What is the laws main purpose in imposing the implied covenant of good faith and fair dealing?

The implied covenant of good faith and fair dealing is an enigma to many lawyers. One reason for the mystery is that there is no concrete rule to guide us in determining what the standard is or what constitutes a breach. Instead, courts address claims on an individualized, fact-specific basis. What’s more, each state has varying jurisprudence on the inquiry, making the criteria difficult to decipher.

The overarching concept of the implied covenant is that even when there is a binding, enforceable written contract between two parties, there exists yet another implied duty imposed upon each of the parties to act in a fair and equitable manner. Plaintiffs often utilize this claim to allege that they are entitled to relief even if there is a contract between the parties that does not specifically prohibit the defendant’s conduct. Defending against this claim can be a challenge because it may be counter-intuitive to basic rules of contract law and because the case law is somewhat erratic.

This article first reviews what the implied covenant of good faith and fair dealing is, and then discusses several approaches for defending against a claim of breach of the implied covenant.

The Implied Covenant of Good Faith and Fair Dealing

A covenant of good faith and fair dealing is implied in every contract. See, e.g., Rest. 2d Contracts § 205; U.C.C. § 1-304. Nevertheless, there is no bright-line rule or single definition of the doctrine.

The implied covenant is governed by state law, and the particular standard thus varies from state to state. But in broad strokes, the implied covenant can generally be described as an obligation imposed on the parties to a contract to act in a way that is consistent with the spirit of the parties’ agreement, and a promise that neither party will intentionally do anything that will injure the right of the other to receive the benefits of the agreement.

The Restatement (Second) of Contracts does not provide much to illuminate this nebulous standard, but it lists several examples of the types of conduct that might be considered to be in breach of the implied covenant:

A complete catalogue of types of bad faith is impossible, but the following types are among those which have been recognized in judicial decisions: evasion of the spirit of the bargain, lack of diligence and slacking off, willful rendering of imperfect performance, abuse of a power to specify terms, and interference with or failure to cooperate in the other party’s performance.

Rest. 2d Contracts § 205.

The obligation imposed by the implied covenant is separate and apart from the obligations imposed by the written terms of the contract. Accordingly, even if a party acts in a way that is not specifically or expressly prohibited by the written terms, that conduct could still be considered a breach of the implied covenant of good faith and fair dealing if it goes against the overall purpose or spirit of the agreement.

The Pennsylvania Superior Court’s decision in Stamerro v. Stamerro, 889 A.2d 1251 (Pa. Super. Ct. 2005), provides a simple illustration. That case concerned a divorce agreement that permitted the husband’s alimony to be modified if his income fell below $200,000 per year. The husband voluntarily left his high-paying executive job to take a position with his new wife’s business at a much lower salary, and then sought to reduce his alimony payments. The appellate court upheld the trial court’s denial of the husband’s petition, explaining that, under the implied duty of good faith and fair dealing, “Husband should not be allowed to evade the spirit or abuse the terms of the agreement by unilaterally and voluntarily reducing his income,” because “[t]o do so would destroy Wife’s right to receive the fruits of her bargained-for agreement.” Although the agreement “did not expressly state that Husband could seek a reduced alimony payment only upon an involuntary salary reduction, to infer otherwise would give Husband the power to unilaterally defeat the purpose for which the alimony agreement was made, and destroy Wife’s right to receive the benefit of the support for which she bargained.” Id. at 1261-62.

Defenses to an Implied Covenant Claim

The most straightforward method of defending against a claim for breach of the implied covenant is to show that the complained-of conduct was permitted by the terms of the contract. A party cannot base a claim for breach of the implied covenant on conduct authorized by the terms of the agreement. See, e.g., Dunlap v. State Farm Fire & Cas. Co., 878 A.2d 434, 441–42 (Del. 2005); Nemec v. Shrader, 991 A.2d 1120, 1125–26 (Del. 2010). This is likely the best defense to pursue when the objective is to get the claim dismissed pursuant to Rule 12(b)(6) because the argument is one based on law and contractual interpretation, rather than a factual inquiry requiring discovery. In pursuing this approach, the goal would be to point to specific, unambiguous language in the agreement indicating that the conduct was permitted. The implied covenant cannot trump express provisions of a written contract. See, e.g., John B. Conomos, Inc. v. Sun Co., Inc. (R&M), 831 A.2d 696, 706 (Pa. Super. Ct. 2003).

Another option for defending against such a claim is to show that the parties anticipated the circumstances surrounding the conduct that gave rise to the dispute. The implied covenant exists for the purpose of inferring equitable contractual terms when new developments arise that neither party anticipated. E.g., Nemec, 991 A.2d at 1126 (“The implied covenant only applies to developments that could not be anticipated.”); Nationwide Emerging Managers, LLC v. Northpointe Holdings, LLC, 112 A.3d 878, 896 (Del. 2015). Accordingly, it stands to reason that an implied duty claim will not survive if it can be shown that the parties did in fact anticipate the circumstances at issue, but chose not to prohibit them in the contract. The best evidence in support of this approach would be the parties’ negotiation history.

A final tactic is to show that the actions taken by the defendant were in line with the parties’ reasonable intentions and expectations at the time the contract was formed. See, e.g., Nemec, 991 A.2d at 1126 (“[W]e must assess the parties’ reasonable expectations at the time of contracting.”); Hanaway v. Parkesburg Grp., LP, 132 A.3d 461, 471 (Pa. Super. Ct. 2015) (implied duty calls on “courts to harmonize the reasonable expectations of the parties with the intent of the contractors and the terms in their contract”); Gerber v. Enterprise Prods. Holdings, LLC, 67 A.3d 400, 418 (Del. 2013) (“The implied covenant seeks to enforce the parties’ contractual bargain by implying only those terms that the parties would have agreed to during their original negotiations if they had thought to address them.”). The parties’ intent may be demonstrated by the contract language, the conduct of the parties, and the course of dealings between them. Even if the plaintiff claims that its intentions were contrary to what the defendant believes, that subjective intention still must be objectively reasonable under the circumstances to hold up.

In short, defending against a claim for breach of the implied covenant can be a challenge, but such claims can be defeated by showing that the defendant’s conduct was reasonable in light of the circumstances.

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