Acting in Good Faith in Business and Law

Key Takeaways

• Acting in good faith means dealing honestly and fairly, without intent to defraud or deceive.
• Courts evaluate good faith using two key standards: reasonableness and intent.
• Bad faith involves more than negligence—it requires deliberate dishonesty or disregard for others.
• The duty of good faith is implied in most contracts, especially under the Uniform Commercial Code.
• Breaching good faith can lead to legal claims and contract damages.
• Specific industries, like insurance and employment, impose heightened good faith obligations.

Good Faith and Bad Faith Overview

Acting in good faith, or bona fide, as it is sometimes also referred to by the courts, refers to the concept of being sincere in one’s business dealings and without a desire to defraud, deceive, take undo advantage, or in any way act maliciously towards others. This concept applies to many field of law, but is especially important in commercial law, where it can apply to many situations, including contract and settlement negotiations, mediation, arbitration, and general business dealings.

Acting in good faith may have a variety of meanings for a variety of situations, but in the eyes of the courts, there will be generally one of two meanings applied to a case to determine if good faith was upheld or not, and these are:

1. The Standard of Reasonableness. By this standard, an individual or entity may be considered to have not acted in good faith if they refused to adhere to their side of a contract for no reason that relates to the terms of the contract. For example, a party refusing to make their car payments due to a personal issue with someone at the dealership would be acting without good faith in an unreasonable manner.
2. The Standard of Intent. By this standard, an individual or entity may be considered to have not acted in good faith if they did not act reasonably and knew their was no reasonable basis for their actions. For example, an insurance company misrepresenting the terms of their policy would be acting without good faith with intent.

A lack of good faith may be viewed by many as acting in bad faith, but the courts will usually define bad faith as acting with reckless, indifferent, arbitrary, or intentional disregard for the wellbeing of other parties. Or, in other words, an act of bad faith must be done with some manner of intent, and not merely the result of ignorance or an error in judgment. It also must be provable as an act of bad faith.

Implied Duty of Good Faith in Contracts

The implied duty of good faith and fair dealing is a fundamental principle in contract law, requiring all parties to act honestly and fairly throughout the performance and enforcement of a contract—even when not explicitly stated in the agreement. This obligation ensures that neither party impedes the other’s right to receive the contract's benefits.

This duty often becomes relevant in situations where a party uses technicalities or ambiguities to avoid fulfilling their obligations. For example, if a franchisor delays approval for a location to block a franchisee from opening a competing store, this could be seen as a breach of good faith.

Courts commonly recognize this duty in commercial contracts, real estate dealings, employment agreements, and insurance policies. The breach of this duty is typically evaluated on a case-by-case basis and may provide grounds for claims such as breach of contract or tortious interference.

Benefits of the Good Faith Doctrine

Good faith doctrines have the benefit of enhancing the flow of commercial goods, since with them in place purchasers need not go to extraordinary lengths to determine that a seller is in good standing. Rather, a purchaser can act under the knowledge that a party acting fraudulently may have to answer for such acts in court, so long as evidence can be shown that the party acted deliberately in bad faith.

This concept is central to many other aspects of business dealings and law, including:

• Holder in due course. This is a concept pertaining to commercial paper (checks, promissory notes, deposit certificates, etc.) that one who holds a paper note may use it with the belief that the payment promised by it will occur in due course. If good faith did not back commercial paper, trust in its value would erode.
• The National Labor Relations Act of 1935. This gave workers in the private sector the right to form or join a union and enter into collective bargaining with their employer over such issues as hours, wages, and working conditions. It also required employers to negotiate with unions in good faith.
• The Uniform Commercial Code. Under certain rules of this code, which has been adopted in every state, a merchant has the right to retain goods that were purchased from a seller that lacked the right or title to sell those goods, if the merchant can prove that they were ignorant of the state of the goods or seller and thus acted in good faith when acquiring them.
• The Business Judgment Rule. This rule obligates directors and officers of corporations to act with good faith in their dealings on behalf of their corporation, while in turn they will not be held liable to incurred losses from their dealings, unless those dealings were proven to have been made in bad faith. This rule allows managers to act quickly, decisively, and sometimes riskily if they believe it will benefit their company, and do so without fear of being held personally liable by shareholders or other members of the company.
• Good faith deposits. A good faith deposit is a payment made to a landlord or seller of such “big ticket” items as cars, boats, and homes that signifies a renter’s or purchaser’s interest in the property in exchange for the property being taken off the market until the deal is closed. Good faith benefits buyers by holding property from other potential buyers and benefits property holders by bringing serious buyers to the forefront.

Acting in Good Faith Under the UCC and Common Law

Under the Uniform Commercial Code (UCC), good faith is defined as “honesty in fact and the observance of reasonable commercial standards of fair dealing.” This standard applies particularly to merchants and plays a vital role in the sale of goods, negotiations, and performance of commercial contracts.

In contrast, common law systems interpret good faith more broadly and often apply it as an implied covenant in a variety of contracts—even when not specified. The degree to which good faith is enforced varies by state. For instance, Delaware and New York courts may strictly interpret contract terms, while California courts more readily imply the duty of good faith into contractual relationships.

This dual framework means that while the UCC provides a codified baseline, courts may impose additional duties based on the nature of the relationship and the conduct of the parties involved.

Examples of Good and Bad Faith in Practice

Understanding how good and bad faith appear in real-world scenarios can help clarify their legal significance:

Examples of Acting in Good Faith:

• A landlord provides timely notice and necessary repairs to comply with a lease agreement.
• A supplier delivers goods on time despite incurring unexpected costs, honoring the original price.
• An employer gives fair warnings and improvement opportunities before terminating an underperforming employee.

Examples of Acting in Bad Faith:

• An insurer intentionally delays claim processing to pressure a policyholder into settling for less.
• A business partner conceals relevant financial information to gain an unfair advantage.
• A seller knowingly misrepresents property conditions during a real estate transaction.

These examples show that acting in good faith involves more than just following the letter of the contract—it requires fairness and honesty in execution.

Legal Consequences of Breaching Good Faith

Breaching the duty of good faith can lead to significant legal consequences, depending on the jurisdiction and the contract involved. Common outcomes include:

• Compensatory Damages: Courts may award actual damages to compensate the injured party for losses directly resulting from the breach.
• Punitive Damages: In egregious cases, particularly involving fraud or malice, punitive damages may be imposed to punish and deter misconduct.
• Termination of Contract: A party acting in bad faith may forfeit rights under the contract or face early termination.
• Tort Claims: Some breaches may give rise to tort actions such as fraudulent misrepresentation or interference with contractual relations.

Because courts take into account context and intent, a party accused of bad faith must be shown to have acted with more than just negligence—proof of dishonesty, obstruction, or unfair advantage is often required.

Frequently Asked Questions

1. What does acting in good faith mean legally?
   Acting in good faith means behaving honestly and fairly in the performance or enforcement of a contract, without intent to deceive or take unfair advantage.
2. Is the duty of good faith always part of a contract?
   Yes, in most cases courts imply the duty of good faith in contracts even when not explicitly stated, especially under the UCC and common law principles.
3. What happens if a party acts in bad faith?
   They may face legal consequences such as contract termination, compensatory or punitive damages, and potentially tort liability.
4. Does the UCC require good faith?
   Yes, the UCC mandates good faith conduct in the sale of goods and commercial transactions, especially for merchants.
5. Can you sue for breach of good faith?
   Yes, if a party breaches the implied duty of good faith, the injured party can sue for damages, depending on the facts and jurisdiction.

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