Legal briefing | Commercial Law, Commercial & Technology, Outsourcing, Joint Ventures, Agency & distribution, Franchising | 08 Jul 2019

Relational contracts: what are they and why do they matter?

Overview

The concept of "relational contracts" is not new but has recently started to crop up more often in judgments on contractual disputes. This matters because, as we explain below, a finding that your contract is "relational" can make a significant difference to the way it is interpreted by a court.

What is a relational contract?

It's perhaps easier to start by looking at an agreement which is unlikely to be regarded as relational. A good example would be an agreement for the sale and purchase of a business. This is unlikely to be relational because the parties are usually looking for a clean break; their relationship is essentially transactional, rather than relational in nature.

Contrast that with a joint venture which is expected to last at least 5-10 years, where both parents are contributing resources and expertise – and to make it work, they need to cooperateclosely with one another on a day-to-day level. Such an agreement is much more likely to be a relational contract. There isn't a definitive test as yet, but the courts have indicated that relational contracts usually involve:

  • a longer term relationship;
  • a substantial degree of commitment from both parties; and
  • a high degree of communication and cooperation between the parties.

Relational contracts in practice

In practice, relational contracts could include:

  • joint ventures;
  • complex outsourcings; and
  • franchising and distribution arrangements.

Why does it matter?

Two recent cases have shown how a finding that a contract is relational can have a significantimpact on how the contract is interpreted.

In Amey v Birmingham City Council (2018), the Court of Appeal ruled that a 25 year PFI contract for maintenance of Birmingham's road network was a relational contract. This appears to have been an important factor in its rejection of Amey's argument (which had been successful at first instance) that it was only obliged to maintainthose parts of the road network included in a dataset supplied by Birmingham City Council at the outset of the contract.

Among other things, the Court of Appeal noted that this was a very complex contract (running to over 5000 pages), which could only work if the parties were prepared to cooperate with one another to achieve its objectives. Given its long term nature, it was inevitable that Amey's precise contractual obligations would evolve over time. This supported the view that Amey was under an obligation to update the road network dataset from time to time.

Any relational contract of this character is likely to be of massive length, containing many infelicities and oddities. Both parties should adopt a reasonable approach in accordance with what is obviously the long-term purpose of the contract.

Lord Justice Jackson, Court of Appeal in Amey v Birmingham City Council (2018)

Although the Court of Appeal also conducted an extensive textual analysis in support of its view, the finding that the contract was relational appears to have had a significant influence on its overall approach - encouraging it to reject Amey's much stricter interpretation of the contract.

Good faith

Meanwhile in Bates v Post Office (2019), a finding that contracts between the Post Office and its sub-post masters were relational led to a wide-ranging duty of good faith being implied.

This litigation arose out of a very long-running saga involving the Post Office and some of its sub-postmasters, who run Post Office branches. Based on discrepancies in their accounts, these sub-postmasters were accused of theft, fraud or false accounting and their contracts were terminated.

Some of them have even been convicted and sent to prison. The sub-postmasters argue that the discrepancies arose because of errors in the Post Office's own computer system, Horizon. The courts haven't yet reached a view on whether that is correct.

The judgment in Bates was concerned with various preliminary issues about the terms of the contracts – for example, the provisions which the Post Office relied upon to suspend or terminate subpostmasters' contracts. The sub-postmasters argue that the Post Office was effectively presuming guilt unless a sub-postmaster could prove that any accounting discrepancy was not their fault. The Post Office argues that it had a broad discretion on this point and that it acted within its rights.

The implied general duty of good faith is likely to mean that the Post Office will need to show that it had sufficient regard to issues of fairness and due process in exercising its discretion. That may prove difficult given its apparent reluctance to accept any suggestion that the Horizon system could possibly have been at fault.

Relational contracts: key points

Relational contracts are typically long term agreements involving substantial mutual commitment and extensive cooperation and communication between the parties. A finding that a contract is relational:

  • can have significant impact on how the contract is interpreted, making it more difficult to rely on a very narrow, strict construction; and
  • may mean that obligations of good faith are implied, with the result that parties should avoid conduct which reasonable and honest people would regard as commercially unacceptable

Click here to view our video explainer on relational contracts.

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