Relational Contracts – what are they and why do they matter?

The Post Office’s Horizon IT system scandal is one of the gravest examples of a miscarriage of justice in modern British history. Hundreds of sub-postmasters were prosecuted and convicted of criminal offences such as fraud and false accounting, or were financially ruined, due to the Post Office’s faulty IT systems which suggested that local Post Office branches were responsible for accounting shortfalls.

Vital for the Claimants in the Post Office litigation was to establish that the Post Office owed an implied duty of good faith towards the Claimants in the group litigation. Whilst English contract law does not recognise a general duty of good faith or fair dealing, courts readily imply such terms where the contract in question is characterised as a ‘relational contract’.

Apart from the Post Office litigation, relational contracts have been a developing area of law with considerable interest. The Court of Appeal in Candey Ltd v Bosheh [2022] EWCA Civ 1103 observed that there has been an “avalanche of claimants in recent years trying to show that the contract…is a relational contract, thereby bringing with it the implied obligation of good faith. Only relatively few have succeeded”. One of the few cases that did succeed in establishing an implied duty of good faith was the Post Office litigation.

Indeed, we at Farore Law have recently appeared in the Commercial Court on behalf of a start-up where the Claimant (a former director/shareholder) argued that the shareholders’ agreement and/or the Articles of Association and/or his Service Agreement were a relational contract, given the considerable sums of money and time he invested in establishing the start-up.

What are relational contracts?

A relational contract has been described by the High Court in Yam Seng Pte Ltd v International Trade Corporation Ltd [2013] EWHC 111 (QB) as a contract which, although not giving rise to a partnership, trusteeship or fiduciary relationship, requires a longer-term relationship between the parties which they make a substantial commitment and require a relationship of trust and confidence.

Fraser J in Bates v Post Office (No 3: Common Issues) [2019] EWHC 606 (QB) listed the following (non-exhaustive) characteristics of a relational contract:

• There must be no specific express terms in the contract that prevents a duty of good faith from being implied.
• The contract must be a long-term one, with the mutual intention of the parties being that there will be a long-term relationship.
• The parties must intend that their respective roles be performed with integrity and fidelity to the bargain.
• The parties will be committed to collaborating with one another in the performance of the contract.
• The spirit and objectives of their venture may not be capable of being expressed exhaustively in a written contract.
• They will each repose trust and confidence in one other, but of a different kind to that involved in fiduciary relationships.
• The contract in question involves a high degree of communication, cooperation and predictable performance based on mutual trust and confidence and loyalty.
• There may be a degree of significant investment by one party or both in the venture.
• Exclusivity of the relationship may also be present.

None of the features above are determinative, save that the implied duty of good faith cannot be inconsistent with the express terms of the contract.

Why was the contract in the Post Office litigation a relational one?

Fraser J concluded that the contracts between the Post Office and the sub-postmasters were relational, as they contained all of the features identified above.

For example, in many cases the sub-postmasters were required to undergo substantial financial investments (in buying or leasing premises for a Post Office branch) and the Post Office was careful when considering potential sub-postmasters for appointment in assessing the financial viability of an applicant. In addition, their relationship was more than a purely commercial one, given that the Post Office was required by the Government to maintain a broad network of branches across the country and trust is integral in almost all of the Post Office’s activities.

Another factor that led the High Court to conclude that the Post Office’s relationship with its sub-postmasters was relational was that the Post Office was tasked to investigate potential false accounting offences, which illustrated how trust was integral to the Post Office’s relationship with its sub-postmasters.

Why are relational contracts so important?

The finding that the contractual relationship between the Post Office and the sub-postmasters was a relational contract in Bates was vital to establish that the Post Office was subject to duties of good faith, fair dealing, transparency, co-operation and trust and confidence – such as the duty to investigate accounting shortfalls in an even-handed manner and a duty not to terminate or suspend sub-postmasters without a reasonable and proper cause. Because the contract was a relational one, the Post Office was subject to additional constraints on the exercise of their contractual powers.

In a wider commercial context, parties under a relational contract are expected not to engage in “sharp practice” or conduct which is regarded as commercially unacceptable. By way of example, parties under a long-term joint venture are expected not to undergo covert negotiations to try and sell jointly owned property or to use their position as a shareholder to obtain financial benefit at the expense of the other party; see, for example, Al Nehayan v Kent [2018] EWHC 333 (Comm).

Farore Law is a boutique litigation firm that specialises in complex, high-value employment litigation in the Employment Tribunals and the High Court. We regularly act for senior executives, founder directors and start-ups in restrictive covenants, shareholders’ disputes and employment-related breach of contract claims. Please contact us if you require legal advice.