Doctrine of Good Faith and Fair Dealing: Lacuna in Indian Contract Law

[Angad Singh Makkar is a 4th year BA LLB (Hons.) student at Jindal Global Law School in Sonipat, Haryana]

Parties enjoying ample discretion to decide the ways of performance and enforceability of their mutual obligations is an inevitability within the realm of contract law.[1] And where there is discretion, there is an appreciable risk of it being exercised in a self-interested or opportunistic manner.[2] Legislatures and judicial bodies have accordingly come up with “various interpretive or gap-filling doctrines”[3] to counteract and restrain self-interested behavior on the part of the parties to a contract. Notably, parties’ failure to explicitly include such constraints in their contract does not preclude their application to the contract by the courts.[4] Arguably, the most important of these doctrines is the implied duty of good faith and fair dealing.

The doctrine of good faith and fair dealing in contractual relations has been reflected in numerous civil law systems, such as the Treu und Glauben provision of the German Civil Code,[5] the Italian Civil Code,[6] as well as the Dutch Civil Code.[7] Among common law countries, the United States has been at the forefront vis-à-vis the recognition of the doctrine of good faith. Section 1-203 of the Uniform Commercial Code explicitly lays down this duty by stating that “every contract or duty within this Act imposes an obligation of good faith in its performance or enforcement”.[8] The Restatement (Second) of Contracts has incorporated a similar provision, insofar as it states that “every contract imposes upon each party a duty of good faith and fair dealing in its performance and its enforcement”.[9] England, on the other hand, does not recognize a general doctrine of good faith and, instead, “piecemeal solutions in response to demonstrated problems of unfairness”[10] are favored and employed by English courts. However, Leggatt J.’s ruling in Yam Seng[11] has the potential to usher in a new era of good faith in English contracts,[12] as any hostility of English courts towards a duty of good faith was deemed to be misplaced and an implication of a doctrine of good faith arose in light of the presumed intention of the parties.[13]

This marked shift towards an express recognition, or at the very least an implied acceptance, of the doctrine of good faith and fair dealing domestically is mirrored in numerous international instruments applicable to commercial contracts, such as the Vienna Convention on International Sales Contracts[14] and the Principles of European Contract Law.[15] Notably, the UNIDROIT Principles for International Commercial Contracts[16] (“the Principles”) lay down a comprehensive doctrine of good faith and fair dealing in international trade.[17] Article 1.7 of the Principles, by stipulating that “the parties may not exclude or limit this duty”,[18] serves as an indicator of the high significance accorded to this doctrine under the Principles. In fact, the comment to Article 1.7 expressly states that good faith and fair dealing are to be deemed as “one of the fundamental ideas underlying the Principles”.[19] Unsurprisingly then, this doctrine finds application in several other articles under the Principles as well. For instance, Article 3.2.2 affords a mistaken party the right to void the contract if the other party was aware of that mistake and, contrary to reasonable commercial standards of fair dealing, left the mistaken party in error.[20] Similarly, Article 3.2.5 widens the construction of ‘fraud’ to include within it the “fraudulent non-disclosure of circumstances which, according to reasonable commercial standards of fair dealing, [a] party should have disclosed”.[21] The Principles pay due regard to the doctrine of good faith and fair dealing even in matters pertaining to determination of omitted terms, with good faith and fair dealing serving as key factors assisting this determination.[22]

Intriguingly, while the Principles lay down a reference point to determine fair dealing (‘reasonable commercial standards of fair dealing’), they do not adequately define what good faith entails. The illustrations to Article 1.7 are helpful in this regard,[23] but a definition along the lines of Section 1-201 of the Uniform Commercial Code[24] would have been more beneficial and aided judicial enforcement of the doctrine of good faith under the Principles. Similar complications arise with regard to Article 2.15 of the Principles,[25] which imposes liability upon a party negotiating in bad faith. Queries pertaining to what amounts to bad faith – is it merely the absence of good faith? Does as absence of fair dealing also amount to bad faith – still loom large.[26]

Contrasting the aforementioned provisions, and specifically the Principles, with the position under Indian contract law is extremely revealing, as the Indian Contract Act (“the Act”) fails to incorporate even a semblance of a doctrine of good faith and fair dealing. At best, one can point to a handful of provisions under the Act that seemingly impose an obligation on parties to act in good faith.[27] Section 223 of the Act, for instance, puts forth a duty on an employer to indemnify an agent, who performs an act for the employer in good faith, against claims arising from injuries caused to third parties.[28] One could infer an obligation to satisfy the doctrine of good faith from such a provision, but even then the doctrine is applied in a limited manner, extending merely to the agent’s contractual performance. The incorporation of this doctrine at the negotiation stage, which the Principles place great emphasis on, is clearly lacking in the text of the Act.

Judicial pronouncements on the application of this doctrine under Indian law have been sparse as well, with the Delhi High Court’s ruling in Association of Unified Telecom Service Providers of India v. Union of India[29] coming across as a flash in the pan. Herein, the Court observed that there was a license agreement – an “enterprise for mutual gain”[30] –  between the parties (Tata Teleservices Ltd. and the Central Government), and stressed upon the trust and confidence that each party to a contract shares with the other. Noting that there is a need to prevent either party from doing anything which “will have the effect of destroying or injuring the right of the other party to receive the fruits of the contract”,[31] the Court propounded the application of an “implied covenant of good faith and fair dealing”[32] in every contract. Unfortunately, this observation of the Court did not go to the core of the dispute and, perhaps brushing it aside as obiter, the Supreme Court of India failed to take heed of it in the subsequent appeal.[33] In doing so, the Supreme Court spurned a precious opportunity to lay the bedrock of a doctrine of good faith under Indian contract law. Nonetheless, insurance contracts in India are governed by a stringent rendition of a doctrine of good faith, namely the doctrine of uberrima fidei (‘utmost good faith’). It is recognized that a non-disclosure of material facts could have serious repercussions on an insurance contract, and to mitigate the same, a doctrine of uberrima fidei must be implemented.[34] Enforced primarily at the negotiation stage of a contract, this doctrine provides a ground for rescission of the contract if any and every material fact is not disclosed.[35] The timely enforcement of this doctrine by Indian courts is an encouraging sign towards the prospective assimilation of a broader doctrine of good faith in Indian contract law.

It is key to note that the Law Commission of India (“the Commission”), in its report on unfair terms in contract,[36] reviewed the legislative and judicial measures taken in various jurisdictions to tackle the issue of unfair terms, and highlighted the lacunae in Indian contract law on this front. While proposing a Bill to govern this field of law, the Commission purported to make a distinction between procedural and substantive unfairness. An inability to comply with the “reasonable standards of fair dealing or commonly accepted standards of dealing” was proposed to be a ground for establishing both procedural and substantive unfairness.[37] Clearly, the Commission attempted to import a doctrine of good faith and fair dealing at the contractual negotiation stage through sections 5, 6, 12 and 13 of its proposed Bill. Despite the Commission correctly pointing out the uncertainty and ambiguity produced by the “ad hoc solutions given by courts in response to their innate sense of justice”,[38] the attempts made in the 199^th Law Report to codify a specific doctrine of good faith and fair dealing came to naught. 

Thus, it is evident that despite the infusion of a doctrine of good faith and fair dealing, as an implied covenant within parties’ contracts, in various jurisdictions and several international instruments, Indian contract law is lagging behind and fails to incorporate such a doctrine. Efforts made by the judiciary, or even by the Law Commission of India, to introduce this doctrine have been rendered futile. Indian legislators must recognize the potential of such a doctrine to improve contractual relations, by increasingly holding parties accountable, mandating faithfulness to the agreed common purpose and demanding consistency.[39] While it is more likely that India will eventually follow the lead of English courts and develop piecemeal ad-hoc solutions to deal with good faith issues, a good faith provision along the lines of the Principles’ good faith articles would be the optimum means for developing a certain and effective doctrine of good faith under Indian contract law.

– Angad Singh Makkar

[1] Paul MacMahon, Good Faith and Fair Dealing as an Underenforced Legal Norm, Minnesota Law Review, 99 (6), ISSN 0026-5535 (2015).

[2] Ibid.

[3] Ibid.

[4] Ibid.

[5] Bürgerliches Gesetzbuch (BGB), 1900, § 242.

[6] Italian Civil Code, 1942, Art 1137.

[7] Niew Burgerlijk Wethoek (NBW), 1992.

[8] Uniform Commercial Code (U.C.C.), 1990, § 1-203.

[9] Restatement (Second) of Contracts, 1981 § 205.

[10] R (European Roma Rights Centre and Others) v. Immigration Officer at Prague Airport, [2004] UKHL 55.

[11] Yam Seng v. International Trade Corporation, [2013] EWHC 111 (QB).

[12] Allen & Overy, A new era for good faith in English contract law?, 5 March, 2013.

[13] Yam Seng, note 11 above.

[14] Final Act of the United Nations Conference on Contracts for the International Sale of Goods, U.N. Doc. A/Conf. 97/18, Annex I (1981).

[15] Principles of European Contract Law, 2002, Article 1:201

[16] International Institute for the Unification of Private Law, Rome, Principles of International Commercial Contracts (2016) (‘PICC’).

[17] Ibid, Article 1.7

[18] Ibid.

[19] Ibid.

[20] Ibid, Article 3.2.2.

[21] Ibid, Article 3.2.5.

[22] Ibid, Article 4.8.

[23] Ibid, Article 1.7 Illustrations.

[24] Uniform Commercial Code (U.C.C.), 1990, § 1-201 (20).

[25] PICC, note 16 above, Article 2.15.

[26] Allan Farnsworth, Duties of Good Faith and Fair Dealing under the UNIDROIT Principles, Relevant International Conventions and National Laws, Tulane Journal of International and Comparative Law (1995).

[27] Lucy Rana – SS Rana & Co. Advocates, India: Doctrine of good faith in contracts.

[28] Indian Contract Act, 1872, section 223.

[29] 207 (2014) DLT 142.

[30] Ibid.

[31] Ibid.

[32] Ibid.

[33] Association of Unified Telecom Service Providers of India v. Union of India, AIR 2014 SC 1984.

[34] Life Insurance Corporation of India v. Asha Goel, AIR 2001 SC 549; Life Insurance Corporation of India v. The Insurance Ombudsman, (2009) 5 MLJ 181.

[35] Ibid.

[36] Law Commission of India, Unfair (Procedural & Substantive) Terms in Contract, Report No. 199 (August 2006).

[37] Ibid.

[38] Ibid.

[39] Rana, note 27 above.