#62: The Implied Covenant of Good Faith and Fair Dealing
“In every agreement, there is an implied covenant that the parties will act in good faith and fairly with one another.” So states Birch Broadcasting, Inc. v. Capitol Broadcasting Corp., Inc., 161 N.H. 192, 198 (2010), and many other New Hampshire court cases. But what does this really mean? And how does it shake out in construction contracts?
As the Birch Broadcasting case notes, “implied good-faith obligations fall into three general categories: (1) contract formation; (2) termination of at-will employment agreements; and (3) limitation of discretion in contractual performance.” The third category is the one most relevant to construction contracts. It prohibits an exercise of contractual discretion “inconsistent with the parties’ agreed-upon common purpose and justified expectations as well as ‘with common standards of decency, fairness and reasonableness.’” Id.
The first thing to notice here is that the implied covenant applies only when one party enjoys a measure of discretion under the contract sufficient to deprive the other party of the benefits of its bargain. Discretion exists where “a legal directive or contract term is indeterminate because it fails to identify a single specific action that is legally permitted, prohibited, or required under the circumstances.” Milford-Bennington R. Co. v. Pan Am Railways, Inc., 2011 WL 6300923 (D.N.H. Dec. 16, 2011), aff’d, 695 F.3d 175 (1st Cir. 2012). In other words, not everything is nailed down; the contract presents one or more performance targets to a party, yet allows the goalposts to be moved by the other party after the contract has been entered into. Conversely, if the claimant has an express contractual right to the benefit it seeks, the other party’s refusal to tender that benefit is simply a breach of an express rather than an implied contract term. No true discretion exists.
The second thing to notice is the tension between “two apparently inconsistent principles: that the covenant of good faith and fair dealing should be implied to limit the exercise of a discretionary power, and that express terms of a contract cannot be varied by an implied covenant.” Hobin v. Coldwell Banker Residential Affiliates, Inc., 144 N.H. 626, 630 (2000). The apparent dilemma is resolved by examining the degree of specificity with which the contract allows the challenged conduct. If the exercise of discretion yields an outcome that is specifically mentioned as authorized by the contract, courts will not impose reasonableness limits on the exercise of that discretion. Rouleau v. U.S. Bank, N.A., 2015 WL 1757104, at *5 (D.N.H. Apr. 17, 2015) (“a party does not breach the duty of good faith and fair dealing simply by invoking a specific, limited right that is expressly granted by an enforceable contract”). In such a case the exercise of discretion would necessarily be consistent with, not inconsistent with, the parties’ “agreed-upon common purpose and justified expectations.”
In construction settings, claims of breach of the implied covenant will almost always be “upstream” claims, by a subcontractor against a general contractor or by a general contractor against an owner. Where I see the implied covenant of good faith and fair dealing implicated most often is in the rescheduling of work. An instance is New Design Constr. Co., Inc. v. Hamon Contractors, Inc., 215 P.3d 1172 (Colo.App.Div. 2 2008). As is commonly the case, Hamon, the general contractor, had the contractual right to modify the project schedule. When it did so to the detriment of its paving sub, it crossed the line. The Court noted that “Hamon was responsible for developing and maintaining a schedule, NDCC was responsible for completing its work when directed by Hamon to do so, and Hamon was required not to abuse its discretion when directing NDCC to complete its work.” Id. at 1182.
The wise contract drafter attempts to identify areas of discretion, and tries to limit them. Nothing prevents contracting parties from flagging potential instances of application of the implied covenant — for example, with language making one party’s action subject to the other’s consent but providing that such consent shall not be unreasonably withheld.