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Doctrine of good faith

15 January, 2016 - 09:11

‘Good faith,’ or bona fide, is the highest principle in Continental civil law system. Article 6 of the Chinese Contract Law provides that ‘the parties shall observe the principle of honesty and good faith in exercising their rights and performing their obligations.’

The doctrine of good faith is applicable in a wide range of transactions, such as gifts, leasing and letting. It is considered crucial in enhancing business ethics. Its two basic functions are: (1) to guide the parties to act honestly in commercial transactions; and (2) to give the necessary discretionary power to the judges.

This doctrine aims to balance the interests between the parties, as well as interests of the parties and the society at large. When applied between the parties, it requires them to respect each other. As regards the society at large, it prevents the parties from prejudicing public interest. It not only balances the interest between the parties, but also safeguards the social interest, such that the market can operate in an orderly manner. The doctrine of good faith is considered in line with the highest ideals of human society.

The following points should be noted from a Chinese law perspective:

  • The doctrine of good faith is used to justify ‘pre-contractual obligations’, i.e. the obligations accrued during the negotiation stage even though the contract is not made eventually, on the ground that the parties should act in good faith at that stage. Article 42 of the Contract Law provides that the party shall be liable for damages if it is under one of the following circumstances in negotiating a contract that causes damage to the other party: (1) pretending to conclude a contract, and negotiating in bad faith; (2) deliberately concealing important facts relating to the conclusion of the contract or providing false information; (3) performing other acts which violate the principle of good faith. Article 43 of the Contract Law prohibits the disclosure or use of any trade secret learned during negotiation.
  • The doctrine of good faith imposes collateral obligations on the parties, i.e. the obligations that are not explicitly stated in the contract or otherwise agreed by the parties, and are undertaken by the parties, on the basis of the doctrine of good faith in accordance with the nature and purpose of the contract and the transaction practice, for advancing the objectives of the contract and protecting the legitimate interest of the parties. Article 60 of the Contract Law provides: Each party shall fully perform its own obligations as agreed upon. The parties shall abide by the principle of good faith, and perform obligations of notification, assistance, and confidentiality, etc. in accordance with the nature and purpose of the contract and the transaction practice. These are known as ‘collateral’ obligations. They are not contractual obligations, but are collateral to the principal obligations, such as the duty of confidence, the duty of notification, etc. For example, A sells a mobile phone set to B, but they do not expressly talk about the user’s manual. However, based on the principle of good faith, it is arguable that A has the obligation to provide the user’s manual to B.
  • The doctrine imposes post-contractual obligations: Article 92 of the Contract Law provides that after the termination of the rights and obligations under the contract, the parties shall observe the principal of honesty and good faith and perform the obligations of notification, assistance and confidentiality in accordance with relevant transaction practices. It refers to the obligations undertaken by the parties after expiry of the contract to protect the legitimate interests of the other party, such as the covenant of confidentiality, non-competition clause, and so on.

The doctrine of good faith is also embodied in the rules governing breach of contract and interpretation of contract.

Case Study 1.4

Application of the doctrine of good faith to a leasing contract

A as lessor rents a shop to B as lessee. They agree that A shall provide the ‘necessary approval’ for B to apply to the government authorities for the licence for renovation and business operation. A fails to provide a permit issued by the government, and simply writes a letter purportedly permitting B to start the renovation work and the business operation, arguing that ‘necessary approval’ can mean the lessor’s approval.

Do you think A’s argument is justified?

Under Chinese contract law, the purposive interpretation of the contract, based on the principle of good faith, requires that the term ‘necessary approval’ be interpreted to mean the necessary government’s approval. A’s argument would not be accepted by the court.