09 May Good Faith & Fail Dealing
One of the first classes that law students take when they begin law school is Contracts. It is a standard first-year course that provides the background and basics for the study of private law. The course is important to learn about how contracts are interpreted by lawyers and judges, the basic rules of contract construction, but not necessarily how they are written. While there are many concepts lawyer learn in a Contracts class, one of the more interesting concepts is something called the “Implied Covenant of Good Faith and Fair Dealing.”
The Implied Covenant of Good Faith and Fair Dealing is grafted into every contract even if the contract does not discuss the elements of the covenant. The covenant is almost never written into the contract (hence why it is implied), and despite many efforts to kill it off, it exists. The Covenant of Good Faith and Fair Dealing means:
Parties to the contract cannot take an action which would defeat the purpose of the contract or deny the other side the benefit of the contract.
This comes up specifically in places where one party has the discretion to act. If a party is given the discretion to act, choose or make a decision with respect to the contract, and they cannot make a decision that would defeat the purpose of the contract. Conceptually, think of the Covenant of Good Faith and Fair Dealing as the contract world’s equivalent of the Golden Rule, a facet of interpersonal relationships we learn in grade school but seems forgotten in the business and legal worlds.
For example, in commercial leases for shopping centers or malls, smaller stores often have a provision in their contract that allows the mall management (the landlord) to relocate a store within the mall. A landlord that exercises the discretion to move a store within the mall cannot exercise that discretion to kick the business out of the mall or take an action that effectively kicks the business out of the mall. Let’s say that business is not one of the anchor stores but one of the larger stores in the mall. The landlord can’t suddenly move them to a kiosk. That’s unfair and defeats the purpose of the lease that the store signed.
If you have the discretion to act, you can’t make decisions that would drastically alter the relationship. The reason why this becomes a problem is that more and more of the contracts that I review have taken this notion of the Covenant of Good Faith and Fair Dealing and restricted it greatly. Usually, this restriction comes in the form of lots of “shall” statements in the contract. Party A shall do this and Party B shall do that. A lot of discretion is taken out in an attempt to add predictability.
The problem with taking out discretion is that we live in a world of humans, a world of changing circumstances. We have never lived in a world where we can predict everything that’s going to happen. And yet, so many contracts look at risk-management and try to limit liability or limit the ability of the parties to act. The problem is that this is not very useful when you’re dealing with the real world. Writing contracts that act to restrain the parties’ discretion often defeat the purpose of the relationship—mutual benefit. If there is an ongoing relationship between the parties, this landlord-tenant relationship, for example, there needs to be some room for humanity, for dealing with an eventuality that could happen, may happen, and may not.
By crafting intensely restrictive contracts, we end up with a situation where this Covenant of Good Faith and Fair Dealing might as well not exist. The Covenant of Good Faith and Fair Dealing encourages the parties to think about their relationship and acknowledge the humanity of the people on the other side, to do unto others as we would have done to us. In having that implied Covenant of Good Faith and Fair Dealing, business relationships are made a bit stronger and more human.
When I’m writing or reviewing contracts, or advising clients about writing their contract, I often encourage them to think about how to structure a contract that demonstrates trust but still protects their interests. So, if there is something that is in a risk assessment likely to happen, and is expensive to happen, then it is important to address it and include in the contract.
But, by the same token, we have to accept the fact that there are some risks that we either can’t define, don’t cost that much, or involve unpredictable activity far in the future. We must accept that risk, work with that risk, and work within the notion of good faith and fair dealing. In doing so, you are able to be honest and open with customers and clients, and treat them as you would want to be treated.
While the Good Faith and Fair Dealing Covenant has become a little passé in legal circles, I think it’s worthwhile to bring it back. It is particularly valuable for businesses with a long-term relationship because we are human and we can’t predict every potential outcome. A contract is mutually beneficial, and the business that is being exchanged is mutually beneficial. So why don’t we accept the fact that this implied covenant is more than just implied, it is, in fact, the underpinning of the entire relationship? We must allow that Covenant of Good Faith and Fair Dealing occupies not just a tiny part of the contractual relationship, but occupies the central part of that contractual relationship because good faith and fair dealing means treating your business with the respect that they deserve.