Contract of Good Faith: Everything You Need to Know
A contract of good faith refers to the implied agreement that both parties will act in good faith and not stand in the way of the other party's performance.3 min read
A contract of good faith refers to the implied agreement that both parties will act in good faith and not stand in the way of the other party's performance.
What Is Good Faith?
Good faith is an implied (unstated) condition of every contract. It's assumed that parties won't do anything to deliberately hinder the contract's completion. If a party fails to act in good faith, it may breach the contract and be held liable for resulting damages.
Good faith is necessary in a variety of situations, such as the following:
- Business dealings
- Settlement negotiations
Typically, good faith means acting with honesty in conduct or transaction. Basically, someone agrees not to lie, cheat, or steal. Business owners who deal in merchandise should be honest and deal fairly with others.
However, good faith in the contract sense doesn't mean a failure to act with fairness, decency, or reasonableness. Instead, it has to do with what the parties have agreed to, along with having reasonable expectations of the other party.
Standards of Good Faith
Although the term “good faith” means specific things in a certain situation, most courts determine whether a person acted in good or bad faith based on one of two separate standards.
The first standard for determining good faith is based on reasonableness. When someone refuses to uphold his end of an agreement for no reason at all or a reason that has almost nothing to do with the situation, he may be liable for bad-faith dealing. For example, a car accident injures a plaintiff. He files a claim with his car insurance company to cover medical bills for accident injuries. However, the company does not pay him the benefits it owes him. Instead, it refuses to send him a check, and when he calls about payment, the agency doesn't take his calls.
A court may find the insurance company is not acting in good faith in this case since the company's actions are not reasonable. The insurance company refused to pay the benefits it owed, and it wouldn't give a satisfactory reason (or any reason at all) for not paying.
The second standard uses reasonableness to see if good faith exists, but it also considers intent. Using intent, someone may be liable for acting in bad faith if he didn't act reasonably and knew he had no reasonable basis to act the way he did.
Using the above example, the insurance company did not act in good faith since it didn't pay the benefits it owed and didn't explain why. Under the intent standard, the company is only liable for acting in bad faith if it also knew there was no reasonable basis for refusing to pay the claims.
Good Faith and Fair Dealing
Say you're a franchisee as part of a large chain. You pay a monthly franchise fee as part of your franchise agreement. In order to make enough money to pay your fee, you ask your franchisor for marketing help or to reach out to your potential investors. However, the franchisor refuses to provide assistance, and you're not able to pay your franchise fee. In this instance, the franchisor could be liable for breaching the duty of good faith and fair dealing, although you didn't perform your part.
There's an implied duty of good faith and fair dealing regarding performance and enforcement in contracts. However, many companies, executives, and attorneys fail to realize that this duty may require parties not to interfere with or refuse to cooperate in the performance of the other party. This is crucial since a contract may not explicitly require cooperation or a lack of interference. Just the implication may require a party to adhere to this duty or risk breaching the contract. This duty requires that neither side destroys the other party's right to receive benefits under the contract.
Good faith has different meanings, depending on the situation. Although it's not expressly stated in a contract, it is expected that all parties act in good faith. Otherwise, one side may be held responsible for bad faith dealings, which could result in costly consequences.
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