In one of our blogs last year, we commented on the fact that there is no implied duty of good faith in English law. Despite the fact that this puts us out of step with many other jurisdictions, the English courts continue to stick to their principles in this area as another recent case demonstrates.
The case was concerned with a private equity backed acquisition of a target company. Part of the funding for the acquisition was provided by loan notes issued to the investors (Investor Loan Notes) and part of the consideration paid to the sellers was also satisfied by the buyer issuing loan notes to the sellers (Seller Loan Notes).
The Seller Loan Notes contained a provision which allowed changes to be made to the terms of those loan notes where the same changes were also made to the Investor Loan Notes. Such a provision is fast becoming market standard to enable a private equity funder to push through a secondary refinancing without being held to ransom by sellers who have a residual interest in the target.
In this case, the investors did indeed carry out a secondary refinancing which involved them being issued with new loan notes in return for further funding. The old Investor Loan Notes, and consequently the Seller Loan Notes, were amended to subordinate those notes to the new loan notes and to postpone the date of redemption of the original notes. The Sellers argued that these amendments effectively made the Seller Loan Notes worthless.
Lack of good faith?
The parties agreed that there was no general duty of good faith in commercial contracts under English law. However, the sellers asked the court to imply a duty of good faith into the power to amend the Seller Loan Notes so that any such amendment could only be made for the benefit of the holders of the Seller Loan Notes and the Investor Loan Notes as a whole.
The court disagreed with the sellers and refused to imply the good faith term into the documents. One of the key factors in the court reaching this decision was that the arrangements between the parties were subject to extensive and detailed legal documents negotiated between the parties. In those circumstances, the courts are generally reluctant to assume that the parties have in fact omitted from the documents something (such as an express duty of good faith) which they meant to include.
In addition, the sellers were already offered some protection under the transaction documents in the circumstances where the target required further financing. The sellers had to be given the opportunity to make a further investment in the target pro rata to the existing investments of the sellers and the investors. Having been offered such opportunity, however, the sellers declined to make the further investment. The court was reluctant to now give them further protection from the consequences of their own decision.
Another factor in the decision was the fact that the Seller Loan Notes and the Investor Loan Notes formed two separate classes. If they had been one class, then the majority (the investors) would only be able to amend the notes to bind the minority (the sellers) if the amendments were made bona fide and for the benefit of all the noteholders as a whole. But the court held that the notes were clearly two separate classes. The investors therefore owed no duty to the sellers when agreeing changes to the Investor Loan Notes. Once such changes had been agreed, the company was then required to make the same changes to the Seller Loan Notes.
Use express wording
This case is the latest to confirm that the courts will only imply a duty of good faith into a commercial contract in very limited circumstances. Therefore, if the parties intend the contract to contain such a duty, it should be expressly set out in the agreement.