The recent decision of Bundanoon Sandstone Pty Ltd v Cenric Group Pty Ltd (Bundanoon) the New South Wales Court of Appeal has addressed the issue of whether a duty of good faith exists in contractual matters. Specifically, what is the existence and content of a duty of good faith in the exercise of contractual powers and discretions, including in respect of the exercise of termination rights such as termination for convenience.

Gleeson JA in Bundanoon, in dealing with the applicable legal principles said:

It is well accepted that, where a contractual power is given to one party for a purpose but in terms wider than necessary for the protection of its legitimate interests, the exercise of the power may be constrained by implied obligations of reasonableness and good faith.

This decision, firstly, highlights the he inherent risks associated with invoking a termination power under a contract, and the importance of any party contemplating the exercise of a putative termination right to seek legal advice.

But the more relevant ratio decidendi is that the decision to issue a show cause notice under the default and termination regime of a construction contract is subject to a good faith test. That involves acting honestly and not capriciously, arbitrarily or for an ulterior purpose. Essentially, good faith goes to the motivation of the party exercising the relevant contractual power or discretion (this motivation can often be unclear, but can be elucidated, for example, through cross-examination).