Legal Definitions - implied covenant of good faith and fair dealing

The implied covenant of good faith and fair dealing is a fundamental legal principle in contract law, particularly in the United States. It means that even if a contract doesn't explicitly say so, every party involved is expected to act honestly, fairly, and reasonably when carrying out their part of the agreement. This principle prevents parties from taking actions that would intentionally frustrate or undermine the other party's ability to receive the benefits they expected from the contract, even if those actions aren't strictly forbidden by the written terms.

This covenant applies to how parties perform their obligations under a contract, not to how they negotiate it. It is automatically included in most contracts, regardless of whether it's explicitly written. While its exact application can vary depending on the specific circumstances and jurisdiction, the core idea is to ensure that contracts are carried out in the spirit of the agreement, not just by the letter, and that neither party acts in a way that deprives the other of their expected benefits.

Here are some examples to illustrate this concept:

• Business Partnership and Royalties: Imagine a small independent game developer licenses their unique game engine technology to a large video game publisher. The agreement grants the publisher exclusive rights to use the engine for five years, in exchange for a percentage of the profits from any games developed using it. The contract doesn't explicitly state that the publisher must develop games using the engine, only that if they do, the developer gets a share of the profits.

  How it illustrates the term: The implied covenant of good faith and fair dealing would likely require the publisher to make a genuine, reasonable effort to develop and release games using the engine. If the publisher, after signing, intentionally shelves the technology indefinitely without a valid business reason—perhaps to prevent the developer from earning royalties because they acquired a competing engine—a court might find this to be a breach. The developer's entire benefit from the contract (royalties) depends on the publisher's active performance, and deliberately undermining that performance would violate the spirit of the agreement.

• Commercial Lease Agreement: A tenant signs a lease for a retail space in a shopping center, intending to open a specialty bakery. The lease specifies that the landlord is responsible for maintaining the common areas, including ensuring adequate lighting and cleanliness in the shared parking lot and walkways. The lease doesn't detail specific brightness levels for lights or cleaning schedules.

  How it illustrates the term: The landlord is expected to maintain these common areas to a reasonable standard that supports the tenant's business. If the landlord intentionally neglects the parking lot lighting and security, making it unsafe and uninviting, or allows the common areas to become consistently filthy, thereby deterring customers from visiting the shopping center, this could be a breach of the implied covenant. Even without specific clauses, the tenant entered the lease with the reasonable expectation of a well-maintained environment conducive to business, and the landlord's deliberate neglect would undermine that expected benefit.

• Employment Contract and Performance Bonuses: An employee's annual employment contract includes a clause stating they are eligible for a performance bonus, to be determined "at the sole discretion of the company's CEO," based on individual and company performance metrics. The employee consistently exceeds all individual performance targets, and the company has a record-breaking profitable year.

  How it illustrates the term: While the CEO has "sole discretion," this discretion must be exercised reasonably and in good faith, not arbitrarily or maliciously. If the CEO decides to award no bonus (or a negligible one) to this high-performing employee, despite their outstanding contributions and the company's success, simply out of personal animosity or to unfairly save money, a court might find this to be a breach. The employee entered the contract with the reasonable expectation that if they performed exceptionally well and the company prospered, they would receive a meaningful bonus. The "sole discretion" clause does not grant the CEO license to act in bad faith and deny an earned benefit.