, from conduct, or from silence when a party would reasonably expect the other to speak to correct a known error or misunderstanding that was being relied upon.
Effect of the principle. The prohibition in Article 1.8 might result in the creation of rights, or in the loss, suspension or modification of rights, deviating from those expressly agreed by the parties. This is because the understanding reasonably relied upon may itself be inconsistent with the agreed or actual rights of the parties.
Because its impact is rather large, there is an important prerequisite for invoking this principle: the understanding must be one on which, in view of all the circumstances, the other party can and does reasonably rely. Whether such reliance is reasonable (and must be given effect) depends, in particular, on the communications and conduct of the parties, on the nature and context of the parties’ dealings, and on the expectations they could reasonably have with regard to each other. This is best illustrated by examples:
Illustration 1 (letting the other party take destructive steps in anticipation of a contract that is not entered into).
A and B have spent lengthy negotiations over a lease contract relating to B’s land under which B is to demolish a building and construct a new one to A’s specification. A communicates with B in terms that induce B reasonably to understand that their contract negotiations have been completed, and that B can begin performance. B then demolishes the building and engages contractors to build the new building. A is aware of this and does nothing to stop it. A later indicates to B that there are additional terms still to be negotiated. A will be precluded from departing from B’s understanding.
Illustration 2 (failing to warn that expected performance should be different).
B mistakenly understands that its contract with A can be performed in a particular way. A is aware of this and stands by while B’s performance proceeds. B and A meet regularly. B’s performance is discussed but no reference is made by A to B’s mistake. A will be precluded from insisting that the performance was not that which was required under the contract.
Illustration 3 (denying that payment is due, now that an affiliate ordered the work).
A regularly uses B to do sub-contract work on building sites. That part of A’s business and the employees involved in it are taken over by A1, a related business. There is no change in the general course of business by which B obtains its instruction to do work. B continues to provide sub-contract services and continues to bill A for work done believing the work is being done for A. A does not inform B of its mistake. A is precluded from denying that B’s contract for work done is with it and must pay for the work done.
Illustration 4 (requiring penalties notwithstanding accepted delays in deliveries).
Because of difficulties it is experiencing with its own suppliers, A is unable to make deliveries on time to B under their contract. The contract imposes penalties for late delivery. After being made aware of A’s difficulties, B indicates it will not insist on strict compliance with the delivery schedule. A year later B’s business begins to suffer from A’s late deliveries. B seeks to recover penalties for the late deliveries to date and to require compliance with the delivery schedule for the future. It will be precluded from recovering the penalties but will be able to insist on compliance with the schedule if reasonable notice is given that compliance is required for the future.
Illustration 5 (failure to claim payment does not preclude a later claim to be paid).
B is indebted to A in the sum of AUD 10,000. Though the debt is due A takes no steps to enforce it. B assumes in consequence that A has pardoned the debt. A has done nothing to indicate that such actually is the case. It later demands payment. B cannot rely on A’s inaction to resist that demand.
Detriment and preclusion. Contracting parties must avoid detriment being occasioned in consequence of reasonable reliance. This principle does not necessarily lead to a prohibition or preclusion to act in the detrimental way. Depending on the circumstances, there may be other reasonable means available that can avert the detriment. For example, unreasonable detriment can be diminished by giving reasonable notice before acting inconsistently (see Illustration 4), or by paying for costs or losses incurred by reason of reliance.
Illustration 6 (compensation of non-commissioned but performed work).
A and B are parties to a construction contract which requires that additional works be documented in writing and be certified by the site architect. A’s contract manager orally requests B to do specified additional work on a ‘time and materials basis’ and assures B it will be documented appropriately in due course. B commissions design works for the additional work at which stage A indicates that the work is not required. The cost incurred in commissioning the design work is far less than the cost that would be incurred if the additional work were to be done. If A pays B the costs incurred by B for the design work, B cannot then complain of A’s inconsistent behaviour.
Illustration 7 (continued request for performance precludes a termination right for breach of contract).
A fails to meet on time a prescribed milestone in a software development contract with B. B is entitled under the contract to terminate the contract because of that failure. B continues to require and pay for changes to the software and acts co-operatively with A in continuing the software development program. A’s continued performance is based on B’s conduct subsequent to the breach. B will in such circumstances be precluded from exercising its right to terminate for the failure to meet the milestone. However, under the Unidroit Principles B will be able to allow A an additional period of time for performance (see Article 7.1.5) and to exercise its right to terminate if the milestone is not met in that period.