REUTERS | Andrew Winning

Frustration and good faith make an uncomfortable mix

It’s not unusual for a commercial or residential property development to run into trouble. In particular, in 2007 and 2008, when a run of boom years came to an abrupt end, developers had to urgently postpone or cancel many of their schemes. Some delays and cancellations inevitably led to disputes.

One of these, the Gold Group (alias Ann Summers) and Barratt saga, has now come to an end in the TCC, which gave judgment last month.

The context

The case concerned a development that never really got off the ground. It was intended to be a partnership between the well-known high street chain and the developer. The developer would complete the construction of various properties at a large site in Surrey, which it would then sell on behalf of Gold (who retained the freehold).

A key part of the development agreement related to the split of the sales revenue. The agreement included a formula to share sales revenue up to £19.5 million, but gave the developer the whole of the next slice up to £26 million. After that, revenue would be split 60:40 in the developer’s favour.

The development agreement provided that each party would, at all times, act in good faith towards the other and use all reasonable endeavours to observe the agreement. It also specifically allowed the parties to vary the sale prices in the agreement.

What could possibly go wrong?

The parties set up their agreement in mid-2007 and works were to commence by June 2008. By late 2007, and certainly by mid 2008, the recession was beginning to bite:

  • By May 2008, the developer’s work had declined by around 33%.
  • In June, its stock market value fell from £488 million to £213 million in a week.
  • Estate agents were reporting a drop in property prices in the area of around 20%. (Units would have to be sold below the minimum prices anticipated in the development agreement.)

The developer tried to re-negotiate, so that the allocation of sales revenue would give Gold its original return if the market recovered to what had been expected in 2007, but otherwise Gold would receive less. Negotiations foundered. Eventually, the developer returned the keys to the development and each side said that the other was in breach. The developer argued that the agreement had been discharged by frustration.

Frustration and the permanence of land

Frustration rarely impinges on building contracts and property-related litigation for the obvious reason that land (apart from landslips and the like) tends to be rather permanent. Not for the first time, a party put forward the argument that a radical change in market conditions amounted to a frustrating event, on the basis that the parties had a common assumption about the minimum prices to be obtained.

That argument was dismissed by the court. In fact, the parties had anticipated the possibility that the property market would drop and the development agreement provided for what should happen, by allowing for renegotiation. In fact, there was no frustrating “event” at all, just a warning that prices had gone down and that nobody knew what would happen next. The developer was in breach of the development agreement in failing to carry out and complete the works.

However, the developer also argued that Gold was itself in breach, on the basis that it refused to renegotiate (in good faith). Was this argument tenable?

No duty to subordinate your self-interest

Clauses on good faith have been examined in a number of cases both here and in Australia, and the court referred to a particularly interesting Australian decision: Overlook v Foxtel. In particular, the court in Overlook said:

“…no party is fixed with the duty to subordinate self-interest entirely which is the lot of the fiduciary… [good faith] is, rather, a duty to recognise and to have due regard to the legitimate interests of both the parties in the enjoyment of the fruits of the contract as delineated by its terms.”

In this light, it’s clear that the developer’s proposal was asking Gold to give up an advantage freely negotiated: Gold would have obtained less revenue, which would then have been transferred to the developer.

Frustration will rarely, if ever, be a tenable argument in most building contract disputes. However, arguments on the limits of the obligation to act in good faith are still being explored. In that respect, as the court said in Overlook, a good faith obligation may indicate little more than:

“A party is precluded from cynical resort to the black letter.”

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