Key Takeaways

  • A good faith clause requires parties to act honestly, fairly, and cooperatively when entering, performing, or terminating a contract.
  • Courts often interpret good faith obligations as both objective (reasonable behavior) and subjective (honest intent).
  • The duty of good faith and fair dealing is often implied in contracts, even if not expressly written.
  • Breach of good faith can lead to legal liability, even without explicit contractual language.
  • Negotiation, performance, and termination of contracts must all adhere to good faith standards to prevent disputes.

A good faith clause refers to the manner in which parties in an agreement act with each other. It is often for an employer and employee relationship, where good faith would cause both parties to act respectfully to one another.

What Is Good Faith?

Good faith is a legal term that describes the intention of the party or parties in a contract to deal in an honest manner with each other. In contracts, the parties signing abide by and uphold the contract. It requires people to act honestly without taking advantage of others.

Good faith is used in many situations, including mediation, business dealings, and contracts, as well as appearing in business law. Directors and officers are required to act in good faith for the corporation. Although good faith may mean different things in certain situations, most courts use one of two standards to determine whether a defendant acted in good faith.

  • Someone or a business may be liable for bad faith if they don't hold their end of the contract for no reason or a reason that has little to do with the situation.
  • The second situation also uses reasonableness but asks for intent. A defendant may be liable for acting in bad faith for unreasonable behavior and if he knew or should have known the action was not reasonable.

Directors and officers of a company need to act in good faith while representing the company for anyone, including shareholders, but it's difficult for shareholders to bring them to court because of the business judgment rule. The court presumes good faith from company officers unless the plaintiff can prove otherwise

The Implied Covenant of Good Faith and Fair Dealing

Even if a contract does not explicitly include a good faith clause, courts in most jurisdictions recognize an implied covenant of good faith and fair dealing. This means that both parties are expected to act honestly, fairly, and consistently with the agreed purpose of the contract. The covenant prevents one party from acting in a way that would deprive the other of the benefits of the agreement.

Examples of behavior that might breach this duty include:

  • Deliberately withholding crucial information that impacts the contract.
  • Exploiting vague terms in a way that undermines the other party’s rights.
  • Taking actions that technically comply with the contract but clearly contradict its intent.

This principle applies in many contexts, from employment and commercial agreements to insurance and franchise contracts, and serves as a vital safeguard against opportunistic or manipulative conduct.

Reasonableness or Good Faith Standard?

A reasonableness criteria is objective — what would a sensible person do in this situation?

A good faith is subjective — was the person thinking he was acting reasonably without considering the perspective of a reasonable person? Sometimes it's not possible to know if a party acted reasonably or not because of a lack of evidence or evidence benefits yourself. It's unreasonable to give the party a chance to act unsensible but in good faith. Courts often decide if a person did something in good faith by thinking about how other people would have behaved in corresponding situations, therefore applying the reasonableness standard.

There are two circumstances where good faith is used to qualify a responsibility to negotiate.

  • A good faith standard is built in every contract through the duty of faith because it reinforces the idea that negotiation is required when a meeting is possible. It's clear a reasonableness standard doesn't apply; just because a reasonable person would have agreed doesn't mean you have to.
  • Good faith is appropriate when you want to make sure the discretion granted is subject to an obligation to act in good faith.

In contracts, it's better to consider lessening the grant of discretion that could be interpreted openly and making it clear that the contract is subject to good faith.

Negotiating in Good Faith

A good faith clause can apply even before a contract is signed — particularly during negotiations. Courts increasingly expect parties to negotiate with a genuine intention to reach an agreement and to avoid misleading or deceptive behavior during discussions.

To demonstrate good faith during negotiations, parties should:

  • Communicate honestly about their intentions and capabilities.
  • Avoid “false negotiations” where one party pretends to bargain with no intention of reaching an agreement.
  • Disclose relevant information that materially impacts the deal’s terms.
  • Refrain from exploiting power imbalances or misleading the other side.

While negotiating in good faith doesn’t require parties to make concessions, it does demand a sincere effort to work toward an agreement. Failing to do so — for example, by using negotiations solely to gather competitive intelligence — could expose a party to legal consequences or reputational harm.

Good Faith Overview

  • If you want the parties to act in good faith, expressly state it in the contract.
  • Specify what it means to act in good faith, such as the actions required to meet good faith.
  • Include objectives, like deadlines and time limits.
  • Good faith obligations don't override the express terms of the contract.
  • Good faith law is an evolving area that can be expanded or limited according to each judge, so it's important to understand the developments in good faith law so that you understand how your contract will be interpreted.
  • Drafting a contract should be done with time and care, which can then save the business or the parties involved money, stress, and time. If the drafting is done clearly, it will reduce the chance of a dispute over the meaning of a good faith clause. Since good faith is open to court interpretation, it's best for the parties to avoid as much as they can heading to court.

A good faith clause in an agreement states that the parties will uphold the agreement, and if they can't for one reason or another, they will act in good faith to come to a mutual agreement.

Breach of a Good Faith Clause and Legal Remedies

A breach of the good faith clause occurs when a party’s conduct, even if not explicitly prohibited by the contract, undermines the purpose of the agreement or unfairly disadvantages the other party. Examples include terminating a contract without notice to avoid fulfilling obligations, acting dishonestly in performance, or manipulating terms to deny expected benefits.

Legal consequences for breaching good faith obligations can include:

  • Damages: Compensation for financial loss caused by the breach.
  • Rescission: Canceling the contract and restoring parties to their pre-contract positions.
  • Specific Performance: A court order requiring a party to fulfill its contractual duties.

Courts carefully examine the facts and context of each case, often focusing on the intent behind the conduct and whether it frustrated the contract’s fundamental purpose.

Drafting an Effective Good Faith Clause

While many jurisdictions imply a duty of good faith, expressly including a good faith clause in a contract can reduce ambiguity and provide stronger legal protection. Effective clauses typically:

  • Define what constitutes “good faith” behavior, such as cooperation, disclosure, and honesty.
  • Clarify obligations during negotiations, performance, and termination.
  • Include dispute resolution procedures for alleged breaches.

Drafting with precision minimizes the risk of litigation and strengthens the enforceability of the agreement. Because good faith law is evolving and varies by jurisdiction, consulting a qualified contract attorney is highly recommended.

Frequently Asked Questions

  1. Is a good faith clause always required in a contract?
    No, but many contracts include one, and courts often imply a duty of good faith and fair dealing even if it’s not written.
  2. Can you sue for breach of good faith?
    Yes. If one party’s conduct undermines the agreement’s purpose or unfairly deprives the other of contractual benefits, they may be liable for damages.
  3. Does negotiating in bad faith have legal consequences?
    Potentially. If a party misleads, deceives, or negotiates without genuine intent, courts may impose liability depending on jurisdiction and the context.
  4. How is good faith different from reasonableness?
    Good faith focuses on honesty and intention, while reasonableness considers objective standards of fair behavior.
  5. Should I include a good faith clause in every contract?
    It’s best practice to do so. Clearly defining expectations reduces legal risk and strengthens the enforceability of contractual obligations.

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