What Is Good Faith and Fair Dealing? A Guide to U.S. Contract Law

In U.S. contract law, the implied covenant of good faith and fair dealing generally requires each party to act honestly and not undermine the other party’s ability to receive the benefits of an agreement. The rule can matter when a contract leaves discretion or details unspecified, but it does not give courts unlimited power to rewrite a deal. Its scope and remedies vary by state and by the type of contract.

What Good Faith and Fair Dealing Means

Good faith and fair dealing is a legal principle implied in many contracts. In broad terms, it requires parties to use contractual rights fairly and to avoid conduct that frustrates the agreement’s purpose. The promise is usually treated as part of the contract even when the written document does not expressly mention it.

For example, a contract may give one party discretion to approve a request, calculate a payment, or set a schedule. That discretion generally cannot be used dishonestly or as a pretext to deprive the other party of an expected contractual benefit. The precise test depends on the governing law and the facts.

The covenant is not a general requirement to be generous, cooperative in every circumstance, or loyal to the other party. Contracting parties may pursue their own interests, including interests that conflict, so long as they comply with the agreement and applicable law. Good faith helps police the way contractual powers are exercised; it does not automatically make a tough bargain unfair.

Where the Rule Comes From

Two influential sources describe the principle in U.S. contract law. The Restatement (Second) of Contracts, Section 205, says every contract imposes on each party a duty of good faith and fair dealing in its performance and enforcement. The Restatement is a summary of legal principles prepared by the American Law Institute. It is influential, but it is not itself a statute, and courts decide whether and how to apply it.

The Uniform Commercial Code (UCC) addresses good faith in commercial transactions. UCC Section 1-304 provides that every contract or duty within the UCC imposes an obligation of good faith in its performance and enforcement. The UCC has been adopted in some form in every state, but state-specific statutes and court decisions govern how its provisions operate. Article 2, which covers sales of goods, also defines good faith, with wording that can distinguish between merchants and other parties.

These sources do not create one identical nationwide rule for every contract. State law determines the applicable standard, and the contract may contain a choice-of-law clause that identifies which state’s law will apply. Some types of agreements, such as insurance, employment, and franchise contracts, may also be subject to specialized statutes or doctrines.

How the Implied Covenant Works

The covenant is most relevant when a contract grants a party discretion or leaves a gap that must be handled during performance. A court may examine whether the party used that discretion in a way consistent with the contract’s purpose and the benefits the parties reasonably expected when they made the agreement.

Consider a sales agreement that pays a salesperson a commission on qualifying completed sales but does not clearly explain how sales are credited after the salesperson leaves. The contract’s language, the parties’ conduct, and relevant state law may all matter. If an employer manipulates the accounting solely to avoid a commission that the contract otherwise promises, the employee may argue that the employer breached the contract or the implied covenant. The result is not automatic; the written terms and jurisdiction are important.

Good faith can also affect the enforcement of contractual conditions. If one party has a contractual right to approve a proposal, that right may need to be exercised honestly and consistently with the agreement. But the covenant does not necessarily require approval whenever refusal would disappoint the other party. The contract’s language and the nature of the decision remain central.

Examples of Possible Bad-Faith Conduct

Whether conduct violates the covenant is fact-specific. Depending on the contract and governing law, examples that may raise concerns include:

• Using discretion as a sham: A party has authority to make a decision but uses it for a purpose unrelated to the contract or to defeat the other party’s expected benefit.
• Manipulating performance calculations: A party alters accounting methods or classifications to avoid a payment required by the agreement.
• Interfering with a condition: A party improperly prevents an event from occurring and then relies on that event’s failure to avoid its own obligation.
• Evading a promised benefit: A party takes steps that technically exploit a contract gap while undermining the deal’s evident purpose.
• Dishonest performance or enforcement: A party knowingly misrepresents relevant facts or uses contractual procedures as a pretext, where the applicable legal standard treats that conduct as a breach.

These are illustrations, not a checklist. A party’s hard bargaining, refusal to renegotiate, or exercise of a right expressly granted by the contract may be lawful even if the result is unfavorable to the other side. Courts generally look at the agreement as a whole rather than judging conduct in isolation.

What the Covenant Does Not Do

A common misconception is that the implied covenant lets a court replace an unfavorable contract term with a more reasonable one. Generally, it does not. Courts typically use the covenant to interpret or supplement the parties’ agreement, not to contradict its express language or create a new bargain.

For instance, if a contract clearly permits a party to terminate after giving specified notice, the covenant usually cannot be used simply to eliminate that termination right. A different issue could arise if the party falsifies notice, applies the provision selectively in a way barred by law, or exercises discretion in a manner the contract does not authorize. The distinction is between enforcing the agreement and rewriting it.

The covenant also does not usually impose a free-standing duty to disclose every fact, provide legal advice, or put the other party’s interests ahead of one’s own. Separate rules may create disclosure duties, including statutes, fiduciary relationships, consumer-protection laws, or particular contract terms. Those duties should not be confused with the implied covenant itself.

Good Faith and Fair Dealing by Contract Type

Commercial Contracts and Sales of Goods

In business agreements, good faith often matters when a contract allows discretion over performance, pricing mechanisms, delivery, acceptance, or payment. UCC rules may apply to transactions involving goods, while common-law contract rules generally govern many services, real estate, and other agreements. A mixed contract can raise questions about which body of law applies.

The UCC’s treatment of good faith includes statutory definitions and rules that may vary according to the transaction and the parties’ status. A merchant may be subject to standards that include reasonable commercial practices in the trade, while nonmerchant transactions may be assessed under a different formulation. A lawyer or court must consult the relevant state’s enacted version and controlling decisions.

Insurance Contracts

Insurance disputes may involve contract claims, statutory requirements, and state-specific rules concerning an insurer’s handling of a claim. Some jurisdictions recognize a separate tort claim for an insurer’s bad-faith claims handling under certain circumstances; others limit the available claim or remedies. The implied covenant should not be treated as a universal guarantee that every denied claim is wrongful. Policy wording, the investigation, the insurer’s stated reasons, and state law all matter.

Employment Agreements

Good-faith arguments sometimes arise over commissions, bonuses, severance, or other compensation promised by an employment agreement. The details of the written plan and the employee’s status can be decisive. The covenant generally does not erase the employment-at-will rule or automatically restrict an employer’s lawful decision to end an at-will relationship. State law differs, and statutory wage protections may create rights separate from contract law.

Franchise and Long-Term Agreements

Franchise, distribution, licensing, and other ongoing agreements may give one party substantial discretion over approvals, marketing, renewal, or performance standards. The implied covenant can become relevant to how that discretion is exercised. However, franchise statutes and regulations may impose additional requirements, and contract language may define procedures or standards that courts must consider.

How a Court May Analyze a Claim

A good-faith-and-fair-dealing claim usually depends on the contract, the conduct at issue, and the governing state law. A court may consider questions such as:

1. What agreement applies? The court identifies the contract, relevant provisions, amendments, and any choice-of-law clause.
2. What benefit did the contract promise? The claimant generally needs to identify a contractual expectation, not merely an unfair outcome.
3. What conduct is challenged? The analysis focuses on what the other party did or failed to do while performing or enforcing the agreement.
4. Was discretion involved? The court examines whether the agreement left room for judgment and whether that judgment was exercised within the contract’s limits.
5. Does the claim conflict with express terms? A claim may fail if it asks the court to impose an obligation that contradicts clear language.
6. What law and remedy apply? State statutes, precedent, and the type of contract can affect both liability and available relief.

Evidence may include the contract and amendments, emails, payment records, internal calculations, notices, performance history, and industry practices when relevant. The strength of a claim depends on how that evidence connects the challenged conduct to a contractual duty.

Potential Remedies

When a court finds a breach, available remedies depend on the claim and jurisdiction. A successful contract claim may support compensatory damages intended to address the loss caused by the breach. In some cases, a court may order specific performance or other equitable relief, although that remedy is not available for every contract.

In ordinary contract cases, punitive damages are generally not awarded merely because conduct was unfair or in bad faith. They may be available only under separate legal rules, such as a recognized tort claim or a statute that authorizes them. Insurance bad-faith cases are one area where state law may provide remedies beyond ordinary contract damages, but the rules differ significantly.

Practical Steps for Preventing Disputes

Clear contract drafting can reduce uncertainty. Agreements can specify approval standards, deadlines, payment formulas, reporting duties, notice methods, audit rights, and procedures for resolving disagreements. When a party has discretion, a contract can identify the criteria for exercising it rather than relying on broad or ambiguous language.

During performance, parties can keep accurate records, follow stated procedures, explain significant decisions, and raise concerns promptly in writing. A party that believes the other side is acting in bad faith should preserve relevant communications and records, review notice and dispute-resolution clauses, and avoid assuming that an informal complaint satisfies a contractual deadline.

Before taking action, it can help to distinguish a breach of an express term from a claim based on the implied covenant, a statutory claim, or a tort. Each may have different elements, deadlines, and remedies. Because state law and contract wording are decisive, an attorney familiar with the relevant jurisdiction can assess the specific facts.

Frequently Asked Questions

Is good faith and fair dealing automatically part of every contract?

Many U.S. contracts carry an implied duty of good faith in performance or enforcement, but its scope and application depend on the governing law and contract type. Exceptions and specialized rules may apply, so it is not safe to assume that every agreement is treated identically.

Can someone breach the covenant without violating a specific written clause?

Potentially. The covenant can address conduct involving discretion, performance, or a contract gap even when no clause expressly describes the conduct. But a claim generally must relate to the agreement’s benefits and cannot simply contradict a clear contractual term.

Is acting unfairly enough to prove a breach?

No. A disappointing or harsh result does not, by itself, establish a legal violation. The claimant generally must show conduct that breaches the applicable contractual standard, based on the agreement and controlling law.

Sources and Further Reading

• Uniform Commercial Code, Section 1-304: Obligation of Good Faith, Legal Information Institute, Cornell Law School.
• Uniform Commercial Code, Section 1-201: General Definitions, Legal Information Institute, Cornell Law School.
• Restatement of the Law, Second, Contracts, American Law Institute.