Introduction
Contracts play increasingly vital roles in our daily lives. While it’s clear that parties enter into contracts with expectations of mutual benefit, the dishonest or negligent behavior of one party can lead to irreversible harm for the other. The Indian Contract Act, 1872, serves as the primary legislation safeguarding parties and regulating contractual relationships. However, due to the broad discretionary powers granted to parties under contracts, actions taken by one party, even within the contract’s terms, can result in harm to the other. The doctrine of good faith, a fundamental legal principle, has long been recognized.
Good faith and fair dealing encompass the principle of honesty, fairness, and reasonableness in contractual relations. It requires parties to contract to act honestly, fairly, and in a manner that does not unjustly harm the interest of the other part. While the Indian Contract Act does not explicitly define good faith, its essence permeates throughout the various provisions of the acts. By incorporating this doctrine, a contract imposes the obligation of good faith in its performance and enforcement within its scope.
Significance
The doctrine of good faith is important due to the very nature of contract. A contract is essentially an agreement between two or more parties who reach an understanding on the basis of promises, which are legally enforceable. What allows them to coordinate their activities over long or short periods of time is trust.
India, throughout the years has done very little in recognizing the doctrine of good faith and fair dealing. Nevertheless, some statutes do mention the term-
- The General Clauses Act, 1897 defines good faith- “a thing shall be deemed to be done in ‘good faith’ where it is in fact done honestly, whether it is done negligently or not”.
- Section 52 of the Indian Penal Code states that “nothing is said to be done or believed in “good faith” which is done or believed without due care and attention”. Further, the term “due care and attention” has not been defined anywhere.
Hence, the two definitions are clearly contradictory of each other. The former stresses on honesty, even if negligence is present and the latter states that due care and attention is a must for an act to be done in good faith, that is, loosely the act must not be negligent. Similarly, in the Indian Contract Act, 1872 the term good faith is not defined anywhere except a mention, here and there. For example-
- section 223 states that an employer must indemnify the agent against the consequences of an act, regardless of the injury caused to third persons if “the agent does the act in good faith”.
- Section 178A also mentions that in case a pawnor has obtained possession of goods under a contract voidable under sections 19 or 19A and it has not been rescinded, and they pledge it, the Pawnee acquires good title “provided he acts in good faith”.
The ambiguity and confusion are clear. As a result, there is no coherent essence or definition of good faith in Indian law.
Scope
Even though the Indian Contract Act, 1872, does not explicitly define the term ‘good faith,’ it is implied in several sections of the legislation. The essence of good faith is honesty, as interpreted by the judiciary in numerous instances. For example, in the case of Kailas Sizing Works v. Municipality of Bhivandi and Nizampur, the court elucidated that acting in good faith requires honesty, fairness, and uprightness. If a person acts in a manner that knowingly causes harm or negligence, they cannot be considered to act with honesty or in good faith. Therefore, it is crucial that good faith is associated with care and concern in fulfilling obligations. The absence of good faith implies a lack of skill, diligence, concern, or even gross negligence. It is notable that similar language is found in the Indian Contract Act, 1872.
Section 212 of the Indian Contract Act stipulates that an agent is obligated to act with diligence and utilize their skills to the best of their ability. They are also required to compensate the principal for any direct consequences resulting from their negligence, lack of skill, or misconduct. This provision implies the principle of good faith on the part of the agent, as someone who works diligently and without neglect is expected to be honest in carrying out their duties. Moreover, an agent is bound to exert reasonable diligence in communicating with their principal to seek instructions. Conversely, if an agent is found to be dishonest, the principal has the right to repudiate the entire transaction. These examples illustrate that the Indian Contract Act, 1872 implies a notion of good faith in contracts, which involves the reasonable diligence expected of an ordinary prudent person. The doctrine of good faith also extends to insurance companies, legally obligating parties to refrain from concealing information or misleading and to act honestly.
In the case of Union of India v. D.N. Revri & Co., the Court emphasized that contracts should be interpreted using a common-sense approach and not be subjected to narrow, pedantic, or legalistic interpretations. Therefore, the fundamental purpose of a contract should be to benefit both parties, and the terms should be construed in such a manner. No party should assert strict adherence to the terms if it results in harm to the other. This principle is especially relevant in commercial contracts, which are susceptible to changes in governmental policies. Additionally, to ascertain the extent of good faith in contracts, it is essential to grasp the essence of the agreements and the intentions of the parties at the time of entering them.
The Hon’ble Court had held in the case of Swarnam Ramachandran v. Aravacode Chakungal Jayapalan, intention of the parties can be determined from-
- the express words used in the contract;
- the nature of the property which forms the subject-matter of the contract;
- the nature of the contract itself; and
- the surrounding circumstances.
However, there exists a presumption that the principle of good faith primarily pertains to contract law. Nonetheless, it is also applied, albeit to a lesser extent, in various other areas of private law such as family law, property law, etc. Therefore, good faith is indispensable for parties as it serves to prevent the exploitation of contractual relationships in the future. While it undeniably plays a significant role in forming contractual obligations, its importance remains acknowledged. It is noteworthy that the application and interpretation of the doctrine of good faith can vary depending on the jurisdiction and context.
In India, insurance contracts are subject to strict interpretation under the principle of good faith. The Law Commission of India’s report on unfair terms in contracts has highlighted the deficiencies in Indian contract law concerning unfair terms. Despite efforts to establish precise rules on good faith and fair dealing, Indian contract law has not fully embraced these concepts.
Conclusion
Through this study, it has become evident that India’s position regarding the doctrine of good faith, particularly in contracts, is rather ambiguous. While it is recognized in the Indian Penal Code, 1860, this recognition contradicts the definition provided under the General Clauses Act, 1897. Moreover, the Indian Contract Act, 1872 barely mentions the doctrine. Although parties entering contracts are expected to act reasonably, there is no explicit mention of an overriding duty of good faith. Merely relying on the vague concept of reasonableness cannot justify ignorance of such an important doctrine.
The Judiciary has occasionally attempted to enforce the doctrine as an implied term, but it is significantly under-enforced and lacks widespread recognition, as evidenced by the mentioned case laws. Therefore, the scope of the doctrine largely depends on judicial interpretation and may not automatically apply to every contract. In certain cases, the Judiciary may establish the doctrine to safeguard contractual morality, as it has done in the past.
By- Esha Gandhi (intern)