What Good Faith Really Means in U.S. Contracts

Every contract in the United States carries an implied duty of good faith and fair dealing. This principle applies whether your agreement mentions it or not, affecting how courts interpret disputes and how parties must behave throughout their contractual relationship. Understanding good faith is essential for anyone entering into commercial agreements.

The concept sounds straightforward, but good faith has generated decades of litigation and scholarly debate. What exactly does it require? When does tough negotiating cross the line into bad faith? How do courts evaluate compliance with this nebulous standard? This article examines the doctrine in depth, explaining what good faith means in practice and how it affects your contractual rights and obligations.

The Legal Foundation of Good Faith

The Implied Covenant

Under American contract law, every contract includes an implied covenant of good faith and fair dealing. This means the obligation exists even when the parties never discussed it and the written agreement says nothing about it. Courts read this duty into all contracts as a matter of law.

The Uniform Commercial Code explicitly imposes good faith obligations on contracts for the sale of goods. The Restatement Second of Contracts extends similar principles to all contracts. Together, these sources establish good faith as a fundamental principle of American contract law.

What Good Faith Requires

At its core, good faith requires honesty in fact and the observance of reasonable commercial standards of fair dealing. This means parties cannot lie, cheat, or deceive each other. But good faith goes beyond mere honesty to require parties to act fairly and reasonably in their dealings.

Good faith prohibits conduct that violates community standards of decency, fairness, or reasonableness. It prevents parties from taking opportunistic advantage of gaps in the contract or using their power to deprive the other party of the benefit of their bargain. The standard looks at whether conduct is consistent with the justified expectations of the parties.

The Relationship to Express Terms

Good faith does not override express contract terms. If your agreement explicitly grants discretion or allows certain conduct, good faith generally will not prohibit that conduct. The implied covenant operates within the framework the parties have established, not as a separate source of obligations that trumps their agreement.

However, good faith affects how express terms are interpreted and exercised. Even when a contract grants broad discretion, that discretion must be exercised in good faith. A party cannot use express rights as a pretext for undermining the contract's purpose or unfairly harming the other party.

Good Faith in Contract Formation

Negotiation Obligations

American law generally does not impose a duty to negotiate in good faith. Parties can walk away from negotiations at any time, even after extensive discussions, without liability. Hard bargaining, bluffing about alternatives, and refusing to make concessions are all permissible.

However, some contexts do require good faith negotiation. When parties have agreed to negotiate exclusively, when a preliminary agreement creates binding obligations, or when specific promises create reasonable reliance, bad faith negotiation can create liability. The governing law in contracts determines which rules apply in your jurisdiction.

Disclosure Requirements

Good faith affects what parties must disclose during negotiations. While there is no general duty to volunteer information, affirmative misrepresentations violate good faith. Half-truths that create false impressions can be as problematic as outright lies.

Some jurisdictions and contexts impose more extensive disclosure duties. Insurance contracts, fiduciary relationships, and consumer transactions often require disclosure of material information. Understanding the specific rules that apply to your transaction is critical.

Good Faith in Contract Performance

The Core Obligation

Good faith most commonly arises during contract performance. Parties must perform their obligations honestly and fairly, without trying to evade the spirit of the agreement. This means taking reasonable steps to fulfill the contract's purposes rather than looking for technical loopholes or exploiting ambiguities.

When contracts grant discretion, good faith requires exercising that discretion reasonably. A party cannot use discretionary powers to harm the other party, to extract additional concessions, or to undermine the benefits the other party expected to receive. The terms of payment contract provisions, for example, must be applied consistently and fairly.

Cooperation and Facilitation

Good faith includes a duty to cooperate in achieving the contract's objectives. Parties cannot hinder the other party's performance or refuse to take reasonable steps necessary for the contract to work. Active obstruction clearly violates good faith, but passive non-cooperation can be equally problematic.

This cooperation duty has practical implications throughout the contract's life. Providing information necessary for the other party to perform, making decisions in a timely manner, and not creating unnecessary obstacles are all aspects of good faith performance.

Contract Payment Terms and Good Faith

Good faith particularly matters in the context of contract payment terms. When a contract establishes payment obligations, both parties have good faith duties regarding those terms. The paying party must pay according to the agreed schedule and not manufacture pretextual disputes to delay payment. The receiving party must provide proper invoices and documentation.

Disputes often arise when one party exercises discretion over payment. If a contract conditions payment on satisfaction or approval, that discretion must be exercised in good faith. A party cannot unreasonably withhold approval or claim dissatisfaction as a pretext for avoiding payment. Courts will look at whether the party's conduct reflects genuine concerns or bad faith obstruction.

Dealing with Changed Circumstances

Good faith affects how parties must respond when circumstances change. While contracts allocate risk and parties cannot escape their bargains simply because performance becomes more difficult or expensive, good faith requires reasonable accommodation of changed conditions when the contract permits flexibility.

If a contract includes mechanisms for adjustment or renegotiation, those mechanisms must be used in good faith. A party cannot demand unreasonable concessions or refuse to engage in required processes. The contract payment terms should be honored even when market conditions have changed.

Good Faith in Contract Enforcement

Exercising Remedies

When a breach occurs, the non-breaching party must exercise remedies in good faith. This does not mean accepting less than the contract provides, but it does require reasonable conduct. Declaring default on minor technicalities, racing to accelerate obligations, or exercising remedies in ways designed to maximize harm rather than protect legitimate interests can violate good faith.

Termination rights are subject to good faith constraints. A party cannot terminate for minor breaches that do not materially affect the contract's value. Pretextual termination, where a party uses a minor violation as an excuse to escape a contract that has become unfavorable, violates good faith even when the underlying breach technically exists.

Waiver and Estoppel

Good faith interacts with waiver and estoppel doctrines. A party that repeatedly accepts late performance or deviations from contract terms may be estopped from later insisting on strict compliance. Inconsistent conduct, where a party sometimes enforces terms and sometimes ignores them, can create good faith issues.

If you intend to enforce contract terms strictly, consistency matters. Establishing clear patterns and providing notice when standards will change helps avoid good faith problems. The payment terms in a contract should be enforced consistently or formally modified.

Industry-Specific Applications

Employment Contracts

Good faith has significant implications in employment. While at-will employment allows termination for any reason, some courts have found that good faith limits this discretion. Terminating an employee to avoid paying earned commissions or benefits can violate good faith even in at-will relationships.

Employment contracts that include performance standards, evaluation processes, or disciplinary procedures must be administered in good faith. Employers cannot manipulate these processes to manufacture grounds for termination or to deny earned compensation.

Insurance Contracts

Insurance law imposes heightened good faith duties on insurers. The duty to defend, the duty to settle within policy limits, and the duty to investigate claims fairly all arise from good faith principles. Bad faith insurance claims represent a significant area of litigation with potential for substantial damages.

Policyholders also have good faith obligations, including duties to provide accurate information, cooperate with investigations, and not make fraudulent claims. The relationship between insurer and insured is governed by mutual good faith expectations.

Commercial Real Estate

Real estate leases frequently involve good faith issues. Landlords exercising approval rights over assignments, subleases, or alterations must do so in good faith. Tenants with options to renew or purchase must exercise those rights in good faith, not as leverage for unrelated disputes.

Percentage rent provisions, common area maintenance charges, and other variable elements of commercial leases require good faith calculation and reporting. Disputes over these items often turn on whether the landlord has acted in good faith rather than on the literal terms of the lease.

Franchise Agreements

Franchise relationships present unique good faith challenges. Franchisors have significant power over franchisees, including the ability to set standards, approve suppliers, and terminate the relationship. Courts scrutinize the exercise of this power for good faith, particularly when franchisors act in ways that seem designed to harm franchisees or appropriate their value.

Changes to system standards, encroachment by new units, and enforcement of compliance requirements all must be conducted in good faith. The governing law in contracts for franchises often includes specific good faith provisions that supplement common law principles.

Proving Bad Faith

Evidence of Intent

Bad faith claims often require proving improper intent. What was the party trying to accomplish? Did they have a legitimate business reason for their conduct, or were they acting opportunistically? Internal communications, the timing of actions, and patterns of behavior all provide evidence of intent.

Direct evidence of bad intent is rarely available. Courts usually must infer intent from circumstantial evidence. Conduct that makes no business sense except as an attempt to harm the other party or escape obligations suggests bad faith. Pretextual explanations that do not match the facts indicate deceptive intent.

Objective Standards

Some courts apply objective standards that do not require proving intent. Under this approach, conduct that violates reasonable commercial standards of fair dealing constitutes bad faith regardless of what the party was thinking. This standard makes bad faith easier to prove but still requires showing that conduct fell below acceptable norms.

Industry custom and practice provide evidence of what reasonable commercial standards require. Expert testimony may establish how similar transactions are typically handled and whether the disputed conduct deviated from those norms.

The Burden of Proof

The party alleging bad faith typically bears the burden of proving it. This means marshaling evidence of improper conduct and presenting a coherent theory of why the other party's actions constituted bad faith. General allegations of unfairness are insufficient; specific conduct must be identified and proven.

Defending against bad faith claims requires showing legitimate business reasons for the disputed conduct. Documentation of decision-making processes, contemporaneous explanations for actions, and evidence of consistent treatment all help rebut bad faith allegations.

Remedies for Bad Faith

Contract Damages

When bad faith causes breach, the non-breaching party can recover standard contract damages. This includes expectation damages, measured by what the party would have received had the contract been performed. Consequential damages flowing from the breach may also be available, subject to foreseeability and mitigation requirements.

Bad faith may affect how damages are calculated. Courts may be more willing to award full consequential damages when the breach was in bad faith rather than merely negligent or inadvertent.

Tort Damages

In some contexts, bad faith gives rise to tort liability with potentially greater damages. The classic example is insurance bad faith, where courts allow tort recovery including emotional distress damages and punitive damages. Some jurisdictions recognize similar claims in other contexts involving special relationships.

Punitive damages require showing conduct that is egregious, willful, or malicious. Garden-variety bad faith typically does not support punitive damages, but particularly outrageous conduct may. The terms of payment contract violations, when intentional and harmful, may cross this threshold.

Specific Performance

When damages are inadequate, courts may order specific performance of the contract. Bad faith conduct may make courts more willing to grant this remedy, particularly when the bad faith party is attempting to escape a contract that has become unfavorable. The court can order the parties to perform their obligations and police good faith compliance going forward.

Avoiding Good Faith Disputes

Clear Drafting

The best protection against good faith disputes is clear contract drafting that leaves little room for interpretation. When parties specify exactly what is required and how discretion will be exercised, there is less opportunity for good faith arguments. Define standards, establish procedures, and anticipate common disputes in your agreements.

However, recognize that no contract can anticipate everything. Good faith will always operate at the margins, filling gaps and guiding interpretation. Draft with this reality in mind, focusing on the most important potential disputes while accepting that some issues will be resolved through good faith principles.

Documentation

Document your decision-making processes, especially when exercising discretion or taking actions that might be challenged. Contemporaneous records of legitimate business reasons protect against later allegations of bad faith. The more your conduct is documented and explained, the harder it is for the other party to prove improper intent.

Keep records of communications, particularly when disputes begin to develop. Email chains, meeting notes, and formal correspondence all create a record of how the parties have dealt with each other. This record will be critical if litigation ensues.

Consistent Conduct

Treat your contractual obligations consistently. Do not strictly enforce some terms while ignoring others. Do not treat different counterparties differently without legitimate business reasons. Inconsistent conduct invites allegations of bad faith and makes it harder to defend your actions.

If you need to change how you enforce contract terms, do so formally and with notice. Explain why the change is necessary and give the other party opportunity to adjust. Abrupt changes without explanation suggest bad faith rather than legitimate business evolution.

Conclusion

Good faith is an essential principle of American contract law that affects every agreement you enter. While it does not override express contract terms, it shapes how those terms are interpreted, how discretion is exercised, and what conduct is acceptable throughout the contractual relationship.

Understanding good faith helps you avoid conduct that could expose you to liability. It also helps you identify when the other party's conduct crosses the line from hard dealing into bad faith. Whether you are performing contract payment terms, exercising discretion, or responding to changed circumstances, good faith provides the backdrop against which your conduct will be evaluated.

The terms of payment contract provisions, like all contractual obligations, must be performed in good faith. This means honesty, fair dealing, and respect for the other party's legitimate expectations. While you can pursue your own interests and take advantage of favorable contract terms, you cannot do so through deception, obstruction, or conduct that violates reasonable commercial standards.

When entering contracts, think about good faith from the start. How will each party's discretion be exercised? What conduct might create disputes? How can the agreement minimize opportunities for bad faith conduct? Addressing these questions during drafting prevents disputes during performance.

Good faith is not about being nice or sacrificing your own interests. It is about dealing honestly and fairly within the framework the parties have established. Understanding this principle helps you both protect your rights and fulfill your obligations under every contract you make.