What's good faith got to do with contracts?

The Uniform Commercial Code (UCC), which is the law in every state with some variations, contains Section 1-304 and makes the obligation to act in good faith a term of every commercial transaction.

The world of construction is governed by rules. Lots of rules. Rules imposed by law through statutes, ordinances, codes and rules imposed by parties through contracts. Through these rules, we set up the parameters for what we can expect in the course of our dealings, and we all operate under them every day, but they are all susceptible to misuse by people bent on taking advantage (see the following examples):

  • An agreement in a contract that allows the customer to direct work, and if there is a dispute over it, it will be resolved later through “change orders.” But what if the owner adds, and adds, and adds more work, refusing to pay for any of it until a court orders it, thereby turning the contractor into a banker?

  • An agreement in a contract that allows the customer to end the contract even if the contractor did nothing wrong, through a “termination for convenience.” But what if after the most difficult part of the contract is completed, the owner terminates the rest for its convenience and gives it to someone else, thus, depriving the contractor of the profit built into its fixed-price?

  • A contract term that requires disputes to be resolved by an arbitrator agreed upon by the parties. But what if one party refuses to agree on an acceptable mediator or arbitrator, so that a dispute cannot be resolved?

  • A regulation requiring that all work is subject to inspection by a government inspector. But what if the inspector repeatedly requires acceptable work to be torn out and redone to punish a contractor just because he can?

  • A term in a contract that provides that all disputes are resolved by the project architect. But what if the architect denies a contractor's legitimate claim for more money due to a design error because the architect would thereby be responsible for the extra cost?

In each of these situations, the party did what the rules “technically” permitted, but did it for a reason that had nothing to do with the contract itself. Is there any recourse when one party does what it is permitted to do, but isn't acting in good faith?

The answer is yes. The Uniform Commercial Code (UCC), which is the law in every state with some variations, contains Section 1-304 and makes the obligation to act in good faith a term of every commercial transaction. “Good faith” means that one acts without any improper motivation. One acts with the truth and not for some ulterior motive that is unconnected with the substance of the agreement in question when one is acting with good faith, according to the case Reid v. Key Bank of Southern Maine Inc. The UCC generally applies only to the sale of goods, and not to construction contracts, however, where labor is a significant part of the transaction.

Most state courts have nevertheless issued rulings making the implied obligation of good faith a part of construction contracts as well. Where the parties conduct reaches a level that the judge, or jury, finds it to be way out of bounds — so far that no one could objectively think that the parties would have willingly agreed to such an outcome — the courts will step in. But courts are also reluctant to override clear contract provisions just because one party didn't anticipate that the other might actually invoke them, because at some point, the contract will become meaningless.

There is good reason for their concern. According to Professor Harold Dubroff, in the St. John's Law Review, in the 60 years from 1945-2004, the number of court cases found using the search term “implied covenant w/one good faith” was more than 10,000. From 1945-1954 there were 11 cases; from 1955-1964 there were 51 cases; from 1965-1974, 80 cases; from 1975-1984, 494 cases; from 1985-1994, 3,656 cases; and from 1995-2004, 6,423 cases.

The legal fight is not typically about whether people should have to act in good faith. It is over what the courts will award as damages for acting in bad faith. Will they just limit the injured party to its breach of contract damages or will they award something more — money for “emotional distress” or “punitive damages”? Allowing recovery for “tortious breach of contract” has turned many garden-variety breach of contract suits into convoluted tort suits, claiming migraine headaches, loss of consortium, damage to reputation, etc. As Dubroff explained, courts and legislatures are starting to find ways to stem this tide and return contract disputes to just contract disputes.

So, here is the bottom line: You do have the right to expect people to act in good faith and not take actions for reasons that are not related to the contract itself. But do not count on courts to relieve you of responsibility for understanding the consequences of what you sign.

Susan McGreevy is a partner at Stinson, Morrison, Hecker LLP, Kansas City, Mo., 816/842-4800, e-mail to smcgreevy@stinson.com.