The Implied Covenant of Good Faith and Fair Dealing
In contract disputes, courts will often enforce a contract as it is written and decline to add terms that do not actually appear within it. But it is very difficult to write a contract that can anticipate every possible circumstance. As a result, people often take actions that another person feels violates the “spirit” of a contract and would have been dealt with in the text of the agreement if the parties had thought to discuss them. These people can sue for these violations under the law of many states by alleging a breach of the implied covenant of good faith and fair dealing.
Why should you read this post about the implied covenant?
Someone has failed to meet your expectations but your contract with that person does not expressly prohibit what they are doing .
You want to bore people and need something to ramble about.
You want to write a scary sounding demand letter but you don’t know what law to cite.
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What is the Implied Covenant?
The implied covenant of good faith and fair dealing is a promise that state law declares is inherent in every contract unless the contract expressly disclaims it. The Uniform Commercial Code, for example, codifies it at UCC 1-304. It basically requires people who enter into contracts to act consistently with the object of the agreement. So, for example, if a sponsor of an apartment building agrees to sell apartments, that agreement contains an implied promise that the sponsor will not wait ten years to do so, making the finances of the building unsustainable.
The covenant also limits how people can act when a contract lets them use their own discretion. In those situations, the covenant includes a promise not to act “arbitrarily or irrationally” when doing so. So, for example, in the case cited in the previous sentence, if a student agrees that a college can suspend her, the college must not do so arbitrarily or irrationally. In another famous case, New York’s highest court held that a promise by a literary agent to be an author’s exclusive agent and to share profits includes the promise to try to solicit those profits in good faith. And in a more recent case, a Delaware court held that an employer breaches the implied covenant by making up fictitious grounds to terminate an employee it otherwise had the right to fire.
It has been around for over a century. For example, New York’s highest court held in 1893 that contracts contain an “implied promise … always exist[s]” to abide by a promise that “would have been made if attention had been drawn to it.”
How Do Lawyers Use It?
Lawyers use the implied covenant in two principal ways, much like they use any cause of action. First, they use it to threaten litigation in demand letters. When someone harms a client, the lawyer writes to the transgressor to demand that they stop and/or compensate the client for the harm. And, to explain why the transgressor should be afraid of a lawsuit if they do not comply, the letter may cite the implied covenant as the basis for a potential case.
Lawyers also use the implied covenant as a separate cause of action in a complaint. This allows the complaint to state a claim for conduct that may not be expressly discussed in a contract so that the claim may survive a motion to dismiss.
Since the implied covenant is technically part of a contract, lawyers can use it to seek the same damages as they could from a breach of an express term of an agreement.
How Does It Work in Litigation?
Defense lawyers often move to dismiss claims for breach of the implied covenant. They may argue that the claim is duplicative of the same arguments raised in a contract claim. Or they may argue that the assertion of the covenant is really asking the court to impose an obligation that contradicts the express terms of the agreement. Courts can be often sympathetic to that argument.
After the pleadings and motion to dismiss phase, the implied covenant often plays a lesser role in a litigation during discovery. Parties may investigate whether another person acted in bad faith, but often take discovery on that issue anyway since it is arguably related to the question of whether a party breached. Then, the parties may decide whether the claim is viable on a motion for summary judgment or in a motion in limine. And, if the claim survives all of those motions, it may proceed to trial, just like any other contract claim.
In my experience, I have read numerous decisions that uphold claims of breach of the implied covenant. But I have yet to personally see such a case actually lead to a money judgment. It is my personal experience that these claims are threatened more often than they succeed.