Good faith (law)
|Part of the common law series|
|Defenses against formation|
|Excuses for non-performance|
|Rights of third parties|
|Breach of contract|
|Related areas of law|
|Other common law areas|
In contract law, the implied covenant of good faith and fair dealing is a general presumption that the parties to a contract will deal with each other honestly, fairly, and in good faith, so as to not destroy the right of the other party or parties to receive the benefits of the contract. It is implied in every contract in order to reinforce the express covenants or promises of the contract. A lawsuit (or a cause of action) based upon the breach of the covenant may arise when one party to the contract attempts to claim the benefit of a technical excuse for breaching the contract, or when he or she uses specific contractual terms in isolation in order to refuse to perform his or her contractual obligations, despite the general circumstances and understandings between the parties.
In U.S. law, the legal concept of implied covenant of good faith and fair dealing arose in the mid-19th century because contemporary legal interpretations of “the express contract language, interpreted strictly, appeared to grant unbridled discretion to one of the parties”. In 1933, in the case of Kirke La Shelle Company v. The Paul Armstrong Company et al. 263 N.Y. 79; 188 N.E. 163; 1933 N.Y., the New York Court of Appeals said:
In every contract there is an implied covenant that neither party shall do anything, which will have the effect of destroying or injuring the right of the other party, to receive the fruits of the contract, which means that in every contract there exists an implied covenant of good faith and fair dealing.
Furthermore, the covenant was discussed in the First Restatement of Contracts by the American Law Institute, but before adoption of the Uniform Commercial Code in the 1950s, when the common law of most states did not recognize an implied covenant of good faith and fair dealing in contracts.
The implied covenant of good faith and fair dealing is especially important in U.S. law. It was incorporated into the Uniform Commercial Code (as part of Section 1-304), and was codified by the American Law Institute as Section 205 of the Restatement (Second) of Contracts.
Most U.S. jurisdictions view the breach of the implied covenant of good faith and fair dealing solely as a variant of breach of contract, in which the implied covenant is merely a "gap-filler" that provides yet another contractual term, and breach thereof simply gives rise to ordinary contractual damages. Of course, this is not the most ideal rule for plaintiffs, since consequential damages for breach of contract are subject to certain limitations (see Hadley v. Baxendale).
In certain jurisdictions, breach of the implied covenant can also give rise to a tort action, e.g. A.C. Shaw Construction v. Washoe County, 105 Nevada 913, 915, 784 P.2d 9, 10 (1989). This rule is most prevalent in insurance law, where the insurer's breach of the implied covenant may give rise to a tort action known as insurance bad faith. The advantage of tort liability is that it supports broader compensatory damages as well as the possibility of punitive damages.
Some plaintiffs have attempted to persuade courts to extend tort liability for breach of the implied covenant from insurers to other powerful defendants like employers and banks. However, most U.S. courts have followed the example of certain landmark decisions from California courts, which rejected such tort liability against employers in 1988 and against banks in 1989.
- Dubroff H. (2006). The Implied Covenant of Good Faith in Contract Interpretation and Gap-filling: Reviling a Revered Relic. St. John’s Law Review. Free full-text.
- See A.C. Shaw Construction v. Washoe County, 105 Nev. 913, 915, 784 P.2d 9, 10 (1989).
- Foley v. Interactive Data Corp., 47 Cal. 3d 654, 665 (1988).
- Price v. Wells Fargo Bank, 213 Cal. App. 3d 465 (1989).