When you enter a business relationship with another party, you draw up one or more contracts to outline and regulate that partnership. That’s just prudent. It goes without saying that both you and your new business partner should have a reasonable expectation of cooperation and mutual benefit; an unwritten understanding that goes beyond the letter of any contract you signed. This is called the implied duty of good faith and fair dealing.
Talk to a Business Litigation Attorney
If you are entering a business agreement, or even if you’re already part of one, it’s best to know exactly where you stand, especially in situations not expressly covered in your contract. Robinson and Henry’s civil litigation team understands the implied duty of good faith and fair dealing and when a violation warrants action. An experienced Colorado litigation attorney can review your specific circumstances and make sure you’re treated fairly. Call us at 303-688-0944 to set up your free case assessment.
What is the Implied Duty of Good Faith and Fair Dealing?
It is widely understood in the business world that every contract carries an implied duty of good faith and fair dealing. This is the reasonable assumption that the parties to an agreement will act with honesty and fairness toward each other so both can reap the benefits of their arrangement.
This duty requires that neither party make decisions or take actions that could hinder or injure the right of the other to receive the benefits of the contract.
Colorado, like most jurisdictions, recognizes the implied duty of good faith and fair dealing:
“Each party to a contract has a justified expectation that the other will act in a reasonable manner in its performance. When one party uses discretion conferred by the contract to act dishonestly or to act outside of accepted commercial practices to deprive the other party of the benefit of the contract, the contract is breached.” Wells Fargo Realty Advisors Funding v. Uioli, Inc., Jan. 1994
Let’s take a closer look at some key terms:
Even if a contract does not explicitly require one party to cooperate, or to refrain from interfering with the other, the implied duty of good faith still guides both ends of the business relationship.
Breaching the Implied Duty
A party can be found in breach of the implied duty of good faith and fair dealing if their conduct is shown to obstruct, undermine, or work in opposition to the other party’s ability to fulfill, or profit from, its performance of the contract.
Since implied duty has no specific definition, the courts have the discretion to determine its scope. When a court weighs whether the duty of good faith and fair dealing has been violated, it must analyze the facts and decide what is fair under the circumstances. This is done on a case-by-case basis.
Good faith can be defined as honesty in a person’s conduct during an agreement. The obligation to perform in good faith holds up even if the charter expressly allows either party to terminate the contract for any reason.
A basic example of conduct that demonstrates good faith is when a person enters a contract that they are certain they will be able to fulfill.
Fair dealing goes beyond just honesty. It means adhering to the spirit of the bargain and not conducting oneself in a way that is contrary to the other party’s interests.
As long as the agreement is in place, each party must act in ways that are forthright and faithful to their contract.
A classic example of unfair dealing is when one party to a business agreement is slow to respond or give support when the other needs it and then takes advantage of that party’s weakened circumstances to force a modification of the contract and further strengthen their own position.
The Uniform Commercial Code
The Uniform Commercial Code (UCC) is a comprehensive set of laws governing all commercial transactions in the United States. It has been called “the backbone of American commerce,” and is therefore taken quite seriously.
The implied duty of good faith and fair dealing is a pillar of the Uniform Commercial Code. It provides that “every contract or duty within the UCC imposes an obligation of good faith in its performance and enforcement.” UCC § 1-304
Formed in 1892, the UCC is not federal law but is uniformly adopted by states. Its most essential function is to govern the interstate transaction of business.
Because the UCC has been universally adopted, businesses can enter contracts with confidence that terms will be enforced in the same way by courts in every jurisdiction. The resulting certainty of business relationships allows commerce to flourish and the American economy to thrive.
Breaching the Spirit of the Deal
When you sign a business contract, you agree to more than what appears on the paper. All parties to a mutual agreement or contract must conduct themselves in ways that adhere to the spirit of the deal.
Just because certain obligations are not expressly written down in a contract does not mean they are unenforceable. In order for that to occur, both parties need to specify that in the contract.
The Importance of Implied Good Faith
Most contracts, especially complex agreements, cannot cover every conceivable situation, nor can they provide detailed terms for every aspect of each party’s obligations.
It’s important that you and your business understand what your obligations are under a contract, not just the actual terms, but the implicit duties as well. For example, let’s say the other party asks for help. After reviewing the contract, you refuse to help because the terms, as written, do not specifically state you must help. You very well could be unintentionally breaching the contract.
It is important to keep in mind the spirit of the agreement and not just the written words.
Examples of Failure to Act in Good Faith
A party cannot participate in any act (or non-act) that would prevent the purpose of the contract from being fulfilled. This means that neither party shall:
- be neglectful or slack off
- abuse of power when specifying terms
- intentionally perform poorly or incorrectly
- interfere with or fail to cooperate with the other party’s performance
Other examples include:
- tamper with goods to be delivered under a contract
- promise to use the services of one company exclusively, but then intentionally use the services of multiple companies
- lie about performing obligations under the contract
- dishonestly agree to perform a service you’re incapable of doing
- contract to purchase a property, get denied the mortgage, then refuse to try a different lender to go through with the sale
Failing to Enforce a Contract in Good Faith
The duty of implied good faith and fair dealing also applies to the enforcement of an agreement. This refers to a party’s assertion, litigation, and resolution of contract claims, and defenses relating to the agreement and will be violated by dishonest conduct.
For example, a party may not ….
- conjure up a nonexistent dispute
- assert interpretations of an agreement that are contrary to its understanding
- falsify facts
In certain cases, implied duty can apply to actions that, while appearing fair on the surface, defeat the intent and spirit of the agreement.
Behaviors that courts have held violate good faith and fair dealing include:
- making harassing demands for assurances of performance
- rejecting the other party’s performance for unstated reasons
- abusing discretionary power
- intentionally failing to mitigate damages
- acting unreasonably when assessing the other party’s compliance with the contract or terminating the agreement
Again, these are only examples. Case law does not reveal any single definition or bright-line meaning for good faith and fair dealing, despite how long the implied duty has been observed.
Adjudication of issues relating to this covenant is almost always fact-specific, examining compelling issues of fairness within the context of a particular business contract. This means that courts retain broad discretion when interpreting good faith and fair dealing.
When “Bad Faith” is Not Considered Bad Faith
Bad faith requires more than just negligence. Courts have held that a compelling case of bad faith can only be shown with a conscious and deliberate act that unfairly frustrates the purpose of the agreed-upon contract and thwarts the reasonable expectations of the other party. In other words, it entails a sinister or self-interested motive.
Conduct deemed to have been the result of an honest mistake, poor judgment, or negligence is not normally considered a violation. Any claim against an honest mistake or even a series of honest mistakes would probably fail.
Negotiation vs. Performance of a Contract
The way the courts see it, the implied duty of good faith and fair dealing doesn’t go into effect until after a contract is agreed upon and signed by all parties.
There is no obligation upon parties to negotiate in good faith. Therefore, any claim based on dishonest conduct that took place during contract negotiations might not provide a valid case for a breach of the implied duty.
This is why it is so important to retain experienced legal counsel while negotiating or evaluating a business contract.
Relevant Factors in the Application of the Implied Duty
Because issues relating to the implied duty of good faith and fair dealing are so fact-sensitive, courts have employed both broad and narrow applications. Numerous factors impact whether a court will provide a more limited or expansive scope when determining whether and how to apply the covenant. These include the:
- motivation behind the defendant’s actions
- sophistication of the parties
- bargaining power of the parties
- type of claim at issue
- length and complexity of the agreement
Furthermore, courts tend not to consider an implied duty of good faith and fair dealing to go around basic principles of contract construction. In other words, clear and unambiguous language on a written contract trumps implied duty whenever the two are in conflict.
You cannot point to the implied duty of good faith and fair dealing to wriggle out of a contract’s express terms.
What If the Other Party Fails to Act in Good Faith?
The covenant is enforceable. When one of the parties to a contract violates the implied duty of good faith and fair dealing, it can be considered in breach. That party can then be held liable for damages that have occurred because of their conduct.
If either party committed fraud, they could face appropriate criminal charges and penalties.
Also, the non-breaching party can have its contractual obligations voided. But it must show that the other party’s failure to act in good faith prevented them from adequately performing their portion of the agreement.
Generally, the consequences for breaching the implied duty of good faith and fair dealing depend on the nature of the contract itself.
The Elements of a Claim
Most disputes relating to unwritten obligations come from (1) agreements that give one party total discretion over its own performance and enforcement, (2) from contracts lacking the terms necessary to fulfill both parties’ expectations, and (3) from cases where bad faith served as a pretext for terminating an agreement.
To state a claim for breach of the implied duty of good faith and fair dealing, a plaintiff must generally plead:
- the existence of a contractual relationship between the plaintiff and defendant,
- plaintiff’s performance (or excuse from performance) of its obligations under the contract,
- that the defendant unfairly prevented the plaintiff from receiving the benefits it was entitled to under the contract; and
- injury to the plaintiff as result of defendant’s conduct.
Courts have said that the application of the implied covenant should be rare and fact-specific, based upon issues of compelling fairness.
Because the covenant is, in essence, a contract term (even if implied) designed to give effect to the contractual intention of the parties, recovery in cases where the covenant has been breached is usually limited to contract remedies.
Some courts have held, however, that tort damages can be available for breach of the covenant of good faith and fair dealing. This particularly goes for limited circumstances where there is a special relationship between the parties, such as those arising from elements of public interest, and fiduciary responsibility, as well as cases involving franchisors and franchisees where one party clearly acted in bad faith.
Make Sure You are Treated Fairly
Contract terms can often be difficult to understand or interpret. If you suspect you are involved in a contract where the implied duty of good faith and fair dealing has been violated, it’s time to talk to an experienced litigation attorney. Don’t wait. Call (303) 688-0944 for your free case assessment.