Good Faith Clauses and Agreements

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A good faith clause in an agreement provides that the parties will abide by the agreement, but if they cannot, they will act in good faith to resolve the concern through mutual agreement and co-operation. An original or new agreement may be contained in a verbal or written contract. A contract law attorney can help craft a good faith clause. The clause should comply with the understanding of the principle of good faith in the jurisdiction where the contract will be performed.

Definitions of Good Faith

Typically, states provide a definition for the term good faith in their commercial code, the state laws that govern the conduct of businesses. Across the U.S., states have adopted the Uniform Commercial Code (UCC), a set of uniformly adopted rules regarding business. Having the same rules across the country assists with normalizing interstate transactions. The UCC covers the sale of goods and tangible assets. Common law and state laws other than provisions of the UCC cover other types of commercial contracts, including contracts for personal services, professional work, construction work, franchise agreements, trademarks, copyrights, software, patents, land sales and real estate.

According to California Commercial Code (CCC) Section 1201, a state law that embodies the UCC, good faith means honesty in fact and the observance of reasonable commercial standards of fair dealing. The exception to this rule is in CCC Section 5102 where the term good faith is applied to letters of credit. There the term means honesty in fact in the conduct or transaction concerned.

Good Faith Dispute and Deposit

Per the California Civil Code, a good faith dispute is one in which the trier of fact, usually a judge, finds that the party refusing to return deposited funds had a reasonable expectation that they were legally entitled to withhold them. A good faith dispute may be different than a dispute about the validity of a good faith clause itself.

The term good faith dispute relates to the colloquial term good faith deposit, or earnest money, in real estate. This is the money a buyer provides with an offer to show they are serious. The good faith deposit is put aside in an escrow account and becomes part of the down payment.

Other References to the Concept of Good Faith

A state’s civil statutes may contain other uses of the term good faith that do not relate to the UCC or to real estate purchases. For example, California Civil Code on renting real estate contain the phrases good faith estimate and good faith belief. The term good faith estimate refers to repairs to be done on the property. Specifically, the statute provides:

“If a repair is to be done by the landlord or the landlord’s employee and cannot reasonably be completed within 21 calendar days after the tenant has vacated the premises, or if the documents from a person or entity providing services, materials or supplies are not in the landlord’s possession within 21 calendar days after the tenant has vacated the premises, the landlord may deduct the amount of a good faith estimate of the charges that will be incurred and provide that estimate with the itemized statement.”

Here, the term good faith belief refers to whether a landlord’s successor in interest has a good faith belief that the lawfully remaining security deposit will be transferred to the successor in interest.

Fiduciary Duty of Good Faith

A fiduciary duty of good faith is different from the duty of good faith in a contract. A fiduciary is a person or organization that acts on behalf of another party to put the party’s interests ahead of their own. Statutes relating to fiduciary duty can be found in various state laws that relate to fiduciaries.

Many types of professionals can be fiduciaries, including attorneys and accountants. For example, the California Corporations Code explains the fiduciary duty of a director of a corporation:

"A director shall perform the duties of a director, including duties as a member of any committee of the board upon which the director may serve, in good faith, in a manner such director believes to be in the best interests of the corporation and its shareholders and with such care, including reasonable inquiry, as an ordinarily prudent person in a like position would use under similar circumstances."

Example of the Doctrine of Good Faith

Acting in good faith includes not trying to avoid performance of the contract by construing contract terms as indefinite. If a contract is ambiguous or vague, the parties should make their best, or at least, reasonable efforts to perform the service or supply or promote the goods that are the subject of the contract. For example, if a music store contracts to deliver five tubas to a school by Tuesday, but receives only two tubas from the manufacturer by Tuesday at 8:00 a.m., acting in good faith would involve reaching out to the manufacturer to see what time the rest of the tubas would come in and working with the school to deliver them as soon as possible.

Examples of Bad Faith in the Performance of a Contract

A willful or intentional breach of contract counts as an act of bad faith. Bad faith can involve trying to escape contractual obligations. One way to do that is by deliberately misconstruing contract terms. Bad faith can relate to reasonableness, in that a party is acting unreasonably, as well as ill intent, in that there was no reasonable basis to act in that way.

For example, a standard, high-quality paint is used to paint a home in the majority of residential contracts, but the painter knowingly used a lower-quality paint for a residential client. That would be acting in bad faith. Similarly, a roofer who knowingly performed services with less care than is standard for the industry would be acting in bad faith.

When one party to a contract does not perform in good faith, the other contracting parties can file a lawsuit for breach of contract. If the first party thought it was acting in good faith, it can appeal an adverse ruling in a court of appeal.

Purpose of the General Duty of Good Faith

The primary purpose of acting in good faith is to ensure that contracts will be fulfilled. Another purpose is to ensure that business partners collaborate well. A third goal of acting in good faith is to reduce the potential of litigation or dispute resolution. The benefits of upholding good faith clauses include fewer breaches of contract and ensuing lawsuits. An additional benefit is the development of a business culture that encourages resolution and innovation rather than disputes.