Key Takeaways

  • Good faith is an implied obligation in every contract, requiring honesty, fairness, and non-interference with the other party’s rights.
  • The duty of good faith and fair dealing applies both during contract performance and enforcement, even if not explicitly written.
  • Courts evaluate good faith based on reasonableness and sometimes intent.
  • Discretionary contract clauses must be exercised in good faith and not used opportunistically.
  • Breaches of good faith often arise when one party acts to undermine the purpose of the contract.
  • Good faith varies by jurisdiction, particularly in employment and commercial contracts.
  • Remedies for breach can include damages, contract termination, or equitable relief like injunctions.

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:

  • Contracts
  • Mediation
  • Business dealings
  • Arbitration
  • 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.

When Good Faith Applies in Contracts

Good faith is not only a general expectation but a binding legal principle applied to many types of contracts. It typically arises in two key situations:

  1. Filling Contractual Gaps: When a contract is silent on specific terms, the implied covenant of good faith can fill in to ensure that both parties perform in a way that aligns with the agreement's purpose.
  2. Discretionary Powers: If one party has sole discretion in making certain decisions—such as setting prices or allocating resources—that discretion must be exercised honestly and not to the detriment of the other party.

For instance, if a supplier has the discretion to adjust delivery schedules, they cannot exploit that power in a way that sabotages the buyer’s operations.

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.

Examples of Bad Faith Conduct

Courts often identify bad faith by examining actions that appear deceptive, evasive, or deliberately obstructive. Some common examples include:

  • Withholding essential information from the other party to gain an unfair advantage.
  • Unreasonable delay or denial in fulfilling contractual duties without justification.
  • Using technical loopholes to avoid obligations while undermining the contract’s spirit.
  • Failing to cooperate when such cooperation is necessary for performance.

Bad faith is not limited to outright fraud—it includes any conduct that defeats the purpose of the agreement.

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.

Legal Remedies for Breach of Good Faith

A breach of the implied covenant of good faith and fair dealing can lead to serious legal consequences. Remedies depend on the extent of the breach and the jurisdiction, but may include:

  • Compensatory damages for losses directly caused by the breach.
  • Punitive damages if the breach was particularly malicious or egregious.
  • Injunctive relief to prevent ongoing harm.
  • Contract rescission or reformation, where appropriate.

In commercial settings, courts often scrutinize whether the breaching party's actions were intended to deprive the other of the contract’s benefits.

Varying Interpretations by Jurisdiction

The application of good faith can differ by state or governing law. For example:

  • New York generally enforces the covenant strictly, focusing on whether the party exercised contractual discretion in a manner consistent with the contract’s purpose.
  • Delaware, a hub for corporate law, recognizes that not all breaches of good faith imply bad faith unless there's clear evidence of intent to harm.
  • California often interprets good faith more broadly, especially in employment and insurance contexts.

Parties to a contract should understand how their jurisdiction defines and enforces good faith obligations.

Preventing Good Faith Disputes

To avoid disputes over good faith, parties should:

  • Clarify ambiguous terms and outline expectations clearly in the contract.
  • Define discretionary powers and how they should be used.
  • Document all major communications and decisions affecting performance.
  • Maintain transparency throughout the business relationship.
  • Seek legal advice before making decisions that could impact the other party’s contractual benefits.

Being proactive reduces the risk of misunderstandings and potential litigation over alleged bad-faith behavior.

Frequently Asked Questions

1. What is a contract of good faith? A contract of good faith implies that both parties will act honestly and not interfere with each other’s right to receive the contract’s benefits.

2. Can you sue for breach of good faith? Yes, if one party violates the implied duty of good faith and fair dealing, the other party may sue for damages or seek other remedies.

3. Is good faith legally required in every contract?Y es, most U.S. jurisdictions recognize an implied covenant of good faith in all contracts, even if it’s not explicitly stated.

4. How is good faith evaluated in court? Courts assess good faith based on reasonableness and, in some cases, intent—evaluating whether actions were honest and consistent with the contract’s purpose.

5. What’s an example of violating good faith? An example would be a landlord refusing to approve a reasonable sublease to force a tenant out, despite having the discretion to approve such arrangements.

If you need help with a contract of good faith, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.