The Covenant of Good Faith and Fair Dealing Underlies Every Contract

No matter what express terms are agreed to by parties to a contract, there is a meta-agreement known as the implied covenant of good faith and fair dealing. It is at heart a contracting party’s duty to act honestly and fairly and not to do anything to injure the other party’s right to receive the contract’s benefits. The covenant is applicable to a wide array of contracts, including commercial agreements, employment agreements and insurance policies.

The covenant of good faith and fair dealing, which is recognized both in common law and in the Uniform Commercial Code (UCC), requires parties to honor not only the explicit provisions of a contract but also its spirit. Each party must avoid arbitrary, unfair or deceptive practices that would prevent the other from enjoying the fruits of the agreement. The doctrine exists to support the reasonable expectations of the contracting parties and to protect against abuses that stem from literal but manipulative interpretations of contractual rights and duties.

When is the covenant typically enforced? It can be invoked whenever one party believes the other has acted in bad faith, even if no technical breach of an express term has occurred. It can be particularly useful in enforcing long-term and relational contracts where ongoing cooperation, discretion or performance is required. 

To invoke the covenant in court, a claimant must generally show that a valid contract exists and that the other party acted in a manner that — while perhaps technically permissible — was contrary to the contract’s spirit or intent, thereby depriving the claimant of expected benefits.

Common scenarios for enforcement include the following:

• Abuse of discretion — For example, if a contract gives one party discretion (such as the power to decide if certain milestones are awarded or bonuses are given), that discretion must be exercised reasonably—not in a way that’s arbitrary or specifically designed to deprive the other party of benefits.
• Withholding cooperation — If one party’s cooperation is necessary for performance but that cooperation is deliberately withheld, courts may find a breach of the covenant, even if the contract does not explicitly require cooperation.
• Undermining performance — A party might create conditions that make it impossible or unreasonably difficult for the other to perform their side of the bargain.

Note that the covenant cannot be used to rewrite the contract. It will not override, supplement or contradict an express, unambiguous term of the agreement. Courts apply it to fill gaps or regulate issues not expressly addressed, so that neither party can exploit silence or ambiguity to the other’s detriment. In contract drafting, parties should be careful not to attempt to define the covenant of good faith and fair dealing, as this can create conflicts in interpretation.

At Law Offices of Donald W. Hudspeth P.C. in Phoenix, Arizona, we take a plain-English approach to contract drafting, ensuring our clients understand their rights and obligations clearly. Call us today at 866-696-2033 or contact us online to set up a consultation.