Contracts play an important role in the allocation of business risks in commercial transactions. Some of them can be simple, consisting of just a few pages. Others can feature more complexity and reach over 100+ pages. The contract can be between a homeowner and contractor for a new kitchen remodel. Or it can be written on the back of a napkin for two budding business partners.
Regardless of the contract's origin or form, there is one thing they all share in common– each one contains an “implied duty of good faith and fair dealing” when it comes to the contract's enforcement and performance.
In this article, we will explain what the implied duty of good faith and fair dealing is in commercial contracts, the elements of a beach claim, and who has the right to the claim. Then, we will briefly discuss what remedies are available to the prevailing party. Finally, we'll take a quick look at how a claim is asserted and viewed in California courts.
Different jurisdictions may have a slightly different judicial interpretations of what an implied duty of good faith and fair dealing would mean under state law. The Court of Appeal of New York holds that the implied duty of good faith and fair dealing in commercial contracts “embraces a pledge 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.” (Dalton v Educ. Testing Serv., 87 NY2d 384, 389  (internal citations and quotations omitted). Moreover, when the contract provides for an exercise of discretion for a party, “this pledge includes a promise not to act arbitrarily or irrationally in exercising that discretion.” (Id.).
But the implied duty has its limit: As the New York high court stated, “no obligation can be implied that would be inconsistent with other terms of the contractual relationship.” (Id.).
Simply put, if we look at it as a whole, the implied duty of good faith and fair dealing is the unspoken rule and obligation (hence it is implicit in commercial contracts based on the dealings of the parties) that both parties will work in each other's favor and not intentionally go against the other.
Although they will vary depending on the jurisdiction, here are the general legal elements the party must be able to plead and prove in a claim of a breach of the implied duty of good faith and fair dealing:
Element 1: There must be a valid contract existed between the parties. Ahead Realty LLC v India House, Inc., 92 AD3d 424, 425 [1st Dept 2012].
Element 2: The plaintiff performed (or was excused from performing) its contractual obligation.
Element 3: The defendant unfairly prevented the plaintiff from reaping full benefits and rights due to the plaintiff under the contract. This would include actions and conduct not explicitly barred by the contract, such as:
- Interfering the other's ability to perform their part of the agreement;
- Intentionally plotting to take away the other party's benefits or right they would see from the contract;
- Attempts to profit and gain from the contract in a manner explicitly prohibited;
- Not informing or intentionally hiding the benefits of the contract;
- Acting in a manner that is objectively deceitful, dishonest, or unreasonable.
Element 4: The defendant's actions resulted in injury or harm to the plaintiff.
It's important to remember that specific elements will vary from state to state. For instance, New Jersey requires that the plaintiff also plead and prove there is a bad motive or dishonesty. Iliadis v Wal-Mart Stores, Inc., 191 NJ 88, 110, 922 A2d 710, 722 .
Either party in the contractual agreement can bring a claim against the other to affirm a breach of the implied duty of good faith and fair dealing. In our case, “plaintiff” refers to the party bringing the claim, and “defendant” is the party alleged to be in violation.
If the plaintiff prevails on its claim, then the prevailing plaintiff may recover the same damages that are available for breach of contract (i.e., compensatory damages, consequential damages, liquidated damages, etc.), and in certain circumstances, tort-based damages may also be recoverable.
For example, in New York, a “willful breach [of the implied duty of good faith and fair dealing] accompanied by egregious and abusive behavior” would allow the plaintiff to recover damages for emotional distress. Brown v Govt. Employees Ins. Co., 156 AD3d 1087, 1090 [3d Dept 2017].
Business disputes often involve complicated factual situations. The business litigation practice group at HAN LLP devises case strategies that work toward ideal outcomes. If your business needs help with dispute resolution, contact us to learn more.