Implied covenant of good faith and fair dealing
Encyclopedia
In contract
law, the implied covenant of good faith and fair dealing is a general presumption that the parties to a contract will deal with each other honestly, fairly, and in good faith, so as to not destroy the right of the other party or parties to receive the benefits of the contract. It is implied in every contract in order to reinforce the express covenants or promises of the contract. A lawsuit (or a cause of action) based upon the breach of the covenant may arise when one party to the contract attempts to claim the benefit of a technical excuse for breaching the contract, or when he or she uses specific contractual terms in isolation in order to refuse to perform their contractual obligations, despite the general circumstances and understandings between the parties.
Furthermore, the covenant was discussed in the First Restatement of Contracts by the American Law Institute
, but before adoption of the Uniform Commercial Code
in the 1950s, when the common law
of most states did not recognize an implied covenant of good faith and fair dealing in contracts
.
(as part of Section 1-304), and was codified by the American Law Institute as Section 205 of the Restatement (Second) of Contracts.
Most U.S. jurisdictions view the breach of the implied covenant of good faith and fair dealing solely as a variant of breach of contract
, in which the implied covenant is merely a "gap-filler" that provides yet another contractual term, and breach thereof simply gives rise to ordinary contractual damages. Of course, this is not the most ideal rule for plaintiffs, since consequential damages for breach of contract are subject to certain limitations (see Hadley v. Baxendale
).
In certain jurisdictions, breach of the implied covenant can also give rise to a tort
action, e.g. A.C. Shaw Construction v. Washoe County, 105 Nevada 913, 915, 784 P.2d 9, 10 (1989). This rule is most prevalent in insurance law, where the insurer's breach of the implied covenant may give rise to a tort action known as insurance bad faith
. The advantage of tort liability is that it supports broader compensatory damages as well as the possibility of punitive damages
.
Some plaintiffs have attempted to persuade courts to extend tort liability for breach of the implied covenant from insurers to other powerful defendants like employers and banks. However, most U.S. courts have followed the example of certain landmark decisions from California courts, which rejected such tort liability against employers in 1988 and against banks in 1989.
Contract
A contract is an agreement entered into by two parties or more with the intention of creating a legal obligation, which may have elements in writing. Contracts can be made orally. The remedy for breach of contract can be "damages" or compensation of money. In equity, the remedy can be specific...
law, the implied covenant of good faith and fair dealing is a general presumption that the parties to a contract will deal with each other honestly, fairly, and in good faith, so as to not destroy the right of the other party or parties to receive the benefits of the contract. It is implied in every contract in order to reinforce the express covenants or promises of the contract. A lawsuit (or a cause of action) based upon the breach of the covenant may arise when one party to the contract attempts to claim the benefit of a technical excuse for breaching the contract, or when he or she uses specific contractual terms in isolation in order to refuse to perform their contractual obligations, despite the general circumstances and understandings between the parties.
History
In U.S. law, the legal concept of implied covenant of good faith and fair dealing arose in the mid-19th century because contemporary legal interpretations of “the express contract language, interpreted strictly, appeared to grant unbridled discretion to one of the parties”. In 1933, in the case of Kirke La Shelle Company v. The Paul Armstrong Company et al. 263 N.Y. 79; 188 N.E. 163; 1933 N.Y., the New York Court of Appeals said:In every contract there is an implied covenant that neither party shall do anything, which will have the effect of destroying or injuring the right of the other party, to receive the fruits of the contract, which means that in every contract there exists an implied covenant of good faith and fair dealing.
Furthermore, the covenant was discussed in the First Restatement of Contracts by the American Law Institute
American Law Institute
The American Law Institute was established in 1923 to promote the clarification and simplification of American common law and its adaptation to changing social needs. The ALI drafts, approves, and publishes Restatements of the Law, Principles of the Law, model codes, and other proposals for law...
, but before adoption of the Uniform Commercial Code
Uniform Commercial Code
The Uniform Commercial Code , first published in 1952, is one of a number of uniform acts that have been promulgated in conjunction with efforts to harmonize the law of sales and other commercial transactions in all 50 states within the United States of America.The goal of harmonizing state law is...
in the 1950s, when the common law
Common law
Common law is law developed by judges through decisions of courts and similar tribunals rather than through legislative statutes or executive branch action...
of most states did not recognize an implied covenant of good faith and fair dealing in contracts
Contract
A contract is an agreement entered into by two parties or more with the intention of creating a legal obligation, which may have elements in writing. Contracts can be made orally. The remedy for breach of contract can be "damages" or compensation of money. In equity, the remedy can be specific...
.
Contemporary usage
The implied covenant of good faith and fair dealing is especially important in U.S. law. It was incorporated into the Uniform Commercial CodeUniform Commercial Code
The Uniform Commercial Code , first published in 1952, is one of a number of uniform acts that have been promulgated in conjunction with efforts to harmonize the law of sales and other commercial transactions in all 50 states within the United States of America.The goal of harmonizing state law is...
(as part of Section 1-304), and was codified by the American Law Institute as Section 205 of the Restatement (Second) of Contracts.
Most U.S. jurisdictions view the breach of the implied covenant of good faith and fair dealing solely as a variant of breach of contract
Contract
A contract is an agreement entered into by two parties or more with the intention of creating a legal obligation, which may have elements in writing. Contracts can be made orally. The remedy for breach of contract can be "damages" or compensation of money. In equity, the remedy can be specific...
, in which the implied covenant is merely a "gap-filler" that provides yet another contractual term, and breach thereof simply gives rise to ordinary contractual damages. Of course, this is not the most ideal rule for plaintiffs, since consequential damages for breach of contract are subject to certain limitations (see Hadley v. Baxendale
Hadley v. Baxendale
Hadley v Baxendale [1854] is a leading English contract law case. It set the basic rule for how to determine the scope of consequential damages arising from a breach of contract, that one is liable for all losses that ought to have been in the contemplation of the contracting parties.-Facts:The...
).
In certain jurisdictions, breach of the implied covenant can also give rise to a tort
Tort
A tort, in common law jurisdictions, is a wrong that involves a breach of a civil duty owed to someone else. It is differentiated from a crime, which involves a breach of a duty owed to society in general...
action, e.g. A.C. Shaw Construction v. Washoe County, 105 Nevada 913, 915, 784 P.2d 9, 10 (1989). This rule is most prevalent in insurance law, where the insurer's breach of the implied covenant may give rise to a tort action known as insurance bad faith
Insurance bad faith
Insurance bad faith is a legal term of art that describes a tort claim that an insured person may have against an insurance company for its bad acts. Under the law of most jurisdictions in the United States, insurance companies owe a duty of good faith and fair dealing to the persons they insure...
. The advantage of tort liability is that it supports broader compensatory damages as well as the possibility of punitive damages
Punitive damages
Punitive damages or exemplary damages are damages intended to reform or deter the defendant and others from engaging in conduct similar to that which formed the basis of the lawsuit...
.
Some plaintiffs have attempted to persuade courts to extend tort liability for breach of the implied covenant from insurers to other powerful defendants like employers and banks. However, most U.S. courts have followed the example of certain landmark decisions from California courts, which rejected such tort liability against employers in 1988 and against banks in 1989.